SECURITIES AND EXCHANGE COMMISSION
Washington, DC. 20549
FORM 10-Q
Quarterly Report Pursuant to Section 13 or 15 (d)
of the Securities Exchange Act of 1934
For the quarterly period ended Commission File Number 0-19437
MARCH 31, 1997
CELLULAR TECHNICAL SERVICES COMPANY, INC.
(Exact Name of Registrant as Specified in Its Charter)
DELAWARE 11-2962080
(State of Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
2401 FOURTH AVENUE, SEATTLE, WASHINGTON 98121
(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code: (206) 443-6400
NOT APPLICABLE
(Former name, former address and former fiscal year,
if changed since last report.)
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to
the filing requirements for the past 90 days. Yes X No
----- -----
22,708,932 Common Shares were outstanding as of May 12, 1997.
Page 1
CELLULAR TECHNICAL SERVICES COMPANY, INC.
TABLE OF CONTENTS FOR FORM 10-Q
PART I. FINANCIAL INFORMATION..............................................3
Item 1. Financial Statements................................................3
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations...........................................7
PART II. OTHER INFORMATION................................................11
Item 6. Exhibits and Reports on Form 8-K...................................11
Page 2
CELLULAR TECHNICAL SERVICES COMPANY, INC.
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
BALANCE SHEETS
(in 000's, except per share amounts)
(unaudited)
March 31, December 31,
1997 1996
----------- --------------
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 4,706 $ 4,854
Accounts receivable, net 12,356 11,616
Inventories, net 7,361 8,275
Prepaid expenses and other current assets 738 831
-------- --------
Total Current Assets 25,161 25,576
PROPERTY AND EQUIPMENT, net 3,772 3,177
SOFTWARE DEVELOPMENT COSTS, net 3,664 3,599
-------- --------
TOTAL ASSETS $32,597 $ 32,352
-------- --------
-------- --------
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable and accrued liabilities $ 3,696 $ 6,365
Payroll related liabilities 1,099 735
Taxes (other than payroll and income) 1,173 660
Customers' deposits 298 4,626
Deferred revenue 3,710 1,781
-------- --------
Total Current Liabilities 9,976 14,167
STOCKHOLDERS' EQUITY
Preferred Stock, $0.01 par value per share,
5,000 shares authorized, none issued
and outstanding
Common Stock, $0.001 par value per share,
30,000 shares authorized, 22,641 shares issued
and outstanding in 1997 and 22,636 in 1996 23 23
Additional paid-in capital 29,160 29,138
Deficit (6,562) (10,976)
-------- --------
Total Stockholders' Equity 22,621 18,185
-------- --------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $32,597 $ 32,352
-------- --------
-------- --------
- --------------------
The accompanying notes are an integral part of these financial statements.
Page 3
CELLULAR TECHNICAL SERVICES COMPANY, INC.
STATEMENTS OF OPERATIONS
(in 000's, except per share amounts)
(unaudited)
Three Months Ended
March 31,
---------------------
1997 1996
------ ------
REVENUES
Systems $16,826 $ 432
Services 542 303
------- ------
Total Revenues 17,368 735
COSTS AND EXPENSES
Cost of systems and services 8,375 1,013
Sales and marketing 1,395 823
General and administrative 892 511
Research and development 2,340 996
------- ------
Total Costs and Expenses 13,002 3,343
------- ------
INCOME (LOSS) FROM OPERATIONS 4,366 (2,608)
INTEREST INCOME 48 107
------- ------
INCOME (LOSS) BEFORE INCOME TAXES 4,414 (2,501)
PROVISION FOR INCOME TAXES - -
------- ------
NET INCOME (LOSS) $ 4,414 $(2,501)
------- ------
------- ------
NET INCOME (LOSS) PER SHARE $ .19 $ (.12)
------- ------
------- ------
WEIGHTED AVERAGE SHARES OUTSTANDING 23,711 21,609
------- ------
------- ------
- --------------------
The accompanying notes are an integral part of these financial statements.
Page 4
CELLULAR TECHNICAL SERVICES COMPANY, INC.
STATEMENTS OF CASH FLOWS
(in 000's, except per share amounts)
(unaudited)
Three Months Ended
March 31,
---------------------
1997 1996
------ ------
OPERATING ACTIVITIES
Net income (loss) $ 4,414 $(2,501)
Adjustments to reconcile net income (loss) to net
cash provided by (used in) operating activities:
Depreciation and amortization of property and equipment 277 181
Amortization of software development costs 305 280
Changes in operating assets and liabilities:
(Increase) decrease in accounts receivable (740) 28
Decrease (increase) in inventories 914 (836)
Decrease (increase) in prepaid expenses and other
current assets 93 (462)
(Decrease) in accounts payable and accrued liabilities (2,669) (241)
Increase in payroll related liabilities 364 73
Increase (decrease) in taxes (other than payroll
and income) 513 (169)
(Decrease) increase in customers' deposits (4,328) (13)
Increase in deferred revenue 1,929 146
------- -------
NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES 1,072 (3,514)
INVESTING ACTIVITIES
Purchase of property and equipment (872) (145)
Capitalization of software development costs (370) (434)
------- -------
NET CASH USED IN INVESTING ACTIVITIES (1,242) (579)
FINANCING ACTIVITIES
Proceeds from exercise of stock options 22 365
------- -------
NET CASH PROVIDED BY FINANCING ACTIVITIES 22 365
------- -------
NET DECREASE IN CASH AND CASH EQUIVALENTS (148) (3,728)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 4,854 9,448
------- -------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 4,706 $ 5,720
------- -------
------- -------
- -----------------------------------
The accompanying notes are an integral part of these financial statements.
Page 5
CELLULAR TECHNICAL SERVICES COMPANY, INC.
NOTES TO FINANCIAL STATEMENTS
NOTE A - BASIS OF PRESENTATION
The accompanying unaudited financial statements of Cellular Technical
Services Company, Inc. (the "Company"), including the December 31, 1996
balance sheet which has been derived from audited financial statements, have
been prepared in accordance with generally accepted accounting principles for
interim financial information and with the instructions to Form 10-Q and Rule
10-01 of Regulation S-X. Accordingly, they do not include all of the
information and footnotes required by generally accepted accounting
principles for complete financial statements. In the opinion of management,
all adjustments (consisting of normal recurring accruals) considered
necessary for a fair presentation have been included. The operating results
for the three month period ended March 31, 1997 are not necessarily
indicative of the results that may be expected for the fiscal year ending
December 31, 1997. For further information, refer to the financial
statements and footnotes thereto included in the Company's Annual Report on
Form 10-K for the year ended December 31, 1996.
NOTE B - INVENTORIES:
Inventory consists of the following (in 000's):
March 31, December 31,
1997 1996
---------- --------------
Raw materials components $ 3,638 $ 2,723
Work in process and finished components 4,693 6,014
---------- ----------
8,331 8,737
Less inventory reserves (970) (462)
---------- ----------
$ 7,361 $ 8,275
---------- ----------
---------- ----------
NOTE C - EARNINGS PER SHARE
In February 1997, the Financial Accounting Standards Board issued Statement
No. 128, Earnings Per Share, which is required to be adopted on December 31,
1997. At that time, the Company will be required to change the method
currently used to compute earnings per share and to restate all prior
periods. Under the new requirements for calculating primary earnings per
share, the dilutive effect of stock options will be excluded. The impact is
not expected to result in an increase in primary earnings per share for the
first quarters ended March 31, 1997 and March 31, 1996, respectively. The
impact of Statement No. 128 on the calculation of fully diluted earnings per
share for these quarters is not expected to be material.
Page 6
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion and analysis provides information which management
believes is relevant to an assessment and understanding of the Company's
results of operations and financial condition. The discussion should be read
in conjunction with the financial statements and notes thereto.
OVERVIEW
To address the wireless communications industry's increasing need for
products to more effectively combat cloning fraud, a major industry problem,
the Company has developed the Blackbird-Registered Trademark- Platform and
related application products and services ("Blackbird Products"). The
Blackbird Platform has been engineered with an open architecture design to
allow the Company and others to develop application products which could run
on or exchange information with it. Prior to the Company's third quarter of
1996, revenues had been primarily derived from the Company's
Hotwatch-Registered Trademark- Platform and related application products and
services ("Hotwatch Products") and, to a lesser extent, phone rental products
which are no longer being marketed by the Company.
In 1995, the Company began conducting trials for the purpose of testing and
evaluating the Blackbird Products. Since that time, the Company has signed
agreements with AirTouch Cellular ("AirTouch"), Bell Atlantic NYNEX Mobile
("BANM"), GTE Mobilnet of California Limited Partnership ("GTE-California"),
GTE Mobilnet Service Corp. ("GTE Corp") and Ameritech Mobile Communications,
Inc. ("Ameritech") to deploy and support the Blackbird Products. During the
last half of 1996, the Company recorded its first substantive revenues from
two of these agreements.
Revenue recognition for the Company's systems is based upon performance
criteria which vary from customer to customer and product to product.
Physical hardware and software delivery, definitions of system delivery, and
customer acceptance are generally the significant factors used in determining
revenue recognition. As a result of such performance criteria, only a portion
of the systems revenues and the majority of the system costs may be recorded
during the early stages of a system deployment. Accordingly, revenues and
direct margins recorded by the Company can be expected to be lower in earlier
periods of deployment and inconsistent from quarter to quarter, especially
during the initial market deployments under new agreements, as was the case
during the last half of 1996. The resulting deferral of revenue is recognized
in subsequent periods as the performance criteria specified in the applicable
agreement is met.
In addition, the Company has incurred substantial operating expenses during
the early deployments, primarily in the areas of sales and marketing,
installation and customer support, and in research and development. The
Company expects that its costs and expenses will continue to increase in the
future, due to a continual need to make substantial investments in research
and development, enhanced sales and marketing activities, and expansion of
customer support capabilities needed to service its anticipated product
deployments in both domestic and international markets.
The Company's revenue and customer base is currently concentrated among a few
large domestic cellular carriers due to the significant concentration of
ownership and/or control of cellular licenses. As the Company expands its
domestic and international marketing efforts, and as the wireless
communications industry expands beyond cellular telephony to include other
wireless communication services, the Company believes that it will be able to
diversify its revenue and customer base. To date, the Company's sales have
been generated by the Company's in-house sales force. The Company currently
uses and expects to continue using agents and/or distributors in conjunction
with its in-house sales efforts for sales in the international marketplace.
While the Company has not yet signed international sales agreements, it is in
the process of exploring and identifying limitations that may be placed upon
it by foreign operations and the expected resulting impact upon the
Page 7
Company's results of operations and liquidity. Its success in exploiting
these expanded markets and in achieving and maintaining profitability on both
domestic and international operations, will depend on, among other things,
its ability to: (i) make its existing and future technology commercially
acceptable, (ii) recognize and successfully adapt to the rapid changes in the
wireless communications industry (including digital services), (iii) enhance
and expand its manufacturing activities concurrent with its growth, (iv)
comply with foreign regulatory requirements without negatively impacting the
Company's results of operations or liquidity, (v) manage intellectual
property protection in foreign countries, (vi) manage foreign currency
exchange rate fluctuations that may be attributed to international sales
contracts, and (vii) engage additional sales agents and/or distributors on a
timely and economic basis. These and other factors could delay revenues
and/or increase the cost of doing business.
THREE MONTHS ENDED MARCH 31, 1997 COMPARED TO THREE MONTHS ENDED MARCH 31, 1996
Total revenues increased 2,263% to $17.4 million in 1997 from $.7 million in
1996 and the Company generated net income of $4.4 million, or $0.19 per share
in 1997 compared to net loss of $2.5 million, or $0.12 per share in 1996.
The increase in revenues and resulting net income is directly attributable to
the Company's deployment and commercial acceptance of its Blackbird Products.
Systems revenues are generated from licensing and sales of the Company's
proprietary software and hardware products, from the sale of third party
equipment sold in support of the proprietary systems, and to a lesser extent,
fees earned associated with the installation and deployment of such systems.
Systems revenues increased 3,795% to $16.8 million in 1997 from $0.4 million
in 1996 and represent revenues primarily from Blackbird Products derived from
sales under the agreements with AirTouch, BANM, GTE-California and Ameritech.
There were no corresponding system revenues during 1996. System revenues
from Hotwatch Products during the period were minimal and are not expected to
contribute significantly to revenues in the future.
Service revenues are derived primarily from hardware and software
maintenance, software upgrades and new releases, No Clone ZoneSM roaming
protection services, system monitoring and related professional services
provided in support of the Company's currently deployed product base. These
revenues increased 79% to $0.5 million in 1997 from $0.3 million in 1996.
This increase is directly attributable to growing service revenues
originating from Blackbird Products that were deployed in late 1996. The
Company anticipates that total service revenues during 1997 and beyond will
continue to increase as a result of continued deployment of the Company's
Blackbird Products.
Costs of systems and services increased 727% to $8.4 million in 1997 from
$1.0 million in 1996. Costs of systems and services are primarily comprised
of the costs of: (i) equipment (which primarily includes proprietary and
third party hardware, and to a lesser extent, manufacturing overhead, and
related expenses), (ii) amortization of capitalized software development,
(iii) system integration and installation, (iv) patent royalty fees, and (v)
customer support. Costs of equipment totaled $6.0 million in 1997 and were
primarily related to Blackbird Product deployments. Such costs for the
corresponding period in 1996 were minimal. Cost of software amortization,
system integration and installation, patent license fees and customer support
increased 140% to $2.4 million in 1997 from $1.0 million in 1996 and is
attributable primarily to increased personnel and related overhead costs
associated with installing and supporting products in the Company's expanded
customer base.
Costs of systems and services, as a percent of total revenues, were 48% and
138% for the 1997 and 1996 periods, respectively. The improvement in 1997 is
attributable to an increased volume of system sales, where direct margins
exceeded fixed costs of systems and services, which was not the case in 1996.
Page 8
Sales and marketing expenses increased 70% to $1.4 million in 1997 from $0.8
million in 1996. This increase is primarily attributable to personnel and
related costs incurred in connection with the Company's increased efforts to
generate demand for its products and the costs incurred during both pre- and
post-sales contract activities related to the Blackbird Products. To a
lesser extent, variable sales incentive compensation contributed to the 1997
increased expenses.
General and administrative expenses increased 75% to $0.9 million in 1997
from $0.5 million in 1996 principally due to increased personnel related
costs associated with the continued expansion of the Company's business, and
to a lesser extent, incentive compensation accruals that would be payable
upon achievement of annual financial and operating goals.
Research and development expenditures include the costs for research, design,
development, testing, preparation of training and user documentation, and
fixing and refining features for the software and hardware components
included in the Company's current and future product lines. Research and
development costs increased 135% to $2.3 million in 1997 from $1.0 million in
1996. Software development costs of $0.4 million were capitalized during
each period for 1997 and 1996 and related to the development of the Blackbird
Products. Capitalized development costs did not increase in 1997 at the same
rate as did research and development expenses primarily due to an increase in
the non-capitalizable research, design, and maintenance activities associated
with the Blackbird Products either deployed or new and/or enhanced products
in the research and design stages. Including capitalized software
development costs, gross research and development expenditures increased 93%
to $2.7 million in 1997 from $1.4 million in 1996, primarily due to expanded
investment in the Blackbird Products.
Interest income decreased 55% to $0.05 million in 1997 from $0.1 million in
1996. The decrease was attributable to lower average cash balances invested
at lower average interest rates during 1997 as compared to 1996.
LIQUIDITY AND CAPITAL RESOURCES
The Company's capital requirements have consisted primarily of funding
software development, property and equipment requirements, working capital
and the Company's operating losses in prior periods. The Company has
historically funded these requirements through issuance of Common Stock
(including proceeds from the exercise of warrants and options) and from
operating profits in certain periods. On March 31, 1997 the Company's cash
balance was $4.7 million as compared to $4.9 million on December 31, 1996.
The Company's working capital increased to $15.2 million at March 31, 1997
from $11.4 million at December 31, 1996.
Cash provided by operating activities amounted to $1.1 million in 1997, as
compared to cash used by operating activities of $3.5 million in 1996. The
major factor contributing to the Company's cash flow from operating
activities is the profit recorded in 1997 and the loss incurred in 1996.
Depreciation and amortization, which provides cash for operating activities,
increased moderately and is attributable to the increased investment in
software development and property and equipment as discussed below. In
addition, the net changes in the balances of the major working capital
components impacted cash flow from operating activities and included: (i)
accounts receivable, which increased in 1997 as a result of Blackbird System
revenues recorded during the first three months of the year, (ii)
inventories, which decreased in response to sales demand for Blackbird
Products during 1997, (iii) accounts payable, which decreased due to payments
made for inventory purchases in late 1996, (iv) deferred revenue, which
increased primarily as a result of the growth of prepaid maintenance and
service contracts related to the Blackbird system sales, and (v) customer
deposits, which decrease reflects revenues associated with initial sales to
new customers that were recorded subsequent to cash received. During the
early stages of deploying the Blackbird Products, the Company has experienced
uneven cash flow and operating
Page 9
results. These factors originate from the deferred revenue recognition and
payment terms contained in customer agreements.
Cash utilized by investing activities totaled $1.2 million and $0.6 million
in 1997 and 1996, respectively. The Company's capital requirements during
such periods were (i) software development of the Blackbird Products and (ii)
property and equipment, primarily for furniture, leaseholds, and equipment
associated with expanding the Company's business. These expenditure levels
are expected to continue in 1997 at or above the current levels. At March
31, 1997, the Company had no significant commitments for capital
expenditures. The Company, as part of its growth strategy, would consider
the cost/benefit of purchasing software and/or hardware technology in the
event that an attractive opportunity arises.
Cash provided by financing activities (exercise of stock options by the
Company's directors, officers and employees) totaled $0.02 million and $0.4
million during 1997 and 1996, respectively.
In November 1996, the Company sold 400,000 shares of common stock to
investors in a private placement with proceeds to the Company approximating
$6.4 million net of estimated expenses. A registration statement for the
resale of such shares was declared effective by the Securities and Exchange
Commission in April 1997. Also, in November 1996, the Company obtained a
$5.0 million line of credit from a major bank. The line, which is secured by
all personal property of the Company, bears interest at the prime rate plus
.75% and expires September 30, 1997. The proceeds from the stock sale and
the line of credit will be used to fund the Company's growth and provide
additional working capital. No funds have been drawn on the line of credit
as of this date.
The Company expects to continue to incur substantial expenses in (i) support
of research and development activities, (ii) growth of its sales and
marketing organization, (iii) support for new products and the anticipated
expanded customer base, (iv) enhancing the hardware design and manufacturing
processes, and (v) administrative activities. The Company believes that cash
flow anticipated from its operating activities, existing cash balances and
cash available under its line of credit, are sufficient to fund its
operations for at least the next 12 months.
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
A number of statements contained in this report are forward-looking
statements within the meaning of the Private Securities Litigation Reform Act
of 1995 that involve risks and uncertainties that could cause actual results
to differ materially from those expressed or implied in the applicable
statements. These risks and uncertainties include but are not limited to:
the Company's dependence on the cellular communications market; its
vulnerability to rapid industry change and technological obsolescence;
uncertainties in duration of the life cycle of its products; risks involved
in the early stages of the life cycle of its products, including worldwide
commercial market acceptance and the risks that its current and future
products may contain errors or be affected by technical problems that would
be difficult and costly to detect and correct; manufacturing difficulties;
potential difficulties in managing growth; dependence on key personnel; the
Company's limited customer base and reliance on a relatively small number of
customers; the possible impact of competitive products and pricing; the
uncertain level of actual purchases of its products by current and
prospective domestic and international customers under existing and future
agreements; uncertainties in the Company's ability to implement these
agreements sufficiently to permit it to recognize revenue under its
accounting policies (including its ability to meet product performance
criteria contained in such agreements); the results of financing efforts;
uncertainties with respect to the Company's business strategy; general
economic conditions; and other risks described in the Company's filings with
the Securities and Exchange Commission.
Page 10
PART II. OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
a) EXHIBITS
10.1 Master Purchase and License Agreement between the Company and GTE
Mobilnet Service Corp. dated April 23, 1997 (2)
11.1 Computation of Earnings Per Share (1)
27 Financial Data Schedule - filed only with EDGAR submission
- --------------------
(1) Filed herewith.
(2) Filed herewith, confidential treatment requested pursuant to Rule 24b-2
of the Securities and Exchange Commission.
b) REPORTS ON FORM 8-K
The Company filed a Current Report on Form 8-K, the date of which was
January 2, 1997, under Item 5 of such Report, relating to a lawsuit
commenced against the Company.
The Company filed a Current Report on Form 8-K, the date of which was
January 21, 1997, under Item 5 of such Report, relating to an agreement
modifying the employment relationship between the Company and its then
President and Chief Operating Officer.
The Company filed a Current Report on Form 8-K, the date of which was
February 19, 1997, under Item 5 of such Report, relating to an employment
agreement entered into with the current President and Chief Operating
Officer of the Company.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
CELLULAR TECHNICAL SERVICES COMPANY, INC.
By: /s/Michael E. McConnell
----------------------------------------
Michael E. McConnell
Vice President and Chief Financial
Officer
May 14, 1997
Page 11