SECURITIES AND EXCHANGE COMMISSION
Washington, DC. 20549
FORM 10-Q
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Quarterly Report Pursuant to Section 13 or 15 (d)
of the Securities Exchange Act of 1934
For the quarterly period ended Commission File Number 0-19437
SEPTEMBER 30, 1997 -------
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CELLULAR TECHNICAL SERVICES COMPANY, INC.
(Exact Name of Registrant as Specified in Its Charter)
DELAWARE 11-2962080
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(State or Other Jurisdiction of (I.R.S. Employer Identification No.)
Incorporation or Organization)
2401 FOURTH AVENUE, SEATTLE, WASHINGTON 98121
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(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code: (206) 443-6400
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NOT APPLICABLE
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(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
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22,795,092 Common Shares were outstanding as of November 7, 1997.
Page 1
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.............................................. 8
PART II. OTHER INFORMATION.................................................. 13
Item 1. Legal Proceedings.................................................. 14
Item 6. Exhibits and Reports on Form 8-K................................... 14
Page 2
CELLULAR TECHNICAL SERVICES COMPANY, INC.
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
CELLULAR TECHNICAL SERVICES COMPANY, INC.
BALANCE SHEETS
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(in 000's, except per share amounts)
(unaudited)
SEPTEMBER 30, DECEMBER 31,
1997 1996
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ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 3,736 $ 4,854
Accounts receivable, net 6,157 11,616
Inventories, net 5,972 8,275
Prepaid expenses and other current assets 559 831
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Total Current Assets 16,424 25,576
PROPERTY AND EQUIPMENT, net 3,961 3,177
SOFTWARE DEVELOPMENT COSTS, net 3,545 3,599
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TOTAL ASSETS $ 23,930 $ 32,352
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LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable and accrued liabilities $ 1,665 $ 6,365
Payroll related liabilities 825 735
Taxes (other than payroll and income) 564 660
Customers' deposits 38 4,626
Deferred revenue 3,236 1,781
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Total Current Liabilities 6,328 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, 22,795
shares issued and outstanding in 1997 and
22,636 in 1996 23 23
Additional paid-in capital 29,886 29,138
Deficit (12,307) (10,976)
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Total Stockholders' Equity 17,602 18,185
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TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 23,930 $ 32,352
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The accompanying notes are an integral part of these financial statements.
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CELLULAR TECHNICAL SERVICES COMPANY, INC.
STATEMENTS OF OPERATIONS
(in 000's, except per share amounts)
(unaudited)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
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1997 1996 1997 1996
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REVENUES
Systems $ 993 $ 10,256 $ 23,432 $ 13,246
Services 1,386 193 3,040 749
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Total Revenues 2,379 10,449 26,472 13,995
COSTS AND EXPENSES
Costs of Systems and Services 3,356 7,810 15,468 10,494
Sales and marketing 744 823 3,127 2,320
General and administrative 1,298 460 3,069 2,131
Research and development 1,805 1,349 6,306 3,702
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Total Costs and Expenses 7,203 10,442 27,970 18,647
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INCOME (LOSS) FROM OPERATIONS (4,824) 7 (1,498) (4,652)
INTEREST INCOME 75 47 167 215
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INCOME (LOSS) BEFORE INCOME TAXES (4,749) 54 (1,331) (4,437)
BENEFIT FOR INCOME TAXES 0 0 0 0
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NET INCOME (LOSS) $(4,749) $ 54 $ (1,331) $ (4,437)
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NET INCOME (LOSS) PER SHARE $ (.21) $ .00 $ (.06) $ (.20)
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WEIGHTED AVERAGE SHARES OUTSTANDING 22,780 23,589 22,705 21,857
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The accompanying notes are an integral part of these financial statements.
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CELLULAR TECHNICAL SERVICES COMPANY, INC.
STATEMENTS OF CASH FLOWS
(in 000's)
(unaudited)
NINE MONTHS ENDED
SEPTEMBER 30,
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1997 1996
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OPERATING ACTIVITIES
Net loss $ (1,331) $ (4,437)
Adjustments to reconcile net loss to net cash provided by (used in) operating
activities:
Depreciation and amortization of property and equipment 897 577
Amortization of software development costs 1,281 820
Changes in operating assets and liabilities:
Decrease (increase) in accounts receivable 5,459 (6,594)
Decrease (increase) in inventories 2,303 (2,045)
Decrease in prepaid expenses and other current assets 272 113
(Decrease) increase in accounts payable and accrued liabilities (4,700) 3,154
Increase in payroll related liabilities 90 307
Decrease (increase) in taxes (other than payroll and income) (96) 152
(Decrease) increase in customers' deposits (4,588) 155
Increase in deferred revenue 1,455 1,896
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NET CASH (USED IN) PROVIDED BY OPERATING ACTIVITIES 1,042 (5,902)
INVESTING ACTIVITIES
Purchase of property and equipment (1,681) (914)
Capitalization of software development costs (1,227) (1,074)
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NET CASH USED IN INVESTING ACTIVITIES
FINANCING ACTIVITIES (2,908) (1,988)
Proceeds from exercise of stock options 748 2,237
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NET CASH PROVIDED BY FINANCING ACTIVITIES 748 2,237
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NET DECREASE IN CASH AND CASH EQUIVALENTS (1,118) (5,653)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 4,854 9,448
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CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 3,736 $ 3,795
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The accompanying notes are an integral part of these financial statements.
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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, including normal
recurring accruals, considered necessary for a fair presentation have been
included. The operating results for the three and nine month periods ended
September 30, 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 and
Forms 10-Q for the three months ended March 31, 1997 and June 30, 1997,
respectively.
NOTE B - INVENTORIES:
Inventory consists of the following (in 000's):
SEPTEMBER 30, DECEMBER 31,
1997 1996
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Raw materials and components $ 2,726 $ 2,723
Work in process and finished components 4,415 6,014
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7,141 8,737
Less inventory reserves (1,169) (462)
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$ 5,972 $ 8,275
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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 (which will be called
"basic" earnings per share), the dilutive effect of stock options will be
excluded. The impact of Statement No. 128 is not expected to result in a
material change in either primary or fully diluted earnings per share for the
three and nine months periods ended September 30, 1997 and September 30, 1996,
respectively.
NOTE D - RECLASSIFICATIONS:
Certain reclassifications have been made to the prior year financial statements
to conform to the current period's presentation.
Page 6
NOTE E - CONTINGENCIES:
In 1996, an action was brought against the Company by Reon International Corp.
and Reon Corp. in the Superior Court of King County, Washington, in which the
plaintiffs allege breach of contract, misappropriation of trade secrets, and
breach of other obligations by the Company. The action was filed in late July
1996 and, since that time, a significant number of the plaintiffs' initial
claims have been dismissed. The plaintiffs amended their complaint three times,
most recently in January 1997, and now allege that certain transactions between
the parties constitute a joint venture partnership. The plaintiffs seek
dissolution of the alleged joint venture partnership, damages in excess of $10
million, and other relief. The Company believes that the lawsuit is without
merit and is vigorously defending against this action.
Between July 1997 and September 1997, eight separate lawsuits were filed
against the Company, its Chairman of the Board and Chief Executive Officer,
and its former President and Chief Operating Officer in the United States
District Court for the Western District of Washington at Seattle. The
lawsuits are similar in nature and each purports to be a class action on
behalf of all persons who purchased the Company's common stock during periods
ranging between March 31, 1995 and July 30, 1997. The lawsuits allege that
the defendants made false and misleading statements, and failed to disclose
material facts, about the ownership of key patents and proprietary technology
and about the Company's anticipated revenues and earnings, thereby violating
certain federal securities laws. The plaintiffs in these lawsuits seek
damages in unspecified amounts. In September 1997, the parties entered into
a stipulation agreement, approved by the court, for the consolidation of
these lawsuits into a single class action lawsuit. The consolidated
complaint is scheduled to be filed by November 17, 1997. The Company
believes this lawsuit is without merit and is vigorously defending against
this action.
Although no estimate of any outcome of the above lawsuits can currently be
made, an unfavorable resolution of such suits could materially affect the
Company's liquidity, operating results, and/or financial position. The
Company is also a party to other legal proceedings from time to time which
arise in the ordinary course of business and/or which management believes
will be resolved without a material adverse effect on Company's liquidity,
operating results, or financial position.
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CELLULAR TECHNICAL SERVICES COMPANY, INC.
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 included in
Item 1. of this Quarterly Report and Management's Discussion and Analysis of
Financial Condition and Results of Operations contained in the Company's
Annual Report on Form 10-K for the year ended December 31, 1996 and Forms
10-Q for the three months ended March 31, 1997, and June 30, 1997,
respectively.
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 analog 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;
reliance on a relatively small number of suppliers for key components and
processes; 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; conversion of existing letters of intent to agreements for
deployment of the Company's products; 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; the results of pending litigation; 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.
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.
Beginning in 1996, the Company signed agreements with AirTouch Cellular and
certain affiliates ("AirTouch"), Bell Atlantic Mobile ("BAM") (formerly known as
Bell Atlantic NYNEX Mobile), GTE Mobilnet of California Limited Partnership
("GTE-California"), GTE Mobilnet Service Corp. ("GTE Corp."), Ameritech Mobile
Communications, Inc. ("Ameritech") and SNET Mobility ("SNET") to deploy and
support the Blackbird Products. During the last half of 1996, the Company
recorded its first substantive Blackbird Product revenues from AirTouch and
BAM. During 1997, the Company has recorded revenues from all of the customers
noted above. In addition, the Company has signed letters of intent to deploy
the Blackbird Products with two additional domestic carriers and two
international carriers. The Company is currently negotiating contracts with
these carriers but cannot predict for certain if, or when, they will result in
additional sales.
Page 8
Revenue recognition for the Company's systems is based upon performance
criteria which vary by customer and/or by product. The significant factors
used in determining revenue recognition generally include physical hardware
and software delivery, definitions of system delivery, and customer
acceptance. As a result of such performance criteria, the Company may record
a portion of the systems revenues and the majority of the system costs at
shipment or during the early stages of a system deployment. In certain cases
no systems revenues or systems costs may be recorded at time of shipment,
while certain operating costs may be recorded during the deployment process.
Accordingly, revenues and direct margins recorded by the Company can be
expected to be lower in earlier periods of deployment and inconsistent from
quarter to quarter, especially during the initial market deployments under
new agreements. The resulting deferral of revenue is recognized in
subsequent periods upon meeting the performance criteria specified in the
applicable agreement.
In addition, the Company has incurred substantial operating expenses during
the system deployment process, primarily in the areas of sales and marketing,
installation, 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: (i) make substantial investments in research and
development; (ii) enhance its sales and marketing activities; (iii) enhance
its manufacturing processes; (iv) expand and enhance its customer support
capabilities needed to service the anticipated product deployments in both
domestic and international markets; and (v) enhance its general and
administrative activities to support the expansion of the Company's business.
In addition, the Company has incurred, and anticipates it will continue to
incur, increased legal fees in connection with pending litigation.
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. Furthermore, the Company's
Blackbird Products currently are used exclusively for analog cellular
networks. As the Company expands its domestic and international marketing
efforts, and as it pursues expansion of its technology to meet the wireless
communications industry's continued expansion beyond analog 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,
distributors and/or referral arrangements in conjunction with its in-house
sales efforts for sales in the international marketplace.
In addition to the risks inherent in operating in domestic markets (as
described in this and previous filings with the Securities and Exchange
Commission), the Company's operations in foreign markets are also susceptible
to various risks, including, among other things, its ability to: (i) make its
existing and future technology commercially acceptable in foreign markets;
(ii) recognize and successfully adapt to the rapid changes in the global
wireless communications industry (including digital services); (iii) enhance
and expand its manufacturing activities concurrent with its potential growth;
(iv) comply with foreign regulatory requirements without negatively affecting
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, or alter the
scope of, potential revenues and/or increase the cost of doing business in
foreign countries.
THREE MONTHS ENDED SEPTEMBER 30, 1997 COMPARED TO THREE MONTHS ENDED SEPTEMBER
30, 1996.
TOTAL REVENUES decreased 77% to $2.4 million in 1997 from $10.5 million in 1996
and the Company incurred a net loss of $4.7 million, or $0.21 per share in 1997
compared to net income of $.05 million, or $0.00 per share in 1996. The
Company's delay in gaining new orders and system acceptances for its Blackbird
Products during the third quarter of 1997, in which no new systems were shipped,
resulted in a revenue decrease in comparison to the third quarter of 1996. In
the 1996 period, the Company's initial deployment of its Blackbird Products
resulted in the Company recording a small profit for the third quarter of 1996
as compared to the net loss in 1997. The Company attributed the slowdown, which
began in the second quarter of 1997, in part, to delays in the release and
Page 9
acceptance of the newest version of its Blackbird Platform/PreTect
application software. In addition, existing customer roll-out of Blackbird
Platform systems had been slower than anticipated and the sales cycle with
potential new domestic and international customers continued to be uneven.
Subsequent to the end of the third quarter of 1997, the Company began to gain
acceptances of systems from its customers based on its newest software
release.
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, from the sale of system
add-ons and hardware upgrades to systems previously deployed, and to a lesser
extent, fees earned associated with the installation and deployment of such
systems. Systems revenues decreased 90% to $1.0 million in 1997, from $10.3
million in 1996, and represent revenues primarily from third party hardware
and add-ons and upgrade sales for existing systems. System revenues from
Blackbird Products in 1997 were $.7 million compared to $9.7 million in 1996,
where the revenues related to the Company's initial deployment of the
Blackbird Products. System revenues from Hotwatch Products, which were $0.3
million in 1997 compared to $.6 million in 1996, 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
fraud protection services, system monitoring and related professional
services provided in support of the Company's currently deployed product
base. These revenues increased over 600% to $1.4 million in 1997 from $.2
million in 1996 with approximately 90% of the 1997 revenues derived from the
Blackbird Products. This increase is directly attributable to growing service
revenues originating from Blackbird Product deployments in late 1996 and
during 1997. The Company anticipates that total service revenues during 1997
and beyond will continue to increase as a result of the anticipated continued
deployment of the Company's Blackbird Products.
COSTS OF SYSTEMS AND SERVICES, the majority of which relate to the Company's
Blackbird Products, decreased 57% to $3.4 million in 1997 from $7.8 million
in 1996. Costs of systems and services are primarily comprised of the costs
of: (i) equipment, which primarily includes both 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) royalty fees related to the licensing of
intellectual property rights from others; (v) customer support; and (vi)
activities associated with the evaluation, rework and testing of replacement
inventory parts in connection with the Company's ongoing hardware maintenance
service activities. Costs of systems and services, as a percent of total
revenues, were 141% and 75% for the 1997 and 1996 periods, respectively. The
higher cost to revenue ratio in 1997 is primarily attributable to: (a)
unabsorbed fixed overhead in the manufacturing and installation areas as a
result of a delay in gaining new orders and acceptances as described above,
(b) increased amortization of capitalized software costs in conjunction with
the expected commercial release of new software in early 1998; and (c)
increased inventory reserves for both resale and service parts inventories
that address excess and obsolete items resulting primarily from expected
changes in technology of the Company's cloning fraud interdiction methods.
The Company believes that increased sales volumes and/or acceptance of
previously shipped systems during the third quarter of 1997 would have
provided improved margins by achieving a greater leverage of its fixed
overhead costs in the manufacturing, installation and customer support
operations.
SALES AND MARKETING EXPENSES decreased 10% to $.7 million in 1997 from $0.8
million in 1996. The decreased expenses resulted primarily from lower
variable sales incentive compensation which is in line with the decreased
sales volume discussed above. Sales and marketing expenses, as a percent of
revenues, increased to 31% in 1997 from 8% in 1996 and reflects these
expenses being fixed in nature regardless of sales volume.
GENERAL AND ADMINISTRATIVE EXPENSES increased 182% to $1.3 million in 1997
from $.5 million in 1996. The increase was principally due to: (i) increased
personnel related costs associated with the anticipated expansion of the
Company's business; (ii) increased legal expenses related to pending legal
proceedings; and (iii) a bad debt expense of $.4 million attributable to the
sale to a distributor of certain parts
Page 10
which were planned to be used for a prospective customer in the Pacific Rim
region. Subsequent to the sale date, certain governmental bidding
requirements changed, thus rendering these parts previously sold as obsolete.
The Company chose to write off the value of this receivable.
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 38% to $1.8 million in 1997 from $1.3 million in
1996. Software development costs of $0.4 million were capitalized for both
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 previously deployed and non-capitalizable
research and design activities associated with new and/or enhanced products.
Including capitalized software development costs, gross research and
development expenditures increased 29% to $2.2 million in 1997 from $1.7
million in 1996, primarily due to expanded investment in the Blackbird
Products.
INTEREST INCOME increased 60% to $0.08 million in 1997 from $0.05 million in
1996. The increase was attributable to higher average cash balances invested
at higher average interest rates during 1997 as compared to 1996.
NINE MONTHS ENDED SEPTEMBER 30, 1997 COMPARED TO NINE MONTHS ENDED SEPTEMBER 30,
1996
TOTAL REVENUES increased 89% to $26.5 million in 1997 from $14.0 million in
1996 and the Company generated net losses of $1.3 million, or $0.06 per share
in 1997 compared to $4.4 million, or $0.20 per share in 1996. The increase
in revenues, and reduction in losses, is directly attributable to the
Company's deployment and commercial acceptance of its Blackbird Products.
However, lower than expected sales resulted in losses in 1997 and is
primarily attributed to the Company's delay in gaining new orders and
acceptances (as described above) for its Blackbird Products during the second
and third quarters of 1997. The Company attributed the slowdown, in part, to
delays in the release and acceptance of the newest version of its Blackbird
Platform/PreTect application software. In addition, existing customer
roll-out of Blackbird Platform systems had been slower than anticipated and
the sales cycle with potential new domestic and international customers
continued to be uneven. Subsequent to the end of the third quarter of 1997,
the Company began to gain acceptances of systems from its customers based on
its newest software release.
SYSTEMS REVENUES increased 77% to $23.4 million in 1997 from $13.2 million in
1996 and represent revenues primarily from Blackbird Products. Systems
revenues from Hotwatch Products, which were $0.7 million in 1997 and $3.1
million in 1996, are not expected to contribute significantly to future
revenues.
SERVICE REVENUES increased over 300% to $3.0 million in 1997 from $0.7
million in 1996 with approximately 87% of the 1997 revenues derived from the
Blackbird Products. This increase is directly attributable to growing
service revenues originating from Blackbird Product deployments in late 1996
and during 1997. The Company anticipates that total service revenues during
1997 and beyond will continue to increase as a result of the anticipated
continued deployment of the Company's Blackbird Products.
COSTS OF SYSTEMS AND SERVICES increased 47% to $15.5 million in 1997 from
$10.5 million in 1996. Costs of systems and services, as a percent of total
revenues, were 58% and 75% for the 1997 and 1996 periods, respectively. The
improvement in 1997 is primarily attributable to: (i) an increased volume of
system sales that carried higher direct variable margins; (ii) leveraging
fixed overhead costs relating to manufacturing, installation and system
integration; and (iii) increased service revenues that benefited from
leveraging fixed customer support operating expenses. This improvement,
however, is worse than expected due to the lower than expected sales
discussed above. The Company believes that increased sales volumes and/or
acceptance of previously shipped systems during the second and third quarters
of 1997 would have provided higher margins by achieving even greater leverage
of its fixed overhead costs in the manufacturing, installation and customer
support operations
Page 11
SALES AND MARKETING EXPENSES increased 35% to $3.1 million in 1997 from $2.3
million in 1996. This increase is primarily attributable to (i) personnel and
related costs incurred in connection with the Company's increased efforts to
generate and maintain demand for its products, (ii) the costs incurred during
both pre- and post-sales contract activities related to the Blackbird
Products, and (iii) variable sales incentive compensation. Sales and
marketing expenses, as a percent of revenues, decreased to 12% in 1997 from
17% in 1996 and is attributable to leveraging the Company's fixed costs in
generating the 89% increase in revenues.
GENERAL AND ADMINISTRATIVE EXPENSES increased 44% to $3.1 million in 1997
from $2.1 million in 1996. The increase of $1.0 million is net of $0.4
million of non-recurring expenses incurred during the second quarter of 1996
with regard to the Company's proposed secondary public offering which was
subsequently withdrawn due to unfavorable stock market conditions. The 1997
expenses include increased legal costs incurred in connection with pending
legal proceedings and also included $.4 million of bad debt expense as
discussed above. The balance of the increase was principally due to
increased personnel related costs associated with the anticipated expansion
of the Company's business.
RESEARCH AND DEVELOPMENT COSTS increased 70% to $6.3 million in 1997 from
$3.7 million in 1996. Software development costs of $1.2 million and $1.1
million were capitalized during 1997 and 1996, respectively, 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
previously deployed and non-capitalizable research and design activities
associated with new and/or enhanced products. Including capitalized software
development costs, gross research and development expenditures increased 60%
to $7.5 million in 1997 from $4.7 million in 1996, primarily due to expanded
investment in the Blackbird Products.
INTEREST INCOME decreased 22% to $0.17 million in 1997 from $0.22 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
and hardware research and development, property and equipment requirements,
working capital and the Company's operating losses in certain 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 September 30, 1997 the Company's cash
balance was $3.7 million as compared to $4.9 million on December 31, 1996. The
Company's working capital decreased to $10.1 million at September 30, 1997 from
$11.4 million at December 31, 1996.
CASH PROVIDED BY OPERATING ACTIVITIES amounted to $1.0 million in 1997, as
compared to cash used by operating activities of $5.9 million in 1996. The
major factor contributing to the Company's improved cash flow from operating
activities is the $3.1 million lower loss that was recorded in 1997 as
compared to 1996. Depreciation and amortization expenses, which do not
utilize cash for operating activities, increased $.8 million and is primarily
attributable to: (a) increased investments in software development and property
and equipment as discussed below; and (b) increased amortization of capitalized
software as discussed above. In addition, the net changes in the balances of
the major working capital components affected cash flow from operating
activities during 1997 and included:
(i) accounts receivable, which decreased as a result of: (a) collection of
older 1996 receivables originating from the initial deployments of the
Blackbird Products; and (b) more favorable payment terms on early 1997
system shipments as compared to the payment terms for the initial 1996
system shipments. Notwithstanding these factors, the age of receivables
lengthened during the third quarter of 1997 due to: (I) selected payment
terms granted to both new and existing customers during the contract
negotiation process in the second quarter of 1997; and (II) delays in
payment by existing customers to address system performance issues
Page 12
encountered during the third quarter. As of the current date, improved
system performance has enabled the Company to collect approximately
$2 million of the September 30, 1997 outstanding accounts receivable
balance;
(ii) inventories, which decreased due to (a) the Company's inventory balancing
efforts undertaken after the significant inventory build-up during the
fourth quarter of 1996. Notwithstanding these inventory balancing
efforts, the Company has placed orders for and is beginning to receive
inventory for more than $2 million which is anticipated to be used for
fourth quarter 1997 and first quarter 1998 production of hardware
primarily for anticipated sales to prospective international customers;
and (b) inventory reserves of $.7 million recorded as a provision for
excess and obsolete inventory, primarily resulting from delayed sales as
discussed above and to technology changes in the Company's cloning fraud
interdiction methods;
(iii) accounts payable, which decreased primarily due to 1997 payments made
for fourth quarter 1996 inventory purchases;
(iv) deferred revenue, which increased primarily as a result of the growth of
prepaid maintenance and service contracts related to system sales of the
Blackbird Products; and
(v) customer deposits, which decrease reflects application of payments
received in 1996 (that originated from 1996 shipments) against related
revenues recorded in 1997.
CASH UTILIZED BY INVESTING ACTIVITIES totaled $2.9 million and $2.0 million
in 1997 and 1996, respectively. The Company's capital requirements during
such periods were for: (i) capitalization of software development of the
Blackbird Products; and (ii) purchase of property and equipment, primarily for
furniture, leaseholds, and equipment associated with expanding the Company's
business. These expenditure levels are expected to be at a lower rate during
the later part of 1997 but could increase more significantly in 1998 should
the Company experience significant growth or increase its expenditures for
product development or product acquisition related activities. At September
30, 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. The Company is currently
evaluating such opportunities complementary to the Blackbird Products.
CASH PROVIDED BY FINANCING ACTIVITIES (exercise of stock options by the
Company's directors, officers and employees) totaled $0.7 million and $2.2
million during 1997 and 1996, respectively. Also contributing to available
cash for use in 1997 was a November 1996 sale of 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%, had an initial term that ended
September 30, 1997, and was renewed through June 30, 1998. The proceeds from
the stock sale have been used and the line of credit may 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.
During the early stages of deploying the Blackbird Products, the Company has
experienced uneven cash flow and operating results. These factors originate
primarily from uneven quarterly sales, cash receipts associated with deferred
revenue recognition and varying payment terms contained in customer
agreements.
A continuation of the lower than expected revenues, significant sales growth
requiring working capital beyond current amounts or other changes in the
Company's operating activities may require additional financing during the next
twelve months. The Company will consider such financing, if required, through
debt, equity or a combination of both.
Page 13
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
In 1996, an action was brought against the Company by Reon International
Corp. and Reon Corp. in the Superior Court of King County, Washington, in
which the plaintiffs allege breach of contract, misappropriation of trade
secrets, and breach of other obligations by the Company. The action was
filed in late July 1996 and, since that time, a significant number of the
plaintiffs' initial claims have been dismissed. The plaintiffs amended their
complaint three times, most recently in January 1997, and now allege that
certain transactions between the parties constitute a joint venture
partnership. The plaintiffs seek dissolution of the alleged joint venture
partnership, damages in excess of $10 million, and other relief. The Company
believes that the lawsuit is without merit and is vigorously defending
against this action.
Between July 1997 and September 1997, eight separate lawsuits were filed
against the Company, its Chairman of the Board and Chief Executive Officer,
and its former President and Chief Operating Officer in the United States
District Court for the Western District of Washington at Seattle. The
lawsuits are similar in nature and each purports to be a class action on
behalf of all persons who purchased the Company's common stock during periods
ranging between March 31, 1995 and July 30, 1997. The lawsuits allege that
the defendants made false and misleading statements, and failed to disclose
material facts, about the ownership of key patents and proprietary technology
and about the Company's anticipated revenues and earnings, thereby violating
certain federal securities laws. The plaintiffs in these lawsuits seek
damages in unspecified amounts. In September 1997, the parties entered into
a stipulation agreement, approved by the court, for the consolidation of
these lawsuits into a single class action lawsuit. The consolidated
complaint is scheduled to be filed by November 17, 1997. The Company
believes this lawsuit is without merit and is vigorously defending against
this action.
Although no estimate of any outcome of the above lawsuits can currently be
made, an unfavorable resolution of such suits could materially affect the
Company's liquidity, operating results, and/or financial position. The
Company is also a party to other legal proceedings from time to time which
arise in the ordinary course of business and/or which management believes
will be resolved without a material adverse effect on Company's liquidity,
operating results, or financial position.
Item 6. Exhibits and Reports on Form 8-K
A) EXHIBITS
--------
10.1 Renewal of Credit Agreement between the Company and Chase Manhattan
Bank dated September 29, 1997 (1)
11.1 Computation of Earnings Per Share (1)
27 Financial Data Schedule (1)
____________________________________________
(1) Filed herewith.
B) No reports on Form 8-K were filed during the quarter for which this report
is filed.
Page 14
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
November 13, 1997
Page 15
EXHIBIT 10.1
(logo) CHASE
THE CHASE MANHATTAN BANK CAROLYN B. LATTANZI
395 North Service Road, Suite 302 Vice President
Melville, NY 11747-3142 Nassau Middle Market
Tel 516-755-5163
Fax 516-755-0152
September 29, 1997
Mr. Stephen Katz
Chairman of the Board/Chief Executive Officer
CELLULAR TECHNICAL SERVICES COMPANY, INC.
2401 Fourth Avenue
Seattle, Washington 98121
Dear Steve,
We are pleased to advise you that based upon your annual financial statements
for the fiscal year ending December 31, 1996, The Chase Manhattan Bank (the
"Bank") has approved your request for a secured line of credit for Cellular
Technical Services Company, Inc., in the aggregate amount of $5,000,000. The
line of credit will be secured by a first priority perfected security
interest in all personal property of Cellular Technical Services Company,
Inc. Our officers may, at their discretion, make short-term loans to
Cellular Technical Services Company, Inc., on such terms as are mutually
agreed upon between us from time to time.
Borrowings under this line of credit are intended to be used to meet your
normal short-term working capital needs and will bear interest at 3/4% over
our prime rate. This line of credit has an associated administration fee of
$4,000, payable in advance.
It is a condition that all outstandings under the line be repaid for a
consecutive 30 day period before the expiration date of this line.
As this line is not a commitment, credit availability is, in addition,
subject to your execution and delivery of such documentation as the Bank
deems appropriate and the receipt and continuing satisfaction with current
financial information, which information will be furnished to the Bank as it
may from time to time reasonably request. This line of credit expires on
June 30, 1998.
We are pleased to be of service and trust you will call upon us to assist in
any of your banking requirements.
Very truly yours,
/s/ Carolyn B. Lattanzi
EXHIBIT 11.1 COMPUTATION OF EARNINGS PER SHARE
CELLULAR TECHNICAL SERVICES COMPANY, INC.
COMPUTATION OF EARNINGS PER SHARE
(in 000's, except per share amounts)
(unaudited)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------- --------------------------
1997 1996 1997 1996
---------- ----------- ----------- ----------
Primary earnings per share:
Net income (loss) for calculation
of primary earnings per share $ (4,749) $ 54 $ (1,331) $ (4,437)
----------- ----------- ----------- ----------
----------- ----------- ----------- ----------
Weighted average number of shares outstanding 22,779,612 22,064,713 22,705,053 21,857,357
Dilutive effect of outstanding stock
options - based upon the Treasury
Stock Method using average market price(1) 1,524,012
----------- ----------- ----------- ----------
Weighted average number of shares,
as adjusted, for calculation of
primary earnings per share 22,779,612 23,588,725 22,705,053 21,857,357
---------- ----------- ----------- ----------
---------- ----------- ----------- ----------
Primary earnings (loss) per share(2) $ (.21) $ .00 $ (.06) $ (.20)
---------- ----------- ----------- ----------
---------- ----------- ----------- ----------
- ----------------------
(1) Common Stock equivalent shares have not been considered in the
calculations for the nine month periods ended September 30, 1996 and the
three and nine month periods ended September 30, 1997 because the effect
would be antidilutive.
(2) Fully diluted earnings per share computations are not included since they
would not materially change results presented on the primary earnings per
share basis.
Page 16
5
1,000
9-MOS
DEC-31-1997
SEP-30-1997
3,736
0
6,319
162
5,972
16,424
7,656
3,695
23,930
6,328
0
0
0
23
17,579
23,930
23,432
26,472
9,869
27,970
0
0
0
(1,331)
0
(1,331)
0
0
0
(1,331)
(0.06)
0
