SECURITIES AND EXCHANGE COMMISSION
Washington, DC. 20549
FORM 10-Q
Quarterly Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the quarterly period ended Commission File Number 0-19437
September 30, 1998
CELLULAR TECHNICAL SERVICES COMPANY, INC.
(Exact Name of Registrant as Specified in Its Charter)
Delaware 11-2962080
- ------------------------------------ ---------------------------------
(State or Other Jurisdiction of (I.R.S. Employer Identification No.)
Incorporation or Organization)
2401 Fourth Avenue, Seattle, Washington 98121
-------------------------------------------------
(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code: (206) 443-6400
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
--- ---
22,815,092 Common Shares were outstanding as of November 12, 1998.
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......8
PART II. OTHER INFORMATION.........................................................................16
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K..........................................................16
Page 2
Cellular Technical Services Company, Inc.
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
BALANCE SHEETS
(in 000's, except per share amounts)
September 30, December 31,
1998 1997
-------------- ---------------
(unaudited)
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 1,976 $ 3,448
Accounts receivable, net of allowances of $58 in 1998 and $187 in 1997 1,609 3,190
Inventories, net 2,875 6,428
Prepaid expenses and other current assets 279 300
-------------- ---------------
Total Current Assets 6,739 13,366
PROPERTY AND EQUIPMENT, net 2,513 3,964
SOFTWARE DEVELOPMENT COSTS, net 1,421 3,391
-------------- ---------------
TOTAL ASSETS $ 10,673 $ 20,721
============== ===============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable and accrued liabilities $ 1,456 $ 2,799
Payroll related liabilities 353 792
Taxes (other than payroll and income) 64 549
Customers' deposits 7 15
Deferred revenue 3,013 2,676
-------------- ---------------
Total Current Liabilities 4,893 6,831
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, 22,815 and 22,795 shares issued
and outstanding in 1998 and 1997, respectively 23 23
Additional paid-in capital 29,931 29,889
Accumulated Deficit (24,174) (16,022)
-------------- ---------------
Total Stockholders' Equity 5,780 13,890
-------------- ---------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 10,673 $ 20,721
============== ===============
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,
--------------------------- ----------------------------
1998 1997 1998 1997
------------ ----------- ------------- ------------
REVENUES
Systems $ 516 $ 993 $ 3,839 $ 23,432
Services 1,900 1,386 5,423 3,040
------------ ----------- ------------- ------------
Total Revenues 2,416 2,379 9,262 26,472
COSTS AND EXPENSES
Cost of systems and services 3,373 3,356 10,515 15,468
Sales and marketing 124 744 762 3,127
General and administrative 516 1,298 1,920 3,069
Research and development 862 1,805 3,941 6,306
Loss on disposal of assets 5 0 334 0
------------ ----------- ------------- ------------
Total Costs and Expenses 4,880 7,203 17,472 27,970
------------ ----------- ------------- ------------
LOSS FROM OPERATIONS (2,464) (4,824) (8,210) (1,498)
INTEREST INCOME, net 17 75 56 167
------------ ----------- ------------- ------------
NET LOSS $ (2,447) $ (4,749) $ (8,154) $ (1,331)
============ =========== ============= ============
NET LOSS PER SHARE:
Basic and Diluted $ (0.11) $ (0.21) $ (0.36) $ (0.06)
============ =========== ============= ============
WEIGHTED AVERAGE SHARES
OUTSTANDING:
Basic and Diluted 22,815 22,780 22,811 22,705
============ =========== ============= ============
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,
------------------------------
1998 1997
------------- -------------
OPERATING ACTIVITIES
Net loss $ (8,154) $ (1,331)
Adjustments to reconcile net loss to net cash (used in) provided by
operating activities:
Depreciation and amortization of property and equipment 1,120 897
Amortization and write off of software development costs 2,540 1,281
Loss on disposal of assets 334 0
(Reduction in) provision for accounts receivable reserves (58) 498
Provision for inventory reserves 2,685 718
Other non cash charges 42 0
Changes in operating assets and liabilities:
Decrease in accounts receivable 1,639 4,961
Decrease in inventories 868 1,585
Decrease in prepaid expenses and other current assets 21 272
(Decrease) in accounts payable and accrued liabilities (1,342) (4,700)
(Decrease) increase in payroll related liabilities (439) 90
(Decrease) in taxes (other than payroll and income) (485) (96)
(Decrease) in customers' deposits (7) (4,588)
Increase in deferred revenue 337 1,455
------------- -------------
NET CASH (USED IN) PROVIDED BY OPERATING ACTIVITIES (899) 1,042
INVESTING ACTIVITIES
Purchase of property and equipment (159) (1,681)
Proceeds from sale of assets 156 0
Capitalization of software development costs (570) (1,227)
------------- -------------
NET CASH USED IN INVESTING ACTIVITIES (573) (2,908)
FINANCING ACTIVITIES
Proceeds from exercise of stock options 0 748
------------- -------------
NET CASH PROVIDED BY FINANCING ACTIVITIES 0 748
------------- -------------
NET DECREASE IN CASH AND CASH EQUIVALENTS (1,472) (1,118)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 3,448 4,854
------------- -------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 1,976 $ 3,736
============= =============
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, 1997 balance sheet
which has been derived from audited financial statements, have been prepared in
accordance with generally accepted accounting principles for interim financial
information and with the instructions to Form 10-Q and Rule 10-01 of Regulation
S-X. Accordingly, they do not include all of the information and footnotes
required by generally accepted accounting principles for complete financial
statements. In the opinion of management, all adjustments (consisting of normal
recurring accruals) considered necessary for a fair presentation have been
included. The operating results for the three and nine month periods ended
September 30, 1998, are not necessarily indicative of the results that may be
expected for the fiscal year ending December 31, 1998. 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, 1997 and
Form 10-Q for the three months ended March 31, 1998 and six months ended June
30, 1998, respectively.
NOTE B - INVENTORIES:
Inventories consist of the following (in 000's):
September 30, December 31,
1998 1997
----------------- -----------------
Raw materials and components $ 1,885 $ 2,571
Work in process and finished components 5,056 5,954
----------------- -----------------
6,941 8,525
Less inventory reserves (4,066) (2,097)
----------------- -----------------
$ 2,875 $ 6,428
================= =================
NOTE C - CONTINGENCIES:
The following legal matters are outstanding as of September 30, 1998:
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. The lawsuits were filed in the
United States District Court for the Western District of Washington at Seattle,
and have now been consolidated. A revised consolidated complaint was filed by
plaintiffs on February 17, 1998. The complaint purports to assert claims on
behalf of the class of persons, other than defendants and their affiliates, who
purchased the Company's common stock or call options on the Company's common
stock, or who sold put options on the Company's common stock, during the period
March 6, 1996 through July 30, 1997, inclusive (the "Class Period"). The
complaint alleges that the defendants made false or misleading statements and
failed to disclose material facts during the Class Period in violation of the
federal securities laws. The plaintiffs in this lawsuit seek damages in an
unspecified amount. The Company believes this lawsuit is without merit and is
vigorously defending against it.
On January 13, 1998, Communications Information Services, Inc. filed an action
against the Company and AirTouch Communications, Inc. for alleged infringement
of United States Patent No. 5,329,591 ("the `591 patent") in the United States
District Court for the Northern District of Georgia at Atlanta. The complaint
asserts that the plaintiff is the exclusive licensee of all rights under the
`591 patent. The complaint alleges that the Company's cellular telephone fraud
prevention technology infringes the `591 patent, and seeks damages in
unspecified amounts. The Company believes this lawsuit is without merit and is
vigorously defending against it.
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CELLULAR TECHNICAL SERVICES COMPANY, INC.
NOTES TO FINANCIAL STATEMENTS (con't)
NOTE C - CONTINGENCIES (continued):
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
financial position, liquidity or results of operations. The Company is also a
party to other legal proceedings which arise from time to time in the ordinary
course of business, and/or which management believes will be resolved without a
material adverse effect on the Company's financial position, liquidity or
results of operations.
NOTE D - RECENT ACCOUNTING STANDARDS:
The Financial Accounting Standards Board released Statement of Financial
Accounting Standards No. 130, "Reporting Comprehensive Income" ("SFAS No. 130"),
governing the reporting and display of comprehensive income and its components,
and Statement of Financial Accounting Standards No. 131, "Disclosures About
Segments of an Enterprise and Related Information" ("SFAS No. 131"), requiring
that all public businesses report financial and descriptive information about
their reportable operating segments. Both statements are applicable to reporting
periods beginning after December 15, 1997. The adoption of SFAS Nos. 130 and 131
is not applicable to the Company at this time, nor to the financial statements
or notes to the financial statements.
NOTE E - NET LOSS PER SHARE:
The calculation of basic and diluted earnings per share is as follows (in 000's,
except per share amounts):
Three Months Ended Nine Months Ended
September 30, September 30,
----------------------------- ------------------------------
1998 1997 1998 1997
------------- ------------- ------------- -------------
Net loss $ (2,447) $ (4,749) $ (8,154) $ (1,331)
============= ============= ============= =============
Weighted average number of shares:
for basic net loss per share 22,815 22,780 22,811 22,705
Effect of dilutive securities:
Employee stock options - - - -
------------- ------------- ------------- -------------
Weighted average number of shares:
for diluted earnings per share 22,815 22,780 22,811 22,705
Net Loss per share - Basic and $ (0.11) $ (0.21) $ (0.36) $ (0.06)
Diluted
============= ============= ============= =============
NOTE F - RECLASSIFICATIONS:
Certain reclassifications have been made to the prior period financial
statements to conform to the current period's presentation.
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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.
Special Note Regarding Forward-Looking Statements
This quarterly report on Form 10Q contains certain forward-looking statements
within the meaning of the Private Securities Litigation Reform Act of 1995.
Generally, such statements are indicated by words or phrases such as
"anticipate," "expect," "intend," "the Company believes," and similar words and
phrases. Such statements are based on current expectations and are subject to
risks, uncertainties and assumptions. Certain of these risks are described in
Item 7, "Business Risks" in the Company's Annual Report on Form 10K for the year
ended December 31, 1997 and other filings with the Securities and Exchange
Commission. Should one or more of these risks or uncertainties materialize or
should underlying assumptions prove incorrect, actual results may vary
materially from those results anticipated, expected, intended or believed.
Overview
The Company has developed the Blackbird'r' Platform, PreTect'TM' cloning fraud
prevention application, and related application products and services
("Blackbird Products") to address the wireless communications industry's need to
more effectively combat cloning fraud. 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 1996, the Company's revenues had been primarily derived from the
Company's Hotwatch'r' Platform and related application products and services
("Hotwatch Products"). The Hotwatch Products, which the Company no longer
actively markets, were designed to provide credit management and prepaid billing
applications and services to the wireless industry. Revenues from sales of
Hotwatch Products have declined over the past two years, and are expected to
continue to decline and most likely be eliminated in future years.
Since 1996, the Company has 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. From time to time, the Company also participates
in trials of its products with the goal of gaining contracts with new customers.
In this regard, the Company has participated in product trials in various
domestic and international markets, the efforts of which have been converted
into agreements for certain domestic carriers described above. To date, the
Company has not been successful in converting its efforts in its international
trials to signed agreements. Whether any of its international opportunities will
result in any new business is unknown at this time.
Revenues
The Company's revenues are derived from two sources: system revenues and service
revenues.
System 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.
Revenues are recognized when all of the following conditions are met: persuasive
evidence of an arrangement exists, delivery has occurred (contract criteria have
been satisfied), the amount is fixed and determinable, and collectability is
probable. Non-revenue generating obligations after delivery are not material.
Service revenues are derived primarily from hardware and software maintenance
(which may include an allocation of system revenue payments as warranty
provisions), software upgrades and releases, No Clone Zone'sm' roaming fraud
prevention services, system monitoring, and related professional services
provided in support of the Company's currently deployed product base. Service
revenues are recognized ratably over the period that the warranty or maintenance
coverage is provided. Hardware
Page 8
and software maintenance generally begins after system acceptance. Prepaid or
allocated maintenance and/or services are recorded as deferred revenues.
Revenue recognition for the Company's systems varies by customer and by product.
The significant factors used in determining revenue recognition generally
include physical hardware and software delivery, definitions of system delivery,
and customer acceptance. For those agreements which provide for payment based
upon meeting actual performance criteria, the Company may record a portion of
the systems revenues and the majority of the systems 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. The Company does not operate
with a significant revenue backlog. Amounts billed and/or received on sales
contracts before revenue is recognized are recorded as customer deposits.
Costs and Expenses
Costs of systems and services are primarily comprised of the costs of: (i)
equipment, which includes both proprietary and third-party hardware and, to a
lesser extent, manufacturing overhead and related expenses; (ii) amortization of
capitalized software development costs; (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 returned from the field in connection with the Company's ongoing hardware
maintenance service activities.
In addition, the Company incurs substantial operating expenses during the system
deployment, maintenance and support processes, primarily in the areas of
installation, customer support, and research and development. The Company
expects that its costs and expenses in these and other areas will be
significantly lower for the balance of 1998 as compared to 1997, but will
continue to be incurred in the future, due to the ongoing need to: (i) make
investments in research and development; (ii) enhance its sales and marketing
activities; (iii) enhance its manufacturing and hardware maintenance processes;
(iv) enhance its customer support capabilities; and (v) enhance its general and
administrative activities.
Market Trends and Recent Developments
The Company's future success will depend on the continued and expanded use of
its existing products and services, its ability to develop new products and
services to meet the needs of the wireless communications industry, and its
ability to adapt existing products and services to keep pace with changes in the
wireless communications industry. Certain industry trends affecting the
Company's business are described below.
Shift to Digital Networks
Currently, the Company's Blackbird Products are used exclusively in analog
cellular networks, although the Company believes that its Blackbird Products may
be adaptable for use in digital networks, such as digital cellular and digital
Personal Communications Services ("PCS") networks, but not without incurring
significant additional expenses. The Company believes that the majority of
domestic wireless telephone service today is provided in the analog mode, but
that the industry is undertaking a shift to digital mode in many markets due to
certain advantages of the digital mode, including expanded capacity, greater
privacy and enhanced security. As a result, industry analysts project that the
number of analog cellular phones will decline over time in favor of digital
cellular and digital PCS phones.
Emergence of A-Key Authentication
The technology used in existing analog and digital networks enables wireless
carriers to incorporate various technologies to combat cloning fraud, including
the RF fingerprinting method utilized by the Blackbird Products and
cryptographic authentication. One form of cryptographic authentication, commonly
known as "A-Key authentication," uses a complex algorithm derived from a
mathematical cryptographic process containing a secret key (number) shared only
by the phone and
Page 9
the carrier's network. Almost all digital and analog phones currently being
distributed into the wireless communications system are now equipped with the
A-Key capability. A-Key authentication is expected to be the most widely adopted
cryptographic authentication by wireless carriers in the United States. A-Key
technology in the digital mode (and to a lesser, but still significant, extent
in an analog mode) is now in extensive use by large cellular carriers in most of
the largest domestic markets. Through the American National Standards Institute
inter-switch signaling standard ANSI-41, A-Key authentication can now provide
roaming protection between like-equipped vendors. The Company believes that such
cryptographic authentication has been effective and could become increasingly
effective in reducing cloning fraud, provided that it is not compromised.
However, the Company believes that full deployment of A-Key authentication
compliant with the ANSI-41 standard could take a number of years to complete.
The Company believes that extensive efforts and cooperation among the large
market carriers, small market carriers, wireless industry associations, and
wireless technology providers is required to implement a fully-functional A-Key
authentication system. Given such factors, the Company believes that subscribers
of digital wireless networks will continue to be susceptible to cloning fraud
while roaming in the analog mode.
Market Penetration of Cloning Fraud Prevention Products
A relatively small number of analog cellular carriers constitute the potential
customers for Blackbird Products in the United States today. Currently, a large
majority of cellular carriers in the largest domestic markets are using cloning
fraud prevention products in varying degrees. The Company believes that the
combined deterrent of RF fingerprinting, A-Key authentication, and other cloning
fraud prevention technologies has significantly reduced cloning fraud in
domestic markets. Although cloning fraud remains a serious concern for the
wireless communications industry, the Company's customers have observed
significant and continual reductions in cloning fraud since their initial
successful deployments of the Company's Blackbird Products.
Affects on the Company's Business
As a result of the above trends, the Company has experienced and expects to
continue to experience a significant decline in demand in the United States for
its PreTect cloning fraud prevention application. The Company believes that
similar declines in demand have occurred and will continue to occur for
competing cloning fraud prevention technologies in the United States. The
Company believes that this trend could also occur in international markets over
time. The Company incurred significant operating losses in 1996 and 1997 during
its initial years of deployment of the Blackbird Products and, in light of the
above trends, such losses have continued during the first nine months of 1998.
In view of these market trends, the Company expects to continue its efforts to:
(i) gain sales of Blackbird Products in both domestic and international markets;
(ii) enhance its existing products and develop new products, including other
application products utilizing the Blackbird platform; and (iii) pursue business
opportunities that complement the Company's existing business, including
strategic alliances with, and acquisitions of, complementary technologies and
businesses. As part of these efforts, in January 1998, the Company began
implementation of a strategic restructuring plan that has included, among other
initiatives, streamlining the Company's operations to achieve more balance
between expenses and revenues, and directing additional development efforts and
resources toward new and complementary products to meet the ongoing needs of the
wireless communications industry and generate new sources of revenue for the
Company. As a result, the Company's workforce has been reduced to approximately
one-third of staffing levels as of December 31, 1997. As an additional part of
this plan, the Company has reevaluated the recoverability of the capitalized
software and inventory values recorded on its balance sheet. In this regard, the
Company has recorded significant reserves and expenses against those values
during 1998, and will continue to reduce the estimated recoverability of those
assets in the coming quarters if it is unsuccessful in generating significant
sales of its existing Blackbird Products.
There can be no assurance that the Company will be able to successfully achieve
further domestic or international market penetration, enhance existing products
or develop new products, acquire complementary technologies and businesses, or
timely introduce and gain acceptance of such enhancements, new products, or
complementary technologies in the marketplace. If the Company is unable, due to
resource, technological or other constraints, to adequately anticipate or
respond to changing market, customer or technological requirements, the
Company's business, financial condition and results of operations will be
materially adversely affected.
Page 10
Year 2000 Processing
The Company is currently utilizing internal resources and, where appropriate,
outside resources to comprehensively identify and timely resolve the potential
impact of the Year 2000 and beyond processing of date-sensitive information by
the Company's three products and systems categories: Blackbird Products,
Hotwatch Products and internal systems. Generally, Year 2000 processing issues
are the result of software that use two digits (rather than four digits) to
define the applicable year. Thus, for example, any software that utilizes
date-sensitive coding may recognize a date using "00" as the Year 1900 rather
than the Year 2000, which could result in miscalculations or system failures.
The Company believes that it has completed the majority of work required to
address its Year 2000 processing issues. The general status of each of the three
categories described above are as follows:
Blackbird Products - The Company has substantially completed its assessment of
Year 2000 compliance for its Blackbird Products. The Company believes that its
software incorporated in these products is Year 2000 compliant in all material
respects. With respect to third-party software incorporated in these products,
all vendors of such software have indicated that their software is Year 2000
compliant. In addition, the Company has tested and verified that the Blackbird
Products, when used in conjunction with such third-party software, is Year 2000
compliant in all material respects.
Hotwatch Products - The Company's Hotwatch Products, which revenues are not
currently material to the Company's financial position, results of operations,
or cash flows, are not currently Year 2000 compliant. The Company has identified
the aspects of these products that would require enhancements to become Year
2000 compliant, and is in the process of determining with its customers whether
it will perform such enhancements. The Company expects that any Year 2000
compliance project for these products, if initiated, will be completed in a
timely manner.
Internal Systems - With regard to the Company's internal systems used in its
operations, the Company is in the process of identifying and testing all systems
for Year 2000 compliance. To date, a majority of such systems have been
confirmed to be either presently Year 2000 compliant in all material respects,
or Year 2000 compliant with the purchase of readily-available software upgrades
or alternatives that are currently identified to be Year 2000 compliant. The
Company expects that all of its Year 2000 compliance projects for internal
systems will be completed in a timely manner.
Costs incurred to date for Year 2000 compliance issues have not been significant
and costs to complete are not currently expected to have a material adverse
impact on the Company's financial position, results of operations, or cash flows
in future periods. If, however, the Company, its customers, or its vendors are
unable to adequately resolve any Year 2000 compliance issues not yet addressed
in a timely manner, the Company's business, financial condition and/or results
of operations may be adversely affected. In addition, the Company has on
occasion agreed to warrant and/or indemnify certain of its customers for claims
and losses arising out of the failure of its products to be Year 2000 compliant.
There can be no assurance that the Company's current and future products and
internal systems do not contain undetected errors related to Year 2000 that may
result in material additional costs or liabilities that could have a material
adverse effect on the Company's business, financial condition and/or results of
operations. Further, to the extent that the Company is not able to test the
technology provided to it by third parties for its own use or for
redistribution, or to obtain adequate assurances from such third parties that
their products are Year 2000 compliant, the Company may experience material
additional costs or liabilities that could have a material adverse effect on the
Company's business, financial condition, and/or results of operations.
THREE MONTHS ENDED SEPTEMBER 30, 1998 COMPARED TO THREE MONTHS ENDED SEPTEMBER
30, 1997
Total revenues remained constant at $2.4 million in 1998 and 1997 and resulted
in the Company incurring a net loss of $2.4 million, or $0.11 per share in 1998,
compared to net loss of $4.7 million, or $0.21 per share in 1997.
System revenues decreased 50% to $0.5 million in 1998 from $1.0 million in 1997,
and primarily represent revenues from customers for the Company's Blackbird
Products. System revenues from Hotwatch Products were zero in 1998, as compared
to $0.3 million in 1997. The Company expects minimal Hotwatch revenue for the
balance of 1998 and beyond. The Company attributes the decrease in revenues from
Blackbird Products to: (i) a reduction in domestic market opportunities for the
Company's cloning fraud prevention technology, due to the effectiveness of this
and other authentication-based products in combating cloning fraud; (ii) lower
penetration than originally planned of Blackbird Platform systems into existing
customers' markets and to new and/or additional markets; and (iii) the continued
uneven sales
Page 11
cycle of, and lengthy trial periods required for, potential new domestic and
international customers. The Company's shipment trends for the past five
quarters (0, 26, 50, 105 and 0 units respectively for the quarters ended
September 30, 1997, December 31, 1997, March 31, 1998, June 30, 1998 and
September 30, 1998, respectively) had initially improved after solving certain
software issues encountered during the second quarter of 1997. However, the
Company has not been able to generate a level of new orders in the first three
quarters of 1998, or through the current date, that would result in
profitability in the immediate future.
Service revenues increased 36% to $1.9 million in 1998 from $1.4 million in
1997. Approximately 93% and 90%, respectively, of the 1998 and 1997 total
service revenues were derived from the Blackbird Products. This increase is
attributable to growing service revenues originating from Blackbird Product
deployments in 1996, 1997 and during the first three quarters of 1998. The
Company anticipates that total service revenues will increase during the balance
of 1998 as a result of the anticipated acceptance of shipments made during the
first two quarters of 1998 and prior periods.
Costs of systems and services, the majority of which relate to the Company's
Blackbird Products, were $3.4 million in 1998, unchanged from 1997. Costs of
systems and services, as a percent of total revenues, were 140% and 141% for the
1998 and 1997 periods, respectively. While the percentages were similar, the
components comprising costs of systems and services differed. These costs, as
a percent of revenues, were negatively impacted by: (i) a decrease in systems
revenues in 1998, resulting in a decreased leveraging of its fixed overhead
costs relating to manufacturing, installation and systems integration, despite
significant cost reductions implemented in 1998 in connection with the Company's
strategic restructuring plan; (ii) an increase in the provision for inventory
reserves to $1.2 million in 1998 from $0.5 million in 1997, reflecting excess
inventory quantities resulting from lower future sales projections based on
changing market conditions; and (iii) an increase in and the acceleration of
the amount of amortization of capitalized software costs to $0.9 million in 1998
from $0.7 million in 1997, reflecting current estimates of recoverability values
resulting from lower future sales projection based on changing market
conditions. Should sales of the Company's products not materialize to levels to
achieve recoverability of the investments in both inventory and capitalized
software, additional substantial reserves and amortization would be required
in future quarters. The investments in inventory and capitalized software at
September 30, 1998 are $2.9 million and $1.4 million, respectively. Conversely,
the Company benefited from increased leveraging of fixed customer support
operating expenses. The Company also benefited from cost reductions implemented
in 1998 in connection with the Company's strategic restructuring plan.
Sales and marketing expenses decreased 83% to $0.1 million in 1998, from $0.7
million in 1997, and, as a percent of revenues, decreased to 5% in 1998 from 31%
in 1997. The decrease in sales and marketing expenses resulted primarily from:
(i) a reduction in staffing levels and related expenses in connection with the
Company's strategic restructuring plan; (ii) reduction in trade shows and other
events in which the Company participated; and (iii) lower incentive compensation
expense, which varies with revenue.
General and administrative expenses decreased 60% to $0.5 million in 1998 from
$1.3 million in 1997 and primarily reflect: (i) a reduction in staffing levels
and related expenses in connection with the Company's strategic restructuring
plan; (ii) reduction in legal expenses related to settled and pending legal
proceedings; and (iii) no bad debt expense in 1998 compared to a bad debt
expense of $0.4 million in 1997.
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
decreased 52% to $0.9 million in 1998 from $1.8 million in 1997. The decrease in
expenditures in 1998 was primarily attributable to reduced staffing levels and
reduced hardware research activities associated with cost reductions implemented
in 1998 in connection with the Company's strategic restructuring plan. No
software development costs were capitalized in 1998, a decrease from the $0.2
million that was capitalized during 1997. The decrease is attributable to the
Company's decision, during the second quarter of 1998, to no longer capitalize
software development and enhancement costs. This change reflects the Company's
ongoing recoverability review, as discussed above.
Interest income (net of interest expense) decreased 77% to $0.02 million in 1998
from $0.08 million in 1997. The decrease was primarily attributable to lower
average cash balances invested during 1998 as compared to 1997 and, to a lesser
extent, miscellaneous interest charges from suppliers in connection with the
payment of supplier liabilities.
Page 12
NINE MONTHS ENDED SEPTEMBER 30, 1998 COMPARED TO NINE MONTHS ENDED SEPTEMBER 30,
1997
Total revenues decreased 65% to $9.3 million in 1998 from $26.5 million in 1997,
resulting in the Company incurring a net loss of $8.2 million, or $0.36 per
share in 1998, compared to net loss of $1.3 million, or $0.06 per share in 1997.
System revenues decreased 84% to $3.8 million in 1998 from $23.4 million in
1997, and primarily represent revenues from customers for the Company's
Blackbird Products. System revenues from Hotwatch Products were $0.2 million in
1998, as compared to $0.7 million in 1997. The Company expects minimal Hotwatch
revenue for the balance of 1998 and beyond. The Company attributes the decrease
in revenues from Blackbird Products to: (i) a reduction in domestic market
opportunities for the Company's cloning fraud prevention technology, due to the
effectiveness of this and other authentication-based products in combating
cloning fraud; (ii) lower penetration than originally planned of Blackbird
Platform systems into existing customers' markets and to new and/or additional
markets; and (iii) the continued uneven sales cycle of, and lengthy trial
periods required for, potential new domestic and international customers. The
Company's shipment trends for the prior four quarters (0, 26, 50, and 105 units
respectively for the quarters ended September 30, 1997, December 31, 1997, March
31, 1998, and June 30, 1998, respectively) had initially improved after solving
certain software issues encountered during the second quarter of 1997. However,
the Company did not ship any units in the most recent quarter and has not been
able to generate a level of new orders in 1998, through the current date, that
would result in profitability in the immediate future.
Service revenues increased 78% to $5.4 million in 1998 from $3.0 million in
1997. Approximately 93% and 85%, respectively, of the 1998 and 1997 total
service revenues, were derived from the Blackbird Products. This increase is
attributable to growing service revenues originating from Blackbird Product
deployments in 1996, 1997 and during the first three quarters of 1998. The
Company anticipates that total service revenues will increase during the
remainder of 1998 as a result of anticipated acceptance of the Company's
Blackbird Products.
Costs of systems and services, the majority of which relate to the Company's
Blackbird Products, decreased 32% to $10.5 million in 1998 from $15.5 million in
1997. Costs of systems and services, as a percent of total revenues, were 114%
and 58% for the 1998 and 1997 periods, respectively. The increased percentage
cost for 1998 relative to 1997 primarily reflects: (i) a decrease in systems
revenues in 1998, resulting in a decrease in leveraging of its fixed overhead
costs relating to manufacturing, installation and systems integration, despite
significant cost reductions implemented in 1998 in connection with the Company's
strategic restructuring plan; (ii) an increase in the amount of inventory
reserves to $2.7 million in 1998 from $1.3 million in 1997, reflecting
provisions for excess inventory quantities resulting from lower future sales
projections based on changing market conditions; and (iii) an increase in and
the acceleration of the amortization of capitalized software costs to $2.5
million in 1998 from $1.3 million in 1997, reflecting current estimates to
recoverability values resulting from lower future sales projections based on
changing market conditions. Should sales of the Company's products not
materialize to levels to achieve recoverability of the investments in both
inventory and capitalized software, additional substantial reserves and
amortization would be required in future quarters. The investments in inventory
and capitalized software at September 30, 1998 are $2.9 million and $1.4
million, respectively. Conversely, the Company benefited from increased service
revenues in 1998, resulting in an increase in leveraging its fixed customer
support operating expenses. The Company also benefited from cost reductions
implemented in 1998 in connection with the Company's strategic restructuring
plan.
Sales and marketing expenses decreased 76% to $0.8 million in 1998, from $3.1
million in 1997, and, as a percent of revenues, decreased to 8% in 1998 from 12%
in 1997. The decrease in sales and marketing expenses resulted primarily from:
(i) a reduction in staffing levels and related expenses in connection with the
Company's strategic restructuring plan; (ii) reduced number of customer and
industry events in which the Company participated; and (iii) lower incentive
compensation expense, which varies with revenue.
General and administrative expenses decreased 37% to $1.9 million in 1998 from
$3.1 million in 1997, primarily due to: (i) a reduction in staffing levels and
related expenses in connection with the Company's strategic restructuring plan;
and (ii) no bad debt expense in 1998 as discussed above.
Research and development costs decreased 38% to $3.9 million in 1998 from $6.3
million in 1997. The decrease in expenditures in 1998 was primarily attributable
to reduced staffing levels and reduced hardware research activities associated
with cost reductions implemented in 1998 in connection with the Company's
strategic restructuring plan. Software
Page 13
development costs of $0.6 million were capitalized in 1998, a decrease from the
$1.2 million that were capitalized during 1997, and relate to the development
and enhancement of the Blackbird Products. The decrease is attributable to the
Company's decision, during the second quarter of 1998, to no longer capitalize
software development and enhancement costs. This change reflects the Company's
ongoing recoverability review, as discussed above.
Loss on disposal of assets of $0.3 million in 1998 relates to the loss on the
sale of furniture and the unamortized balance of leasehold improvements
associated with the consolidation of certain facilities at the Company's
corporate offices during the first half of 1998. Additional facilities and
equipment consolidation during the fourth quarter of 1998 is expected to result
in additional losses on the disposal of assets, currently estimated to exceed
$0.3 million.
Interest income (net of interest expense) decreased 66% to $0.06 million in 1998
from $0.17 million in 1997. The decrease was primarily attributable to lower
average cash balances invested during 1998 as compared to 1997 and, to a lesser
extent, miscellaneous interest charges from suppliers in connection with the
payment of supplier liabilities.
LIQUIDITY AND CAPITAL RESOURCES
The Company's capital requirements have consisted primarily of funding: (i)
software and hardware research and development; (ii) property and equipment
requirements; (iii) working capital; and (iv) the Company's operating losses.
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, 1998, the Company's
cash balance was $2.0 million as compared to $3.4 million on December 31, 1997.
The Company's working capital decreased to $1.8 million at September 30, 1998
from $6.5 million at December 31, 1997. Approximately $2.7 million (57%) of this
working capital decline is attributable to increased inventory reserves,
reflecting the Company's ongoing recoverability review, as discussed above.
Cash used in operating activities amounted to $0.9 million in 1998, as compared
to cash provided by operating activities of $1.0 million in 1997. The major
factors contributing to the Company's reduced cash flow from operating
activities in 1998 were: (i) the $8.2 million net loss that was recorded in 1998
as compared to the $1.3 million net loss that was recorded in 1997, both of
which were before considering the impact of non-cash items such as depreciation,
amortization, loss on disposal of assets and inventory reserves as discussed
above; and (ii) the net changes in the balances of the major working capital
components affecting cash flow from operating activities as described below.
(a) Accounts receivable declined $1.6 million in 1998 primarily as a result of:
(I) lower third quarter 1998 revenues of $2.4 million as compared to fourth
quarter 1997 revenues of $3.8 million; and (II) a changed receivable mix
comprised of payment terms more favorable to the Company
(b) Inventories decreased $3.6 million in 1998 primarily as a result of: (I)
systems sales, the majority of which utilized existing inventory with only
minimal inventory purchases required; and (II) the addition of $2.7 million
to inventory reserves for excess and obsolete inventory, primarily resulting
from delayed sales, technology changes in the Company's cloning fraud
interdiction methods and changing market conditions as discussed above
(c) Accounts payable and accrued liabilities declined $1.3 million in 1998
primarily due to: (I) a lower fixed cost structure resulting from
implementation of the Company's 1998 strategic restructuring plan
of inventory purchases in response to reduced sales levels.
(d) Payroll related liabilities decreased 55%, or $0.4 million in 1998 primarily
as a result of substantial reduction in staffing levels and correspondingly
lower liabilities for employee related benefits.
(e) Taxes (other than payroll and income) decreased $0.5 million in 1998 and
reflect payments made on certain liabilities accrued throughout 1997 that
were payable on an annual basis.
(f) Deferred revenue increased $0.3 million in 1998, resulting from the growth
of prepaid maintenance and service revenues related to system sales of the
Blackbird Products.
Page 14
Cash utilized in investing activities totaled $0.6 million and $2.9 million in
1998 and 1997, respectively. The Company's capital requirements during such
periods were primarily for: (i) purchase of property and equipment totaling $0.2
million and $1.7 million in 1998 and 1997 respectively, primarily for furniture,
leaseholds, and equipment associated with maintaining the Company's business;
and (ii) capitalization of software development costs of the Blackbird Products
totaling $0.6 million and $1.2 million, respectively. Expenditure levels for
property and equipment for 1998 have been, and are expected to continue to be,
lower in 1998 as compared to prior periods, due to the cost and expenditure
reductions implemented in 1998 in connection with the Company's strategic
restructuring plan. As discussed above, the Company does not expect to
capitalize software development in the foreseeable future. At September 30,
1998, 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 and the Company has either sufficient capital or the ability
to raise capital to effect such transactions.
Cash provided by financing activities totaled $0.7 million during 1997 and
originated from the exercise of stock options. The Company's $5.0 million line
of credit from a major bank expired on June 30, 1998. The Company did not
utilize the bank line during the line's two year term and it has elected to
defer its renewal process of the line of credit until completion of its 1999
business plan and further assessment of its financing needs.
Historically, the Company has experienced uneven revenues, operating results
(including significant losses) and cash flow during the past several years.
Operating information during the past seven quarters is as follows (in 000's):
Cash Provided From
Net (Used in) Operating
Three Months ended Revenues Income (Loss) Activities EBITDA+
- ---------------------- ---------------- -------------- ----------------------- --------------
March 31, 1997 $17,368 $ 4,414 $ 1,072 $ 5,466
June 30, 1997 6,725 (996) 3,402 (101)
September 30, 1997 2,379 (4,749) (3,432) (3,376)
December 31, 1997 3,783 (3,715) 560 (1,643)
March 31, 1998 3,422 (1,789) (1,450) (1,036)
June 30, 1998 3,423 (3,916) 1,185 (527)
September, 30 1998 2,416 (2,447) (634) 34
The uneven operating results and cash flow from operations originate primarily
from: (i) operating losses resulting from a combination of lower than expected
revenues, an unbalanced cost structure in relation to those revenues and the
changing market conditions discussed above; (ii) uneven quarterly shipments of
systems; (iii) cash receipts associated with deferred revenue recognition; and
(iv) varying payment terms contained in customer agreements.
The EBITDA+ information shown above reflects earnings (loss) before interest and
taxes, and certain non-cash charges to operations for depreciation,
amortization, loss on disposal of assets and inventory reserves. This is one of
the Company's important cash flow monitoring tools in evaluating the
effectiveness of its 1998 strategic restructuring plan. The plan was designed to
focus on streamlining the Company's operations to achieve more balance between
expenses and revenues and directing additional development efforts and resources
toward new and complementary products to meet the ongoing needs of the wireless
communications industry and generate new sources of revenue for the Company. To
date, the results of the Company's 1998 plan are showing improvement towards its
goals of achieving both consistent positive cash flow by the end of 1998 and
profitability during 1999. While the Company believes that its current cash
reserves and projected cash flow from operations provide sufficient cash to fund
its operations for at least the next twelve months, further delays in achieving
profitability, failure to convert existing inventory into cash, unanticipated
changes in customer needs and/or other external factors may require additional
financing and/or further expense reductions.
Page 15
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
a) Exhibits
27 Financial Data Schedule - filed only with EDGAR submission
- --------------------------------------------
b) Reports on Form 8-K
The Company filed a Current Report on Form 8-K, dated September 23,
1998, under Item 5 of such Report, relating to the Company's naming
Joyce Jones as the new Chief Operating Officer of the Company and a
member of the Board of Directors effective September 18, 1998. No
financial statements were included in such Report.
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 12, 1998
Page 16
STATEMENT OF DIFFERENCES
------------------------
The trademark symbol shall be expressed as.............................. 'TM'
The registered trademark symbol shall be expressed as................... 'r'
The service mark symbol shall be expressed as........................... 'sm'
5
1000
DEC-31-1998
JAN-01-1998
SEP-30-1998
9-MOS
1,976
0
1,667
58
2,875
6,739
7,321
4,808
10,673
4,893
0
23
0
0
5,757
10,673
3,839
9,262
10,515
17,472
0
0
0
(8,154)
0
(8,154)
0
0
0
(8,154)
(0.36)
(0.36)
