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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K/A
Amendment No. 2
x | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
FOR THE FISCAL YEAR ENDED: MAY 31, 2004
¨ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
Commission File No. 1-13436
TELETOUCH COMMUNICATIONS, INC.
(Name of registrant in its charter)
Delaware | 75-2556090 | |
(State or other jurisdiction of incorporation or organization) | (IRS Employer Identification Number) |
1913 Deerbrook Drive, Tyler, Texas 75703 (903) 595-8800
(Address and telephone number of principal executive offices)
Securities registered pursuant to Section 12(b) of the Exchange Act:
Common Stock, $0.001 par value, listed on the American Stock Exchange.
Securities registered pursuant to Section 12(g) of the Exchange Act:
None.
Indicate by check mark whether the registrant has (1) filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding twelve 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. Yes ¨ No x
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.¨
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes ¨ No x
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ¨ No x
As of November 1, 2005, the aggregate market value of the voting stock held by non-affiliates of the registrant, based on the closing price on that date, was approximately $1,362,457. As of November 1, 2005, the registrant had outstanding 48,796,667 shares of Common Stock.
Documents Incorporated by Reference
None.
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EXPLANATORY NOTE
This Amendment No. 2 on Form 10-K/A (the 2004 Form 10-K/A) amends the Annual Report on Form 10-K of Teletouch Communications Inc. (the “Company”) for the year ended May 31, 2004 (the 2004 Form 10-K), which was originally filed on September 1, 2004. This Form 10-K/A is being filed to reflect the results of comments that the Company received from the staff of the Division of Corporation Finance (the Staff) of the Securities and Exchange Commission (the SEC) in connection with the Staff’s normal periodic review of its filings.
In the 2004 Form 10-K, the fiscal 2002 and 2003 financial statements were reported as previously filed. The fiscal 2002 and 2003 financial statements included the accounting for the Company’s May 2002 extinguishment of certain junior debt (the “May 2002 Exchange Transaction”) and its November 2002 exchange of Series C Preferred Stock and redeemable common stock purchase warrants for its Series A and Series B Preferred Stock, warrants for the purchase of shares of Series B Preferred Stock, common stock warrants and shares of its common stock (the “November 2002 Exchange Transaction”). The SEC staff initiated discussions with the Company about the Company’s accounting for the two Exchange Transactions which included discussions concerning the method used to value the shares of the Series C Preferred Stock issued and whether or not the Series C Preferred Stock contained a “beneficial conversion feature” which should be accounted for under Emerging Issues Task Force Issue No. (EITF) 98-5 and EITF 00-27. The accounting under EITF 98-5 and EITF 00-27 would have required an amount to be recorded as period dividends on the Series C Preferred Stock.
In the May 2002 Exchange Transaction the Company retired certain junior debt, and later, after receiving shareholder approval in November 2002 and in conjunction with the November 2002 Exchange Transaction, issued to the holders of that debt shares of its Series C Preferred Stock or redeemable stock purchase warrants in exchange for outstanding shares of its Series A and Series B Preferred Stock, warrants for the purchase of shares of Series B Preferred Stock, common stock warrants and shares of its common stock (the Exchanged Securities). The holders of the Exchanged Securities included an entity affiliated with the Company’s Chairman of the Board, Robert M. McMurrey. In its original accounting for the two transactions, the Company based the value of the Series C Preferred Stock, which reflected a $.04 per share value for the Common Stock (44,000,000 shares in the aggregate) into which the Series C Preferred Stock was convertible, on the present value methodology used by Hoak Breedlove Wesneski & Co (“HBW”), an independent third party, which had been retained by the Company to issue a fairness opinion related to the Exchange Transactions. The Company used this valuation to record the securities issued and apportioned the value of the securities which it issued between the May 2002 Exchange Transaction and the November 2002 Exchange Transaction.
Based upon its evaluation and response to the Staff’s comments the Company has concluded that the shares of the Series C Preferred Stock issued in the May 2002 and November 2002 Exchange Transactions should have been valued based the market value of the underlying 44,000,000 share of common stock into which the Series C Preferred Stock could be converted, which was $.33 per share when the Series C Preferred Stock was issued in November, 2002, rather than the present value methodology originally used. In addition, the Company has concluded that the change in the value assigned to the Series C Preferred Stock would mean that it does not contain a beneficial conversion feature as defined in EITF 98-5 and EITF 00-27. This change in the valuation of the shares of the Series C Preferred Stock and the restatement of the Company’s 2002 and 2003 consolidated financial statements changes the following items:
• | reduce by $5.1 million, to $64.5 million from $69.6 million, the gain on the May 2002 Exchange Transaction thereby reducing net income applicable to common shareholders of $58.7 million or $12.14 and $0.64 per share basic and diluted, respectively, to $53.6 million or $11.09 and $0.59 per share basic and diluted, respectively, for the year ended May 31, 2002; and |
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• | reduce, by $7.6 million to $28.8 million from $36.4 million, the gain from the November 2002 Exchange Transaction thereby reducing net income applicable to common shareholders of $35.6 million or $1.21 and $0.39 per share basic and diluted, respectively, to $28.0 million which was further reduced by $23.6 million to $4.4 million as a result of allocating the undistributed earnings to the Series C Preferred Stock or $0.96 and $0.30 per share basic and diluted, respectively, for the year ended May 31, 2003. |
The reduction in net income applicable to common shareholders in the second quarter of fiscal 2003 by the rights of the Series C Preferred Stock to participate in earnings resulted from the Company calculating and presenting earnings per share (“EPS”) using the two-class method as illustrated in EITF 03-06. This change in method of computing EPS was recommended by the staff at the SEC but because Company has never declared or paid dividends on its common stock and because the Series C Preferred Stock participates in dividends on a pro rata basis with the common stock, the two-class method of computing EPS results in the same EPS as would be mathematically arrived at using the alternative “if-converted” method of computing EPS.
Total shareholders’ equity is not affected, although there is a change in the components of shareholders’ equity. The specific change is:
• | The reduction in the gain from the May 2002 Exchange Transaction increases the Company’s accumulated deficit by $5.1 million with an offsetting increase of the amount recorded for the outstanding Series C preferred Stock, |
In connection with the Company’s restatement of its consolidated financial statements the Company’s registered public accounting firms have also reissued their reports, which are included under the heading “Reports of Registered Public Accounting Firms” with the accompanying consolidated financial statements. For the convenience of the reader, this 2004 Form 10-K/A sets forth the complete text of the Company’s originally filed 2004 Form 10-K in its entirety rather than just the amended portions thereof. No attempt has been made in this 2004 Form 10-K/A to modify or update other disclosures presented in the 2004 Form 10-K, other than to correct typographical and other immaterial errors or to include amended information set forth in prior amendments thereto. Except for the adjustments described above, this 2004 Form 10-K/A does not reflect events occurring after September 1, 2004, the date of the original filing of the Company’s 2004 Form 10-K, or modify or update those disclosures that may have been affected by subsequent events. Accordingly, this 2004 Form 10-K/A should be read in conjunction with our filings made with the SEC subsequent to the filing of the 2004 Form 10-K, and any amendments thereto.
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The following items have been amended as a result of the restatement described above:
Part II — Item 6. — Selected Financial Data |
Part II — Item 7. — Management’s Discussion and Analysis of Financial Condition and Results of Operations |
Part II — Item 8. — Financial Statements and Supplementary Data |
Part II — Item 9A. — Controls and Procedures |
Part IV — Item 15. — Exhibits, Financial Statement Schedules |
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TELETOUCH COMMUNICATIONS, INC.
ANNUAL REPORT ON FORM 10-K/A
Amendment No. 2
For the Year Ended May 31, 2004
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Statements contained or incorporated by reference in this document that are not based on historical fact are “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements may be identified by use of forward-looking terminology such as “may”, “will”, “expect”, “estimate”, “anticipate”, “continue”, or similar terms, variations of those terms or the negative of those terms. Forward-looking statements are based upon numerous assumptions about future conditions that could prove not to be accurate. Actual events, transactions and results may differ materially from the anticipated events, transactions and results described in such statements. The Company’s ability to consummate such transactions and achieve such events or results is subject to certain risks and uncertainties.
Item 1. | Business |
General
Teletouch is a leading provider of telecommunications services, primarily paging services, in non-major metropolitan areas and communities in the Southeast United States. Currently the Company provides services in Alabama, Arkansas, Georgia, Louisiana, Mississippi, Missouri, Oklahoma, Texas, Tennessee and Florida. The Company has 20 service centers and 6 two-way radio shops in those states. Through inter-carrier arrangements, Teletouch also provides nationwide and expanded regional coverage.
Teletouch Communications, Inc. (“Teletouch” or the “Company”) was incorporated under the laws of the State of Delaware in July 1994 and is headquartered in Tyler, Texas. Teletouch, or one of its several predecessors, has operated two-way mobile communications services and telemessaging services in East Texas for approximately 40 years. References to Teletouch or the Company as used throughout this document means Teletouch Communications, Inc. or Teletouch Communications, Inc. and its subsidiaries, as the context requires.
Our principal office is located at 1913 Deerbrook Drive, Tyler, Texas 75703, and our telephone number is (800) 232-3888. Our address on the world wide web is www.teletouch.com. The information on our web site is not incorporated by reference into this Annual Report on Form 10-K and should not be considered part of this report. We make available free of charge through our web site our annual, quarterly and current reports, and any amendments to those reports, as soon as reasonably practicable after we electronically file those reports with the Securities and Exchange Commission.
Teletouch has experienced a substantial decline in the paging business over the last several years and expects that net paging subscriber deletions will continue as the demand for one-way paging continues to decline. At May 31, 2004, the Company had approximately 168,000 pagers in service as compared to approximately 217,700 and 271,100 at May 31, 2003 and May 31, 2002, respectively. For fiscal year 2004, the Company had total revenues of $26.8 million as compared to $34.8 million and $46.6 million in fiscal years 2003 and 2002, respectively.
Teletouch’s primary focus during the fiscal years of 2002 and 2003 was on positioning the Company for growth in the future through the recapitalization of its debt and certain equity securities and the restructuring of its operations to maximize efficiency and profitability. The Company succeeded in
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recapitalizing its debt and certain equity securities in May 2002. By May 2003, the Company had completed its restructuring efforts and exited its retail distribution channel (see “Restructuring Activities” discussion below). The Company continues to follow its overall business strategy of minimizing the level of customer attrition while attempting to develop new revenue streams from telemetry products to minimize the impact of the loss in recurring revenues from its declining paging subscriber base. The Company’s successful recapitalization of its debt and certain equity securities and the previous restructuring of its operations has allowed the Company to be able to generate sufficient cash flows to meet its capital needs for the previous two fiscal years. In order for the Company to continue to generate sufficient cash flow to meet its operating and capital needs during fiscal 2005 management believes it may become necessary to restructure its operations to reduce certain operating expenses if the new revenue streams anticipated from the telemetry products are not realized during the first half of fiscal 2005. If additional funds are needed to operate the business in fiscal 2005, the Company has an additional $2.0 million available under a lending arrangement with TLL Partners, a company controlled by Robert McMurrey, Chairman of the Board of Teletouch. During fiscal year 2005, the Company intends to continue focusing on developing its telemetry services but will place an increased emphasis on stabilizing its core paging business. By continuing to reduce overhead costs, developing a strategy to defend itself in the increasingly competitive pager market and focusing on paging customer retention, the Company believes that it can minimize the impact on operating margins of its declining paging subscriber base while it develops recurring revenue streams from its telemetry products and services to offset the declining paging service revenue. Additionally, if the opportunity to acquire other paging or two-way radio companies arises, the Company believes it can achieve better operating results than those achieved by the businesses separately by consolidating administrative functions, taking advantage of economies of scale, and sharing common frequencies to offer existing customers a wider area of coverage.
Restructuring Activities
In May 2002, the Company undertook a review of the financial performance of its retail stores. This review resulted in the decision to close 22 of the Company’s 66 locations. The Company continued to evaluate the profitability of the remaining retail stores and its overall retail distribution channel and in November 2002 the Company developed a restructuring plan to exit the retail business and focus the Company on its direct distribution channels (“Retail Exit Plan”). The Retail Exit Plan resulted in the closing of an additional 10 of the Company’s retail locations, transferring 4 of its retail locations to an affiliated company, the conversion of 22 of its retail locations to customer service centers and the reduction of its workforce by 210 people. Locations selected to be reduced to “Customer Service Only” locations were not contributing to the Company’s operating income, although they were supporting a sizable paging subscriber base that would not be easily serviced from any other location. The purpose of the restructuring was to reduce operating expenses while minimizing the impact on the recurring revenues from the paging subscribers that were being serviced by the affected locations. As of May 31, 2003, the Retail Exit Plan was substantially completed. As of May 31, 2004, the Company has 20 customer service centers and 6 two-way radio shops remaining in operation of which one two-way radio shop was acquired during fiscal 2004 as part of the asset purchase transaction with Delta Communications, Inc. (see “Two Way Operations” discussion below).
Paging Industry Background
In 1949 the Federal Communications Commission (“FCC”) allocated a group of radio frequencies for use in providing one-way and two-way mobile communications services, effectively creating the paging industry. Since 1949, the paging industry has been characterized by consolidation and technological change.
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In the early years, the paging industry was highly fragmented, with a large number of small, local operators. Many of the firms that entered the paging business during the first two decades of the industry did so as a complement to their existing telephone answering service or two-way radio communications sales and service businesses. The industry grew slowly as the quality and reliability of equipment gradually improved and consumers began to perceive the benefits of mobile communications. Further improvements in equipment reliability and cost-effective technological innovations accelerated the use of paging services in the 1970s.
Some of the paging industry’s most significant technological developments occurred in the 1980s. The digital display (numeric) pager was introduced and quickly replaced tone and voice pagers as the most popular paging product. In 1982, the FCC allocated additional frequencies which expanded coverage areas and introduced competition into the market. More significant technological developments occurred in the 1990s, including the advent of two-way paging capabilities that do not require the use of traditional or cellular telephones to return a page and cellular telephones that incorporate paging capability.
Since 1997 growth rates have been negative. It is difficult to predict when the negative growth rates in the one-way paging industry will flatten out but Teletouch management believes that the industry will not see growth again in the future and is working toward a stabilization in its own customer base. Factors contributing to the paging industry’s negative growth include: (i) expanding coverage of other mobile communications networks; (ii) an increased consumer demand for products capable of two-way mobile communications; (iii) the rapidly declining costs of other mobile communications services such as cellular telephone service; and (iv) technological advances in cellular equipment and services.
Three types of carriers remain in the paging industry: (i) large, national paging companies, primarily Arch Wireless, Inc. (“Arch”) and Metrocall Wireless, Inc. (“Metrocall”); (ii) regional carriers, of which Teletouch is the largest, that operate in regional markets in the U.S. that can also offer service outside of their home regions through a network of interconnections between their own systems, a national firm, and/or other regional providers; and (iii) small, single market operators.
The Company’s Products and Markets
Paging Operations
Teletouch’s paging network has been primarily built through a number of acquisitions that it has completed over the years. The Company continues to look at expansion possibilities but is primarily interested in only those networks transmitting on a common frequency that is currently utilized by Teletouch. The costs of converting customers to new frequencies is prohibitive given the low margins remaining in the business; therefore, adjoining networks on other frequencies are less attractive to Teletouch. Teletouch currently operates on 10 frequencies that it licenses in various locations throughout the Southeast United States; 152.240 (OP5), 152.480 (PC1), 152.780 (OJT), 157.740 (PC2), 158.100 (OT2), 158.700 (OP6), 462.800 (OU1), 929.7875 (NO1), 939.7125 (NO4) and 939.4875 (OAT).
On May 20, 2004, Teletouch acquired substantially all of the paging assets of Preferred Networks, Inc. (“PNI”), a corporation headquartered in Atlanta, Georgia. These assets were acquired out of bankruptcy and consisted of two distinct paging networks, one in the Southeast and one in the Northeast United States. The total purchase price for the assets of PNI was approximately $257,000. In a concurrent transaction, Teletouch sold the paging network and the associated paging subscribers in the Northeast for $155,000. Subsequent to
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May 31, 2004, the Company sold certain excess paging infrastructure equipment acquired from PNI for $55,000. The net result of the asset purchase and sale transactions by Teletouch involving the PNI assets was that Teletouch retained all of the paging infrastructure in the Southeast, primarily around Atlanta, Georgia and the associated 24,000 paging subscribers.
Teletouch’s paging network provides a one-way communications link to its subscribers within a specified coverage area. Each subscriber is assigned a distinct telephone number or personal identification number that a caller dials to activate the subscriber’s pager. When one of the Company’s paging terminals receives a telephone call for a subscriber, a radio signal is transmitted to the subscriber’s pager that then causes the pager to emit a tone, a vibration, or a voice signal to alert the subscriber. Depending on the type of pager used, the subscriber may respond directly to the caller using information displayed on the pager or by calling a designated location or voice mail system to retrieve the message. The advantage of paging over conventional telephone service is that a pager’s reception is not restricted to a single location. The advantage over cellular telephones is that pagers are smaller, have a longer battery life, and are substantially less expensive to use. Pagers may also be used in areas where cellular telephone use is prohibited, such as hospitals, due to interference with sensitive monitoring equipment. Some cellular subscribers use a pager along with their cellular telephone to screen incoming calls and to lower the expense of their cellular telephone service.
Teletouch currently provides primarily two basic types of one-way paging services: numeric and alphanumeric. Subscribers carry a pocket-sized radio receiver (a pager) that is preset to monitor a designated radio frequency and is activated by radio signals emitted from a transmitter when a call is received. Numeric pagers display a caller’s message that may consist of an area code and telephone number or up to 12 digits of other numeric information. Alphanumeric pagers allow subscribers to receive and store messages consisting of both numbers and letters. Subscribers may be paged using traditional or cellular telephones, computer software, alpha entry devices, or over the Internet from the Company’s web page. Teletouch is licensed by the FCC to transmit numeric, alphanumeric, tone, and voice messages to pagers it either sells or leases to customers.
Paging companies traditionally distributed their services through direct marketing and sales activities. During the last decade additional distribution channels evolved including: (i) carrier-operated stores; (ii) resellers, who purchase paging services on a wholesale basis from carriers and resell those services on a retail basis to their own customers; (iii) agents who solicit customers for carriers and are compensated on a commission basis; and (iv) retail outlets that often sell a variety of merchandise, including pagers and other telecommunications equipment. Use of pagers by retail consumers has significantly declined over the past several years.
Teletouch’s paging customers include various-sized companies with field sales and service operations as well as individuals in occupations requiring substantial mobility and the need to receive timely information. Teletouch is not dependent upon any single or small group of customers for a material part of its overall business.
Teletouch’s sales strategy for its paging services is to concentrate on business accounts who value continuity, quality, and personal service. The Company currently leases pagers to a large percentage of its business accounts. As the price of pagers continues to decline, the Company is attempting to emphasize pager sales over rentals. To date, the Company has been unsuccessful in converting its business customers away from leasing pagers as most of Teletouch’s competitors continue to offer this service. If the Company were
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successful in migrating customers away from leasing pager equipment, the Company’s annual capital needs would be significantly reduced.
The Company markets all its paging products and services under the Teletouch name. The Company currently distributes its paging products and services through two channels which include (i) a direct sales staff that concentrates on business accounts; and (ii) resellers, who purchase pagers and paging services in bulk and resell them to their own subscribers. Through November 2002, the Company sold paging products and services through Company-operated sales offices (“Retail Stores”), and by May 2003 the Company had completely exited its retail distribution channel (see “Restructuring Activities” discussion above).
Two-Way Radio Operations
Since 1963, Teletouch has been an authorized Motorola two-way radio dealer in the East Texas area. The Company has locations in Tyler, Longview, Nacogdoches, Lufkin, Livingston, and Garland Texas and services a large percentage of the law enforcement and public safety agencies as well as other industries in the East Texas and Dallas / Fort Worth markets. Teletouch is currently a member of Motorola’s Pinnacle Club, a group of preferred Motorola dealers.
On January 29, 2004, Teletouch acquired substantially all of the two-way radio assets of DCAE, Inc. d/b/a Delta Communications, Inc. (“Delta”), a corporation headquartered in Garland, Texas, which continues to operate the business providing Nextel cellular service in the Dallas / Fort Worth market. As part of the purchase, Teletouch acquired approximately 2,500 additional two-way radio subscribers and the logic trunked radio (“LTR”) infrastructure in the Dallas / Fort Worth market. The total purchase price for the assets of Delta was approximately $1,597,000 which consisted of certain cash and equity consideration. This acquisition allows the Company to expand its operations from its mid-sized markets in eastern Texas to the larger Dallas/Fort Worth market as well as creates an opportunity to combine these networks to provide larger two way radio coverage for its customers.
LTR radio service is licensed for the 450 MHz spectrum and includes voice, data, and voice mail capabilities. The LTR Passport-enabled service, which Teletouch offers in certain markets, includes “follow-me-roaming” features that are similar to the automatic handoff of radio signals characteristic of cellular radio systems. The market for LTR radio service includes customers desiring an upgrade in features and extended roaming compared with traditional two-way radio service. LTR radio service is also a cost-efficient communications alternative to cellular telephones since LTR service is based on a fixed monthly fee per-radio versus per-minute cellular charges.
During the fourth quarter of fiscal 2004, Teletouch was able to secure several sales contracts with entities utilizing recently released Homeland Security funds from the Federal Government. These sales contracts significantly increased the revenues of the two-way radio business during the fourth quarter. The Company anticipates that these funds will continue to be made available over the next couple of years to allow city, county and local emergency response units to upgrade their communications equipment. Teletouch’s long relationships and reputation with these city, county and local entities over its almost 41 year presence in East Texas has allowed the Company to procure this business to date and the Company’s management believes it is positioned to continue to be successful in procuring more of this business as the Homeland Security funds continue to be made available.
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Telemetry Operations
Wireless telemetry provides machine to machine or machine to people communications, which enable immediate notification of specific events. Sale of telemetric products and services provides Teletouch the opportunity to generate recurring service revenue as well as realize positive earnings and cash flow on the sale of equipment.
In November 2001, Teletouch entered the wireless telemetry market with a product line branded “Tracker by Teletouch”, which operates on the cellular network in virtually all areas of the United States. The initial product offering centered on fixed monitoring applications in the water/wastewater and poultry industries. In February 2002, Teletouch increased its telemetry product offering to include Tracker AVL, which monitors mobile assets using global positioning satellites to help customers monitor and track their vehicles, detached trailers and virtually any other mobile asset. In fiscal year 2004, the Company decided to discontinue the Tracker by Teletouch product line to focus on mobile asset tracking and personal monitoring telemetry products. Teletouch will continue to support all fixed monitoring applications that it has previously installed but will not continue to seek new business due to the high cost of the custom engineering required with this product in a market where margins on such products are very slim.
In July 2002, Teletouch’s telemetry product line was expanded to include a satellite communications network in addition to the cellular network. This provides more enhanced communications capability for large fleet operators and trucking companies as well as products with more advanced fixed and mobile asset monitoring capabilities, including the ability to operate on multiple networks. To complement the Company’s telemetry offerings, Teletouch announced its GeoFleet™ brand software, which is customizable for mobile fleet and fixed asset management, and gives the user the ability to monitor and track multiple vehicles on multiple networks at the same time on the same screen.
In January 2003 Teletouch developed the LifeGuard™ system which is designed to effectively locate and monitor personnel resources. Designed specifically to safeguard lone workers, LifeGuard™ can signal a distress call to a company dispatcher, pinpointing the worker’s location and automatically provide vital information on the worker’s medical history, giving the dispatcher the necessary information for notifying emergency personnel. For example, should a lone worker have a heart attack, the worker can manually signal an emergency using the LifeGuard™ device worn on the worker’s belt. Should a worker suffer an injury that renders him unconscious, the device will sense the lack of movement and automatically signal a distress call.
In July 2003, the Company announced the introduction of its GeoTrax product line which in 2004 was re-branded VisionTrax™. Developed specifically to monitor mobile assets and detached equipment such as trailers and rail cars, VisionTrax™ gives companies the ability to pinpoint the location of these assets. Of the six to eight million detachable trailers in the United States, as many as 10 percent are unaccounted for at any given time. VisionTrax™ provides location information on trailers, allowing companies to remotely monitor and track their movement. Trailers equipped with VisionTrax™ will report back to the monitoring station at regular intervals and more frequently when certain events occur.
In May 2004, Teletouch created a wholly-owned subsidiary under the name of Visao Systems, Inc. (“Visao”) for the purpose of developing and distributing its telemetry products. The new Delaware corporation allows Teletouch to focus certain resources exclusively on its telemetry business as well as
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recognizes that the market and customer needs vary from Teletouch’s traditional core businesses in paging and two-way radio.
To date, revenues from telemetry sales and service have been insignificant to the Company’s overall revenue. The Company has been unable to generate significant revenues from this business to date primarily due to a variety of technical issues that have arisen within its products. All identified technical problems have been communicated to the Company’s suppliers and have been addressed at this time. Although the Company believes it has overcome the majority of the technical problems identified it continues to face a challenging marketplace where pricing is very competitive and customers are slow to adopt this new technology. For these reasons the Company is continuing to develop this business line but will be analyzing the viability of this business during the first half of fiscal 2005.
Financial Information about Industry Segments
Teletouch operates in the wireless telecommunications industry, providing paging and messaging, two-way radio and telemetry services to a diversified customer base. Teletouch’s two-way radio and telemetry operations represent less than 10% individually and in the aggregate of operating income and assets of the Company. Two-way radio and telemetry operations represent approximately 14% in the aggregate of the Company’s revenue. Two-way and telemetry revenues for fiscal years 2004, 2003 and 2002, respectively, were $3.7 million, $3.3 million and $3.5 million. The Company has no foreign operations.
Sources of System Equipment and Inventory
Teletouch does not manufacture any of its paging network equipment used to provide paging services, including but not limited to antennas, transmitters, and paging terminals, nor does it manufacture any of the pagers, cellular telephones, two-way radios, consumer electronics or telemetry devices it sells or leases. This equipment is available for purchase from multiple sources, and the Company anticipates that such equipment will continue to be available in the foreseeable future, consistent with normal manufacturing and delivery lead times. Because of the high degree of compatibility among different models of transmitters, computers and other paging and voice mail equipment manufactured by its suppliers, Teletouch’s paging network is not dependent upon any single source of such equipment. The Company currently purchases pagers and pager network equipment from several competing sources.
Competition
Competition for subscribers is based primarily on the price and quality of services offered and the geographic area covered. Teletouch has one or more direct competitors in all its markets, some of which have greater financial resources than Teletouch. The Company believes, however, that the value and quality of its services and its geographic coverage areas within its markets compare favorably with those of its competitors.
Although some competitors are small, privately owned companies serving only one market area, others are subsidiaries or divisions of larger companies, such as telephone companies, which provide paging and other telecommunications services in multiple market areas. The largest of the Company’s paging competitors are Arch and Metrocall. There has been a proposed merger of Arch and Metrocall filed with the Securities and Exchange Commission which has not been approved as of the date of this filing. Both Arch and Metrocall
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grew through acquisition using borrowed funds and offering service at non-economic rates which allowed them to increase their share of the market and drive smaller companies out of business. Then they both went into bankruptcy to eliminate their debt. They are now attempting to merge to create a virtual monopoly in the industry which could impact Teletouch negatively. The financial resources of both Arch and Metrocall have historically allowed them provide competing paging services in certain markets that Teletouch operates in at rates that could not be economically sustained by Teletouch. Teletouch remains concerned that a merger of these two companies would do nothing but worsen the current market pricing and possibly drive pricing down to a level in these markets at which Teletouch could not economically operate.
Companies offering wireless two-way communications services, including 800 MHz cellular service, 1900 MHz wireless personal communications service (“PCS”), and specialized mobile radio services (“SMR”), continue to compete with Teletouch’s paging services. Cellular and PCS services are generally more expensive than paging services. Where price is a consideration or access to fixed wire communications (such as ordinary telephones) is available, paging can compete successfully with or be an adjunct to cellular and PCS systems. However, the price of cellular and PCS services continues to decline and is quickly approaching the higher end pricing on some paging services. If the pricing on cellular and PCS services continues to decline and this trend continues to erode the number of paging subscribers in the marketplace, the viability of the paging industry in general and of the Company’s paging operations in particular could be adversely affected.
Patents and Trademarks
In fiscal year 2004, Teletouch registered the trademark for its GeoFleet™ software, a product that compiles, reports and maps the data provided from any or all of Teletouch’s many telemetry devices. In fiscal year 2004, Teletouch also registered trademarks for its LifeGuard™ and VisionTrax™ products. LifeGuard™ is a wireless telemetry system that tracks and monitors personnel assets using satellite communication technology. VisionTrax™ is a self-powered wireless telemetry device that tracks and monitors mobile or remote assets using satellite communication technology. The Company considers these registered trademarks to be beneficial and will consider registering trademarks or service marks for future services or products it may develop.
Regulation
The FCC regulates Teletouch’s paging operations under the Communications Act of 1934, as amended (the “Communications Act”), by granting the Company licenses to use radio frequencies. These licenses also set forth the technical parameters, such as location, maximum power, and antenna height, under which the Company is permitted to use those frequencies.
In 1996, the FCC implemented rules that revised the classification of most private-carrier paging licensees. Traditionally, the FCC has classified licenses as either Radio Common Carrier licenses (“RCC”) or Private Carrier Paging (“PCP”) licenses. Now all licenses are classified either as Commercial Mobile Radio Service (“CMRS”) or Private Mobile Radio Service (“PMRS”). Carriers like Teletouch and its competitors, who make service available to the public on a for-profit basis through interconnections with the public switched telephone network, are classified as CMRS licensees. Until recently, Teletouch’s RCC licenses were subject to rate and entry regulations in states that chose to impose tariff and certification obligations, whereas PCP licenses were not subject to such regulations. As a result of Congressional legislation, the state regulatory
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differences between RCCs and PCPs have been eliminated. The FCC also adopted rules that license paging channels in the UHF and VHF bands, as well as in the 929 and 931 MHz bands, on a geographic area basis. These geographic area licenses are awarded through public auctions. Incumbent licensees, such as Teletouch, will retain their exclusivity under the FCC’s new rules.
The FCC grants radio licenses for varying terms of up to 10 years, and the FCC must approve renewal applications. In the past, FCC renewal applications have been more or less routinely granted. Although there can be no assurance the FCC will approve or act upon Teletouch’s future applications in a timely manner, the Company believes that such applications will continue to be approved with minimal difficulties.
Teletouch regularly applies to the FCC for authority to use additional frequencies and to add additional transmitter sites to expand coverage on existing frequencies. Under current FCC guidelines, the Company can expand its coverage and add additional sites only on frequencies formerly classified as PCP frequencies below 929 MHz. All other paging frequencies below 929 MHz on which Teletouch holds licenses are frozen in a status quo condition pending the final announcement and implementation of geographic area licensing auctions. The Communications Act also requires prior FCC approval for the Company’s acquisitions of radio licenses held by other companies, as well as transfers of controlling interests of any entities that hold radio licenses. Although there can be no assurance the FCC will approve or act upon Teletouch’s future applications in a timely manner, the Company knows of no reason why such applications would not be approved or granted. The FCC has also determined that all major modification and expansion applications will be subject to competitive bidding (auction) procedures. Teletouch cannot predict the impact of these procedures on its licensing practices.
The Communications Act requires the FCC to limit foreign ownership of licenses. These foreign ownership restrictions limit the percentage of company stock that may be owned or voted, directly or indirectly, by aliens or their representatives, a foreign government or its representatives, or a foreign corporation. The FCC also has the authority to restrict the operation of licensed radio facilities or to revoke or modify such licenses. The FCC may adopt changes to its radio licensing rules at any time, subject to following certain administrative procedures. The FCC may also impose fines for violations of its rules. Under certain circumstances, Teletouch’s license applications may be deemed “mutually exclusive” with those of other paging companies, in which case the FCC would select between the mutually exclusive applicants. The FCC has previously used lottery procedures to select between mutually exclusive paging applications; however, in response to a Congressional mandate, the FCC adopted rules to grant mutually exclusive CMRS paging applications through the auction process.
The FCC could change its rules or policies in a manner that could have a material adverse effect on the Company’s business by limiting the scope and manner of Teletouch’s services or by increasing competition in the paging industry. Beginning in 1994, the FCC was ordered by Congress to hold auctions to award licenses for new personal communications services. These PCS and other new mobile services could enable other service providers to compete directly or indirectly with the Company. In addition, from time to time, federal and state legislators propose and enact legislation that could affect the Company’s business either beneficially or adversely. Teletouch cannot predict the impact of such legislative actions on its operations.
The foregoing description of certain regulatory factors does not purport to be a complete summary of all the present and proposed legislation and regulations pertaining to the Company’s operations.
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Employees
At May 31, 2004, Teletouch employed 135 people, of which 130 were employed full-time and 5 were employed on a part-time or temporary basis. Most of these employees perform sales, operations support, and clerical roles. The Company considers its relationships with its employees to be satisfactory and is not a party to any collective bargaining agreement.
Item 2. | Properties |
Teletouch owns an office building and one transmitter site, along with the broadcast tower on that site. In addition, the Company currently leases 32 office locations (including 3 previously closed retail locations that the Company is currently seeking to sublease) in its market areas, including its corporate offices in Tyler, Texas. The Company has 20 customer service centers and 6 two-way radio shops through which it will service its customer base. The remaining lease liability at May 31, 2004 was approximately $113,000 for the closed stores and is expected to be paid through 2005. Teletouch also leases transmitter sites on commercial towers, buildings, and other fixed structures in approximately 401 locations. The Company’s leases are for various terms and provide for monthly rental payments at various rates. Teletouch is obligated to make total lease payments of approximately $1.6 million under its office facility and tower site leases for fiscal year 2005.
The Company believes that its facilities are adequate for its current needs and that it will be able to obtain additional space as needed at reasonable cost.
Item 3. | Legal Proceedings |
Teletouch is a party to various legal proceedings arising in the ordinary course of business. The Company believes there is no proceeding, either threatened or pending, against it that will result in a material adverse effect on its results of operations or financial condition.
Item 4. | Submission of Matters to a Vote of Security Holders |
No matters were submitted to a vote of security holders during the fourth quarter of fiscal year 2004.
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Item 5. | Market for Registrant’s Common Equity, Related Shareholder Matters and Issuer Repurchases of Equity Securities |
Teletouch’s Common Stock is traded on the American Stock Exchange (“AMEX”) under the symbol TLL.
The following table lists the reported high and low transaction prices for Teletouch Common Stock for the periods indicated, which correspond to our quarterly fiscal periods for financial reporting purposes. These prices reflect inter-dealer prices, but do not include retail mark-ups, markdowns, or commissions and may not necessarily represent actual transactions.
Common Stock | ||||||
High | Low | |||||
Fiscal Year 2003 | ||||||
1st Quarter | $ | 0.65 | $ | 0.23 | ||
2nd Quarter | 0.33 | 0.15 | ||||
3rd Quarter | 0.50 | 0.29 | ||||
4th Quarter | 0.48 | 0.30 | ||||
Fiscal Year 2004 | ||||||
1st Quarter | $ | 1.73 | $ | 0.45 | ||
2nd Quarter | 1.21 | 0.69 | ||||
3rd Quarter | 1.18 | 0.82 | ||||
4th Quarter | 1.00 | 0.47 |
As of August 12, 2004, 4,976,189 shares of Common Stock were issued and 4,546,980 shares of Common Stock were outstanding, 1,000,000 shares of Series C Preferred Stock, 937,487 options and 6,000,000 warrants to purchase common stock were issued and outstanding. The common stock is the only class of stock which has voting rights or that is traded publicly. As of August 20, 2004, there were 43 holders of record of the Company’s Common Stock based upon information furnished by Continental Stock Transfer & Trust Company, New York, New York, the Company’s transfer agent. The number of holders of record does not reflect the number of beneficial holders, estimated to be in excess of 800, of Teletouch’s Common Stock for whom shares and warrants are held by banks, brokerage firms, and other entities.
Teletouch has never paid and does not anticipate paying any cash dividends on its Common Stock in the foreseeable future. Dividends on the Series A Preferred Stock accrued at 14% per annum compounded quarterly through May 17, 2002 when, pursuant to the Restructuring Agreement effective as of that date, dividend accruals ceased. On November 7, 2002, the Company’s common shareholders approved the issuance of 1,000,000 shares of Series C Preferred Stock which were issued in exchange for all of the outstanding shares of Series A Preferred Stock as well as certain other securities. The Series C Preferred Stock was convertible into shares of common stock after May 20, 2005 and to date no cash dividends have been paid on the Series C Preferred Stock.
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Item 6. | Selected Consolidated Financial Data |
The following table represents certain items from the Company’s consolidated statements of operations and certain other information for the periods indicated. This information should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the consolidated financial statements and notes set forth below.
(In Thousands, except Per Share Data, Pagers in Service and ARPU) | ||||||||||||||||||||
2004 | 2003 (9) | 2002 (10) | 2001 | 2000 | ||||||||||||||||
(Restated) | (Restated) | |||||||||||||||||||
Service, rent, and maintenance revenue | $ | 23,192 | $ | 27,929 | $ | 34,335 | $ | 42,929 | $ | 45,164 | ||||||||||
Product sales revenue | 3,562 | 6,893 | 12,234 | 13,366 | 11,427 | |||||||||||||||
Total operating revenues | 26,754 | 34,822 | 46,569 | 56,295 | 56,591 | |||||||||||||||
Total operating expenses (1)(5)(7)(8) | 26,920 | 36,510 | 45,249 | 92,979 | 54,706 | |||||||||||||||
Operating income (loss) (1) | (166 | ) | (1,688 | ) | 1,320 | (36,684 | ) | 1,885 | ||||||||||||
Interest expense, net(3) | (357 | ) | (384 | ) | (7,412 | ) | (8,775 | ) | (7,908 | ) | ||||||||||
Loss on investments | — | — | — | (356 | ) | — | ||||||||||||||
Gain on extinguishment of debt (3)(4) | — | 510 | 64,505 | — | — | |||||||||||||||
Gain on litigation settlement (6) | — | 429 | — | — | — | |||||||||||||||
Income (loss) before income taxes and extraordinary item(1)(3)(4)(5)(6)(7)(8) | (523 | ) | (1,133 | ) | 58,413 | (45,815 | ) | (6,023 | ) | |||||||||||
Income tax expense/(benefit) | 60 | (372 | ) | — | — | — | ||||||||||||||
Income (loss) before extraordinary item (1)(3)(4)(5)(6)(7)(8) | (583 | ) | (761 | ) | 58,413 | (45,815 | ) | (6,023 | ) | |||||||||||
Extraordinary item – Gain derived from negative goodwill on purchase of certain assets, net of income tax | 64 | — | — | — | — | |||||||||||||||
Net income (loss) before preferred stock dividends (1)(3)(4)(5)(6)(7)(8) | $ | (519 | ) | $ | (761 | ) | $ | 58,413 | $ | (45,815 | ) | $ | (6,023 | ) | ||||||
Net income (loss) applicable to common shareholders (1)(3)(4)(5)(6)(7)(8) | $ | (519 | ) | $ | 4,437 | $ | 53,624 | $ | (50,117 | ) | $ | (9,741 | ) | |||||||
Earnings (loss) per share applicable to common stock: | ||||||||||||||||||||
Earnings (loss) per share – basic | ||||||||||||||||||||
Earnings (loss) before extraordinary item applicable to common shareholders (1)(3)(4)(5)(6)(7)(8) | $ | (0.12 | ) | $ | 0.96 | $ | 11.09 | $ | (10.65 | ) | $ | (2.29 | ) | |||||||
Extraordinary item | $ | 0.01 | $ | — | $ | — | $ | — | $ | — | ||||||||||
Earnings (loss) applicable to common shareholders | $ | (0.11 | ) | $ | 0.96 | $ | 11.09 | $ | (10.65 | ) | $ | (2.29 | ) | |||||||
Earnings (loss) per share - diluted | ||||||||||||||||||||
Earnings (loss) before extraordinary item applicable to common shareholders (1)(3)(4)(5)(6)(7)(8) | $ | (0.12 | ) | $ | 0.30 | $ | 0.59 | $ | (10.65 | ) | $ | (2.29 | ) | |||||||
Extraordinary item | $ | 0.01 | $ | — | $ | — | $ | — | $ | — | ||||||||||
Earnings (loss) applicable to common shareholders | $ | (0.11 | ) | $ | 0.30 | $ | 0.59 | $ | (10.65 | ) | $ | (2.29 | ) | |||||||
Pagers in service at end of period | 168,000 | 217,700 | 271,100 | 354,700 | 411,700 | |||||||||||||||
Total assets (1) | $ | 14,704 | $ | 16,090 | $ | 23,638 | $ | 31,445 | $ | 77,693 | ||||||||||
Long-term debt and redeemable equity securities, net of current portion (2)(3)(4)(1) | $ | 2,531 | $ | 2,230 | $ | 2,511 | $ | — | $ | 71,927 | ||||||||||
Shareholders’ equity (deficit) (1)(3)(4)(5)(6)(7)(8) | $ | 6,802 | $ | 7,253 | $ | 9,301 | $ | (55,814 | ) | $ | (11,438 | ) | ||||||||
(1) | 2001 information includes impairment charges of $36.6 million related to certain intangible assets recorded in the three month period ended May 31, 2001. |
(2) | $66,935,000 of long-term debt was reclassified as a current liability as of May 31, 2001 |
(3) | $57,100,000 in outstanding principal on the Company’s senior debt and $25,513,000 in outstanding principal and accrued interest were retired on May 20, 2002 as the Company concluded its efforts to recapitalize its debt and certain equity securities. The Company recorded a gain on the extinguishment of debt of $64,505,000. See Note H of Notes to Consolidated Financial Statements. |
(4) | $2,536,000 in outstanding principal and accrued interest were retired on December 31, 2002. The Company recorded a gain on the extinguishment of debt of $510,000. Note H of Notes to Consolidated Financial Statements. |
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(5) | During the second quarter of fiscal 2003, the Company completed verification procedures of its property, plant and equipment. As a result, certain paging infrastructure inventory was not identified therefore a charge of $810,000 was recorded to write off the remaining carrying value of this equipment. Note B of Notes to Consolidated Financial Statements. |
(6) | In December 2002, the Company received $429,000 as the result of a favorable legal settlement. |
(7) | 2002 information includes charges related to the closure of 22 retail stores in the amount of $488,000 for the abandonment of certain leased retail space and $120,000 for the abandonment of related leasehold improvements recorded in the fourth quarter of fiscal 2002. |
(8) | 2003 information includes charges related to the Company’s exit from its retail distribution channel in the amount of $2,303,000 recorded in the second and third quarter of fiscal 2003. These charges included $456,000 for personnel related costs, $477,000 for the abandonment of certain leased retail space, $34,000 for the abandonment of related leasehold improvements and $1,426,000 for write-downs on excess furniture and fixtures and computer equipment held for sale. |
(9) | We have restated our 2003 consolidated financial statements to reduce the gain recognized on the issuance of Series C Preferred Stock to retire certain other preferred and common stock by $7.6 million to $28.8 million from $36.4 million,. Also, we have restated our basic and diluted earnings per share for 2003 (including the interim periods therein) to include the effect of the reduction in the gain. Note A of Notes to Consolidated Financial Statements. |
(10) | We have restated our 2002 consolidated financial statements to reduce the gain recognized on the extinguishment if debt by $5.1 million, to $64.5 million from $69.6 million, the gain on the May 2002 Exchange Transaction thereby reducing net income applicable to common shareholders of $58.7 million Also, we have restated our basic and diluted earnings per share for 2003 (including the interim periods therein) to include the effect of the reduction in the gain. Note A of Notes to Consolidated Financial Statements. |
(11) | Included are the Company’s long-term obligations under its outstanding redeemable common stock warrants issued in November 2002 and its outstanding redeemable common stock payable issued in January 2004. See footnote M to the consolidated financial statements. |
The effect of the restatement on the amounts previously reported in the Company’s 2002 consolidated financial statements included in the Form 10-K are as follows (in thousands except for per share data):
2002 | ||||||||
As Previously Reported | As Restated | |||||||
INCOME STATEMENT DATA: | ||||||||
Gain on extinguishment of debt | $ | 69,571 | $ | 64,505 | ||||
Net income | 63,479 | 58,413 | ||||||
Net income applicable to common shareholders | 58,690 | 53,624 | ||||||
Earnings per share – basic | $ | 12.14 | $ | 11.09 | ||||
Earnings per share – diluted | $ | 0.64 | $ | 0.59 | ||||
CASH FLOWS DATA | ||||||||
Net income | $ | 63,479 | $ | 58,413 | ||||
Gain on extinguishment of debt | (69,571 | ) | (64,505 | ) | ||||
Net cash provided by operating activities | $ | 9,950 | $ | 9,950 |
The effect of the restatement on the amounts previously reported in its 2003 consolidated financial statements included in the Form 10-K are as follows (in thousands except for per share data):
2003 | ||||||||
As Previously Reported | As Restated | |||||||
BALANCE SHEET DATA: | ||||||||
Additional paid-in capital | $ | 26,834 | $ | 31,900 | ||||
Accumulated deficit | (19,402 | ) | (24,468 | ) | ||||
Total shareholders equity | $ | 7,253 | $ | 7,253 | ||||
INCOME STATEMENT DATA: | ||||||||
Gain on preferred stock transaction | $ | 36,377 | $ | 28,778 | ||||
Net income applicable to common shareholders | 35,616 | 4,437 | ||||||
Earnings per share - basic | $ | 1.21 | $ | 0.96 | ||||
Earnings per share - diluted | $ | 0.39 | $ | 0.30 |
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Item 7. | Management’s Discussion and Analysis of Financial Condition and Results of Operations |
Forward-Looking Statements
Our disclosure and analysis in this document may contain forward-looking statements with respect to financial condition, results of operations, cash flows, financing plans, business strategies, operating efficiencies or synergies, capital and other expenditures, network upgrades, competitive positions, availability of capital, growth opportunities for existing and new products and services, our acquisition and growth strategy, benefits from new technologies, availability and deployment of new technologies, plans and objectives of management, and other matters.
Statements in this document that are not historical facts are hereby identified as forward-looking statements. These forward-looking statements, including, without limitation, those relating to the future business prospects, revenues, working capital, liquidity, capital needs, network build-out, interest costs and income, in each case, relating to us, wherever they occur in this document, are necessarily estimates reflecting the best judgment of senior management and involve a number of risks and uncertainties that could cause actual results to differ materially from those suggested by the forward-looking statements. These forward-looking statements should, therefore, be considered in light of various important factors. Important factors that could cause actual results to differ materially from estimates or projections contained in the forward-looking statements include, without limitation:
• | The effects of vigorous competition in the markets in which we operate and competition for more valuable customers, which may decrease prices charged, increase churn, and change the customer mix, profitability, and average revenue per unit; |
• | Uncertainty concerning the growth rate for the wireless industry in general; |
• | The risks associated with the implementation of our telemetry products and services and our technology development strategy, including risks relating to the implementation and operations of new systems and technologies, and potential unanticipated costs, the need to enter into agreements with third parties, uncertainties regarding the adequacy of suppliers on whom we must rely to provide both network and consumer equipment, and consumer acceptance of the products and services to be offered; |
• | Uncertainty about the level of consumer demand for our telemetry products and services, including the possibility of consumer dissatisfaction which could result from unfamiliarity with new technology and different footprint, service areas, and levels of customer care; |
• | The ability to enter into agreements to provide services throughout the United States and the cost of entering new markets necessary to provide these services; |
• | Our ability to effectively develop and implement new services, offers, and business models to profitably serve that segment of the population not currently using telemetry services and the possible impact of those services and offers on our business; |
• | The risk of increased churn and adverse impacts on our ability to grow our paging subscriber base resulting from popularity of cellular products and services provided by our competitors, or customer dissatisfaction with our products and services; |
• | The ongoing global and U.S. trend towards consolidation in the telecommunications industry, which may have the effect of making our competitors larger and better financed and give these competitors more extensive resources, improved buying power, and greater geographic reach, allowing them to compete more effectively; |
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• | The requirements imposed on us or latitude allowed to competitors by the FCC or state regulatory commissions under the Telecommunications Act of 1996 or other applicable laws and regulations; |
• | The inability to establish a significant market presence in new geographic and service markets; |
• | The availability and cost of capital and the consequences of increased leverage; |
• | The impact of any unusual items resulting from ongoing evaluations of our business strategies; |
• | The risks and uncertainties associated with the acquisition and integration of businesses and operations; |
• | The risk of insolvency of vendors, customers, and others with whom we do business; |
• | The additional risks and uncertainties not presently known to us or that we currently deem immaterial; and |
• | Those factors discussed under “Additional Factors That May Affect Our Business, Future Operating Results, and Financial Condition.” |
The words “estimate,” “project,” “intend,” “expect,” “believe,” “plan,” and similar expressions are intended to identify forward-looking statements. These forward-looking statements are found at various places throughout this document. You are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date of this document. Moreover, in the future, we may make forward-looking statements about the matters described in this document or other matters concerning us. The Company undertakes no obligation and does not intend to update, revise, or otherwise publicly release the results of any revisions to these forward-looking statements that may be made to reflect future events or circumstances.
Restatement of Previously Issued 2002 and 2003 Consolidated Financial Statements
As described below and in Note A of Notes to Consolidated Financial Statements, we have restated our consolidated financial statement for the years ended May 31, 2002 and 2003. The restatement of our consolidated financial statements for the years ended May 31, 2002 and 2003 also caused a change in the components of shareholders’ equity on our May 31, 2004 consolidated balance sheet, although total assets, liabilities and shareholders’ equity and the results of operations, cash flows as of and for the year ended May 31, 2004 were not affected.
The restatements of our consolidated financial statements reflects an increase in the value at which shares of Series C Preferred Stock issued in November 2002 were recorded. This increase, from $1.76 per share to $14.42 per share (or $.03 per share of underlying common stock into which the Series C Preferred Stock is convertible to $.33 per underlying common share), resulted in an aggregate increase of the value of Series C Preferred Stock of $12.7 million. In our original accounting for the two transactions, we based the value of the Series C Preferred Stock on the present value methodology used by Hoak Breedlove Wesneski & Co (“HBW”), an independent third party, which had been retained by the Company to issue a fairness opinion related to the Exchange Transactions. We used this valuation to record the securities issued and apportioned the value of the securities which it issued between the May 2002 Exchange Transaction and the November 2002 Exchange Transaction.
In May 2002, the holders of the Company’s junior subordinated debt and its outstanding Series A and Series B Preferred Stock, warrants for the purchase of shares of Series B Preferred Stock and common stock warrants forgave the junior subordinated debt obligations (“the May 2002 Exchange Transaction”) contemplating the issuance of the Series C Preferred Stock and redeemable common stock warrants at a later date upon shareholder approval. In November 2002 the Company’s shareholders approved the exchange of
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Series C Preferred Stock and redeemable common stock purchase warrants for its outstanding Series A and Series B Preferred Stock, warrants for the purchase of shares of Series B Preferred Stock, common stock warrants and shares of its common stock (the “November 2002 Exchange Transaction”). The value of the securities contemplated to be issued in the November 2002 Exchange Transaction were apportioned against the gain recognized on the retirement of the junior subordinated debt in the May 2002 Exchange Transaction since the shareholder approval of this exchange was probable due to the benefits to the Company.
Based upon our evaluation and response to the Staff’s comments we have concluded that the shares of the Series C Preferred Stock issued in the May 2002 and November 2002 Exchange Transactions should have been valued based the market value of the underlying 44,000,000 share of common stock into which the Series C Preferred Stock could be converted, which was $.33 per share when the Series C Preferred Stock was issued in November, 2002), rather than the present value methodology originally used.
As a result we have restated our 2002 consolidated financial statements to reduce by $5.1 million, to $64.5 million from $69.6 million, the gain on the May 2002 Exchange Transaction, thereby reducing net income applicable to common shareholders of $58.7 million or $12.14 and $0.64 per share basic and diluted, respectively, to $53.6 million or $11.09 and $0.59 per share basic and diluted, respectively.
We have restated our 2003 consolidated financial statements to reduce by $7.6 million to $28.8 million from $36.4 million, the gain from the November 2002 Exchange Transaction thereby reducing net income applicable to common shareholders of $35.6 million or $1.21 and $0.39 per share basic and diluted, respectively, to $28.0 million which was further reduced by $23.6 million to $4.4 million as a result of allocating the undistributed earnings to the Series C Preferred Stock or $0.96 and $0.30 per share basic and diluted, respectively.
The reduction in net income applicable to common shareholders in the second quarter of fiscal 2003 by the rights of the Series C Preferred Stock to participate in earnings resulted from the Company calculating and presenting earnings per share (“EPS”) using the two-class method as illustrated in EITF 03-06. This change in method of computing EPS was recommended by the staff at the SEC but because Company has never declared or paid dividends on its common stock and because the Series C Preferred Stock participates in dividends on a pro rata basis with the common stock, the two-class method of computing EPS results in the same EPS as would be mathematically arrived at using the alternative “if-converted” method of computing EPS.
Total shareholders’ equity is not affected in 2003 or 2004, although there is a change in the components of shareholders’ equity. The reduction in the gain from the May 2002 Exchange Transaction increases the Company’s accumulated deficit by $5.1 million with an offsetting increase of the amount recorded for the outstanding Series C Preferred Stock.
Certain information below has been amended to reflect the restatement made to the consolidated financial statements.
Overview
The following discussion and analysis of the results of operations and financial condition of the Company should be read in conjunction with the consolidated financial statements and the related notes and the discussions under “Application of Critical Accounting Policies,” which describes key estimates and assumptions we make in
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the preparation of our financial statements and “Additional Factors That May Affect Our Business, Future Operating Results, and Financial Condition” which describes key risks associated with our operations and industry.
Teletouch is a leading provider of wireless telecommunications services, primarily paging services, in non-major metropolitan areas and communities in the southeast United States. As of May 31, 2004, the Company had approximately 168,000 pagers in service. The Company derives the majority of its revenues from fixed, periodic fees, not dependent on usage, charged to subscribers for paging services. As long as a subscriber remains on service, operating results benefit from the recurring payments of the fixed, periodic fees without incurring additional selling expenses or other fixed costs.
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Results of Operations for the fiscal years ended May 31, 2004, 2003 and 2002
Total revenue: changes in Teletouch’s total revenue are shown in the table below:
Year Ended May 31, | Year Ended May 31, | |||||||||||||||||||
2004 | 2003 | Change | 2003 | 2002 | Change | |||||||||||||||
Service, rent and maintenance revenue | $ | 23,192 | $ | 27,929 | $ | (4,737 | ) | $ | 27,929 | $ | 34,335 | $ | (6,406 | ) | ||||||
Product sales revenue | 3,562 | 6,893 | (3,331 | ) | 6,893 | 12,234 | (5,341 | ) | ||||||||||||
Gross Revenue | $ | 26,754 | $ | 34,822 | $ | (8,068 | ) | $ | 34,822 | $ | 46,569 | $ | (11,747 | ) | ||||||
Service, rent and maintenance revenue:Service, rent and maintenance revenues declined due to losses in paging and messaging revenues of $4.9 million in fiscal year 2004 from fiscal year 2003 and $6.4 million in fiscal year 2003 from fiscal year 2002 This resulted from fewer pagers in service and lower demand for one-way paging. Pagers in service decreased to approximately 168,000 at May 31, 2004 as compared to 217,700 and 271,100 at May 31, 2003 and May 31, 2002, respectively, due to a continuing decline in the demand for one-way paging service.
As discussed earlier, demand for one-way paging services has declined over the past several years and Teletouch anticipates that it will continue to decline for the foreseeable future, which will result in reductions in service, rent and maintenance revenues due to the lower volume of subscribers.
Teletouch continues to strive to develop new products and services that could partially offset the loss in paging subscribers and the related recurring revenues. To date, the revenues generated by the Company’s new telemetry products have offset only an insignificant portion of the decline in paging revenues. The Company continues to be able to generate sufficient cash to operate the business as a result of certain cost saving measures it has implemented over the past several years. If revenues from its new telemetry products do not increase significantly during the first half of fiscal 2005, the Company will have to consider restructuring its operations to reduce expenses further to help offset some of the continuing paging revenue deterioration in order to ensure sufficient cash to operate the business during the coming year. If additional funds are needed to operate the business in fiscal 2005 beyond cash flows from operations, the Company has an additional $2.0 million available under a lending arrangement with TLL Partners, a company controlled by Robert McMurrey, Chairman of the Board of Teletouch as well as a revolving line of credit with First Community Financial Corporation with borrowings available up to $2.0 million based primarily on the Company’s eligible accounts receivable. The Company will be implementing certain programs during fiscal 2005 in an attempt to stabilize its current paging subscriber base and reduce the cost of supporting these customers. Some areas of focus include: more aggressive customer retention efforts, pricing strategies to combat the increasingly competitive paging market and locating strategic paging carrier partners to share in the relatively fixed network costs of the paging infrastructure.
Product sales revenue: The decline in product sales revenues was due primarily to the Company’s exit from the retail business in November 2002 which resulted in a decline in cellular revenues of $2.9 million for fiscal year 2004 as compared to fiscal year 2003 and $4.3 million for fiscal 2003 as compared to fiscal 2002. Compounding the decline in product sales revenue was a decline in pager equipment sales of $0.7 million for
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fiscal year 2004 as compared to fiscal year 2003 and $1.0 million in fiscal year 2003 as compared to fiscal year 2002 resulting from the decrease in demand for these devices. The decline in product sales revenue was partially offset by an increase in Two-Way equipment sales revenue of $0.3 million for fiscal year 2004 as compared to fiscal year 2003. The Two-Way equipment sales revenue increase is attributable to the purchase of the assets and customer base of Delta Communications, Inc., in the third quarter of fiscal year 2004, which enabled Teletouch to expand its coverage to the Dallas / Fort Worth area as well as certain sales contracts achieved during the fourth quarter of fiscal 2004 that were the result of the release of federal grant monies under the Homeland Security programs which allow city, county and local emergency response entities to upgrade their communications equipment.
Total operating expenses: The comparability of cost of services and selling and general and administrative expenses is affected by the inclusion of certain restructuring costs relating to the Company’s closing of retail stores. Total costs and expenses, as listed below, are presented excluding restructuring costs of $2.3 million and $0.6 million, included in operating expenses in the Company’s consolidated statement of operations, for fiscal years 2003 and 2002 respectively.
($ in thousands) | ||||||||||||||||||||||||
Year Ended May 31, | Year Ended May 31, | |||||||||||||||||||||||
2004 | 2003 | Change | 2003 | 2002 | Change | |||||||||||||||||||
Cost of services | $ | 11,025 | $ | 14,460 | $ | (3,435 | ) | $ | 14,460 | $ | 15,086 | $ | (626 | ) | ||||||||||
Selling and general and administrative expense | 8,613 | 11,007 | (2,394 | ) | 11,007 | 15,177 | (4,170 | ) | ||||||||||||||||
Less: restructuring costs | — | (2,303 | ) | 2,303 | (2,303 | ) | (608 | ) | (1,695 | ) | ||||||||||||||
Cost of services, selling and general and administrative expense excluding restructuring cost | $ | 19,638 | $ | 23,164 | $ | (3,526 | ) | $ | 23,164 | $ | 29,655 | $ | (6,491 | ) | ||||||||||
% of total revenue | 73 | % | 67 | % | 67 | % | 64 | % | ||||||||||||||||
Cost of products sold | 3,184 | 5,315 | (2,131 | ) | 5,315 | 8,539 | (3,224 | ) | ||||||||||||||||
Depreciation and amortization | 3,726 | 4,665 | (939 | ) | 4,665 | 6,338 | (1,673 | ) | ||||||||||||||||
Loss on disposal of assets | 372 | 253 | 119 | 253 | 109 | 144 | ||||||||||||||||||
Write-off of equipment | — | 810 | (810 | ) | 810 | — | 810 | |||||||||||||||||
Add: restructuring costs | — | 2,303 | (2,303 | ) | 2,303 | 608 | 1,695 | |||||||||||||||||
Total operating expenses | $ | 26,920 | $ | 36,510 | $ | (9,590 | ) | $ | 36,510 | $ | 45,249 | $ | (8,739 | ) | ||||||||||
Cost of services, selling and general and administrative expenses: The decline in cost of services and selling and general and administrative expenses excluding restructuring costs for the year ended May 31, 2004 as compared to the year ended May 31, 2003, reflects declines in payroll and commission expense of $2.0 million, office lease expense of $0.5 million, and general office expense, including utilities, office supplies and repairs and maintenance of buildings and equipment of $0.4 million primarily related to fewer facilities which resulted from the Company’s complete exit of it retail distribution channel in fiscal 2003. Bad debt also declined $0.2 million from fiscal year 2004 over fiscal year 2003 resulting primarily from the decline in the Company’s retail
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subscriber base along with increased collection efforts. In addition, third party airtime expense declined $0.3 million from fiscal year 2004 over fiscal year 2003 due to better rates negotiated by the Company combined with lower use as a result of the decline in the Company’s retail paging subscriber base.
The decline in cost of services and selling and general and administrative expenses excluding restructuring costs for the year ended May 31, 2003 as compared to the year ended May 31, 2002, reflects declines in payroll and commission expense of $2.9 million, advertising expense of $1.2 million, office lease expense of $0.6 million, general office expense, including utilities, office supplies and repairs and maintenance of buildings and equipment of $0.4 million, and insurance expense of $0.1 million primarily due to the Company operating less facilities in a fiscal 2003 than as compared to fiscal 2002 which resulted from the Company’s complete exit from its retail distribution channel throughout fiscal 2003. Bad debt expense also declined $0.4 million from fiscal year 2003 over fiscal year 2002 resulting primarily from the decline in the Company’s retail paging subscriber base along with increased collections efforts. In addition, third party airtime expense declined $0.8 million due to better rates negotiated by the Company combined with lower use as a result of the decline in the Company’s retail paging subscriber base.
In May 2002, the Company completed a review of the financial performance of its retail stores. This review resulted in the decision to close 22 of the Company’s 66 locations. Provisions for estimated losses on the abandonment of certain leased retail space were $488,000 and the loss recorded on the abandonment of related leasehold improvement costs was $120,000 as of May 31, 2002 and these charges were included in the operating expense of the Company during fiscal 2002.
After completing the Retail Exit Plan discussed in Item 1 “Restructuring Activities” and during the quarter ending February 28, 2003, the Company increased its provision for losses for certain changes in estimates related to the Company’s Retail Exit Plan including $45,000 for personnel related costs and $112,000 for lease obligations. Quarter end November 30, 2002 charges related to the Company’s Retail Exit Plan included $365,000 for the abandonment of certain leased retail space, $34,000 for the abandonment of related leasehold improvements, $411,000 for personnel related costs and $1,426,000 for write-downs on excess furniture and fixtures and computer equipment held for sale. Such charges have been included in operating expenses in the Company’s Consolidated Statement of Operations.
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The following table provides a rollforward of store closing liabilities for the years ended May 31, 2002, 2003 and 2004:
(amounts in 000’s) | ||||||||||||
Future Lease Payments | Personnel Costs | Total | ||||||||||
Balance at May 31, 2001 | $ | — | $ | — | $ | — | ||||||
Additions to provision | 488 | — | 488 | |||||||||
Balance at May 31, 2002 | $ | 488 | $ | — | $ | 488 | ||||||
Changes in estimates | (214 | ) | — | (214 | ) | |||||||
Additions to provision | 477 | 456 | 933 | |||||||||
Cash outlay | (353 | ) | (456 | ) | (809 | ) | ||||||
Balance at May 31, 2003 | $ | 398 | $ | — | $ | 398 | ||||||
Changes in estimates | (66 | ) | — | (66 | ) | |||||||
Cash outlay | (219 | ) | (219 | ) | ||||||||
Balance at May 31, 2004 | $ | 113 | $ | — | $ | 113 | ||||||
Operating costs as a percentage of total revenue have increased while the Company’s paging subscriber base continues to decline for the year ended May 31, 2004 as compared to the same period in fiscal year 2003 and fiscal year 2002. The Company has a relatively fixed cost structure related to maintaining its paging network which includes rental of tower space or other fixed location space for its transmitting equipment, telecommunication charges to connect its paging network, and repair and maintenance costs. As paging subscribers and the related recurring revenues continue to decline, operating expenses as a percentage of total revenue will continue to increase unless the Company is able to generate sufficient revenue growth in its other product and service offerings or it restructures its operations again to reduce its operational costs. Future restructuring of the Company’s operations will be difficult as the personnel and facilities costs have been reduced to a level that the Company’s management believes that further reductions in these areas may have a greater negative impact on revenues due to a potential impairment in Teletouch’s ability to service its existing customers. Although no restructuring plans have been formalized by the Company it is currently evaluating the profitability of each of its paging systems throughout the Southeast United States. If the revenues on a system were to decline to the point that the system were unprofitable, the Company would be forced to shut that system down and forfeit the revenues associated unless it were able to convert those customers to another compatible system.
Depreciation and amortization: Depreciation and amortization expense decreased to $3.7 million in fiscal year 2004 from $4.7 million and $6.3 million in fiscal years 2003 and 2002, respectively. The declines in depreciation and amortization expense in fiscal years 2004 and 2003 are due primarily to a write off, in fiscal year 2003, of certain paging infrastructure equipment of $0.8 million, write-downs on excess furniture, fixtures and computer equipment held for sale of $1.5 million, and charges to write off leasehold improvements relating to store closings of $0.2 million.
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Loss on disposal of assets:The increase in loss on disposal of assets is due primarily to the write-off of $0.3 million of computer software programs in the third quarter of fiscal 2004. The Company purchased the computer software, in fiscal 2003, which was represented to be a fully integrated system. After a year of implementation, it was determined that the software was not capable of handling the complexities of a telecommunications company. The Company is currently proceeding with a potential legal claims it may have against the vendor.
Write-off of equipment: During the second quarter of fiscal 2003, the Company completed verification procedures of its property, plant and equipment. As a result of the procedures performed, certain paging infrastructure equipment was not identified. The Company believes that a significant amount of the equipment not identified was attributable to ongoing significant repair and upgrades of its network performed on its paging infrastructure over the seven years prior to this verification without always accurately accounting for the replacement or removal of capitalizable infrastructure equipment. During these prior periods, the removal of certain equipment during the maintenance process was not recorded. Due to the seven year time period over which this activity likely took place it was impractical for the Company to accurately attribute this loss to the period in which it occurred, therefore, the Company recorded a charge of approximately $810,000 during the second quarter of fiscal 2003 to write off the remaining carrying value of this equipment. The Company believes that the amount of the loss attributable to any prior year is not significant to any prior annual operating results or financial position.
Interest expense:Net interest expense decreased to $0.4 million in fiscal years 2004 and 2003 from $7.4 million in fiscal 2002. The decline in interest expense in fiscal years 2004 and 2003 as compared to fiscal year 2002, is directly attributable to the Company’s successful restructuring of the senior and junior subordinated debt on May 20, 2002 which resulted in the Company extinguishing approximately $86.2 million in unpaid principal and accrued interest in exchange for approximately $9.8 million in cash and the delivery of a new promissory note in the amount of $2.75 million and certain other securities.
Income taxes: The effective tax rate is 13% for the twelve months ended May 31, 2004, due partially to the interest expense related to the redeemable common stock warrants being non-deductible for tax purposes and due to a change in the tax accrual estimates made at May 31, 2003. The Company’s net operating loss carryforwards were reduced to $0 at May 31, 2002 from approximately $29.5 million at May 31, 2001. Other deferred tax assets were reduced as well. This reduction occurred in accordance with the attribute reduction rules of Internal Revenue Code Section 108 related to the Company’s debt restructuring. A corresponding reduction to the valuation allowance previously recorded against these assets was also recorded and the valuation allowance as of May 31, 2002 was $0.
Financial Condition
Teletouch’s cash balance was $72,000 at May 31, 2004 as compared to $688,000 at May 31, 2003. Cash provided by operating activities decreased to $3.6 million in fiscal year 2004 from $6.7 million and $10.0 million in fiscal year 2003 and fiscal year 2002, respectively. The decrease in cash provided by operations during fiscal years 2004 and 2003 was primarily due to the continued decline in paging and messaging service revenue. In addition during fiscal year 2004, the Company made payments of $643,000 related to fiscal year 2003 federal income taxes and $227,000 for fiscal year 2004 estimated federal income taxes. The decrease in cash provided by operations is partially offset by a reduction in operating costs as a result of the completion of the Retail Exit Plan in fiscal year 2003. The increase in cash provided by operations during fiscal year 2002 was
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primarily due to the Company ceasing interest payments on the Credit Agreement in June 2001 during the continued negotiations with the lenders to reorganize this senior debt instrument. The Company was successful in restructuring its senior debt in May 2002 by paying its senior lenders an aggregate cash amount of approximately $9,800,000 and delivering a new promissory note to one of the original senior lenders in the amount of $2,750,000 (discussed below under “Senior Debt Reorganization”). Additionally, pursuant to the Restructuring Agreement dated May 17, 2002 by and among TLL Partners, GM Holdings and Teletouch, the two holders of the Company’s Junior Subordinate Notes reached an agreement that released and discharged Teletouch of its Junior Debt obligations without recourse. GM Holdings forgave Teletouch’s debt obligations totaling $3,062,000 including accrued interest and TLL Partners forgave Teletouch’s debt obligations totaling $22,451,000. If the revenues from the Company’s new telemetry product initiatives materialize during the first half of fiscal 2005, the Company expects that cash flow provided from operations, together with the Company’s existing credit facilities, will be sufficient to fund its working capital needs in fiscal 2005. Otherwise, the Company may have to eliminate certain costs from its operations to meet its cash requirements during fiscal 2005.
Teletouch’s operations require capital investment to purchase pagers for lease to customers and to acquire paging infrastructure equipment to support the Company’s existing subscribers. Net capital expenditures, including pagers, amounted to $2.3 million, $3.6 million and $4.3 million for fiscal 2004, 2003 and 2002, respectively. The decrease in fiscal 2004 from fiscal 2003 and fiscal 2002 was due to less capital spending on opening new retail stores as well as the declining number of paging subscribers requiring leased pager equipment. Teletouch anticipates that capital expenditures will decline in fiscal 2005 as the Company plans to only replace necessary equipment to maintain the paging infrastructure while continuing to purchase an adequate supply of pagers to lease to its declining customer base. Teletouch expects to pay for these expenditures with cash generated from operations.
Under the Company’s credit agreement with First Community Financial Corporation, the Company has available borrowings of up to $2.0 million which is dependent on the Company’s borrowing base primarily consisting of accounts receivable at any point in time. Based on the eligible accounts receivable as of May 31, 2004, the Company’s allowable borrowings under this agreement were $1.1 million. Under this credit facility, $0.0 million was funded as of May 31, 2004.
Under the Company’s credit agreement with TLL Partners, the Company has available borrowings of up to $2.0 million. Under this credit facility, $0.3 million was funded as of May 31, 2004.
During the third quarter of fiscal 2004, the Company was unable to maintain compliance with certain financial covenants under the FCFC loan agreement but these covenants were waived by FCFC to allow the Company to remain in good standing for this period. The FCFC loan agreement is a revolving line of credit that the Company has utilized to bridge the timing of the receipt of customer payments with its operating cash outflows. Effective February 1, 2004, the Company negotiated an extension of its loan agreement with FCFC through May 1, 2005 which included modifications to certain of the financial covenants included in the agreement. These modifications made it easier for the Company to comply with the financial covenants during fiscal 2004. If the Company is unable to develop additional revenues from its new telemetry products in fiscal 2005, the Company anticipates it will be difficult to comply with these financial covenants without additional restructuring. If this loan facility were to be unavailable, the Company could experience temporary cash shortages during the year that could cause payments to vendors to be delayed. The Company was in compliance with its financial covenants at May 31, 2004.
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Obligations and Commitments
As of May 31, 2004, our contractual payment obligations under our long-term debt agreements and operating leases for office and transmitter locations are indicated in the table below. For purposes of the table below, purchase obligations are defined as agreements to purchase goods or services that are enforceable and legally binding and that specify significant terms, including: fixed or minimum quantities to be purchased, minimum pricing and the approximate timing of transactions. Teletouch has no such purchase obligations at May 31, 2004. Other long-term liabilities is comprised of certain redeemable common stock warrants issued in conjunction with the Company’s debt restructuring in May 2002 (see “Restructure of Senior Debt” discussion below) and certain shares of Teletouch Common Stock to be issued in February 2005 in conjunction with the purchase of certain assets from Delta Communications, Inc. (see “Redeemable Common Stock Payable” discussion below).
Payments Due By Period (in thousands) | ||||||||||||||||||
Significant Contractual Obligations | Total | 2005 | 2006 | 2007 | 2008 | Thereafter | ||||||||||||
Debt obligations | $ | 493 | $ | 45 | $ | 45 | $ | 396 | $ | 7 | $ | — | ||||||
Operating lease obligations | 4,093 | 1,616 | 1,061 | 855 | 544 | 17 | ||||||||||||
Purchase obligations | — | — | — | — | — | — | ||||||||||||
Other long-term liabilities | 3,682 | 294 | 263 | 3,125 | ||||||||||||||
Total significant contractual cash obligations | $ | 8,268 | $ | 1,955 | $ | 1,369 | $ | 4,376 | $ | 551 | $ | 17 | ||||||
Redeemable Common Stock Payable: On January 29, 2004, Teletouch acquired substantially all of the two-way radio assets of DCAE, Inc. d/b/a Delta Communications, Inc. (“Delta”), and in conjunction, the Company deferred the issuance of 640,000 shares of Teletouch’s common stock subject to certain reductions specified in the Delta Asset Purchase Agreement that cannot exceed 100,000 shares of common stock. This obligation is payable quarterly beginning February 15, 2005 during which up to 640,000 restricted shares of common stock will be issued. The shares of common stock to be issued contain a put option allowing the holder to sell 25% of the remaining shares held each quarter, beginning February 28, 2005, back to the Company at a specified price as follows:
Date to be Sold Back to Company | Sell Price | ||
February 28, 2005 – November 30, 2005 | $ | 1.05 | |
December 1, 2005 – November 30, 2006 | $ | 1.10 | |
December 1, 2006 – November 30, 2007 | $ | 1.15 |
Because of this mandatory redemption feature, the Company has recorded the estimated fair value of the Redeemable Common Stock Payable as both a current and long-term liability on its consolidated balance sheet, and will adjust the amount to reflect changes in the fair value of the obligation, including accretion in value due to the passage of time, with such changes charged or credited to net income.
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Restructure of Senior Debt
On May 20, 2002, pursuant to agreements executed on May 17, 2002, Teletouch reorganized its debt, retiring approximately $57,100,000 in outstanding principal and $3,600,000 in accrued interest in senior debt owed by Teletouch under its senior credit agreement to a syndicate of commercial lenders, by paying those lenders an aggregate cash amount of $9,800,000 and delivering a Promissory Note in the principal amount of $2,750,000 to one of the lenders, ING Prime Rate Trust (formerly known as Pilgrim America Prime Rate Trust) (“Pilgrim”) (the “Debt Reorganization”). The Second Amended and Restated Credit Agreement (the “Amended Credit Agreement”) dated as of May 17, 2002 by and among Teletouch and Pilgrim, as administrative agent for the lender, which amended and restated the prior credit agreement effected the Debt Reorganization and resulted in the reduction of the aggregate principal debt under the debt facility to $2,750,000 (the “Pilgrim promissory note”).
On December 31, 2002, Teletouch paid off the principal and interest amounts outstanding under the Amended Credit Facility by remitting a one time payment in the amount of $1,947,874 as full satisfaction of all amounts owed by Teletouch thereunder. The Amended Credit Facility, together with all security interests arising in connection therewith was terminated and cancelled as of that date. The Company recognized a gain on the extinguishment of this debt of $510,000. The funds used to pay off the amount included approximately $429,000 received by the Company in December 2002 as the result of a favorable legal settlement.
In order to complete the reorganization of its debt and to provide for necessary working capital financing, Teletouch also entered into new credit agreements with First Community Financial Corporation and TLL Partners. Proceeds from these facilities combined with working capital from the Company were used to fund the cash payments to lenders in the amount of $9,800,000 required to restructure the senior debt in May 2002.
Preferred Stock and Junior Debt Restructuring Activities: The Company reached an agreement with the two holders of the Company’s junior subordinated debt (the “Junior Debt”), GM Holdings and TLL Partners concerning the Junior Debt held by each of GM Holdings and TLL Partners simultaneously with the restructuring of the senior debt discussed above. The material provisions of the agreement are discussed below.
On May 17, 2002, TLL Partners paid $800,000 and exercised an option it had previously purchased to acquire all of the Teletouch securities held by Continental Illinois Venture Corporation (“CIVC”) which included $22,451,000 of the total $25,513,000 in outstanding principal and accrued interest under the Junior Debt, 295,649 shares of Teletouch common stock, 2,660,840 warrants to purchase Teletouch common stock, 36,019 shares of Series B Preferred Stock, 324,173 warrants to purchase Series B Preferred Stock, and 13,200 shares of Series A Preferred Stock.
Pursuant to the Restructuring Agreement dated May 17, 2002 by and among TLL Partners, GM Holdings and Teletouch, the two holders of the Company’s Junior Debt reached an agreement that released and discharged Teletouch of its Junior Debt obligations without recourse. GM Holdings forgave Teletouch’s debt obligations totaling $3,062,000 including accrued interest and TLL Partners forgave Teletouch’s debt obligations totaling $22,451,000.
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Pursuant to the Restructuring Agreement dated as of May 17, 2002, by and among TLL Partners, GM Holdings and Teletouch (“Restructuring Parties”), Teletouch agreed to issue warrants to purchase 6,000,000 shares of Teletouch common stock to GM Holdings and TLL Partners agreed to exchange certain preferred and common stock, as described below, for 1,000,000 shares of Teletouch’s Series C Preferred Stock. The issuance of the warrants to purchase 6,000,000 shares of Teletouch common stock and the 1,000,000 shares of Series C Preferred Stock was subject to shareholder approval and satisfaction of applicable American Stock Exchange Rules. Additionally, each of the Restructuring Parties agreed that no dividends would accrue, be declared or made on the Series A Preferred Stock or the Series B Preferred Stock pending the completion of the transactions contemplated by the Restructuring Agreement.
The securities exchanged by TLL Partners included all of the common stock, common stock warrants, Series A Preferred Stock, Series B Preferred Stock and Series B Preferred Stock Warrants which TLL Partners acquired from CIVC as well as the Series A Preferred Stock and Series B Preferred Stock previously held by GM Holdings, which TLL Partners acquired pursuant to an option granted to it by GM Holdings at no cost in connection with the Restructuring Agreement. As an inducement for entering into the Restructuring Agreement, TLL Partners paid $59,000 to GM Holdings upon its execution.
On November 7, 2002, the Company’s common shareholders voted to approve the issuance by the Company of 1,000,000 shares of Series C Preferred Stock and warrants to purchase 6,000,000 shares of the Company’s Common Stock to TLL Partners and GM Holdings, respectively completing the Restructuring Agreement entered into May 17, 2002.
The Company estimated the fair value of the Series C Preferred Stock and the 6,000,000 warrants to purchase common stock to be issued to GM Holdings at $14,520,000 and $1,345,000, respectively, and recorded a portion of the fair value of these securities, $5,808,000 for the Series C Preferred Stock and $538,000 for the warrants to purchase common stock, as a reduction to the gain on extinguishment of debt during fiscal 2002. The shares of Series C Preferred Stock were valued at $14.52 per share, reflecting the market vale of $.33 for each share of common stock into which the share of the Series C Preferred Stock is convertible and the conversion rate of 44 shares of common stock for each share of Series C Preferred Stock. The warrants to purchase common stock were recorded at the fair value of the embedded put feature which and is being accreted in value over time to their redemption value of $3,000,000 in May 2007.
The gain on extinguishment of debt for the year ended May 31, 2002, of approximately $64,500,000 was calculated as follows:
Senior debt, including accrued interest, extinguished | $ | 60,700,000 | |
Junior subordinated debt extinguished | 25,500,000 | ||
Total | 86,200,000 | ||
Less: | |||
Cash paid | 9,800,000 | ||
Pilgrim promissory note, including interest to be paid | 3,200,000 | ||
Allocated portion of the fair value of the Series C Preferred Stock | 5,800,000 | ||
Allocated portion of the fair value of the 6,000,000 warrants to purchase common stock | 500,000 | ||
Allocated portion of cash paid by significant shareholder | 400,000 | ||
Write-off of related debt issue costs | 1,100,000 | ||
Fees and expenses incurred | 900,000 | ||
Gain on extinguishment of debt | $ | 64,500,000 |
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In conjunction with the issuance of the Series C Preferred Stock and 6,000,000 warrants to purchase common stock in exchange for the 15,000 shares of Series A Preferred Stock, 85,394 shares of Series B Preferred Stock, 2,660,840 warrants to purchase common stock, 324,173 warrants to purchase Series B Preferred Stock and 295,649 shares of common stock, the Company recognized a gain of $28,778,000, in the second quarter of fiscal year 2003, that was included in income applicable to common stock and is reflected in the Company’s earnings per share calculations for the year ended May 31, 2003. The amount of the gain represents the amount by which the carrying value of the Series A Preferred Stock as of November 7, 2002 $38,297,000 which included accrued dividends which were recorded in paid-in capital, exceeded the allocated portion of the fair value of the securities issued, $8,712,000 for the Series C Preferred Stock and $807,000 for the 6,000,000 warrants to purchase common stock issued by the Company.
Application of Critical Accounting Policies
The preceding discussion and analysis of financial condition and results of operations are based upon Teletouch’s consolidated financial statements, which have been prepared in conformity with accounting principles generally accepted in the United States. The preparation of these financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues, expenses and related disclosures. On an on-going basis, Teletouch evaluates its estimates and assumptions, including but not limited to those related to the impairment of long-lived assets, reserves for doubtful accounts, revenue recognition and certain accrued liabilities. Teletouch bases its estimates on historical experience and various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.
Impairment of Long-Lived Assets:In accordance with Statement of Financial Accounting Standards (“SFAS”) No. 144 – “Accounting for the Impairment or Disposal of Long-Lived Assets” Teletouch evaluates the recoverability of the carrying value of its long-lived assets and certain intangible assets based on estimated undiscounted cash flows to be generated from such assets. As a result of the closure of the Company’s retail stores in fiscal 2003, the Company identified excess furniture and fixtures and computer equipment used previously in its retail business, classified these excess assets as Assets Held for Sale and recorded a charge to reduce the carrying value of these assets to their estimated recoverable value less any anticipated disposition costs. In the second quarter of fiscal 2003, the Company reduced the carrying value of these assets now classified as Assets Held for Sale from $1.7 million to $0.2 million by recording a charge of $1.5 million to restructuring expense. At May 31, 2004, all such Assets Held for Sale had been disposed of by the Company.
Teletouch’s review of the carrying value of its long-lived assets at May 31, 2004 indicates that the carrying value of these assets is recoverable through future estimated cash flows. If the cash flow estimates, or the significant operating assumptions upon which they are based, change in the future, Teletouch may be required to record additional impairment charges related to its long-lived assets.
Allowance for Doubtful Accounts: Estimates are used in determining the allowance for doubtful accounts and are based on historic collection experience, current trends and a percentage of the accounts receivable aging categories. In determining these percentages Teletouch reviews historical write-offs, including comparisons of write-offs to provisions for doubtful accounts and as a percentage of revenues;
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Teletouch compares the ratio of the allowance for doubtful accounts to gross receivables to historic levels and Teletouch monitors collections amounts and statistics. Teletouch’s allowance for doubtful accounts was $0.2 million as of May 31, 2004. While write-offs of customer accounts have historically been within our expectations and the provisions established, management cannot guarantee that Teletouch will continue to experience the same write-off rates that it has in the past which could result in material differences in the allowance for doubtful accounts and related provisions for write-offs.
Reserve for Inventory Obsolescence: Estimates are used in determining the reserve for inventory obsolescence and are based on sales trends, a ratio of inventory to revenue, and a review of specific categories of inventory. In establishing its reserve, Teletouch reviews historic inventory obsolescence experience including comparisons of previous write-offs to provision for inventory obsolescence and the inventory count compared to recent sales trends. Teletouch’s reserve for inventory obsolescence was $0.4 million as of May 31, 2004. Prior to fiscal 2004, inventory obsolescence has been within our expectations and the provision established. During fiscal 2004, the Company recorded additional reserves for inventory obsolescence to recognize the deterioration in the market value of certain pager, cellular and electronics and telemetry inventory. Pager inventory was impaired primarily due to a decline in market value of certain damaged pagers that are repaired by the Company. Cellular and electronic inventory became impaired after many months of attempting to sell off this excess equipment and the Company recorded a reserve equaling the total value of this inventory. Certain telemetry inventory, primarily related to the Company’s fixed monitoring product line, was impaired subsequent to the Company exiting this business line. Teletouch management cannot guarantee that the Company will continue to experience the same obsolescence rates that it has in the past which could result in material differences in the reserve for inventory obsolescence and the related inventory write-offs.
Revenue Recognition: Teletouch’s revenue consists primarily of monthly service and lease revenues charged to customers on a monthly, quarterly, semi-annual or annual basis. Deferred revenue represents prepaid monthly service fees paid by customers. Revenue also includes sales of messaging devices and other products directly to customers and resellers. Teletouch recognizes revenue over the period the service is performed in accordance with SEC Staff Accounting Bulletin No. 104, “Revenue Recognition in Financial Statements” (SAB 104). SAB 104 requires that four basic criteria must be met before revenue can be recognized: (1) persuasive evidence of an arrangement exists, (2) delivery has occurred or services rendered, (3) the fee is fixed and determinable, and (4) collectibility is reasonably assured. Teletouch believes, relative to sales of one-way messaging equipment, that all of these conditions are met, therefore, product revenue is recognized at the time of shipment. Revenue from sales of other products is recognized upon delivery.
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Recent Accounting Pronouncements
In December 2002, the FASB issued Statement No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure, and Amendment of FASB Statement No. 123.” SFAS No. 148 amends SFAS No. 123, “Accounting for Stock-Based Compensation,” to provide alternative methods of transition for a voluntary change to the fair value method of accounting for stock-based employee compensation. In addition, SFAS No. 148 amends the disclosure requirements of SFAS No. 123 to require more prominent disclosures about the method of accounting for stock-based compensation and the effect of the method used on reported results in both annual and interim financial statements. The transition and annual disclosure provisions of SFAS No. 148 are effective for fiscal years ending after December 15, 2002. The Company has adopted the annual disclosure provisions of SFAS No. 148 and enhanced disclosures related to the accounting for stock-based employee compensation are provided in footnote A to the consolidate financial statements.
In January 2003, the FASB issued FIN No. 46, Consolidation of Variable Interest Entities. In general, a variable interest entity (“VIE”) is a corporation, partnership, trust, or any other legal structure used for business purposes that either (a) does not have equity investors with voting rights or (b) has equity investors that do not provide sufficient financial resources for the entity to support its activities. FIN No. 46 requires a VIE to be consolidated by a company if that company is subject to a majority of the risk of loss from the VIE’s activities or is entitled to receive a majority of the VIE’s residual returns or both. The consolidation requirements of FIN No. 46 are effective immediately for VIEs created after January 31, 2003. The consolidation requirements for older VIEs are effective for financial statements of interim or annual periods beginning after June 15, 2003. However, in October 2003, the FASB deferred the effective date of FIN 46 for older VIEs to the end of the first interim or annual period ending after December 15, 2003. Certain of the disclosure requirements are effective for all financial statements issued after January 31, 2003, regardless of when the VIE was established. The adoption of FIN No. 46 had no impact on the Company’s financial position or results of operations.
In April 2003, the FASB issued SFAS No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities.” SFAS No. 149 amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts (collectively referred to as derivatives) and for hedging activities under SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities.” This statement is effective for contracts entered into or modified after June 30, 2003, and for hedging relationships designated after June 30, 2003. The adoption of this Statement did not have a material impact on our financial position and results of operations.
In May 2003, the FASB issued SFAS No. 150, which establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. Specifically, it requires that financial instruments within the scope of the statement be classified as liabilities because they embody an obligation of the issuer. Under previous guidance, many of these instruments could be classified as equity or be reflected as mezzanine equity between liabilities and equity on the balance sheet. The Company’s initial adoption of this statement on June 1, 2003 did not have a material impact on its results of operations, financial position or cash flows. Certain redeemable common stock warrants issued in November 2002 were recorded at their estimated fair value as a long-term liability within the Company’s Consolidated Balance Sheet. Additionally, a deferred issuance of certain shares of common was granted in connection with the Company’s purchase of certain assets in February 2004. These shares of common stock contain put options at a stated value. The Company has recorded these shares of common stock at their estimated fair value appropriately between current and a long-term liabilities within the Company’s Consolidated Balance Sheet.
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The accretion related to these redeemable common stock warrants and the deferred issuance of common stock is classified as Interest Expense within its Consolidated Statement of Operations.
In April 2004, the Financial Accounting Standards Board’s (“FASB”) Emerging Issues Task Force (“EITF”) reached a consensus on EITF No. 03-06, “Participating Securities and the Two Class Method Under FASB Statement No. 128, Earnings Per Share”. EITF 03-06 addresses a number of questions regarding the computation of earnings per share by companies that have issued securities other than common stock that contractually entitle the holder to participate in dividends and earnings of the company when, and if, it declares dividends on its common stock. The issue also provides further guidance in applying the two-class method of calculating earnings per share, clarifying what constitutes a participating security and how to apply the two-class method of computing earning per share once it is determined that a security is participating, including how to allocate undistributed earnings to such a security. EITF 03-06 is effective for fiscal periods beginning after March 31, 2004. The adoption of EITF 03-06 is not expected to have a material effect on our financial position or results of operations.
Additional Factors That May Affect Our Business, Future Operating Results, and Financial Condition
You should carefully consider the following factors that may affect our business, future operating results and financial condition, as well as other information included in this report. The risks and uncertainties described below are not the only ones we face. Additional risks and uncertainties not presently known to us, that we have not identified as risks, or that we currently deem immaterial may also impair our business operations. If any of the following risks actually occur, our business, financial condition and operating results could be materially adversely affected.
• | We could experience increased subscriber attrition and reduction in average revenue per unit as a result of more competitive services products and pricing. |
• | The proposed merger of Arch Wireless and Metrocall Wireless, the paging industry’s two largest carriers and direct competitors of Teletouch, could result in further deterioration in market pricing of paging services, and increased competition from this entity in rural markets in which Teletouch operates could result in increased attrition of Teletouch subscribers. |
• | Termination or impairment of our relationship with a small number of key telemetry suppliers or vendors could adversely affect our revenue opportunities and results of operations. |
• | Market prices for paging, two-way and telemetry services may decline in the future as competition increases. |
• | We rely on airtime arrangements with other carriers to provide our telemetry services, which we may be unable to obtain or maintain in the future. |
• | If the demand for telemetry services does not grow, or if we fail to capitalize on such demand, it would have an adverse effect on our growth potential. |
• | We may increase our debt in the future to fund potential acquisitions, which could subject us to various restrictions and higher interest costs and decrease our cash flow and earnings. |
• | If we do not maintain compliance with the American Stock Exchange requirements for continued listing, our common stock could be de-listed. |
• | Our ability to fund the costs inherent with complying with new statutes and regulations applicable to public reporting companies, such as the Sarbanes-Oxley Act of 2002, could have an adverse impact on the operations of the Company; |
• | There are substantial capital requirements that we will need to fund in order to maintain, operate and upgrade our information systems network to a level at which we can support any new revenue initiatives. |
• | Our ability to efficiently integrate future acquisitions, if any, could alter the plans for future growth and profitability. |
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• | Our operations are subject to government regulation that could have adverse effects on our business. |
• | Equipment failure and natural disasters or terrorist acts may adversely affect our business. |
Item 7A. | Quantitative and Qualitative Disclosures about Market Risk |
The risk inherent in Teletouch’s market risk sensitive instruments, such as its credit facilities is the potential loss arising from adverse changes in interest rates. As of May 31, 2004, the debt obligation with FCFC, comprised of the MAP Note was subject to a variable interest rate. The MAP Note is a short term revolving line of credit that is borrowed against and repaid as often as daily. Due to the revolving nature of the MAP Note and the Company’s ability to choose whether to obligate itself through borrowings, the inherent risk in the MAP Note is minimal related to changes in interest rates.
We did not have any foreign currency hedges or other derivative financial instruments as of May 31, 2004. We do not enter into financial instruments for trading or speculative purposes and do not currently utilize derivative financial instruments. Our operations are conducted primarily in the United States and as such are not subject to material foreign currency exchange rate risk.
Item 8. | Financial Statements and Supplementary Data |
The financial statements required by this item are included in this report beginning on page F-1.
Item 9. | Changes In and Disagreements with Accountants On Accounting and Financial Disclosure |
Not applicable.
Item 9A. | Controls and Procedures |
In connection with the Company’s filing of its Form 10-K for the year ended May 31, 2004, as of the end of the period covered by that annual report, the Company carried out, under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer (the “Certifying Officers”), an evaluation of the effectiveness of its “disclosure controls and procedures” (as the term is defined under Rules 13a-15(e) and 15d-15(e) promulgated under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)). Based on this evaluation, the Certifying Officers concluded that the Company’s disclosure controls and procedures were effective to ensure that material information is recorded, processed, summarized and reported by management of the Company on a timely basis in order to comply with the Company’s disclosure obligations under the Exchange Act, and the rules and regulations promulgated thereunder.
In connection with the preparation of this Amended Annual Report on Form 10-K/A (Amendment No. 2) for the year ended May 31, 2004, the Chief Executive Officer and Chief Financial Officer of the Company (the “Certifying Officers”) conducted re-evaluations of the Company’s disclosure controls and procedures, as of the end of the period covered by this Annual Report. As defined under Rules 13a-15(e) and 15d-15(e) promulgated under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), the term “disclosure controls and procedures” means controls and other procedures of an issuer that are designed to ensure that information required to be disclosed by the issuer in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the
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Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to the issuer’s management, including its principal executive officer or officers and principal financial officer or officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure. Based on this evaluation, the Certifying Officers concluded that our disclosure controls and procedures were not effective to ensure that material information is recorded, processed, summarized and reported by our management on a timely basis in order to comply with our disclosure obligations under the Exchange Act, and the rules and regulations promulgated thereunder. An explanation of the deficiencies and remedies is set forth below. In compliance with Section 302 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. 1350), each of the Certifying Officers executed an Officer’s Certification included in this Annual Report on Form 10-K.
On September 2, 2005, the Company announced that as the result of the then ongoing conversations with the SEC staff (previously reported in the Company’s Form 10-Q for the Quarterly Period ended February 28, 2005) concerning the accounting for the May 2002 Exchange Transaction and the November 2002 Exchange transaction the Company had to restate its Consolidated Statement of Operations for the years ended May 31, 2002 and 2003 and its Consolidated Balance Sheet as of May 31, 2003.
In the May 2002 Exchange Transaction the Company retired certain junior debt, and later, after receiving shareholder approval in November 2002 and in conjunction with the November 2002 Exchange Transaction, issued to the holders of that debt shares of its Series C Preferred Stock and redeemable stock purchase warrants in exchange for outstanding shares of its Series A and Series B Preferred Stock, warrants for the purchase of shares of Series B Preferred Stock, common stock warrants and shares of its common stock (the Exchanged Securities). The holders of the Exchanged Securities included an entity affiliated with the Company’s Chairman of the Board, Robert M. McMurrey. In its original accounting for the two transactions, the Company based the value of the Series C Preferred Stock, which reflected a $.04 per share value for the Common Stock (44,000,000 shares in the aggregate) into the Series C preferred Stock was convertible, on the present value methodology used by Hoak Breedlove Wesneski & Co (“HBW”), an independent third party, which had been retained by the Company to issue a fairness opinion related to the Exchange Transactions. The Company used this valuation to record the securities issued and apportioned the value of the securities which it issued between the May 2002 Exchange Transaction and the November 2002 Exchange Transaction.
Based upon its evaluation and response to the Staff’s comments the Company has concluded that the shares of the Series C Preferred Stock issued in the May 2002 and November 2002 Exchange Transactions should have been valued based on the market value of the underlying 44,000,000 share of common stock into which the Series C Preferred Stock could be converted, which was $0.33 per share when the Series C Preferred Stock was issued in November, 2002, rather than the present value methodology originally used. In addition, the Company has concluded that the change in the value assigned to the Series C Preferred Stock would mean that it does not contain a beneficial conversion feature as defined in EITF 98-5 and EITF 00-27.
This change in the valuation of the shares of the Series C Preferred Stock and the restatement of the Company’s 2002 and 2003 consolidated financial statements changed the following items:
• | reduce by $5.1 million, to $64.5 million from $69.6 million, the gain on the May 2002 Exchange Transaction thereby reducing net income applicable to common shareholders of $58.7 million or |
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$12.14 and $0.64 per share basic and diluted, respectively, to $53.6 million or $11.09 and $0.59 per share basic and diluted, respectively, for the year ended May 31, 2002; and |
• | reduce, by $7.6 million to $28.8 million from $36.4 million, the gain from the November 2002 Exchange Transaction thereby reducing net income applicable to common shareholders of $35.6 million or $1.21 and $0.39 per share basic and diluted, respectively, to $28.0 million which was further reduced by $23.6 million to $4.4 million as a result of allocating the undistributed earnings to the Series C Preferred Stock or $0.96 and $0.30 per share basic and diluted, respectively, for the year ended May 31, 2003. |
The reduction in net income applicable to common shareholders in the second quarter of fiscal 2003 by the rights of the Series C Preferred Stock to participate in earnings resulted from the Company calculating and presenting earnings per share (“EPS”) using the two-class method as illustrated in EITF 03-06. This change in method of computing EPS was recommended by the staff at the SEC but because Company has never declared or paid dividends on its common stock and because the Series C Preferred Stock participates in dividends on a pro rata basis with the common stock, the two-class method of computing EPS results in the same EPS as would be mathematically arrived at using the alternative “if-converted” method of computing EPS.
Total shareholders’ equity is not affected, although there is a change in the components of shareholders’ equity. The specific change is:
• | The reduction in the gain from the May 2002 Exchange Transaction increases the Company’s accumulated deficit by $5.1 million with an offsetting increase of the amount recorded for the outstanding Series C preferred Stock, |
In addition, the change in the value assigned to the Series C Preferred Stock meant that it did not contain a beneficial conversion feature as defined in EITF 98-5 and EITF 00-27.
At the same time as it was discussing these issues with the SEC staff, the Company, under the supervision of its Audit Committee and with the assistance of an independent accounting expert, began its inquiry into the circumstances relating to the above-referenced accounting treatments to assure that there are no other financial reporting or disclosure control items that may be of concern. Having considered the circumstances underlying the accounting errors and their effects upon the Company’s prior filings, and having discussed the matter with the Company’s management, the Audit Committee concluded that that the previously issued 2002 and 2003 financial statements should not be relied upon and authorized the Company’s management to amend certain previously filed public reports. Therefore, in its Current Report on Form 8-K and a press release, both filed on September 2, 2005, the Company urged investors and other users of the Company’s SEC filings not to rely on the Company’s financial statements for the affected periods (to the extent they were affected by the accounting issues described above) until the Company has restated and reissued its results of operations for the applicable periods.
Additionally, management and the Audit Committee considered what changes, if any, were necessary to the Company’s disclosure controls and procedures to ensure that the errors described above would not reoccur and to provide that material information is recorded, processed, summarized and reported by management of the Company on a timely basis in order to comply with the Company’s disclosure obligations under the Exchange Act, and the rules and regulations promulgated thereunder. In its review the Audit
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Committee noted that the errors described above did not result from the failure of the Company’s disclosure controls and procedures to make known to the appropriate officials and auditors the facts concerning the Company’s convertible securities, but rather the error occurred due to the Company’s incomplete understanding of EITF 98-5 and EITF 00-27 and the acceptable valuation methods allowed under this and other accounting literature and its resulting reliance, for financial reporting purposes, on the valuation methods used by HBW in arriving at its opinion on the fairness of the Exchange Transactions. The valuation used to originally record the Series C Preferred Stock was brought into question as a result of the SEC staff questions of whether the Series C Preferred Stock contained a beneficial conversion feature under EITF 98-5 and 00-27. Had the Company more fully considered the required accounting under EITF 98-5 and 00-27 it would most likely have identified the error in the valuation of the Series C Preferred Stock since the intent of the Company was not to provide a benefit to the holder of the Series C Preferred Stock. Although the valuation method used by HBW was reasonable and within the range of acceptable methods for fairness evaluations it did not fall within the range of methods acceptable for GAAP, as it could not be quantitatively reconciled to the market price of the common stock underlying the shares of Series C Preferred Stock and the HBW valuation would have required recognition of a beneficial conversion feature which should not have been present. As a result management and the Audit Committee determined that education and professional development of accounting staff on the complications of EITF 98-5 and EITF 00-27 and their application, as well as on the methods acceptable under GAAP for the valuation of debt and equity securities, would be sufficient to prevent a reoccurrence. These educational steps and development have been completed as of September 2, 2005. No additional changes to the Company’s disclosure controls and procedures were needed in response to the discovery of the errors described above.
Apart from the foregoing, there were no changes in the Company’s “internal control over financial reporting,” as that term is defined in Rules 13a-15(f) and 15d-15(f) promulgated under the Exchange Act, identified in connection with the above-described evaluations that occurred during the fourth fiscal quarter of the period addressed by this Annual Report, that has materially affected or is reasonably likely to materially affect, the Company’s internal control over financial reporting.
Our internal control system is designed to provide reasonable assurance to our management and Board of Directors regarding the preparation and fair presentation of published financial statements. All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation and may not prevent or detect misstatements.
Item 9B. | Other Information |
None.
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Item 10. | Directors, Executive Officers, Promoters, and Control Persons; Compliance with Section 16(a) of the Exchange Act. |
Teletouch’s By-Laws provide that the Board of Directors shall be divided into three classes, and that the total number of directors shall consist of a minimum of three and a maximum of twelve members. The Board of Directors currently consists of six members: two Class I Directors (Messrs. McMurrey and McFarland), two Class II Director (Messrs. Crotty, and Webb) and two Class III Directors (Mr. Toh and Ms. Ciallella). Mr. McMurrey and Mr. McFarland, the Class I directors are standing for re-election for a three-year term at the next Annual Meeting. The Class II Directors will stand for re-election in 2005 and the Class III directors will stand for re-election in 2006.
The directors and executive officers of the Company are as follows:
Name | Age | Title | ||
Robert M. McMurrey | 58 | Chairman of the Board of Directors | ||
J. Kernan Crotty | 60 | Director, President, Chief Operating Officer, Chief | ||
Financial Officer and Assistant Secretary | ||||
Clifford E. McFarland | 48 | Director | ||
Marshall G. Webb | 61 | Director | ||
Henry Y.L. Toh | 47 | Director | ||
Susan Stranahan Ciallella | 46 | Director |
Biographical information with respect to the executive officers and directors of Teletouch are set forth below. There are no family relationships between any present executive officers or directors.
Robert M. McMurrey, Chairman of the Board of Directors, has been a director of Teletouch since 1984. He served as Chief Executive Officer until February 2000. He is also the President, Chief Executive Officer, a director and the sole shareholder of Rainbow Resources, Inc. Through Rainbow Resources, Inc., Mr. McMurrey acquired a controlling interest in Teletouch in 1984. Mr. McMurrey is the sole shareholder, a director and an officer of Progressive Concepts Communications, Inc. which is the sole shareholder of Progressive Concepts, Inc. (PCI), a Texas corporation, which is a provider of radio communications, telephone and telecommunication equipment, accessories and supplies. Mr. McMurrey is also an officer and director of PCI. Mr. McMurrey is also a control person of TLL Partners. The principal business of TLL Partners is to act as a holding company for Mr. McMurrey’s investment in Teletouch securities. Mr. McMurrey was active in the oil and gas industry for over 30 years. Mr. McMurrey received a B.S. Degree in Petroleum Engineering from the University of Texas in 1971.
Susan Stranahan Ciallellawas appointed to fill a vacancy on the Teletouch Board of Directors in August 2002. Ms. Ciallella is an attorney specializing in securities law, broker-dealer regulation and sports law, and is a licensed securities broker. In 2003 she joined the law firm of Dilworth Paxson, LLP as a partner in the Philadelphia office. From 1998 through 2003 Ms. Ciallella was associated with the law firm of Cozen O’Connor. Prior to 1998, Ms. Ciallella was a member of the firm of Adler & Gold in Cherry Hill, New Jersey. In 2001 Ms. Ciallella was a forum participant in the Securities and Exchange Commission’s 20th Annual Government-Business Forum on Small Business Capital Formation; she is a member of the Pennsylvania and
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New Jersey bars. She is a graduate of the University of Florida (B.S., 1980) and Rutgers University Law School (J.D., 1995).
J. Kernan Crotty joined Teletouch as Executive Vice President and Chief Financial Officer in November 1998. In May 2001 he was promoted to President and Chief Operating Officer in addition to his other duties. Mr. Crotty has been a director of Teletouch since May 2001. From 1995 to 1998, Mr. Crotty was founder and a principal of Latah Creek Investment Company, a manufacturer and importer of home furnishings, as well as a principal and Vice President of Courtside Products, Inc., a manufacturer and importer of sporting goods. Mr. Crotty holds a B.A. degree in Economics from Fordham College and holds an MBA degree in Corporation Finance from New York University.
Clifford E. McFarland has been a director of Teletouch since May 1995. In 1991 Mr. McFarland co-founded McFarland, Grossman & Company (MGCO), an investment bank in Houston, Texas. Mr. McFarland has served as the President and a Managing Director of MGCO since its inception. From time to time, MGCO has rendered investment banking services to Teletouch, and to certain affiliates of Teletouch. See “Compensation of Directors and Executive Officers—Consulting and Other Arrangements.”
Henry Y.L. Toh has been a director of Teletouch since November 2001. He is currently serving as a director with four other publicly traded companies. Since 1992, Mr. Toh has served as an officer and director of Acceris Communications, Inc., a publicly held voice-over-IP company. Since December, 1998, Mr. Toh has served as a director of National Auto Credit, Inc., previously an originator of sub-prime automobile financing that is transitioning into new lines of business). From April 2002 until February 2004, Mr. Toh served as a director of Bigmar, Inc., a Swiss pharmaceuticals company. Since January 2004 Mr. Toh has served as a director of Isolagen, Inc., a biotechnology company and since March 2004, Mr. Toh has served as a director of Crown Financial Group, Inc., a publicly traded registered broker dealer. Since 1992 Mr. Toh has served as an officer and director of Four M International, Inc., a privately held offshore investment entity. Mr. Toh began his career with KPMG Peat, Marwick from 1980 to 1992, where he specialized in international taxation and mergers and acquisitions. Mr. Toh is a graduate of Rice University.
Marshall G. Webbhas been a director of Teletouch since November 2001. He is President of Polaris Group, an advisory firm he founded in January 1999, to provide financial consulting and merger & acquisition services to public and private companies. Since February 2003 he also serves as Chief Executive Officer of HWIGroup, Inc., an early stage company formed to create security services solutions for maritime and land-based facilities including private companies and governmental agencies. Mr. Webb founded and led the IPO of BrightStar Information Technology Group, Inc., a global provider of IT solutions to government and business, and served as its CEO and director from 1997 through 1998. He serves as a member of the Boards of Directors of two additional public companies, and various committees of those Boards. Mr. Webb attended Southern Methodist University, is a Certified Public Accountant, and began his career with Peat, Marwick, Mitchell & Co. Mr. Webb is a “financial expert” as that term is defined in Section 407 of the Sarbanes-Oxley Act of 2002 and under the federal securities laws.
Each officer of Teletouch is appointed by the Board of Directors and holds his office(s) at the pleasure and discretion of the Board of Directors.
There are no material proceedings to which any director, director nominee, officer or affiliate of Teletouch, any owner of record or beneficially of more than five percent of any class of voting securities of
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Teletouch, or any associate of any such director, officer, affiliate or security holder is a party adverse to Teletouch or any of its subsidiaries or has a material interest adverse to Teletouch or any of its subsidiaries.
No director, officer or affiliate of Teletouch, any owner of record or any beneficial owner of more than five percent of any class of voting securities of Teletouch has, during the last five years (i) been convicted of any criminal proceeding (excluding traffic violations or similar misdemeanors) or (ii) been a party to a civil proceeding of a judicial or administrative body of competent jurisdiction and as a result of such proceeding was or is subject to a judgment, decree or final order enjoining future violations of, or prohibiting or mandating activities subject to, United States federal or state securities laws or finding any violations with respect to such laws. No family relationships exist by or between any director nominee.
Compliance With The Section 16(a) Beneficial Ownership Requirements
Section 16(a) of the Exchange Act requires our executive officers and directors, and persons who own more than ten percent of any publicly traded class of our equity securities, to file reports of ownership and changes in ownership of equity securities of the Company with the SEC and the American Stock Exchange. Officers, directors, and greater-than-ten-percent shareholders are required by the SEC’s regulation to furnish the Company with copies of all Section 16(a) forms that they file.
Based solely upon a review of Forms 3 and Forms 4 furnished to Teletouch during the most recent fiscal year, and Forms 5 with respect to its most recent fiscal year, we believe that all such forms required to be filed pursuant to Section 16(a) of the Exchange Act were timely filed, as necessary, by the officers, directors, and security holders required to file the same during the fiscal year ended December 31, 2003 with the following exceptions: Although all filings have been made as of the date hereof, each of the following persons had one Form 4 filed after the required submission date, namely, Messrs. Webb (1 transaction), Crotty (1 transaction), Toh (3 transactions) and Ms. Ciallella (2 transactions) and Mr. McFarland (2 transactions) each had two Forms 4 filed after the required submission date.
The Board of Directors
The Board of Directors oversees the business affairs of Teletouch and monitors the performance of management. Pursuant to the Teletouch By-Laws, the Board of Directors has established that the Board of Directors shall consist of no less than three and no more than twelve members; currently the number of seats on the Board of Directors is six. The Board of Directors held three meetings during the fiscal year ended May 31, 2004. Mr. Toh and Ms. Ciallella attended fewer than seventy-five percent of the meetings of the Board of Directors or of the committee(s) on which he or she served. Mr. Toh and Ms. Ciallella each attended two of the three meetings held during the fiscal year.
Committees of The Board of Directors
Audit Committee. We have a separately-designated standing Audit Committee established in accordance with Section 3(a)(58)(A) of the Exchange Act. The members of the audit committee are Susan Stranahan Ciallella (Chairperson), Marshall G. Webb and Henry Y.L. Toh. The Audit Committee held eleven meetings during the fiscal year ended May 31, 2004.
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Compensation Committee.The members of the Compensation Committee are Henry Y.L. Toh (Chairman), Marshall G. Webb and Susan Stranahan Ciallella. During the fiscal year ended May 31, 2004, the compensation committee held two meetings.
Executive Committee.Robert M. McMurrey (Chairman), J. Kernan Crotty and Clifford E. McFarland are the members of the Executive Committee, which held no meetings during the fiscal year ended May 31, 2004.
Nominating Committee.The Nominating Committee was established during the current fiscal year so had no meetings during the fiscal year ended May 31, 2004. Its members are Henry Y.L. Toh (Chairman), Marshall G. Webb and Susan Stranahan Ciallella.
Audit Committee Financial Expert
The Board of Directors has determined that Marshall G. Webb is an audit committee financial expert as defined by Item 401(h) of Regulation S-K of the Securities Exchange Act of 1934, as amended (the “Exchange Act”) and is independent within the meaning of Item 7(d)(3)(iv) of Schedule 14A of the Exchange Act. As a financial expert, Mr. Webb has an understanding of GAAP and financial statements, experience in preparing or auditing financial statements of generally comparable companies; has applied such principles in connection with accounting for estimates, accruals and reserves; and has experience with internal accounting controls and an understanding of Audit Committee functions.
Code of Ethics
Teletouch has adopted a code of ethics that applies to its directors, officers and employees. The Code of Ethics was filed as Exhibit 14 to the Company’s Annual Report on Form 10-K.
Shareholder Communications with Directors.
The Board of Directors has adopted policies and procedures to facilitate written communications by shareholders to the Board. Persons wishing to write to the Board of Directors of Teletouch, or to a specified director or committee of the Board, should send correspondence to the Corporate Secretary at 110 North College, Suite 200, Tyler, Texas 75702. Electronic submissions of shareholder correspondence will not be accepted.
The Corporate Secretary will forward to the directors all communications that, in his or her judgment, are appropriate for consideration by the directors. Examples of communications that would not be appropriate for consideration by the directors include commercial solicitations and matters not relevant to the shareholders, to the functioning of the Board, or to the affairs of Teletouch. Any correspondence received that is addressed generically to the Board of Directors will be forwarded to the Chairman of the Board. If the Chairman of the Board is not an independent director, a copy will be sent to the Chairman of the Audit Committee as well.
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Item 11. | Executive Compensation |
The following table sets forth the aggregate cash compensation paid for services rendered to Teletouch during the last three fiscal years by each person serving as Teletouch’s Chief Executive Officer and Teletouch’s most highly compensated executive officers serving as such as of May 31, 2004 whose compensation was in excess of $100,000 (“Named Executive Officers”).
Annual Compensation | Long Term Compensation Awards | |||||||||||
Name and Principal Position | Year | Salary($) | Bonus ($) (3) | Other Annual Compensation ($) (4) | Restricted Stock Awards ($) (5) | Securities Underlying Options/ SARs(#) | ||||||
Robert M McMurrey; Chairman of the Board (1) | 2004 2003 2002 | 75,000 29,463 — | — 50,000 100,000 | — — — | — — — | — — — | ||||||
J. Kernan Crotty, President, CFO (2) | 2004 2003 2002 | 240,000 240,000 190,385 | — 75,000 100,000 | 10,651 4,316 7,356 | — — — | — 166,667 333,333 |
(1) | Mr. McMurrey was also Chief Executive Officer of Teletouch until February 2000. He ceased receiving a salary effective April 30, 2001. Beginning January 1, 2003, Mr. McMurrey began receiving a salary of $75,000 annually. In 2003, Mr. McMurrey was granted a bonus of $50,000 by the Compensation Committee in view of his substantial efforts in effecting the Company’s debt retirement activities. This bonus was paid in August 2003. In 2002, Mr. McMurrey was granted a bonus of $100,000 by the Compensation Committee in view of his substantial efforts in effecting the Company’s debt restructuring and equity recapitalization. |
(2) | Mr. Crotty became President, Chief Operating Officer, and Chief Financial Officer in May 2001. In April 2002, Mr. Crotty entered into an employment agreement with the Company at an annual salary of $240,000 and he is entitled to receive yearly performance related bonus payments in the range of $50,000–$100,000. Upon entering this employment agreement in April 2002, Mr. Crotty was paid a signing bonus of $38,000. |
(3) | Unless otherwise indicated, bonuses shown were paid in the fiscal year following the year in which services were provided. |
(4) | Represents contributions made by Teletouch pursuant to its 401(k) Plan. |
(5) | The number and value of the aggregate restricted stock holdings as of the end of the last fiscal year for each of our Named Executive Officers were as follows: Mr. McFarland, 6,000 shares which are held by McFarland Grossman & Co. or $4,080; Robert McMurrey, 1,238,942 shares, of which 1,200,000 are held by Rainbow Resources, Inc. or $842,481; and Mr. Crotty, 49,000 shares or $33,320. |
OPTION/SAR GRANTS IN LAST FISCAL YEAR (2004)
There were no options granted during the fiscal year ended May 31, 2004 for the named executive officers.
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AGGREGATED OPTION/SAR EXERCISES IN LAST FISCAL YEAR; FISCAL YEAR-END OPTION/SAR VALUES
The following table sets forth certain information with respect to options exercised during the fiscal year ended May 31, 2004 by named executive officers and with respect to unexercised options held by such persons at the end of the fiscal year ended May 31, 2004.
Name | Shares Acquired on Exercise (#) | Value Realized ($) | Number of Securities Underlying Unexercised Options/SARs at FY-End (#) | Value of Unexercised in the Money Options/SARs at FY-End ($) | ||||||||||
Exercisable | Unexercisable | Exercisable | Unexercisable | |||||||||||
Robert M. McMurrey | — | — | 16,666 | 0 | $ | 7,333 | $ | — | ||||||
J. Kernan Crotty | — | — | 568,417 | 81,583 | $ | 225,101 | $ | 31,399 |
Compensation of Directors
Each director of Teletouch who is not a salaried officer or employee of Teletouch or of a subsidiary of Teletouch receives compensation for serving as a director and fees for attendance at meetings of the Board of Directors or of any committee appointed by the Board of Directors as determined by the Board of Directors from time to time. All non-employee non-affiliate directors are compensated at the rate of $22,000 annually. Teletouch’s policy is that every non-employee, non-affiliate director of Teletouch shall be paid $500 for attendance at meetings of the Board of Directors ($100 for telephonic attendance). Such amounts are in addition to reimbursement to such directors for out-of-pocket expenses related to meeting attendance.
The directors are also eligible to receive options under our stock option plans at the discretion of the Board of Directors. Under the Company’s 2002 Plan, all non-employee non-affiliate directors receive a one-time grant of options to purchase 10,000 shares of common stock upon election as a director plus an additional grant of 666 options on the first trading day of each year. There may be additional annual grants of options.
Employment Agreements
Crotty Employment Agreement. On April 1, 2002, the Company entered into a three-year Employment Agreement with J. Kernan Crotty, to serve as President, Chief Financial Officer, Chief Operating Officer and Assistant Secretary. The Employment Agreement may be renewed for one additional year, if the Company and Mr. Crotty so agree, no later than thirty days before the expiration of the initial term. On September 16, 2003, Teletouch and Mr. Crotty executed an Amended and Restated Employment Agreement for an initial term ending April 1, 2006, also renewable for one additional year, if the Company and Mr. Crotty so agree, no later than thirty days before the expiration of the initial term.
As compensation Mr. Crotty is paid a base salary of $240,000 per year. Subject to periodic review by the Board of Directors, and based on the Company’s earnings performance or meritorious performance of his duties, his salary may be increased. He will be entitled to receive yearly bonus payments in the target range of $50,000-$100,000, after the issuance of final audited financial statements. The Compensation Committee will consider
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actual operating performance compared to budgeted performance of the Company, EBITDA less capital expenditures, and other traditional and subjective performance criteria when determining the Annual Bonus. In addition to monetary compensation, Mr. Crotty’s employment benefits include disability, health and life insurance, sick leave, vacation and participation in the Company’s Section 401(k) retirement plan. On December 17, 2001, he was granted a ten-year non-qualified stock option to purchase 333,333 shares of the Company’s common stock, exercisable for $0.282 per share, which price was the average closing price for the twenty days preceding the date of grant. Vesting is pro rata daily over a three-year period commencing December 17, 2001.
On September 1, 2002, Mr. Crotty was granted a non-qualified option to purchase 166,667 shares of the Company’s common stock, exercisable for $0.333 per share, which price was the average closing price for the twenty days preceding the date of grant. Vesting is pro rata daily over a two-year period commencing September 1, 2002. In the event of a change of control (as defined in the Employment Agreement) or upon sale of substantially all of the assets of the Company or merger of the Company out of existence, vesting shall accelerate.
The Company may terminate his employment, upon written notice of (1) death; (2) disability, if the disability continues for 120 days in any year or 90 consecutive days; or (3) for cause. The Company may also terminate Mr. Crotty’s employment in the absence of cause for any reason provided that it pay his base salary through April 1, 2006 and a minimum severance bonus of the greater of $100,000 or the amount of the Annual Bonus pro rated for the portion of the year employed prior to termination. The Company has no obligation to pay a severance bonus if the Company’s reported EBITDA for the fiscal year is less than 75% of budgeted EBITDA for that fiscal year.
Mr. Crotty may voluntarily terminate his employment upon written notice of a good reason arrived at in good faith. All unvested options granted under his Employment Agreement shall immediately terminate and all vested options shall terminate in accordance with their terms. In the event of Mr. Crotty’s resignation of his employment, for good reason, as defined in the Employment Agreement, the Company shall pay a severance package the same as provided for involuntary termination without cause, with the same exceptions.
In the event of termination by the Company for the reasons set forth above, each of the Company and Mr. Crotty shall execute mutual releases of claims against each other prior to Mr. Crotty receiving any post-termination payments. In addition, during the period of his employment, Mr. Crotty may not compete with the Company in any state in which it does business or within 100 miles of such states. However, if the Company fails to make its post-termination payments to him, the non-competition provisions, if any, will be suspended for that period.
Consulting and Other Arrangements
Clifford E. McFarland, a director of Teletouch, is President and a Managing Director of McFarland, Grossman & Company (MGCO). Mr. McFarland’s firm has provided services to Teletouch in connection with seeking additional financing to facilitate the Company’ efforts to retire its obligations with certain lenders as well as provide additional operating capital. In July 2003, the Company entered into an agreement with MGCO to raise funding to allow Teletouch to explore certain acquisition opportunities. During fiscal 2004, MGCO received $70,000 in remuneration from Teletouch for those services and as of May 31, 2004 this agreement has been cancelled.
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Item 12. | Security Ownership of Certain Beneficial Owners and Management and Related Shareholder Matters |
The following table shows beneficial ownership of (1) each director and Named Executive Officer individually; (2) all executive officers and directors of Teletouch as a group; and (3) all persons known by Teletouch to be the beneficial owners of five percent or more of Teletouch common stock as of the close of business on September 24. As of September 24, 4,976,189 shares of Common Stock were issued and 4,546,980 shares of Common Stock were outstanding, 1,000,000 shares of Series C preferred stock were issued and outstanding.
Name and Address of Beneficial Owner | Number of Beneficially | % of Common Shares Beneficially Owned | |||
Robert M. McMurrey (2)(3)(5)(6)(7) 110 N. College, Suite 200 Tyler, TX 75702 | 1,255,608 | 27.5 | % | ||
Rainbow Resources, Inc. (5) 110 N. College, Suite 200 Tyler, TX 75702 | 1,200,000 | 26.4 | % | ||
J. Kernan Crotty (2)(3)(4) 110 N. College, Suite 200 Tyler, TX 75702 | 693,216 | 13.4 | % | ||
John C. Maggart (8) 201 Fourth Avenue North 11th Floor Nashville, TN 37219 | 267,523 | 5.9 | % | ||
Clifford E. McFarland (3)(9) McFarland, Grossman & Co. 9821 Katy Freeway, Suite 500 Houston, TX 77024 | 19,996 | * | |||
Henry Y.L. Toh (3)(10) 1111 Hermann Drive, Unit 6E Houston, TX 77004 | 11,332 | * | |||
Marshall G. Webb (3)(10) 6110 Inwood Houston, TX 77057 | 11,332 | * |
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Name and Address of Beneficial Owner | Number of Beneficially | % of Common Shares Beneficially Owned | |||
Susan Stranahan Ciallella (3)(10) Dilworth Paxson, LLP 1735 Market Street, 32nd Floor Philadelphia, PA 19103 | 10,666 | * | |||
TLL Partners, L.L.C. (6) 110 N. College, Suite 200 Tyler, TX 75702 | 0 | — | % | ||
Progressive Concepts Communications, Inc. (7) 5718 Airport Freeway Fort Worth, TX 76107 | 0 | — | % | ||
All Executive Officers & Directors as a Group (6 Persons) | 2,002,150 | 38.1 | % |
* | Indicates less than 1.0%. |
(1) | Unless otherwise noted in these footnotes, Teletouch believes that all shares referenced in this table are owned of record by each person named as beneficial owner and that each person has sole voting and dispositive power with respect to the shares of common stock owned by each of them. In accordance with Rule 13d-3, each person’s percentage ownership is determined by assuming that the options or convertible securities that are held by that person, and which are exercisable within 60 days, have been exercised or converted, as the case may be. |
(2) | Executive Officer |
(3) | Director |
(4) | Includes 635,997 shares of common stock underlying stock options granted to Mr. Crotty. |
(5) | Mr. McMurrey has voting and dispositive power over all Teletouch securities owned by Rainbow Resources, Inc. (“RRI”). The figures for Mr. McMurrey include the 1,200,000 shares held of record by RRI. Also includes 16,666 shares which may be acquired upon exercise of an option granted to Mr. McMurrey. Does not include 44,000,000 shares of common stock issuable upon the conversion of 1,000,000 shares of Series C Preferred Stock held by TLL Partners, a wholly-owned subsidiary of Progressive Concepts Communications Inc. (“PCCI”); Mr. McMurrey is the controlling person of PCCI by virtue of his being its majority shareholder over which entity Mr. McMurrey exercises control. The terms of Series C Preferred Stock state that it cannot be exercised or converted into the common shares until May 15, 2005. |
(6) | As of the September 24, 2004, TLL Partners does not beneficially own any shares of Teletouch. Mr. McMurrey has voting and dispositive power over all Teletouch securities owned by RRI and TLL Partners. The principal business of TLL Partners is to act as a holding company for investment in Teletouch securities. TLL Partners is a wholly-owned subsidiary of PCCI; Mr. McMurrey is the controlling person of PCCI by virtue of his being its majority shareholder. Number and percentage of |
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common shares beneficially owned by TLL Partners assuming the issuance of 44,000,000 shares of common stock upon the conversion of 1,000,000 shares of Series C Preferred Stock held by TLL Partners would be 44,000,000 or 90.6%, respectively. |
(7) | As of the September 24, 2004, PCCI does not beneficially own any shares of Teletouch. PCCI is the parent holding company of its wholly-owned subsidiaries, Progressive Concepts, Inc. (PCI) and TLL Partners. Mr. McMurrey is the controlling person of PCCI by virtue of his being its majority shareholder. TLL Partners is a wholly-owned subsidiary of PCCI; Mr. McMurrey is the controlling person of PCCI by virtue of his being its majority shareholder. The number and percentage of common shares beneficially owned by PCCI assuming the issuance of 44,000,000 shares of common stock upon the conversion of 1,000,000 shares of Series C Preferred Stock held by TLL Partners would be 44,000,000 or 90.6%, respectively. |
(8) | Includes a total of 94,302 common shares that are held in three individual trusts for which Mr. John C. Maggart is the trustee. Also includes 173,221 common shares individually held by Mr. Maggart as of the Record Date. Further, Mr. Maggart holds warrants to purchase additional 500,000 shares of the Teletouch common stock. The terms of the warrant state that it cannot be exercised or converted into the common shares until May 15, 2005. |
(9) | Includes 13,996 shares underlying stock options granted to Mr. McFarland and 12,000 shares registered in the name of McFarland, Grossman & Co. (MGCO), of which Mr. McFarland is the President and a director. Such 12,000 shares are held by MGCO for the benefit of another entity of which Mr. McFarland is a 50% owner. Mr. McFarland disclaims ownership of 6,000 of such shares. Does not include securities owned by TLL Partners; Mr. McFarland owns a minority interest in PCCI, the indirect parent of the Company, which is also the parent of TLL Partners. |
(10) | Represents shares underlying stock options. |
Securities Authorized For Issuance Under Equity Compensation Plans
The following table summarizes information as of May 31, 2004, about the Company’s outstanding stock options and shares of Common Stock reserved for future issuance under the Company’s existing equity compensation plans.
Equity Compensation Plan Information
Plan Category | Number of securities to be issued upon exercise of outstanding options, warrants and rights | Weighted-average exercise price of outstanding options, warrants and rights | Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in col. (a)) | ||||
Equity compensation plans approved by security holders(1) | 937,487 | $ | 0.44 | 10,062,513 | |||
Equity compensation plans not approved by security holders | — | — | — | ||||
Totals | 937,487 | $ | 0.44 | 10,062,513 |
(1) | The equity compensation plans approved by security holders are the 1994 Stock Option and Appreciation Rights Plan and the 2002 Stock Option and Appreciation Rights Plan. |
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Item 13. | Certain Relationships and Related Transactions |
See Item 11. “Employment Agreements” and “Consulting and Other Arrangements” for descriptions of the terms of employment and consulting agreements between Teletouch and certain officers, directors and other related parties.
Item 14. | Principal Accountant Fees and Services |
The accounting firm of BDO Seidman LLP (BDO) was the Company’s independent accounting firm during the fiscal year ended May 31, 2004.
Audit fees.For the fiscal year ended May 31, 2004 Teletouch paid to BDO audit fees of approximately $149,787, billed for professional services rendered during the audit of the financial statements and reviews of the financial statements included in Teletouch’s financial statements included in its annual filing on Form 10-K or quarterly filings on Form 10-Q for the respective period.
Audit-related fees. For the fiscal year ended May 31, 2004 Teletouch paid to BDO fees of approximately $35,710, billed for assurance and related services by the Company’s auditors that are reasonably related to the performance of the audits. The services thus provided by the Company’s auditors during fiscal 2004 included fees and expenses related to the audit of the employee benefit plans and accounting consultations related to the asset purchase from Delta Communications, the issuance of the Streamwaves Note, and the conversion of the general ledger system.
Tax fees. For the fiscal year ended May 31, 2004, Teletouch paid to BDO fees of approximately $46,460, billed for tax compliance, tax advice and tax planning. The services thus provided by Teletouch’s auditors during fiscal 2004 included state and local tax consultation and tax compliance services.
All other fees. There were no fees billed or rendered by BDO for other services for the fiscal year ended May 31, 2004.
The accounting firm of Ernst & Young LLP (E&Y) was the Company’s independent accounting firm during the fiscal year ended May 31, 2003.
Audit fees. For the fiscal year ended May 31, 2003 Teletouch paid to E&Y audit fees of approximately $173,325, billed for professional services rendered for the audit of Teletouch’s annual financial statements for the fiscal year ended May 31, 2003 and the reviews of the financial statements included in Teletouch’s financial statements included in its quarterly filings on Form 10-Q for the respective period.
Audit-related fees. For the fiscal year ended May 31, 2003 Teletouch paid to E&Y fees of approximately $77,600 billed for assurance and related services by the Company’s auditors that are reasonably related to the performance of the audit of Teletouch’s annual financial statements for the fiscal year ended May
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31, 2003 or reviews of the Company’s financial statements included in the Company’s quarterly filings on Form 10-Q for the respective period. The services thus provided by the Company’s auditors during fiscal 2003 included fees and expenses related to accounting consultations related to the Company’s store closings, fixed asset write-off, and general ledger system conversion.
Tax fees. For the fiscal year ended May 31, 2003, Teletouch paid to E&Y fees of approximately $56,250 billed for tax compliance, tax advice and tax planning. The services thus provided by Teletouch’s auditors during fiscal 2003 included state and local tax consultation and compilation services.
All other fees. There were no fees billed or rendered by E&Y for other services for the fiscal year ended May 31, 2003.
Audit Committee Pre-Approval of Audit and Non-Audit Services
The Audit Committee pre-approves all audit and permissible non-audit services provided to the Company by the independent auditor. These services may include audit services, audit-related services, tax services and other services. The Audit Committee has adopted policies and procedures for the pre-approval of services provided by the independent auditor. Such policies and procedures provide that management and the independent auditor shall jointly submit to the Audit Committee a schedule of audit and non-audit services for approval as part of the Annual Plan for each fiscal year. In addition, the policies and procedures provide that the Audit Committee may also pre-approve particular services not in the Annual Plan on a case-by-case basis. Management must provide a detailed description of each proposed service and the projected fees and costs (or a range of such fees and costs) for the service. The policies and procedures require management and the independent auditor to provide quarterly updates to the Audit Committee regarding services rendered to date and services yet to be performed.
As permitted under the Sarbanes-Oxley Act of 2002, the Audit Committee may delegate pre-approval authority to one or more of its members, for audit and non-audit services to a subcommittee consisting of one or more members of the Audit Committee. Any service pre-approved by a delegatee must be reported to the Audit Committee at the next scheduled quarterly meeting.
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Item 15. | Exhibits, Financial Statement Schedules, and Reports on Form 8-K |
(a) (1) Financial Statements.
Consolidated Balance Sheets as of May 31, 2004 and 2003
Consolidated Statements of Operations for Each of the Three Years in the Period Ended May 31, 2004
Consolidated Statements of Cash Flows for Each of the Three Years in the Period Ended May 31, 2004
Consolidated Statements of Shareholders’ Equity (Deficit) for Each of the Three Years in the Period Ended May 31, 2004
Notes to Consolidated Financial Statements
Report of Registered Public Accounting Firms
(a) (2) Financial Statement Schedules.
Schedule II – Valuation and Qualifying Accounts and Reserves
Schedules, other than those referred to above, have been omitted because they are not required or are not applicable or because the information required to be set forth therein either is not material or is included in the financial statements or notes thereto.
(a) (3) Exhibits.
The exhibits listed in the following index to exhibits are filed as part of this annual report on Form 10-K/A.
Index of Exhibits
Exhibit No. | Description of Exhibit | Footnote | ||
3.1 | Form of Restated Certificate of Incorporation of the Company | 3 | ||
3.2 | Bylaws of Teletouch Communications, Inc., as amended July 31, 1995 | 1 | ||
3.3 | Certificate of Designation, Preferences and Rights of Class A and Class B Preferred Stock | 1 | ||
4.4 | Form of Common Stock Purchase Warrant issued to Continental Illinois Venture Corporation (“CIVC”) et al. on August 3, 1995. | 1 | ||
4.5 | Form of Series B Preferred Stock Purchase Warrant issued to CIVC et al. on August 3, 1995. | 1 | ||
4.6 | Form of 14% Junior Subordinated Note issued to CIVC et al. August 3, 1995. | 1 |
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Exhibit No. | Description of Exhibit | Footnote | ||
10.1 | J. Kernan Crotty Employment Agreement | 3 | ||
10.2 | Stockholders Agreement dated August 3, 1995 among the Company and CIVC et al | 1 | ||
10.3 | Form of Stock Purchase Warrant in favor of GM Holdings, LLC dated May 17, 2002 | 4 | ||
10.4 | Investor Rights Agreement dated May 17, 2002 by and among the Company, TLL Partners and GM Holdings | 4 | ||
10.5 | Principal Stockholders Agreement dated May 17, 2002 by and among TLL Partners, GM Holdings, Rainbow Resources, Inc., Robert M. McMurrey and J. Kernan Crotty | 4 | ||
10.6 | Mutual Release dated May 3, 2002 by and among Continental Illinois Venture Corporation, CIVC Partners I, TLL Partners, the Company, Marcus D. Wedner, Thomas E. Van Pelt, Jr. and Christopher J. Perry | 4 | ||
10.7 | Form of Multiple Advance Promissory Note dated May 17, 2002 in favor of FCFC in the maximum principal amount of $2 million | 4 | ||
10.8 | Form of Term Promissory Note dated May 17, 2002 in favor of FCFC in the principal amount of $250,000 | 4 | ||
10.9 | Form of Subordinated Promissory Note dated May 17, 2002 in favor of TLL Partners in the principal amount of $2.2 million | 4 | ||
10.10 | Form of Amended and Restated Promissory Note dated May 17, 2002 in favor of ING Primate Rate Trust in the principal amount of $2.75 million | 4 | ||
10.11 | Second Amended and Restated Credit Agreement dated as of May 17, 2002 by and among the Company and ING Prime Rate Trust | 4 | ||
10.12 | Loan Modification Agreement dated as of May 17, 2002 by and among the Company, Teletouch Licenses, Inc. and ING Prime Rate Trust | 4 | ||
10.13 | Restructuring Agreement dated as of May 17, 2002 by and among the Company, TLL Partners and GM Holdings | 4 | ||
10.14 | Partial Payoff, Agent Replacement and Assignment and Assumption Agreement dated May 17, 2002 by and among the Company, JPMorgan Chase Bank, certain Lenders and ING Prime Rate Trust | 4 | ||
10.15 | Accounts Receivable Security Agreement dated May 17, 2002 by and between Teletouch and FCFC | 4 | ||
10.16 | Intercreditor Agreement dated May 17, 2002 by and between the Company, Teletouch, FCFC and TLL Partners | 4 | ||
10.17 | Intercreditor Agreement dated May 17, 2002 by and between the Company, FCFC and ING Prime Rate Trust | 4 | ||
10.18 | Amended and Restated Operating Agreement dated as of May 17, 2002 by and between the Company and Teletouch Licenses, Inc., | 4 | ||
10.19 | Deed of Trust, Assignment of Rents, Security Agreement and Fixture Filing dated May 17, 2002 by and among the Company, David M. Ratchford, as Trustee, and ING Prime Rate Trust, as beneficiary | 4 | ||
10.20 | Subordination Agreement dated as of May 17, 2002 by and among TLL Partners and ING Prime Rate Trust | 4 |
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Exhibit No. | Description of Exhibit | Footnote | ||
10.21 | Pledge and Security Agreement dated May 17, 2002 by and among the Company, Teletouch Licenses, Inc. and ING Prime Rate Trust | 4 | ||
10.22 | Co-Sale Agreement dated as of May 17, 2002 by and between TLL Partners and GM Holdings | 4 | ||
10.23 | Termination Agreement dated May 17, 2002 by and among the Company, Continental Illinois Venture Corporation, CIVC Partners I, and certain other Investors and Other Stockholders | 4 | ||
10.24 | Amendment Agreement dated June 17, 2002 by and among the Company, TLL Partners and GM Holdings (amending the Restructuring Agreement dated as of May 17, 2002) | 5 | ||
10.25 | 1994 Stock Option and Appreciation Rights Plan | 6 | ||
10.26 | Asset Purchase Agreement between the Company and DCAE, Inc. | 7 | ||
10.27 | Asset Purchase Agreement between the Company and Glen Binion | 7 | ||
10.28 | Thomas A. Hyde, Jr. Employment Agreement | 8 | ||
10.29 | Asset Purchase Agreement between the Company and Teletouch Paging, LP | 9 | ||
14 | Code of Ethics | 10 | ||
21 | Subsidiaries of the Company | 10 | ||
31.1 | Certification pursuant to Rule 13a-14(a) and Rule 15d-14(a) | 10 | ||
31.2 | Certification pursuant to Rule 13a-14(a) and Rule 15d-14(a) | 10 | ||
32.1 | Certification pursuant to 1350, Chapter 63, Title 18 of the U.S. Code | 10 | ||
32.2 | Certification pursuant to 1350, Chapter 63, Title 18 of the U.S. Code | 10 |
Footnotes
* | Indicates a management contract or compensatory plan or arrangement. | |||
1 | Filed as an exhibit to the Company’s Current Report on Form 8-K filed on August 18, 1995 (File No. 1-13436) and incorporated herein by reference. | |||
2 | Filed as an exhibit to the Company’s Registration Statement on Form SB-2 (File No. 33-82912) and incorporated herein by reference. | |||
3 | Filed as an exhibit to the Company’s Form 10-Q for the quarter ended February 28, 2002 (File No. 1-13436) and incorporated herein by reference. | |||
4 | Filed as an exhibit to the Company’s Form 8-K filed with the Commission on June 3, 2002 (File No. 1-13436) and incorporated herein by reference. | |||
5 | Filed as an exhibit to the Company’s Form 8-K/A filed with the Commission on June 17, 2002 (File No. 1-13436) and incorporated herein by reference. | |||
6 | Filed as an exhibit to the Company’s Form S-8 registration statement (No. 333-108946) and incorporated herein by reference. | |||
7 | Filed as an exhibit to the Company’s Form 10-Q for the quarter ended February 28, 2004 (File No. 1-13436) and incorporated herein by reference. | |||
8 | Filed as an exhibit to the Company’s Form 8-K filed with the Commission on October 25, 2004 (File No. 1-13436) and incorporated herein by reference. | |||
9 | Filed as an exhibit to the Company’s Form 8-K filed with the Commission on August 22, 2005 (File No. 1-13436) and incorporated herein by reference. | |||
10 | Filed herewith. |
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Exhibit No. | Description of Exhibit | Footnote | ||
(b) | Reports on Form 8-K. | |||
Teletouch filed no reports on Form 8-K during the fourth quarter of Fiscal 2004 |
.
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Index to Consolidated Financial Statements
F-2 | ||
F-4 | ||
F-6 | ||
F-7 | ||
F-8 | ||
F-9 |
Table of Contents
Report of Independent Registered Public Accounting Firm – BDO Seidman, LLP
We have audited the accompanying consolidated balance sheet of Teletouch Communications, Inc. (“TLL” or “the Company”) as of May 31, 2004 and the related consolidated statements of operations, shareholders’ equity, and cash flows for the year then ended. Our audit also included the financial statement schedule for the year ended May 31, 2004 listed in the Index at Item 15(a)(2). These financial statements and schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedule based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (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 audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of the Company at May 31, 2004 and the results of its operations and its cash flows for the year then ended in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
/s/ BDO Seidman, LLP
Houston, Texas
August 6, 2004
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Report of Independent Registered Public Accounting Firm – Ernst & Young LLP
We have audited the accompanying consolidated balance sheet of Teletouch Communications, Inc. and subsidiaries as of May 31, 2003 and the related consolidated statements of operations, shareholders’ equity (deficit), and cash flows for the years ended May 31, 2003 and May 31, 2002. Our audits also included the financial statement schedule listed in the Index at Item 15(a)(2) for the years ended May 31, 2003 and May 31, 2002. These financial statements and schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (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 consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Teletouch Communications, Inc. and subsidiaries at May 31, 2003 and the consolidated results of their operations and their cash flows for the years ended May 31, 2003 and May 31, 2002, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
The accompanying consolidated financial statements, as of May 31, 2003 and for the years ended May 31, 2003 and 2002 have been restated, as discussed in paragraphs two through eight of Note A.
/s/ Ernst & Young LLP
Dallas, Texas
August 15, 2003, except for the matters discussed in paragraphs two through eight of Note A, as to which the date is October 14, 2005
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TELETOUCH COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
ASSETS
May 31 | ||||||||
2004 | 2003 | |||||||
(Restated) | ||||||||
CURRENT ASSETS: | ||||||||
Cash and cash equivalents | $ | 72 | $ | 688 | ||||
Accounts receivable, net of allowance of $180 in fiscal 2004 and $150 in fiscal 2003 | 1,585 | 1,381 | ||||||
Accounts receivable – related party | 5 | 68 | ||||||
Inventories, net of reserve of $421 in fiscal 2004 and $215 in fiscal 2003 | 2,273 | 2,441 | ||||||
Deferred income tax assets | 174 | 191 | ||||||
Note receivable | 256 | — | ||||||
Certificates of deposit, restricted as to use | — | 10 | ||||||
Prepaid expenses and other current assets | 402 | 417 | ||||||
Property held for sale | — | 46 | ||||||
Total current assets | 4,767 | 5,242 | ||||||
PROPERTY, PLANT AND EQUIPMENT, net of accumulated depreciation of $14,976 in fiscal 2004 and $13,803 in fiscal 2003 | 8,622 | 10,846 | ||||||
INTANGIBLES AND OTHER ASSETS: | ||||||||
Goodwill | 883 | — | ||||||
Subscriber bases | 225 | 77 | ||||||
FCC licenses | 103 | — | ||||||
Non-compete agreements | 95 | — | ||||||
Internally-developed software | 185 | — | ||||||
Accumulated amortization | (176 | ) | (75 | ) | ||||
Total intangible assets | 1,315 | 2 | ||||||
TOTAL ASSETS | $ | 14,704 | $ | 16,090 | ||||
See Accompanying Notes to Consolidated Financial Statements
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TELETOUCH COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
LIABILITIES AND SHAREHOLDERS’ EQUITY
May 31 | ||||||||
2004 | 2003 | |||||||
(Restated) | ||||||||
LIABILITIES AND SHAREHOLDERS’ EQUITY | ||||||||
CURRENT LIABILITIES: | ||||||||
Accounts payable and accrued expenses | $ | 2,859 | $ | 3,365 | ||||
Accounts payable – related party | 5 | 159 | ||||||
Short-term debt | — | 109 | ||||||
Current portion of long-term debt | 45 | — | ||||||
Current portion of redeemable common stock payable | 280 | — | ||||||
Current portion of unearned sale/leaseback profit | 418 | 418 | ||||||
Deferred revenue | 678 | 726 | ||||||
Total current liabilities | 4,285 | 4,777 | ||||||
LONG-TERM LIABILITIES: | ||||||||
Long-term debt, net of current portion | 448 | 760 | ||||||
Redeemable common stock purchase warrants | 1,757 | 1,470 | ||||||
Redeemable common stock payable, net of current portion | 326 | — | ||||||
Unearned sale/leaseback profit, net of current portion | 1,064 | 1,487 | ||||||
Deferred income taxes | 22 | 343 | ||||||
Total long-term liabilities | 3,617 | 4,060 | ||||||
TOTAL LIABILITIES | 7,902 | 8,837 | ||||||
COMMITMENTS AND CONTINGENCIES | — | — | ||||||
SHAREHOLDERS’ EQUITY : | ||||||||
Series A cumulative convertible preferred stock, $.001 par value, 15,000 shares authorized and 0 shares issued and outstanding in fiscal 2004 and fiscal 2003 | — | — | ||||||
Series B convertible preferred stock, $.001 par value, 411,457 shares authorized 0 shares issued and outstanding in fiscal 2004 and fiscal 2003 | — | — | ||||||
Series C convertible preferred stock, $.001 par value, 1,000,000 shares authorized, 1,000,000 issued and outstanding in fiscal 2004 and fiscal 2003 | 1 | 1 | ||||||
Common stock, $.001 par value, 70,000,000 shares authorized and 4,976,189 shares issued in fiscal 2004 and fiscal 2003 | 5 | 5 | ||||||
Treasury Stock, 429,209 shares held in fiscal 2004 and fiscal 2003 | (185 | ) | (185 | ) | ||||
Additional paid-in capital | 31,968 | 31,900 | ||||||
Accumulated deficit | (24,987 | ) | (24,468 | ) | ||||
Total shareholders’ equity | 6,802 | 7,253 | ||||||
$ | 14,704 | $ | 16,090 | |||||
See Accompanying Notes to Consolidated Financial Statements
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TELETOUCH COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except shares and per share amounts)
Year ended May 31, | ||||||||||||
2004 | 2003 | 2002 | ||||||||||
(Restated) | (Restated) | |||||||||||
Operating revenues: | ||||||||||||
Service, rent, and maintenance revenue | $ | 23,192 | $ | 27,929 | $ | 34,335 | ||||||
Product sales revenue | 3,562 | 6,893 | 12,234 | |||||||||
Total operating revenues | 26,754 | 34,822 | 46,569 | |||||||||
Operating expenses: | ||||||||||||
Cost of services (exclusive of depreciation and amortization included below) | 11,025 | 14,460 | 15,086 | |||||||||
Cost of products sold | 3,184 | 5,315 | 8,539 | |||||||||
Selling and general and administrative | 8,613 | 11,007 | 15,177 | |||||||||
Depreciation and amortization | 3,726 | 4,665 | 6,338 | |||||||||
Loss on disposal of assets | 372 | 253 | 109 | |||||||||
Write-off of equipment | — | 810 | — | |||||||||
Total operating expenses | 26,920 | 36,510 | 45,249 | |||||||||
Operating income (loss) | (166 | ) | (1,688 | ) | 1,320 | |||||||
Gain on extinguishment of debt | — | 510 | 64,505 | |||||||||
Gain on litigation settlement | — | 429 | — | |||||||||
Interest expense, net | (357 | ) | (384 | ) | (7,412 | ) | ||||||
Income (loss) before income taxes (benefit) and extraordinary item | (523 | ) | (1,133 | ) | 58,413 | |||||||
Income tax expense (benefit) | 60 | (372 | ) | — | ||||||||
Income (loss) before extraordinary item | (583 | ) | (761 | ) | 58,413 | |||||||
Extraordinary item – Gain derived from negative goodwill on purchase of certain assets, net of income tax | 64 | — | — | |||||||||
Net income (loss) | (519 | ) | (761 | ) | 58,413 | |||||||
Gain on preferred stock transaction | — | 28,778 | — | |||||||||
Participation rights of Series C Preferred Stock in undistributed earnings | — | (23,580 | ) | — | ||||||||
Preferred stock dividends | — | — | (4,789 | ) | ||||||||
Net income (loss) applicable to common shareholders | $ | (519 | ) | $ | 4,437 | $ | 53,624 | |||||
Earnings (loss) per common share – basic: | ||||||||||||
Earnings (loss) applicable to common shareholders before extraordinary item | $ | (0.12 | ) | $ | 0.96 | $ | 11.09 | |||||
Extraordinary item | $ | 0.01 | $ | — | $ | — | ||||||
Earnings (loss) applicable to common shareholders | $ | (0.11 | ) | $ | 0.96 | $ | 11.09 | |||||
Earnings (loss) per common share – diluted: | ||||||||||||
Earnings (loss) applicable to common shareholders before extraordinary item | $ | (0.12 | ) | $ | 0.30 | $ | 0.59 | |||||
Extraordinary item | $ | 0.01 | $ | — | $ | — | ||||||
Earnings (loss) applicable to common shareholders | $ | (0.11 | ) | $ | 0.30 | $ | 0.59 | |||||
Weighted average common shares outstanding-basic | 4,546,980 | 4,644,978 | 4,834,255 | |||||||||
Weighted average common shares outstanding-diluted | 4,546,980 | 92,053,503 | 98,893,353 | |||||||||
See Accompanying Notes to Consolidated Financial Statements
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TELETOUCH COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
Year Ended May 31, | ||||||||||||
2004 | 2003 | 2002 | ||||||||||
(Restated) | ||||||||||||
Operating Activities: | ||||||||||||
Net income (loss) | $ | (519 | ) | $ | (761 | ) | $ | 58,413 | ||||
Adjustments to reconcile net income (loss) to net cash provided by operating activities: | ||||||||||||
Depreciation and amortization | 3,726 | 4,665 | 6,338 | |||||||||
Gain on extinguishment of debt | — | (510 | ) | (64,505 | ) | |||||||
Non-cash compensation expense | 68 | 11 | 31 | |||||||||
Non-cash interest expense | 287 | 125 | 6,999 | |||||||||
Extraordinary income | (64 | ) | — | — | ||||||||
Write-down – assets held for sale | — | 1,460 | — | |||||||||
Provision for losses on accounts receivable | 182 | 400 | 843 | |||||||||
Loss on disposal of assets | 372 | 253 | 229 | |||||||||
Write-off of equipment | — | 810 | — | |||||||||
Amortization of unearned sale/leaseback profit | (423 | ) | (420 | ) | (420 | ) | ||||||
Deferred income taxes | (305 | ) | (834 | ) | — | |||||||
Changes in operating assets and liabilities, net of acquisitions: | ||||||||||||
Accounts receivable, net | (29 | ) | 493 | (833 | ) | |||||||
Inventories | 976 | 2,382 | 1,431 | |||||||||
Prepaid expenses and other assets | 146 | (4 | ) | 99 | ||||||||
Accounts payable and accrued expenses | (804 | ) | (1,206 | ) | 1,700 | |||||||
Deferred revenue | (48 | ) | (211 | ) | (375 | ) | ||||||
Net cash provided by operating activities | 3,565 | 6,653 | 9,950 | |||||||||
Investing Activities: | ||||||||||||
Capital expenditures, including pagers | (2,326 | ) | (3,563 | ) | (4,258 | ) | ||||||
Intangible assets | (220 | ) | — | — | ||||||||
(Purchase) Redemption of certificates of deposit | 10 | (10 | ) | 101 | ||||||||
Acquisitions, net of cash acquired | (1,019 | ) | — | (57 | ) | |||||||
Net proceeds from sale of assets | 66 | 59 | 25 | |||||||||
Note receivable | (256 | ) | — | — | ||||||||
Net cash used for investing activities | (3,745 | ) | (3,514 | ) | (4,189 | ) | ||||||
Financing Activities: | ||||||||||||
Increase in short-term debt, net | (109 | ) | (1,633 | ) | (713 | ) | ||||||
Purchase of treasury stock | — | — | (35 | ) | ||||||||
Proceeds from borrowings | 117 | 310 | 2,801 | |||||||||
Payments on long-term debt | (444 | ) | (2,600 | ) | — | |||||||
Debt extinguishment costs | — | — | (10,341 | ) | ||||||||
Net cash used for financing activities | (436 | ) | (3,923 | ) | (8,288 | ) | ||||||
Net decrease in cash and cash equivalents | (616 | ) | (784 | ) | (2,527 | ) | ||||||
Cash and cash equivalents at beginning of period | 688 | 1,472 | 3,999 | |||||||||
Cash and cash equivalents at end of period | $ | 72 | $ | 688 | $ | 1,472 | ||||||
Supplemental Cash Flow Data: | ||||||||||||
Interest paid | $ | 90 | $ | 269 | $ | 284 | ||||||
Income taxes paid | $ | 870 | $ | — | $ | — | ||||||
See Accompanying Notes to Consolidated Financial Statements
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TELETOUCH COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
(In Thousands Except Number of Shares)
Preferred Stock | Common Stock | Additional Paid-In Capital | Treasury Stock | Accumulated Earnings (Deficit) | ||||||||||||||||||||||||||||||||
Series A | Series B | Series C | ||||||||||||||||||||||||||||||||||
Shares | Amount | Shares | Amount | Shares | Amount | Shares | Amount | Shares | Amount | |||||||||||||||||||||||||||
(Restated) | (Restated) | |||||||||||||||||||||||||||||||||||
Balance at May 31, 2001 | 15,000 | $ | — | 86,025 | $ | — | — | $ | — | 4,926,210 | $ | 5 | $ | 26,363 | 49,400 | $ | (62 | ) | $ | (82,120 | ) | |||||||||||||||
Net income | — | — | — | — | — | — | — | — | — | — | — | 58,413 | ||||||||||||||||||||||||
Securities to be issued upon concurring shareholder vote | — | — | — | — | — | — | — | — | 6,706 | — | — | — | ||||||||||||||||||||||||
Compensation earned under employee stock option plan | — | — | — | — | — | — | — | — | 31 | — | — | — | ||||||||||||||||||||||||
Other | — | — | (631 | ) | — | — | — | — | — | — | — | — | — | |||||||||||||||||||||||
Purchase of Treasury Stock | — | — | — | — | — | — | — | — | — | 84,160 | (35 | ) | — | |||||||||||||||||||||||
Restated Balance at May 31, 2002 | 15,000 | $ | — | 85,394 | $ | — | — | $ | — | 4,926,210 | $ | 5 | $ | 33,100 | 133,560 | $ | (97 | ) | $ | (23,707 | ) | |||||||||||||||
Net loss | — | — | — | — | — | — | — | — | — | — | — | (761 | ) | |||||||||||||||||||||||
Stock issuance and retirement related to debt and equity restructure in May 2002 and approved by Shareholders in November 2002 | (15,000 | ) | — | (85,394 | ) | — | 1,000,000 | $ | 1 | — | — | (1,248 | ) | 295,649 | (88 | ) | — | |||||||||||||||||||
Compensation earned under employee stock option plan | — | — | — | — | — | — | — | — | 11 | — | — | — | ||||||||||||||||||||||||
Exercise of warrants | — | — | — | — | — | — | 49,979 | — | 37 | — | — | — | ||||||||||||||||||||||||
Balance at May 31, 2003 | — | $ | — | — | $ | — | 1,000,000 | $ | 1 | 4,976,189 | $ | 5 | $ | 31,900 | 429,209 | $ | (185 | ) | $ | (24,468 | ) | |||||||||||||||
Net loss | — | — | — | — | — | — | — | — | — | — | — | (519 | ) | |||||||||||||||||||||||
Compensation earned under employee stock option plan | — | — | — | — | — | — | — | — | 68 | — | — | — | ||||||||||||||||||||||||
Balance at May 31, 2004 | — | $ | — | — | $ | — | 1,000,000 | $ | 1 | 4,976,189 | $ | 5 | $ | 31,968 | 429,209 | $ | (185 | ) | $ | (24,987 | ) |
See Accompanying Notes to Consolidated Financial Statements
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TELETOUCH COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE A – BASIS OF PRESENTATION
Organization: Teletouch is a leading provider of telecommunications services, primarily paging services, in non-major metropolitan areas and communities in the Southeast United States. Currently the Company provides paging services in Alabama, Arkansas, Georgia, Louisiana, Mississippi, Missouri, Oklahoma, Texas, Tennessee and Florida. The Company provides telemetry services nationally through agreements with various satellite and cellular providers. The Company has 20 service centers and 6 two-way radio shops in those states. Through inter-carrier arrangements, Teletouch also provides nationwide and expanded regional coverage. The Company has no foreign operations.
Restatement of Previously Issued 2002 and 2003 Consolidated Financial Statements:The Company has restated its consolidated statement of operations, statement of shareholders’ equity and statement of cash flows for the year ended May 31, 2002 and has restated its consolidated balance sheet and statement of operations for the year ended May 31, 2003 presented in this Amendment No. 2 on Form 10-K/A (the 2004 Form 10-K/A) to its Annual Report on Form 10-K for the year ended May 31, 2004 (the 2004 Form 10-K) which was originally filed on September 1, 2004, to reflect the results of a normal periodic review of its financial reports by the staff of the Division of Corporation Finance (the Staff) of the Securities and Exchange Commission (the SEC) and the resulting discussions with the staff.
In the 2004 Form 10-K, the fiscal 2002 and 2003 financial statements were reported as previously filed. The fiscal 2002 and 2003 financial statements included the accounting for the Company’s May 2002 extinguishment of certain junior debt (the “May 2002 Exchange Transaction”) and its November 2002 exchange of Series C Preferred Stock and redeemable common stock purchase warrants for its Series A and Series B Preferred Stock, warrants for the purchase of shares of Series B Preferred Stock, common stock warrants and shares of its common stock (the “November 2002 Exchange Transaction”). The SEC staff initiated discussions with the Company about the Company’s accounting for the two Exchange Transactions which included discussions concerning the method used to value the shares of the Series C Preferred Stock issued and whether or not the Series C Preferred Stock contained a “beneficial conversion feature” which should be accounted for under Emerging Issues Task Force Issue No. (EITF) 98-5 and EITF 00-27. The accounting under EITF 98-5 and EITF 00-27 would have required an amount to be recorded as period dividends on the Series C Preferred Stock.
In the May 2002 Exchange Transaction the Company retired certain junior debt, and later, after receiving shareholder approval in November 2002 and in conjunction with the November 2002 Exchange Transaction, issued to the holders of that debt shares of its Series C Preferred Stock and redeemable stock purchase warrants in exchange for outstanding shares of its Series A and Series B Preferred Stock, warrants for the purchase of shares of Series B Preferred Stock, common stock warrants and shares of its common stock (the Exchanged Securities). The holders of the Exchanged Securities included an entity affiliated with the Company’s Chairman of the Board, Robert M. McMurrey. In its original accounting for the two transactions, the Company based the value of the Series C Preferred Stock, which reflected a $.04 per share value for the
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Common Stock (44,000,000 shares in the aggregate) into which the Series C Preferred Stock was convertible, on the present value methodology used by Hoak Breedlove Wesneski & Co (“HBW”), an independent third party, which had been retained by the Company to issue a fairness opinion related to the Exchange Transactions. The Company used this valuation to record the securities issued and apportioned the value of the securities which it issued between the May 2002 Exchange Transaction and the November 2002 Exchange Transaction.
Based upon its evaluation and response to the Staff’s comments the Company has concluded that the shares of the Series C Preferred Stock issued in the May 2002 and November 2002 Exchange Transactions should have been valued based on the market value of the underlying 44,000,000 share of common stock into which the Series C Preferred Stock could be converted, which was $0.33 per share when the Series C Preferred Stock was issued in November, 2002, rather than the present value methodology originally used. In addition, the Company has concluded that the change in the value assigned to the Series C Preferred Stock would mean that it does not contain a beneficial conversion feature as defined in EITF 98-5 and EITF 00-27. This change in the valuation of the shares of the Series C Preferred Stock and the restatement of the Company’s 2002 and 2003 consolidated financial statements changes the following items:
• | reduce by $5.1 million, to $64.5 million from $69.6 million, the gain on the May 2002 Exchange Transaction thereby reducing net income applicable to common shareholders of $58.7 million or $12.14 and $0.64 per share basic and diluted, respectively, to $53.6 million or $11.09 and $0.59 per share basic and diluted, respectively, for the year ended May 31, 2002; and |
• | reduce, by $7.6 million to $28.8 million from $36.4 million, the gain from the November 2002 Exchange Transaction thereby reducing net income applicable to common shareholders of $35.6 million or $1.21 and $0.39 per share basic and diluted, respectively, to $28.0 million which was further reduced by $23.6 million to $4.4 million as a result of allocating the undistributed earnings to the Series C Preferred Stock or $0.96 and $0.30 per share basic and diluted, respectively, for the year ended May 31, 2003. |
The reduction in net income applicable to common shareholders in the second quarter of fiscal 2003 by the rights of the Series C Preferred Stock to participate in earnings resulted from the Company calculating and presenting earnings per share (“EPS”) using the two-class method as illustrated in EITF 03-06. This change in method of computing EPS was recommended by the staff at the SEC but because Company has never declared or paid dividends on its common stock and because the Series C Preferred Stock participates in dividends on a pro rata basis with the common stock, the two-class method of computing EPS results in the same EPS as would be mathematically arrived at using the alternative “if-converted” method of computing EPS.
Total shareholders’ equity is not affected, although there is a change in the components of shareholders’ equity. The specific change is:
• | The reduction in the gain from the May 2002 Exchange Transaction increases the Company’s accumulated deficit by $5.1 million with an offsetting increase of the amount recorded for the outstanding Series C preferred Stock, |
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This 2004 Form 10-K/ A does not reflect events occurring after September 1, 2004, the date of the original filing of our 2004 Form 10-K, or modify or update those disclosures that may have been affected by subsequent events.
The effect of the restatement on the amounts previously reported in the Company’s 2002 consolidated financial statements included in the Form 10-K are as follows (in thousands except for per share data):
2002 | ||||||||
As Previously Reported | As Restated | |||||||
INCOME STATEMENT DATA: | ||||||||
Gain on extinguishment of debt | $ | 69,571 | $ | 64,505 | ||||
Net income | 63,479 | 58,413 | ||||||
Net income applicable to common shareholders | 58,690 | 53,624 | ||||||
Earnings per share – basic | $ | 12.14 | $ | 11.09 | ||||
Earnings per share – diluted | $ | 0.64 | $ | 0.59 | ||||
CASH FLOWS DATA | ||||||||
Net income | $ | 63,479 | $ | 58,413 | ||||
Gain on extinguishment of debt | (69,571 | ) | (64,505 | ) | ||||
Net cash provided by operating activities | $ | 9,950 | $ | 9,950 |
The effect of the restatement on the amounts previously reported in the Company’s 2003 consolidated financial statements included in the Form 10-K are as follows (in thousands except for per share data):
2003 | ||||||||
As Previously Reported | As Restated | |||||||
BALANCE SHEET DATA: | ||||||||
Additional paid-in capital | $ | 26,834 | $ | 31,900 | ||||
Accumulated deficit | (19,402 | ) | (24,468 | ) | ||||
Total shareholders equity | $ | 7,253 | $ | 7,253 | ||||
INCOME STATEMENT DATA: | ||||||||
Gain on preferred stock transaction | $ | 36,377 | $ | 28,778 | ||||
Net income applicable to common shareholders | 35,616 | 4,437 | ||||||
Earnings per share - basic | $ | 1.21 | $ | 0.96 | ||||
Earnings per share - diluted | $ | 0.39 | $ | 0.30 |
Principles of Consolidation:The consolidated financial statements include the accounts of Teletouch Communications, Inc. and its wholly-owned subsidiaries (together, “Teletouch” or the “Company”).
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Teletouch Communications, Inc. owns all of the shares of Teletouch Licenses, Inc., Visao Systems, Inc. and TLL Georgia, Inc.. Teletouch Licenses, Inc. is a company formed for the express purpose of owning all of the FCC licenses utilized by Teletouch in its paging network. Visao Systems, Inc. is a company formed to develop and distribute the Company’s telemetry products. TLL Georgia, Inc. was formed for the express purpose of entering into an asset purchase agreement with Preferred Networks, Inc. in May 2004 (see Note Q). All significant intercompany accounts and transactions have been eliminated in consolidation.
Use of Estimates:Preparing financial statements in conformity with generally accepted accounting principles (“GAAP”) requires management to make estimates and assumptions. Those assumptions affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Reclassifications:Certain reclassifications were made to the prior period financial statements to conform to the current period financial statement presentation.
The Company issued 1,000,000 shares of Series C Preferred Stock and 6,000,000 warrants to purchase common stock in November 2002 as an exchange for the outstanding Series A and B Preferred Stock. The Series A and B Preferred Stock was convertible into approximately 125,358,776 shares of common stock at the exchange date. The Series C Preferred Stock is convertible into 44,000,000 shares. The issuance of the Series C Preferred Stock was to TLL Partners, a related entity. The Company recorded a gain on the retirement of its Series A and B Preferred Stock of $28,778,000 for common stock holders in accordance with the EITF Topic D-42. The Series C Preferred stock was included in the dilutive earnings per share calculation in 2003. Per the Series C Preferred Stock agreement the holders have the right to participate with common shareholders on an as-if converted basis. As such, the Company should have allocated its undistributed earnings to the Series C Preferred Stock in the basic earnings per share calculation for 2003 in accordance with EITF 03-06. The effect of this change reduced basic earnings per share from $7.67 to $1.21 for the year ended May 31, 2003. As a result of the Company’s restatement of it’s May 31, 2003 consolidated financial statements, due to a $5.1 million reduction in gain on preferred stock transaction, basic earnings per share was reduced from $1.21 to $0.96.
These reclassifications did not have an impact on the Company’s previously reported financial position or net income (loss) applicable to common shareholders.
NOTE B – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Cash Equivalents: Cash equivalents are recorded at cost, which approximates market, and include investments in financial instruments with maturities of three months or less at the time of purchase.
Allowance for Doubtful Accounts: Estimates are used in determining the allowance for doubtful accounts and are based on historic collection experience, current trends and a percentage of the accounts receivable aging categories. In determining these percentages Teletouch reviews historical write-offs, including comparisons of write-offs to provisions for doubtful accounts and as a percentage of revenues; Teletouch compares the ratio of the allowance for doubtful accounts to gross receivables to historic levels and
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Teletouch monitors collections amounts and statistics. Teletouch’s allowance for doubtful accounts was $180,000 at May 31, 2004 and $150,000 at May 31, 2003. Based on the information available to the Company, management believes the allowance for doubtful accounts as of May 31, 2004 and 2003 were adequate. However, actual write-offs might exceed the recorded allowance.
Inventories:The Company’s inventories consist primarily of pagers, telemetry equipment, two-way radios, accessories, and spare parts held for sale or lease. Inventories are carried at the lower of cost or market using the weighted-average first-in, first-out method. A substantial portion of the Company’s pager inventory is leased in connection with term service contracts. All sold and leased pager inventory is transferred to fixed assets and depreciated using a three-year useful life. Leased pagers returned after the termination of the service contracts are valued at the lower of net depreciable cost or market and transferred to “used inventory”. Reserves for inventory obsolescence are computed using estimates that are based on sales trends, a ratio of inventory to sales, and a review of specific categories of inventory. In establishing its reserve, Teletouch reviews historic inventory obsolescence experience including comparisons of previous write-offs to provision for inventory obsolescence and the inventory count compared to recent sales trends. Prior to fiscal 2004, inventory obsolescence has been within our expectations and the provision established. During fiscal 2004, the Company recorded additional reserves for inventory obsolescence to recognize the deterioration in the market value of certain pager, cellular and electronics and telemetry inventory. Pager inventory was impaired primarily due to a decline in market value of certain damaged pagers that are repaired by the Company. Cellular and electronic inventory became impaired after many months of attempting to sell off this excess equipment and the Company recorded a reserve equaling the total value of this inventory. Certain telemetry inventory, primarily related to the Company’s fixed monitoring product line, was impaired subsequent to the Company exiting this business line. Teletouch management cannot guarantee that the Company will continue to experience the same obsolescence rates that it has in the past which could result in material differences in the reserve for inventory obsolescence and the related inventory write-offs. The reserve for inventory obsolescence was $420,500 at May 31, 2004 and $214,500 at May 31, 2003.
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Property, Plant and Equipment:Property, plant and equipment is recorded at cost. Depreciation is computed using the straight-line method for financial reporting purposes and accelerated methods for tax purposes over their useful lives. The straight-line method estimated useful lives are as follows:
Pagers | 3 years | |
Paging infrastructure | 5-15 years | |
Building and improvements | 10-20 years | |
Other equipment | 5-10 years | |
Leasehold improvements | Shorter of estimated useful life or term of lease |
During the second quarter of fiscal 2003, the Company completed verification procedures of its property, plant and equipment. As a result of the procedures performed, certain paging infrastructure equipment was not identified. The Company believes that a significant amount of the equipment not identified was attributable to ongoing significant repair and upgrades of its network performed on its paging infrastructure over the seven years prior to the verification without always accurately accounting for the replacement or removal of capitalizable infrastructure equipment. During these prior periods, the removal of certain equipment during the maintenance process was not recorded. Due to the seven year time period over which this activity likely took place it was impractical for the Company to accurately attribute this loss to the period in which it occurred, therefore, the Company recorded a charge of approximately $810,000 during the second quarter of fiscal 2003 to write off the remaining carrying value of this equipment. The Company believes that the amount of the loss attributable to any prior year is not significant to any prior annual operating results or financial position.
Intangible Assets:Intangible assets are recorded at cost. Amortization is computed using the straight-line method based on the following estimated useful lives:
Goodwill | — | |
Subscriber bases | 1-5 years | |
FCC licenses | 9 years | |
Non-competition agreements | 5 years | |
Internally-developed software | 3 years |
The Company adopted the provisions of Statement of Financial Accounting Standards (SFAS) No. 142 – “Goodwill and Other Intangible Assets” during the year ended May 31, 2003 and, accordingly, no longer amortizes goodwill. Instead the Company makes periodic assessments for impairment of its goodwill pursuant to the provisions of SFAS No. 142 as described below.
During May 2004, the Company purchased the assets of Preferred Networks, Inc. for a total purchase price of $257,000 (see Note Q). In recording the purchase transaction, the valuation of the current assets and assets held for sale acquired in this transaction exceeded the purchase price by approximately $64,000. In accordance with Statement of Financial Accounting Standards No. 141 (“SFAS 141”), “Business Combinations”, the gain recognized on this transaction has been reported separately on the Consolidated Statement of Operations as extraordinary income during fiscal 2004.
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Impairment of Long-lived Assets: In accordance with Statement of Financial Accounting Standards (“SFAS”) No. 144 – “Accounting for the Impairment or Disposal of Long-Lived Assets” Teletouch evaluates the recoverability of the carrying value of its long-lived assets based on estimated undiscounted cash flows to be generated from such assets. In assessing the recoverability of these assets, Teletouch must project estimated cash flows which are based on various operating assumptions such as average revenue per unit in service, disconnect rates, sales productivity ratios and expenses. Management develops these cash flow projections on a periodic basis and reviews the projections based on actual operating trends. The projections assume that general economic conditions will continue unchanged throughout the projection period and that their potential impact on capital spending and revenues will not fluctuate. Projected revenues are based on the Company’s estimate of units in service and average revenue per unit, as well as revenue from various new product initiatives. Projected revenues assume a continued decline in traditional messaging units in service throughout the projection period, which is partially offset by growth of advanced messaging units in service and revenue from the new product initiatives. Projected operating expenses are based upon historic experience and expected market conditions adjusted to reflect an expected decrease in expenses resulting from cost saving initiatives. During the second quarter of fiscal 2003, the Company restructured its operations and exited its retail distribution channel by closing all but 2 of its retail locations. The Company restructured the operations of 22 other retail stores to serve as service centers to provide customer service to its existing customer base. As a result of the closure of its retail stores, the Company identified excess furniture and fixtures and computer equipment used previously in its retail business, classified these excess assets as Assets Held for Sale and recorded a charge to reduce the carrying value of these assets to their estimated recoverable value less any anticipated disposition costs. In the second quarter of fiscal 2003, the Company reduced the carrying value of these assets classified as Assets Held for Sale from $1.7 million to $0.2 million by recording a charge of $1.5 million to restructuring expense which is a component of operating expenses in the Company’s consolidated statement of operations. At May 31, 2004, all such Assets Held for Sale had been disposed of by the Company.
Teletouch’s review of the carrying value of its long-lived assets at May 31, 2004 indicates that the carrying value of these assets is recoverable through future estimated cash flows. If the cash flow estimates, or the significant operating assumptions upon which they are based, change in the future, Teletouch may be required to record additional impairment charges related to its long-lived assets.
Revenue Recognition:Teletouch’s revenue consists primarily of monthly service and lease revenues charged to customers on a monthly, quarterly, semi-annual or annual basis. Deferred revenue represents prepaid monthly service fees paid by customers. Revenue also includes sales of messaging devices, cellular telephones, and other products directly to customers and resellers. Teletouch recognizes revenue over the period the service is performed in accordance with SEC Staff Accounting Bulletin No. 104, “Revenue Recognition in Financial Statements” (SAB 104). SAB 104 requires that four basic criteria must be met before revenue can be recognized: (1) persuasive evidence of an arrangement exists, (2) delivery has occurred or services rendered, (3) the fee is fixed and determinable, and (4) collectibility is reasonably assured. Teletouch believes, relative to sales of one-way messaging equipment, that all of these conditions are met, therefore, product revenue is recognized at the time of delivery. Revenue from sales of other products is recognized upon delivery.
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Advertising Costs:All costs related to advertising activities begun during the fiscal year are expensed when incurred. Advertising costs were $0.3 million, $0.4 million, and $1.6 million in fiscal 2004, 2003, and 2002, respectively.
Stock-based Compensation:SFAS No. 123, “Accounting for Stock-Based Compensation”, as amended by SFAS No. 148, “Accounting for Stock-Based Compensation-Transition and Disclosure”, provides companies with a choice to follow the provisions of SFAS No. 123 in determination of stock-based compensation expense under the alternative fair value accounting or to continue with the provisions of APB No. 25, “Accounting for Stock Issued to Employees” and related interpretations in accounting for stock-compensation plans. The Company has elected to follow the provisions of APB No. 25 under which no compensation expense is recognized if the exercise price of the Company’s stock options equals or exceeds the market price of the underlying Common Stock on the date of grant, generally no compensation expense is recognized. The Company recognized compensation expense of $68,000, $11,000 and $31,000 in 2004, 2003 and 2002, respectively, related to the repricing of its outstanding stock options during fiscal 2000. During fiscal year 2004 there were no material option grants made by the Company.
Pro forma information regarding net income (loss) and earnings (loss) per share is required by SFAS No. 123, which also requires that the information be determined as if the Company has accounted for its stock options granted under the fair value method of that Statement. The fair value for these options was estimated at the date of grant using a binomial option pricing model with the following weighted-average assumptions for 2003 and 2002, respectively: risk-free interest rates of 2.00% and 3.70%; dividend yields of 0% for both years; volatility factors of the expected market price of the Company’s common stock of 1.59 in 2003 and 1.31 in 2002, and a weighted-average expected life of the option of 2 to 5 years. As there were only an insignificant amount of stock options granted during fiscal 2004, all of which were issued at the market price on the date of the grant, the Company has not included these grants in its pro forma compensation expense calculations for fiscal 2004.
The binomial option valuation model used was developed for use in estimating the fair value of traded options which have no vesting restriction and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. The Company’s stock options have characteristics significantly different from those of traded options. Further, changes in the subjective input assumptions related to the options can materially affect the fair value estimate. Therefore, in management’s opinion the existing models do not necessarily provide a reliable single measure of the fair value of the Company’s stock options.
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For purposes of pro forma disclosures, the estimated fair value of stock options is amortized to expense over the options’ vesting period. Therefore, future pro forma compensation expense may be greater as additional options are granted. The Company’s pro forma information follows:
2004 | 2003 | 2002 | |||||||||
Net income (loss) applicable to common shareholders | $ | (519 | ) | $ | 4,437 | $ | 53,624 | ||||
Plus stock-based employee compensation expense included in reported net income (loss), net of related tax effects | 45 | 7 | 31 | ||||||||
Less total stock-based employee compensation determined under fair-value-based method, net of related tax effects | (27 | ) | (41 | ) | 95 | ||||||
Pro forma net income (loss) | $ | (501 | ) | $ | 4,403 | $ | 53,750 | ||||
Pro forma earnings (loss) per share: | |||||||||||
Basic | $ | (0.11 | ) | $ | 0.95 | $ | 11.12 | ||||
Diluted | $ | (0.11 | ) | $ | 0.30 | $ | 0.59 | ||||
Net Income (Loss) Per Common Share: Basic net income (loss) per common share for common stock is computed by dividing net income (loss) available to common shareholders by the weighted-average number of common shares outstanding. The Company also has outstanding Series C convertible participating preferred stock (the Series C preferred stock participates in all undistributed earnings with the common stock). The Company allocates earnings to the common shareholders under the two-class method as required by EITF 03-6, “Participating Securities and the Two-Class Method under FASB Statement No. 128.” The two-class method is an earnings allocation method under which basic net income per share is calculated for the Company’s common stock and its Series C convertible participating preferred stock considering participation rights in undistributed earnings as if all such earnings had been distributed during the year. Since the Company’s Series C convertible participating preferred stock is not contractually responsible to share in the Company’s losses, in applying the two-class method to compute basic net income per common share, no allocation is made to the Series C preferred stock if there is an undistributed net loss.
Diluted net income (loss) per common share is computed by dividing net income (loss) including the gain on preferred stock transaction by the sum of the weighted-average number of common shares and dilutive common share equivalents then outstanding using the treasury stock method and the assumed conversion of the Series A and Series B convertible preferred stock and the Series C convertible participating preferred stock to common shares (if-converted method).
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If the above calculations result in a net loss available to the common shareholders (due to a net loss for the period or the effect of accrued preferred stock dividends) and if the effect of including common shares equivalents and the assumed conversion of preferred stock, or use of the two-class method, is anti-dilutive, then diluted net loss per common share will equal basic net loss per common share.
Basic and diluted net income (loss) per common share for the years ended May 31, 2004, 2003 and 2002 are calculated as follows (in thousands except per share amounts):
2004 | 2003 | 2002 | ||||||||||
Numerator: | ||||||||||||
Net income (loss) | $ | (519 | ) | $ | (761 | ) | $ | 58,413 | ||||
Preferred stock dividends | — | — | (4,789 | ) | ||||||||
Gain on preferred stock transaction | — | 28,778 | — | |||||||||
Undistributed earnings | (519 | ) | 28,017 | 53,624 | ||||||||
Participation rights of preferred stock in undistributed earnings (see percentage calculation below) | — | (23,580 | ) | — | ||||||||
Numerator for basic net income (loss) per common share – income (loss) available to common shareholders under the two-class method | (519 | ) | 4,437 | 53,624 | ||||||||
Preferred stock dividends and participation rights of preferred stock | — | 23,580 | 4,789 | |||||||||
Numerator for diluted net income (loss) per common share - income (loss) available to common shareholders after assumed conversion of preferred stock | $ | (519 | ) | $ | 28,017 | $ | 58,413 | |||||
Denominator: | ||||||||||||
Denominator for basic net income (loss) per common share - weighted-average shares | 4,547 | 4,645 | 4,835 | |||||||||
Effect of dilution due to participating convertible preferred stock - Series C Preferred | — | 24,689 | — | |||||||||
Subtotal | 4,547 | 29,334 | 4,835 | |||||||||
Percentage of undistributed earnings allocated to participating preferred stock | 0.0 | % | 84.2 | % | 0.0 | % | ||||||
Effect of dilution due to: | ||||||||||||
Stock options | — | 159 | 150 | |||||||||
Common stock purchase warrants | — | 4,411 | 2,597 | |||||||||
Series B Preferred Stock | — | 1,077 | 2,461 | |||||||||
Series A Preferred Stock | — | 57,073 | 88,850 | |||||||||
Denominator for diluted net income (loss) per common share - adjusted weighted average shares | 4,547 | 92,054 | 98,893 | |||||||||
Net income (loss) per common share: | ||||||||||||
Basic | $ | (0.11 | ) | $ | 0.96 | $ | 11.09 | |||||
Diluted | $ | (0.11 | ) | $ | 0.30 | $ | 0.59 |
The Company issued 1,000,000 shares of Series C Preferred Stock and 6,000,000 warrants to purchase common stock in November 2002 as an exchange for the outstanding Series A and B Preferred Stock. The Series A and B Preferred Stock was convertible into approximately 125,358,776 shares of common stock at the exchange date. The Series C Preferred Stock is convertible into 44,000,000 shares. The issuance of the Series C Preferred Stock was to TLL Partners, a related entity. The Company recorded a gain on the retirement of its Series A and B Preferred Stock of $28,778,000 for common shareholders in accordance with the EITF Topic D-42 which represented the difference between the carrying value of the securities retired and the fair value of Series C Preferred Stock valued at the market price of the underlying common stock on the date of issuance. The Series C Preferred Stock was included in the dilutive earnings per share calculation in 2003. Per the Series C Preferred Stock agreement the holders have the right to participate with common shareholders on an as-if converted basis. As such, the Company should have included the dilutive common
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shares underlying the Series C Preferred Stock in the basic earnings per share calculation for 2003 in accordance with EITF Topic D-95.
Recent Accounting Pronouncements:In December 2002, the FASB issued Statement No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure, and Amendment of FASB Statement No. 123.” SFAS No. 148 amends SFAS No. 123, “Accounting for Stock-Based Compensation,” to provide alternative methods of transition for a voluntary change to the fair value method of accounting for stock-based employee compensation. In addition, SFAS No. 148 amends the disclosure requirements of SFAS No. 123 to require more prominent disclosures about the method of accounting for stock-based compensation and the effect of the method used on reported results in both annual and interim financial statements. The transition and annual disclosure provisions of SFAS No. 148 are effective for fiscal years ending after December 15, 2002. The Company has adopted the annual disclosure provisions of SFAS No. 148 and enhanced disclosures related to the accounting for stock-based employee compensation are provided in “Stock-based Compensation” in footnote A to the consolidated financial statements.
In January 2003, the FASB issued FIN No. 46, Consolidation of Variable Interest Entities. In general, a variable interest entity (“VIE”) is a corporation, partnership, trust, or any other legal structure used for business purposes that either (a) does not have equity investors with voting rights or (b) has equity investors that do not provide sufficient financial resources for the entity to support its activities. FIN No. 46 requires a VIE to be consolidated by a company if that company is subject to a majority of the risk of loss from the VIE’s activities or is entitled to receive a majority of the VIE’s residual returns or both. The consolidation requirements of FIN No. 46 are effective immediately for VIEs created after January 31, 2003. The consolidation requirements for older VIEs are effective for financial statements of interim or annual periods beginning after June 15, 2003. However, in October 2003, the FASB deferred the effective date of FIN 46 for older VIEs to the end of the first interim or annual period ending after December 15, 2003. Certain of the disclosure requirements are effective for all financial statements issued after January 31, 2003, regardless of when the VIE was established. The adoption of FIN No. 46 had no impact on the Company’s financial position or results of operations.
In April 2003, the FASB issued SFAS No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities.” SFAS No. 149 amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts (collectively referred to as derivatives) and for hedging activities under SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities.” This statement is effective for contracts entered into or modified after June 30, 2003, and for hedging relationships designated after June 30, 2003. The adoption of this Statement did not have a material impact on our financial position and results of operations.
In May 2003, the FASB issued SFAS No. 150, which establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. Specifically, it requires that financial instruments within the scope of the statement be classified as liabilities because they embody an obligation of the issuer. Under previous guidance, many of these instruments could be classified as equity or be reflected as mezzanine equity between liabilities and equity on the balance sheet. The Company’s initial adoption of this statement on June 1, 2003 did not have a material impact on its results of operations, financial position or cash flows. Certain redeemable common stock warrants issued in November 2002 were recorded at their estimated fair value as a long-term liability within the Company’s Consolidated Balance
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Sheet. Additionally, a deferred issuance of certain shares of common was granted in connection with the Company’s purchase of certain assets in February 2004. These shares of common stock contain put options at a stated value. The Company has recorded these financial instruments at their estimated fair value appropriately between current and a long-term liabilities within the Company’s Consolidated Balance Sheet. The accretion related to these redeemable common stock warrants and the deferred issuance of common stock is classified as Interest Expense within its Consolidated Statement of Operations.
In April 2004, the Financial Accounting Standards Board’s (FASB”) Emerging Issues Task Force (“EITF”) reached a consensus on EITF No. 03-06, “Participating Securities and the Two Class Method Under FASB Statement No. 128, Earnings Per Share”. EITF 03-06 addresses a number of questions regarding the computation of earnings per share by companies that have issued securities other than common stock that contractually entitle the holder to participate in dividends and earnings of the company when, and if, it declares dividends on its common stock. The issue also provides further guidance in applying the two-class method of calculating earnings per share, clarifying what constitutes a participating security and how to apply the two-class method of computing earning per share once it is determined that a security is participating, including how to allocate undistributed earnings to such a security. EITF 03-06 is effective for fiscal periods beginning after March 31, 2004. The adoption of EITF 03-06 is not expected to have a material effect on our financial position or results of operations.
NOTE C – LIQUIDITY, RISKS AND OTHER IMPORTANT FACTORS
Sources of System Equipment and Inventory:Teletouch does not manufacture its paging network equipment, including but not limited to antennas, transmitters, and paging terminals, nor does it manufacture any of the pagers, two-way radios or telemetry devices it sells or leases. This equipment is available for purchase from multiple sources, and the Company anticipates that such equipment will continue to be available in the foreseeable future, consistent with normal manufacturing and delivery lead times. Because of the high degree of compatibility among different models of transmitters, computers and other paging and voice mail equipment manufactured by its suppliers, Teletouch’s paging network is not dependent upon any single source of such equipment. The Company currently purchases pagers and paging network equipment from several competing sources and the Company expects that there will be an adequate supply of equipment to meet the Company’s needs in fiscal 2005.
Concentration of Credit Risk: Teletouch provides paging and other wireless telecommunications services to a diversified customer base of mid-size to small businesses and individual consumers, primarily in non-metropolitan areas and communities in the southeast United States. As a result, no significant concentration of credit risk exists. The Company performs periodic credit evaluations of its customers to determine individual customer credit risks and promptly terminates services for nonpayment. Credit losses have been within management’s expectations and continue to decline as the Company’s higher credit risk individual customer base continues to decline.
Financial Instruments: Management believes that the carrying value of its financial instruments approximates fair value.
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Risks and Uncertainties: The Company’s future results of operations and financial condition could be impacted by the following factors, among others:
• | We could experience increased subscriber attrition and reduction in average revenue per unit as a result of more competitive services products and pricing. |
• | Termination or impairment of our relationship with a small number of key telemetry suppliers or vendors could adversely affect our revenue opportunities and results of operations. |
• | Market prices for paging, two-way and telemetry services may decline in the future as competition increases. |
• | We rely on airtime arrangements with other carriers to provide our telemetry services, which we may be unable to obtain or maintain in the future. |
• | If the demand for telemetry services does not grow, or if we fail to capitalize on such demand, it could have an adverse effect on our growth potential. |
• | We may increase our debt in the future to fund potential acquisitions, which could subject us to various restrictions and higher interest costs and decrease our cash flow and earnings. |
• | If we do not maintain compliance with the American Stock Exchange requirements for continued listing, our common stock could be de-listed. |
• | Our ability to fund the costs inherent with complying with new statutes and regulations applicable to public reporting companies, such as the Sarbanes-Oxley Act of 2002, could have an adverse impact on the operations of the Company. |
• | There are substantial capital requirements that we will need to fund in order to maintain, operate and upgrade our information systems network to a level at which we can support our new revenue initiatives. |
• | Our ability to efficiently integrate future acquisitions, if any, could alter the plans for future growth and profitability. |
• | Our operations are subject to government regulation that could have adverse effects on our business. |
• | Equipment failure and natural disasters or terrorist acts may adversely affect our business. |
NOTE D – NOTE RECEIVABLE
On November 7, 2003, the Company issued a $250,000 convertible secured promissory note (the “Streamwaves Note”) to Streamwaves.com, Inc. (Streamwaves). Streamwaves is an internet digital music provider. The Streamwaves Note is secured by substantially all of Streamwave’s assets and bears interest at a rate of 10%. All outstanding principal and unpaid accrued interest is payable on June 20, 2004.
The Streamwaves Note contains a conversion feature which, at the option of Teletouch, allows the outstanding principal and unpaid accrued interest to be converted into shares of Streamwaves Common Stock. The conversion price of the Streamwaves Common Stock will be $1.00 if the conversion date is on or before June 20, 2004 or $0.20 if the conversion date is after June 20, 2004.
On June 20, 2004, Teletouch assigned its interest in the Streamwaves Note to TLL Partners, an entity controlled by Robert McMurrey, Chairman of Teletouch. Consideration paid by Mr. McMurrey equaled $257,778, the full value of the Streamwaves Note and interest accrued through June 20, 2004. Payment of the note was in the form of a reduction in the amount due on the TLL Note (see Note G) held by TLL Partners.
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NOTE E – PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment at May 31, 2004 and 2003 consisted of the following (in thousands):
2004 | 2003 | |||||||
Leased pagers and radios | $ | 3,511 | $ | 4,417 | ||||
Paging infrastructure | 16,867 | 16,865 | ||||||
Buildings and improvements | 708 | 901 | ||||||
Other equipment | 2,512 | 2,466 | ||||||
23,598 | 24,649 | |||||||
Accumulated depreciation | (14,976 | ) | (13,803 | ) | ||||
$ | 8,622 | $ | 10,846 | |||||
Depreciation expense was $3.6 million, $4.6 million and $6.3 million in fiscal 2004, 2003, and 2002, respectively.
NOTE F – SHORT-TERM DEBT
2004 | 2003 | |||||
Short-term debt at May 31, 2004 and 2003 consists of the following (in thousands): | ||||||
FCFC MAP note | $ | — | $ | 109 |
Agreements With First Community:On May 20, 2002, Teletouch executed two promissory notes in favor of First Community Financial Corporation (“FCFC”), (a) a $2,000,000 Multiple Advance Promissory Note (“MAP Note”) and (b) a Term Promissory Note in the initial principal amount of $250,000 (“Term Note”, and together with the MAP Note, the “Credit Facility”). In May 2003, the Company paid the Term Note in full and has no additional borrowing available under this note. The remaining MAP Note is collateralized by an accounts receivable security agreement (“FCFC Security Agreement”) which gives FCFC a superior priority security interest in all accounts receivable and substantially all other assets of the Company, excluding its FCC licenses and certain real property. FCFC is an unrelated third party with no prior relationships with the Company or its affiliates.
FCFC MAP Note: The MAP Note provides for a revolving line of credit of up to a maximum amount of $2,000,000 which is dependent on the Company’s borrowing base primarily consisting of accounts receivable at any point in time. Based on the eligible accounts receivable as of May 31, 2004, the Company’s allowable borrowings under this agreement were $1.1 million. Under this credit facility, $0.0 million was funded as of May 31, 2004.
The MAP Note bears interest at a floating rate of 5.25% above the prime rate of Bank One Arizona, Phoenix, Arizona. The interest rate cannot be less than an annual rate of 10%. Interest is payable on the MAP Note on the first day of each month and is the greater of actual calculated interest or $5,000. Borrowings under the MAP Note are limited to amounts, which together with amounts previously borrowed, do not exceed a borrowing base. This borrowing base is defined as 75% of the Company’s eligible commercial accounts
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receivable and 50% of the Company’s eligible reseller accounts receivable, with certain adjustments. Repayments under the MAP Note have been arranged by assigning the proceeds of the Company’s lockbox to FCFC. Deposits into the lockbox are transferred automatically each day to FCFC. No advances will be made by FCFC if an event of default (as that term is defined under the FCFC Security Agreement) occurs and Teletouch fails to cure the event of default. The MAP Note matures upon the termination of the FCFC Security Agreement. The FCFC Security Agreement provides for an initial term of two years from date of execution and subsequent one-year renewal terms. In consideration for establishing the line of credit, Teletouch paid to FCFC a commitment and funding fee of 1.5% of the line of credit amount, or $30,000, on the date the Company executed the MAP Note. In the event FCFC and Teletouch agree to extend the term of the MAP Note, Teletouch will pay an additional 0.5% or $10,000, of the line of credit amount on each anniversary of any MAP Note extensions.
Under the terms of the MAP Note, the Company is required to comply with certain financial covenants on a monthly basis. Failure to maintain compliance with these covenants is an event of default as defined under FCFC Security Agreement. During the third quarter of fiscal 2004, the Company was unable to maintain compliance with certain financial covenants in the MAP Note for the months of December 2003 and January 2004 but did maintain compliance with the financial covenants for the month of February 2004. The Company did receive a waiver of these covenants for these months, which allowed the Company to remain in good standing under the terms of the MAP Note for the quarter ending February 29, 2004. The Company was in compliance with its financial covenants at May 31, 2004.
Effective February 1, 2004, the Company negotiated an extension of the MAP Note through May 1, 2005 which included modifications to certain of the financial covenants included in the agreement.
NOTE G – LONG-TERM DEBT
Long-term debt at May 31, 2004 and 2003 consists of the following (in thousands):
2004 | 2003 | |||||
TLL note – affiliate, including accrued interest | $ | 347 | $ | 760 | ||
Binion note | 60 | — | ||||
Vehicle notes | 86 | — | ||||
493 | 760 | |||||
Less current portion | 45 | — | ||||
$ | 448 | $ | 760 | |||
TLL Note:On May 17, 2002, the Company entered into a note agreement with TLL Partners (TLL Note), an entity controlled by Robert McMurrey, Chairman of Teletouch, which allows for borrowings in the aggregate principal amount of $2,200,000. As of May 31, 2004 the Company has available borrowing under the TLL Note of $1,950,000 as accrued but unpaid interest does not reduce the availability of funds under this note agreement. The outstanding principal and accrued interest becomes payable in full May 17, 2007 and accrues interest at the rate of 10% annually. The TLL Note is subordinated to the interests of FCFC and does not require the maintenance of any financial or operating covenants. On July 20, 2004 the Company
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transferred its interest in a promissory note it held to TLL Partners and in consideration received a reduction in the balance due under the TLL Note in the amount of $257,778 (see Note D).
Binion Note: On January 29, 2004, Teletouch acquired substantially all of the two-way radio assets of DCAE, Inc. d/b/a Delta Communications, Inc. (“Delta”) and in conjunction, the Company issued a note payable to Glen Binion, an employee of Delta, in the amount of $60,000 for the purchase of certain FCC licenses owned by Mr. Binion. The note bears interest at a rate of 5% per year and is payable in three annual installments of $20,000 beginning February 28, 2005.
Vehicle Notes: The Company enters into various vehicle financing arrangements, as necessary, to purchase vehicles for its service technicians. The terms of these financing arrangements extend between 24 and 48 months and such notes are fully collateralized by the vehicles purchased.
Maturities: Scheduled maturities of long-term debt outstanding at May 31, 2004 are as follows:
Payments Due By Period (in thousands) | ||||||||||||||||||
Total | 2005 | 2006 | 2007 | 2008 | Thereafter | |||||||||||||
Debt | $ | 493 | $ | 45 | $ | 45 | $ | 396 | $ | 7 | $ | — |
NOTE H – DEBT AND EQUITY RESTRUCTURING
On May 20, 2002, pursuant to agreements executed on May 17, 2002, Teletouch reorganized its debt, retiring approximately $57,100,000 in outstanding principal and $3,600,000 in accrued interest in senior debt owed by Teletouch under its senior credit agreement to a syndicate of commercial lenders, by paying those lenders an aggregate cash amount of $9,800,000 and delivering a Promissory Note in the principal amount of $2,750,000 to one of the lenders, ING Prime Rate Trust (formerly known as Pilgrim America Prime Rate Trust) (“Pilgrim”) (the “Debt Reorganization”). The Second Amended and Restated Credit Agreement (the “Amended Credit Agreement”) dated as of May 17, 2002 by and among Teletouch and Pilgrim, as administrative agent for the lender, which amended and restated the prior credit agreement effected the Debt Reorganization and resulted in the reduction of the aggregate principal debt under the debt facility to $2,750,000 (the “Pilgrim promissory note”).
On December 31, 2002, Teletouch paid off the principal and interest amounts outstanding under the Amended Credit Facility by remitting a one time payment in the amount of $1,947,874 as full satisfaction of all amounts owed by Teletouch thereunder. The Amended Credit Facility, together with all security interests arising in connection therewith was terminated and cancelled as of that date. The Company recognized a gain on the extinguishment of this debt of $510,000. The funds used to payoff the amount included approximately $429,000 received by the Company in December 2002 as the result of a favorable legal settlement.
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In order to complete the reorganization of its debt and to provide for necessary working capital financing, Teletouch also entered into new credit agreements with First Community Financial Corporation (see Note F) and TLL Partners (see Note G). Proceeds from these facilities combined with working capital from the Company were used to fund the cash payments to lenders in the amount of $9,800,000 required to restructure the senior debt in May 2002.
Preferred Stock and Junior Debt Restructuring Activities
The Company reached an agreement with the two holders of the Company’s junior subordinated debt (the “Junior Debt”), GM Holdings and TLL Partners concerning the Junior Debt held by each of GM Holdings and TLL Partners simultaneously with the restructuring of the senior debt discussed above. The material provisions of the agreement are discussed below.
On May 17, 2002, TLL Partners, paid $800,000 and exercised an option it had previously purchased to acquire all of the Teletouch securities held by Continental Illinois Venture Corporation (“CIVC”) which included $22,451,000 of the total $25,513,000 in outstanding principal and accrued interest under the Junior Debt, 295,649 shares of Teletouch common stock, 2,660,840 warrants to purchase Teletouch common stock, 36,019 shares of Series B Preferred Stock, 324,173 warrants to purchase Series B Preferred Stock, and 13,200 shares of Series A Preferred Stock.
Pursuant to the Restructuring Agreement dated May 17, 2002 by and among TLL Partners, GM Holdings and Teletouch, the two holders of the Company’s Junior Debt reached an agreement that released and discharged Teletouch of its Junior Debt obligations without recourse. GM Holdings forgave Teletouch’s debt obligations totaling $3,062,000 including accrued interest and TLL Partners forgave Teletouch’s debt obligations totaling $22,451,000.
Pursuant to the Restructuring Agreement dated as of May 17, 2002, by and among TLL Partners, GM Holdings and Teletouch (“Restructuring Parties”), Teletouch agreed to issue warrants to purchase 6,000,000 shares of Teletouch common stock to GM Holdings (see Note M) and TLL Partners agreed to exchange certain preferred and common stock, as described below, for 1,000,000 shares of Teletouch’s Series C Preferred Stock (see Note M). The issuance of the warrants to purchase 6,000,000 shares of Teletouch common stock and the 1,000,000 shares of Series C Preferred Stock was subject to shareholder approval and satisfaction of applicable American Stock Exchange Rules. Additionally, each of the Restructuring Parties agreed that no dividends would accrue, be declared or made on the Series A Preferred Stock or the Series B Preferred Stock pending the completion of the transactions contemplated by the Restructuring Agreement.
The securities exchanged by TLL Partners included all of the common stock, common stock warrants, Series A Preferred Stock, Series B Preferred Stock and Series B Preferred Stock Warrants which TLL Partners acquired from CIVC as well as the Series A Preferred Stock and Series B Preferred Stock previously held by GM Holdings, which TLL Partners acquired pursuant to an option granted to it by GM Holdings at no cost in connection with the Restructuring Agreement. As an inducement for entering into the Restructuring Agreement, TLL Partners paid $59,000 to GM Holdings upon its execution.
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On November 7, 2002, the Company’s common shareholders voted to approve the issuance by the Company of 1,000,000 shares of Series C Preferred Stock and warrants to purchase 6,000,000 shares of the Company’s Common Stock to TLL Partners and GM Holdings, respectively completed the Restructuring Agreement entered into May 17, 2002.
The Company estimated the fair value of the Series C Preferred Stock and the 6,000,000 warrants to purchase common stock to be issued to GM Holdings at $14,520,000 and $1,345,000, respectively, and recorded a portion of the fair value of these securities, $5,808,000 for the Series C Preferred Stock and $538,000 for the warrants to purchase common stock, as a reduction to the gain on extinguishment of debt during fiscal 2002. The shares of Series C Preferred Stock were valued at $14.52 per share, reflecting the market vale of $.33 for each share of common stock into which the share of the Series C Preferred Stock is convertible and the conversion rate of 44 shares of common stock for each share of Series C Preferred Stock. The warrants to purchase common stock were recorded at the fair value of the embedded put feature which and is being accreted in value over time to its redemption value of $3,000,000 in May 2007.
The gain on extinguishment of debt for the year ended May 31, 2002, of approximately $64,500,000 was calculated as follows:
Senior debt, including accrued interest, extinguished | $ | 60,700,000 | |
Junior subordinated debt extinguished | 25,500,000 | ||
Total | 86,200,000 | ||
Less: | |||
Cash paid | 9,800,000 | ||
Pilgrim promissory note, including interest to be paid | 3,200,000 | ||
Allocated portion of the fair value of the Series C Preferred Stock | 5,800,000 | ||
Allocated portion of the fair value of the 6,000,000 warrants to purchase common stock | 500,000 | ||
Allocated portion of cash paid by significant shareholder | 400,000 | ||
Write-off of related debt issue costs | 1,100,000 | ||
Fees and expenses incurred | 900,000 | ||
Gain on extinguishment of debt | $ | 64,500,000 |
In conjunction with the issuance of the Series C Preferred Stock and 6,000,000 warrants to purchase common stock in exchange for the 15,000 shares of Series A Preferred Stock, 85,394 shares of Series B Preferred Stock, 2,660,840 warrants to purchase common stock, 324,173 warrants to purchase Series B Preferred Stock and 295,649 shares of common stock, the Company recognized a gain of $28,778,000, in the second quarter of fiscal year 2003, that was included in income applicable to common stock and is reflected in the Company’s earnings per share calculations for the year ended May 31, 2003. The amount of the gain represents the amount by which the carrying value of the Series A Preferred Stock as of November 7, 2002 $38,297,000 which included accrued
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dividends which were recorded in paid-in capital, exceeded the allocated portion of the fair value of the securities issued, $8,712,000 for the Series C Preferred Stock and $807,000 for the 6,000,000 warrants to purchase common stock issued by the Company.
NOTE I – PROVISION FOR LEASE ABANDONMENT AND OTHER COSTS
In May 2002, the Company completed a review of the financial performance of its retail stores. This review resulted in the decision to close 22 of the Company’s 66 locations. Provisions for estimated losses on the abandonment of certain leased retail space were $488,000 and the loss recorded on the abandonment of related leasehold improvement costs was $120,000 as of May 31, 2002 and are included in operating expenses in the Company’s consolidated statement of operations.
Subsequent to the retail store closings discussed above, the Company evaluated the profitability of the remaining retail stores and its overall retail distribution channel. This evaluation was completed in November 2002 and the Company developed a restructuring plan to exit the retail business and focus the Company on its direct distribution channels (“Retail Exit Plan”). The Retail Exit Plan resulted in the closing of an additional 10 of the Company’s retail locations, transferring 4 of its retail locations to an affiliated company, the conversion of 22 of its retail locations to customer service centers and the reduction of its workforce by 111 people. As a result of the Retail Exit Plan and during the quarter ending February 28, 2003, the Company increased its provision for losses for certain changes in estimates related to the Company’s Retail Exit Plan including $45,000 for personnel related costs and $112,000 for lease obligations. Quarter end November 30, 2002 charges related to the Company’s Retail Exit Plan included $365,000 for the abandonment of certain leased retail space, $34,000 for the abandonment of related leasehold improvements, $411,000 for personnel related costs and $1,426,000 for write-downs on excess furniture and fixtures and computer equipment held for sale. As of May 31, 2003, the Retail Exit Plan was substantially completed Such charges have been included in operating expenses in the Company’s Consolidated Statement of Operations.
The following table provides a rollforward of the Retail Exit Plan liabilities for the years ended May 31, 2004 and 2003:
(amounts in 000’s) | ||||||||||||
Future Lease Payments | Personnel Costs | Total | ||||||||||
Balance at May 31, 2002 | $ | 488 | $ | — | $ | 488 | ||||||
Changes in estimates Additions to provision | | (214 477 | ) | | — 456 | | | (214 933 | ) | |||
Cash outlay | (353 | ) | (456 | ) | (809 | ) | ||||||
Balance at May 31, 2003 | $ | 398 | $ | — | $ | 398 | ||||||
Changes in estimates | (66 | ) | — | (66 | ) | |||||||
Cash outlay | (219 | ) | — | (219 | ) | |||||||
Balance at May 31, 2004 | $ | 113 | $ | — | $ | 113 | ||||||
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The remaining amount at May 31, 2004 of $113,000 is expected to be paid through 2005. Although the Company does not anticipate significant changes, the actual costs may differ from these estimates.
NOTE J – UNEARNED SALE/LEASEBACK PROFIT
In 1997, the Company entered into a sale/leaseback arrangement. Under the arrangement, the Company sold transmission towers and leased them back for a period of 10 years. The leaseback has been accounted for as an operating lease. The gain of $4.1 million realized in this transaction has been deferred and is being amortized as an offset to rental expense in proportion to the rental expense charges recorded over the term of the lease.
NOTE K – INCOME TAXES
Teletouch uses the liability method to account for income taxes. Under this method, deferred income tax assets and liabilities are determined based on differences between the financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates that are expected to be in effect when the differences reverse.
The Company made cash payments of $643,000 for fiscal year 2003 federal income taxes and $227,000 for fiscal year 2004 estimated federal income taxes during fiscal year 2004. The Company made no cash payments for federal income taxes in fiscal 2002 and 2001.
The Company’s net operating loss carryforwards were reduced to $0 at May 31, 2002 from approximately $29.5 million at May 31, 2001. Other deferred tax assets were reduced as well. This reduction occurred in accordance with the attribute reduction rules of Internal Revenue Code Section 108 related to the Company’s debt restructuring (see Note H). A corresponding reduction to the valuation allowance previously recorded against these assets was also recorded and the valuation allowance at May 31, 2002 was $0.
Significant components of Teletouch’s deferred income tax liabilities and assets as of May 31, 2004 and 2003 follow (in thousands):
2004 | 2003 | ||||||
Deferred income tax liabilities: | |||||||
Depreciation methods | $ | 2,112 | $ | 2,720 | |||
Other intangible assets | 39 | — | |||||
Other | 40 | 100 | |||||
Total deferred income tax liabilities | $ | 2,191 | $ | 2,820 | |||
Deferred income tax assets: | |||||||
Intangible assets | 1,626 | 1,733 | |||||
Allowance for doubtful accounts | 61 | 51 | |||||
Inventory reserve | 70 | — | |||||
Unrecognized gain | 504 | 648 | |||||
Accrued liabilities | 82 | 236 | |||||
Total deferred income tax assets | 2,343 | 2,668 | |||||
Net deferred income tax asset (liability) | $ | 152 | $ | (152 | ) | ||
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The provision (benefit) for income taxes for each of the last three fiscal years consists of the following (in thousands):
2004 | 2003 | 2002 | |||||||||
Current | $ | 364 | $ | 462 | $ | — | |||||
Deferred | (304 | ) | (834 | ) | — | ||||||
$ | 60 | $ | (372 | ) | $ | — | |||||
A reconciliation from the federal statutory income tax rate to the effective income tax rate for the fiscal years 2004, 2003, and 2002 follows:
2004 | 2003 | 2002 | |||||||
Statutory income tax rate (benefit) | (34.0 | )% | (34.0 | )% | 34.0 | % | |||
Change in accrual estimates | 23.3 | % | — | — | |||||
Change in valuation allowance | — | — | (34.0 | )% | |||||
Expenses not deductible for tax purposes | 23.8 | % | 1.2 | % | — | ||||
Other | — | — | — | ||||||
Effective income tax rate | 13.1 | % | (32.8 | )% | — | ||||
NOTE L – COMMITMENTS AND CONTINGENCIES
Teletouch leases buildings, transmission towers, and equipment under non-cancelable operating leases. These leases contain various renewal terms and restrictions as to use of the property, and some leases have built-in escalation clauses. Rent expense (in thousands) was $3,037, $3,405, and $3,960 in fiscal 2004, 2003, and 2002, respectively. Future minimum rental commitments under non-cancelable leases, including amounts related to closed stores, are as follows (in thousands):
Payments Due By Period (in thousands) | ||||||||||||||||||
Total | 2005 | 2006 | 2007 | 2008 | Thereafter | |||||||||||||
Significant Contractual Obligations | ||||||||||||||||||
Operating leases | $ | 4,093 | $ | 1,616 | $ | 1,061 | $ | 855 | $ | 544 | $ | 17 | ||||||
Teletouch is party to various legal proceedings arising in the ordinary course of business. The Company believes there is no proceeding, either threatened or pending, against it that will result in a material adverse effect on its results of operations or financial condition.
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NOTE M – SHAREHOLDERS’ EQUITY
Capital Structure: Subsequent to the common shareholder approval obtained on November 7, 2002 of an amendment to the Company’s Certificate of Incorporation, Teletouch’s authorized capital structure allows for the issuance of 70,000,000 shares of common stock with a $0.001 par value and 5,000,000 shares of preferred stock with a $0.001 par value. Prior to the amendment of the Company’s Certificate of Incorporation, Teletouch’s authorized capital structure allowed for the issuance of 25,000,000 shares of common stock with a $0.001 par value and 5,000,000 shares of preferred stock with a $0.001 par value.
In connection with its initial public offering, Teletouch issued to certain consultants the Consultant Warrants to purchase 266,666 shares of common stock at an exercise price of $0.75 per share. The Consultant Warrants expired in January 2004.
In connection with the acquisition of Dial-A-Page, Inc., Teletouch designated 15,000 shares of authorized preferred stock as “Series A 14% Cumulative Preferred Stock” (the “Series A Preferred Stock”) and 411,457 shares as “Series B Preferred Stock”. The Series A Preferred Stock carried an initial liquidation value of $1,000 per share while the Series B Preferred Stock was convertible into 6 shares of Common Stock. The Series A Preferred Stock and the Series B Preferred Stock were non-voting except as to the merger or consolidation with another entity or entities, or the sale of substantially all of the assets of the Company. The holder of the Series A Preferred Stock and the Series B Preferred Stock had the right to require that its securities be registered for public sale two years after the conversion into common stock.
On May 17, 2002, TLL Partners, exercised an option it had previously purchased to acquire all of the securities held by Continental Illinois Venture Corporation (“CIVC”) which included 295,649 shares of common stock, 36,019 shares of Series B Preferred Stock, 2,660,840 warrants to purchase common stock, 324,173 warrants to purchase Series B Preferred Stock and 13,200 shares of Series A Preferred Stock from CIVC (see Note H for further discussion).
There were 15,000 shares of the Series A Preferred Stock originally sold by the Company to the CIVC Investors, with an initial liquidation value of $15 million ($38.2 million including accrued dividends at May 31, 2002). TLL Partners purchased these shares of Series A Preferred Stock on May 17, 2002. Dividends on the Series A Preferred Stock accrued at the rate of 14% per annum and compounded on a quarterly basis. Each share of Series A Preferred Stock, as well as dividends in arrears, were convertible after August 3, 2003 into common stock, at the option of the Series A Preferred Shareholder, based on a stated formula. As of May 31, 2002, the conversion of Series A Preferred Stock would have resulted in an estimated issuance of 2.9 million shares of common stock (7.3 million shares of common stock if dividends in arrears were paid “in kind”) using the conversion price stated in the agreement. However, the agreement stated that the conversion price would in no event be more than the market price of the Company’s common stock. Based on the closing market price of the Company’s stock on May 31, 2002, the conversion of Series A Preferred Stock would have resulted in an estimated issuance of 33.3 million shares of common stock (85.0 million shares of common stock if dividends in arrears were paid “in kind”).
The CIVC Investors also originally received warrants, exercisable at a nominal price, to purchase 3,377,301 shares of Teletouch common stock (the “Common Stock Purchase Warrants”) and 411,457 shares
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of Series B Preferred Stock (the “Series B Preferred Stock Purchase Warrants”). As of May 17, 2002, holders had exercised an aggregate of 716,461 Common Stock Purchase Warrants and 87,284 Series B Preferred Stock Purchase Warrants. The remaining 324,173 Series B Preferred Stock Purchase Warrants and the remaining 2,660,840 Common Stock Purchase Warrants were purchased by TLL Partners on May 17, 2002 (see Note B)
As discussed in Note H, the Amended Credit Agreement prohibits the payment of dividends on the Series A Preferred Stock. At May 31, 2002, approximately $23.3 million of dividends ($1,550.00 per share) were in arrears (or 4.4 million shares of common stock if paid “in kind” using the conversion price stated in the agreement and 51.7 million shares of common stock if paid “in kind” using the closing market price of the Company’s common stock on May 31, 2002, as previously discussed). Dividends earned per share in fiscal years 2004, 2003, and 2002 were $0.00, $0.00 and $319.28, respectively.
Series C Preferred Stock: At May 31, 2004, 1,000,000 shares of Series C Preferred Stock with a par value of $0.001 are issued and outstanding.
The material terms of the Series C Preferred Stock are as follows: after payment of all amounts due under the Amended Credit Agreement which was paid in full in December 2002, (1) dividends may be paid on a pro rata basis; (2) assets may be distributed upon voluntary or involuntary liquidation, dissolution or winding up of the Company; and (3) holders may convert all, but not less than all, of their Series C Preferred Stock into shares of Common Stock after May 20, 2005, subject to the following terms and conditions. The Series C Preferred Stock will be convertible into a number of shares of Common Stock computed by dividing (1) the product of (A) the number of shares of Series C Preferred Stock to be converted and (B) 22, by (2) the conversion price in effect at the time of conversion. The conversion price for delivery of Common Stock shall initially be $0.50 and subject to adjustment. The Series C Preferred Stock is non-voting. Holders of Series C Preferred Stock are entitled to notice of all shareholders meetings. The consent of at least a majority of the Series C Preferred Stock (calculated on an “as converted” basis) is required to effect any amendment (a) to voting powers, preferences or rights of the holders of Series C Preferred Stock or (b) to the Certificate of Incorporation authorizing, creating or increasing the amount of any shares of any class or series prior or equal to the Series C Preferred Stock for payment of dividends or (c) any merger or consolidation unless the surviving entity shall have no class or series of shares or securities authorized or outstanding ranking prior to the Series C Preferred Stock.
Common Stock Purchase Warrants: At May 31, 2004, the Company has 6,000,000 issued and outstanding warrants (the “GM Warrants”) to purchase shares of Teletouch Common Stock. The GM Warrants will be exercisable beginning in May of 2005, terminating in May of 2010. In May of 2007, the holder of the GM Warrants may require the Company to redeem the warrants at $0.50 per warrant. Because of this mandatory redemption feature, the Company has recorded the estimated fair value of the GM Warrants as a long-term liability on its consolidated balance sheet, and will adjust the amount to reflect changes in the fair value of the warrants, including accretion in value due to the passage of time, with such changes charged or credited to net income.
Securities Retired Under the Restructuring Agreement:Pursuant to the terms and conditions of the Restructuring Agreement completed upon the approval and issuance of the Series C Preferred Stock and the GM Warrants, the following securities were surrendered to the Company by TLL Partners as of November 30,
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2002; a) 15,000 shares of Series A Preferred Stock, b) 85,394 shares of Series B Preferred Stock, c) 2,660,840 common stock purchase warrants, d) 295,649 share of Teletouch common stock, e) 324,172 Series B Preferred Stock purchase warrants. As of May 31, 2003, the Company has 15,000 shares of Series A Preferred Stock and 411,457 shares of Series B Preferred Stock authorized with no shares issued and outstanding. The 295,649 shares of Teletouch common stock surrendered are being held in treasury.
Redeemable Common Stock Payable:On January 29, 2004, Teletouch acquired substantially all of the two-way radio assets of DCAE, Inc. d/b/a Delta Communications, Inc. (“Delta”), and in conjunction, the Company deferred the issuance of 640,000 shares of Teletouch’s common stock subject to certain reductions specified in the Delta Asset Purchase Agreement that cannot exceed 100,000 shares of common stock. This obligation is payable on February 15, 2005 at which time up to 640,000 restricted shares of common stock will be issued. The shares of common stock to be issued contain a put option allowing the holder to sell 25% of the remaining shares held each quarter, beginning February 28, 2005, back to the company at a specified price as follows:
Date to be Sold Back to Company | Sell Price | ||
February 28, 2005 – November 30, 2005 | $ | 1.05 | |
December 1, 2005 – November 30, 2006 | $ | 1.10 | |
December 1, 2006 – November 30, 2007 | $ | 1.15 |
Because of this mandatory redemption feature, the Company has recorded the estimated fair value of the Redeemable Common Stock Payable as both a current and long-term liability on its consolidated balance sheet, and will adjust the amount to reflect changes in the fair value of the obligation, including accretion in value due to the passage of time, with such changes charged or credited to net income.
Common stock reserved: The following represents the shares of common stock to be issued on an “if-converted” basis at May 31, 2004. As discussed in Note H, on November 7, 2002, the common shareholders approved the issuance 1,000,000 shares of Series C Preferred Stock initially convertible into 44,000,000 shares of common stock to TLL Partners and warrants to purchase 6,000,000 shares of common stock to GM Holdings to in exchange for the Series A Preferred Stock, Common Stock Purchase Warrants, and Series B Preferred Stock.
Conversion of Series C Preferred Stock | 44,000 | |
Common Stock Purchase Warrants | 6,000 | |
1994 Stock Option and Stock Appreciation Rights Plan | 850 | |
2002 Stock Option and Stock Appreciation Rights Plan | 87 | |
50,937 | ||
NOTE N – STOCK OPTIONS
Teletouch’s 1994 Stock Option and Stock Appreciation Rights Plan (the “1994 Plan”) was adopted in July 1994 and provides for the granting of incentive and non-incentive stock options and stock appreciation rights to officers, directors, employees and consultants to purchase not more than an aggregate of 1,000,000 shares of Common Stock. The Compensation Committee of the Board of Directors administers the Plan and has authority to determine the optionees to whom awards will be made, the terms of vesting and forfeiture, the
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amount of the awards, and other terms. Under the terms of the Plan, the option price approved by the Board of Directors shall not be less than the fair market value of the common stock at date of grant. Exercise prices in the following table have been adjusted to give effect to the repricing that took effect in December 1999 and November 2001 (discussed below).
On November 7, 2002, the Company’s common shareholders voted to adopt and ratify the Teletouch 2002 Stock Option and Appreciation Rights Plan (“2002 Plan”). Under the 2002 Plan, Teletouch may issue options which will result in the issuance of up to an aggregate of ten million (10,000,000) shares of Teletouch common stock. The 2002 Plan provides for options which qualify as incentive stock options (Incentive Options) under Section 422 of the Code, as well as the issuance of non-qualified options (Non-Qualified Options). The shares issued by Teletouch under the 2002 Plan may be either treasury shares or authorized but unissued shares as Teletouch’s Board of Directors may determine from time to time. Pursuant to the terms of the 2002 Plan, Teletouch may grant Non-Qualified Options and Stock Appreciation Rights (SARs) only to officers, directors, employees and consultants of Teletouch or any of Teletouch’s subsidiaries as selected by the Board of Directors or the Compensation Committee. The 2002 Plan also provides that the Incentive Options shall be available only to officers or employees of Teletouch or any of Teletouch’s subsidiaries as selected by the Board of Directors or Compensation Committee. The price at which shares of common stock covered by the option can be purchased is determined by Teletouch’s Compensation Committee or Board of Directors; however, in all instances the exercise price is never less than the fair market value of Teletouch’s common stock on the date the option is granted. To the extent that an Incentive Option or Non-Qualified Option is not exercised within the period in which it may be exercised in accordance with the terms and provisions of the 2002 Plan described above, the Incentive Option or Non-Qualified Option will expire as to the then unexercised portion. As of May 31, 2004, approximately 87,200 Non-Qualified Options and no Incentive Options or SARs are outstanding under the 2002 Plan.
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Stock option activity has been as follows:
Number of Shares | Exercise Price Per Share | Weighted Average Exercise Price Per Share | |||||||
Options outstanding at May 31, 2001 | 820,319 | $ | 0.24 - $3.38 | $ | 1.36 | ||||
Options granted to officers and management | 95,000 | $ | 0.24 | $ | 0.24 | ||||
Options granted to directors | 358,664 | $ | 0.18 - $0.61 | $ | 0.28 | ||||
Options forfeited | (531,661 | ) | $ | 0.81 - $2.26 | $ | 1.31 | |||
Options outstanding at May 31, 2002 | 742,322 | $ | 0.18 - $3.38 | $ | 0.45 | ||||
Options granted to officers and management | 241,167 | $ | 0.33 - $0.40 | $ | 0.35 | ||||
Options granted to directors | 12,664 | $ | 0.34 - $0.38 | $ | 0.37 | ||||
Options forfeited | (14,330 | ) | $ | 0.24 | $ | 0.24 | |||
Options outstanding at May 31, 2003 | 981,823 | $ | 0.18 - $3.38 | $ | 0.43 | ||||
Options granted to officers and management | — | — | — | ||||||
Options granted to directors | 2,664 | $ | 0.89 | $ | 0.89 | ||||
Options exercised | (35,500 | ) | $ | 0.24 | $ | 0.24 | |||
Options forfeited | (11,500 | ) | $ | 0.24 | $ | 0.24 | |||
Options outstanding at May 31, 2004 | 937,487 | $ | 0.18 - $3.38 | $ | 0.44 | ||||
Exercisable at May 31, 2004 | 786,590 | $ | 0.46 | ||||||
Exercisable at May 31, 2003 | 535,240 | $ | 0.54 | ||||||
Exercisable at May 31, 2002 | 266,559 | $ | 0.79 | ||||||
Weighted-average fair value of options granted during 2004 | $ | 0.89 | |
Weighted-average fair value of options granted during 2003 | $ | 0.21 | |
Weighted-average fair value of options granted during 2002 | $ | 0.20 | |
Weighted-average remaining contractual life | 8.0 years |
Pro forma information regarding net loss and loss per share is required by SFAS 123, and has been determined as if Teletouch had accounted for its stock options under the fair value method of that statement. The fair value for these options was estimated at the date of grant using a binomial option pricing model with the following weighted-average assumptions for 2003 and 2002, respectively: risk-free interest rates of 2.00% and 3.70%; dividend yields of 0% for both years; volatility factors of the expected market price of the Company’s common stock of 1.59 in 2003 and 1.31 in 2002, and a weighted-average expected life of the option of 2 to 5 years. As there were only an insignificant amount of stock options granted during fiscal 2004,
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all of which were issued at the market price on the date of the grant, the Company has not included these grants in its pro forma compensation expense calculations for fiscal 2004.
Binomial option valuation models are used 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 the expected stock price volatility. Because Teletouch’s stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management’s opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its stock options. For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense on a straight-line basis over the options’ vesting period.
In December 1999, the Company reduced the exercise price of all outstanding employee and director owned stock options to $0.87, which was equal to the average of the closing price of the Company’s common stock for the 20-trading days prior to December 1, 1999. In November 2001, the Company reduced the exercise price of all outstanding employee and director owned stock options to $0.24, which was equal to the average of the closing price of the Company’s common stock for the 20-trading days prior to November 21, 2001. Compensation expense associated with these repriced options is being measured and recognized in accordance with the Financial Accounting Standards Board Interpretation No. 44, “Accounting for Certain Transactions Involving Stock Compensation”. Based on the market value of Teletouch’s common stock and in accordance with Financial Accounting Standards Board Interpretation No. 44, compensation expense of $68,000, $11,000 and $31,000 was recorded in fiscal years 2004, 2003 and 2002, respectively. Additional compensation expense may be recorded in future periods based on fluctuations in the market value of the Company’s common stock.
NOTE O – RETIREMENT PLAN
Effective October 1995, Teletouch began sponsoring a defined contribution retirement plan covering substantially all of its employees. Employees who are at least 21 years of age are eligible to participate. Eligible employees may contribute up to a maximum of 16% of their earnings. The Company pays the administrative fees of the plan and began matching 75% of the first 6% of employees’ contributions in October 1998. Contributions of approximately $181,000, $182,000 and $199,000 were made in fiscal years 2004, 2003, and 2002, respectively.
NOTE P – RELATED PARTY TRANSACTIONS
The Company had certain related party sales during fiscal 2004 and 2003 to Progressive Concepts, Inc. (“PCI”) a company controlled by Robert McMurrey, Teletouch’s Chairman. During fiscal 2004 and 2003, Teletouch recognized approximately $40,000 and $295,000, respectively, in product sales revenue and $7,000 and $14,000, respectively, in gross margin on the sales of pagers and cellular products to PCI. Teletouch also recognized $51,000 and $12,000 in fiscal 2004 and 2003, respectively, in paging service revenue, commissions revenue earned on sales of equipment and rent income from PCI. Additionally, the Company purchased cellular equipment from this related party during fiscal 2004 totaling approximately $15,700. During fiscal 2003, the Company purchased both car audio equipment and cellular accessories from this related party totaling
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approximately $228,000. The Company has negotiated purchase prices with PCI on both cellular and audio equipment equaling cost plus 5%. The negotiated pricing with PCI represents similar pricing that could be obtained in an arm-length transaction with an unrelated third party. During fiscal 2004 and 2003, Teletouch also recognized expenses of $360,000 and $270,000, respectively, for costs incurred by PCI related to the outsourcing of the Company’s answering service center operations.
On June 20, 2004, Teletouch assigned its interest in the Streamwaves Note to TLL Partners, an entity controlled by Robert McMurrey, Chairman of Teletouch. In consideration for the assignment of the Streamwaves Note, Teletouch received a reduction in its TLL Note (see Note G) held with TLL Partners in the amount of $257,778.
NOTE Q – ACQUISITIONS
On January 29, 2004, Teletouch acquired substantially all of the two-way radio assets of DCAE, Inc. d/b/a Delta Communications, Inc. (“Delta”), a corporation headquartered in Garland, Texas, which continues to operate the business providing Nextel cellular service in the Dallas / Fort Worth market. As part of the purchase, Teletouch acquired approximately 2,500 additional two-way radio subscribers and the logic trunked radio (“LTR”) infrastructure in the Dallas / Fort Worth market. This purchase allowed the Company to expand its LTR network to the Dallas / Fort Worth market which complements its existing East Texas coverages. The total purchase price for the assets of Delta was approximately $1,597,000 which consisted of certain cash and equity consideration. The consideration paid or payable in cash consisted of a cash payment of $650,000, a cash payment to be made within one year of $50,000 (“Cash Holdback”) which is subject to certain adjustments, a promissory note payable in the amount of $60,000 (see “Binion Note” in Note G), approximately $62,000 in other cash expenditures related to closing and the assumption of $135,000 in other liabilities from Delta. The equity consideration given is a note which is payable in 640,000 shares of Teletouch’s common stock which was valued at $640,000, based on market price, on the date of closing (see “Redeemable Common Stock Payable” in Note M). The acquisition was accounted for using the purchase method of accounting and the total purchase price was allocated as follows:
Property, plant and equipment | $ | 161,000 | |
Two-way radio subscriber bases | 112,000 | ||
FCC licenses | 104,000 | ||
Non-compete agreements | 95,000 | ||
Radio and pager inventory | 100,000 | ||
Accounts receivable | 142,000 | ||
Goodwill | 883,000 | ||
Total purchase price | $ | 1,597,000 |
The allocation of the purchase price is subject to refinement in the future as acquired asset and liability values become finalized. The results of operations of the acquisition, which are immaterial to the consolidated operations, are included with that of the Company from the date of closing.
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On May 20, 2004, Teletouch acquired substantially all of the paging assets of Preferred Networks, Inc. (“PNI”), a corporation headquartered in Atlanta, Georgia. These assets were acquired out of bankruptcy and consisted of two distinct paging networks, one in the Southeast and one in the Northeast United States. The total purchase price for the assets of PNI was approximately $257,000. In a concurrent transaction, Teletouch sold the paging network and the associated paging subscribers in the Northeast for $155,000. Subsequent to May 31, 2004, the Company sold certain excess paging infrastructure equipment acquired from PNI for $55,000. The net result of the asset purchase and sale transactions by Teletouch involving the PNI assets was that Teletouch retained all of the paging infrastructure in the Southeast, primarily around Atlanta, Georgia and the associated 24,000 paging subscribers. The results of operations of the acquisitions, which are immaterial to the consolidated operations, are included with that of the Company from the date of closing.
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NOTE R – SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
Summarized quarterly financial data for the years ended May 31, 2004 and 2003 are set forth below (in thousands except per share amounts):
Three Months Ended | |||||||||||||||
Fiscal 2004 | August 31, 2003 | November 30, 2003 | February 28, 2004 | May 31, 2004 | |||||||||||
Service, rent, and maintenance revenue | $ | 6,177 | $ | 5,856 | $ | 5,783 | 5,376 | ||||||||
Product sales revenue | 772 | 699 | 769 | 1,322 | |||||||||||
Total operating revenues | 6,949 | 6,555 | 6,552 | 6,698 | |||||||||||
Operating income (loss) | 255 | 52 | (492 | ) | 19 | ||||||||||
Net income (loss) | 104 | (53 | ) | (435 | ) | (135 | ) | ||||||||
Net income applicable to common shareholders(3) | $ | 10 | $ | (53 | ) | $ | (435 | ) | $ | (135 | ) | ||||
Earnings (loss) per share – basic | $ | 0.00 | $ | (0.01 | ) | $ | (0.10 | ) | $ | (0.03 | ) | ||||
Earnings (loss) per share – diluted | $ | 0.00 | $ | (0.01 | ) | $ | (0.10 | ) | $ | (0.03 | ) | ||||
Three Months Ended | |||||||||||||||
Fiscal 2003 | August 31, 2002 | November 30, 2002 | February 28, 2003 | May 31, 2003 | |||||||||||
(Restated) | |||||||||||||||
Service, rent, and maintenance revenue | $ | 7,550 | $ | 7,082 | $ | 6,781 | $ | 6,516 | |||||||
Product sales revenue | 2,501 | 2,048 | 1,421 | 923 | |||||||||||
Total operating revenues | 10,051 | 9,130 | 8,202 | 7,439 | |||||||||||
Operating income (loss)(1) | 259 | (2,600 | ) | 431 | 222 | ||||||||||
Net income (loss) | 124 | (2,564 | ) | 1,195 | 484 | ||||||||||
Net income (loss) applicable to common shareholders(2)(3) | $ | 124 | $ | 7,994 | $ | 111 | $ | 45 | |||||||
Earnings (loss) per share – basic | $ | 0.03 | $ | 1.69 | $ | 0.02 | $ | 0.01 | |||||||
Earnings (loss) per share – diluted | $ | 0.00 | $ | 0.18 | $ | 0.02 | $ | 0.01 |
(1) | Includes charges of $2.2 million in the quarter ended November 30, 2002 and $0.2 million in the quarter ended February 28, 2003 related to the Company’s exit from its retail distribution channel. |
(2) | Includes the gain on preferred stock transaction of $28.8 million for the quarter ended November 30, 2002 less the participation rights of the Series C Preferred Stock in the earnings of the quarter. |
(3) | The sum of quarterly net income (loss) applicable to common shareholders may differ from the full-year amounts due to participation rights of Series C Preferred Stock in undistributed earnings but not in losses or because the Series C Preferred Stock was not outstanding for the entire period. |
F-38
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The effect of the restatement on the amounts previously reported in consolidated financial statements for the three months ended November 30, 2002 is as follows (in thousands except for per share data):
Three Months Ended November 30, 2002 | ||||||
As Previously Reported | As Restated | |||||
INCOME STATEMENT DATA: | ||||||
Net income applicable to common shareholders | 33,813 | 7,994 | ||||
Earnings per share - basic | $ | 2.19 | $ | 1.69 | ||
Earnings per share - diluted | $ | 0.23 | $ | 0.18 |
F-39
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SCHEDULE II
TELETOUCH COMMUNICATIONS, INC.
Valuation and Qualifying Accounts and Reserves
(in thousands)
Year Ended May 31 | ||||||||||||
2004 | 2003 | 2002 | ||||||||||
Allowance for Doubtful Accounts | ||||||||||||
Balance at beginning of year | $ | 150 | $ | 238 | $ | 238 | ||||||
Additions charged to income | 182 | 400 | 843 | |||||||||
Balances written off, net of recoveries | (152 | ) | (488 | ) | (843 | ) | ||||||
Balance at end of year | $ | 180 | $ | 150 | $ | 238 | ||||||
F-40
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In accordance with Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on November 8, 2005.
TELETOUCH COMMUNICATIONS, INC. | ||
By: | /s/ ROBERT M. MCMURREY | |
Robert M. McMurrey, Chairman |
In accordance with the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the Registrant, in the capacities and on the dates indicated.
Signature | Title | Date | ||
/s/ ROBERT M. MCMURREY Robert M. McMurrey | Chairman of the Board | November 8, 2005 | ||
/s/ THOMAS A. HYDE, JR. Thomas A. Hyde, Jr. | Chief Executive Officer principal executive officer | November 8, 2005 | ||
/s/ J. KERNAN CROTTY J. Kernan Crotty | President, Chief Financial Officer, principal financial officer, Director | November 8, 2005 | ||
/s/ CLIFFORD E. MCFARLAND Clifford E. McFarland | Director | November 8, 2005 | ||
/s/ HENRY Y.L. TOH Henry Y.L. Toh | Director | November 8, 2005 | ||
/s/ MARSHALL G. WEBB Marshall G. Webb | Director | November 8, 2005 | ||
/s/ SUSAN STRANAHAN CIALLELLA Susan Stranahan Ciallella | Director | November 8, 2005 |
Table of Contents
The following exhibits are included with this report:
14 | Code of Ethics | |
21 | Subsidiaries | |
31.1 | Certification pursuant to Rule 13a-14(a) and Rule 15d-14(a) | |
31.2 | Certification pursuant to Rule 13a-14(a) and Rule 15d-14(a) | |
32.1 | Certification pursuant to 1350, Chapter 63, Title 18 of U.S. Code | |
32.2 | Certification pursuant to 1350, Chapter 63, Title 18 of U.S. Code |