NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
NOTE 1 – BASIS OF PRESENTATION AND NATURE OF BUSINESS
Nature of Business:
Teletouch Communications, Inc. was
incorporated under the laws of the State of Delaware on July 19, 1994, and its corporate headquarters are in Fort Worth, Texas.
References to Teletouch or the Company as used throughout this document mean Teletouch Communications, Inc. or Teletouch Communications,
Inc. and its subsidiaries, as the context requires.
For over 48 years, Teletouch together with its predecessors
has offered a comprehensive suite of telecommunications products and services including cellular, two-way radio, GPS-telemetry,
wireless messaging and public safety equipment. As of August 31, 2012, the Company operated 11 retail and agent locations in Texas,
3 through its sub-agents and 8 “Hawk Electronics” branded in-line and free-standing stores and service centers. Teletouch’s
wholly-owned subsidiary, Progressive Concepts, Inc. (“PCI”) is an Authorized Service Provider, billing agent and Executive
Dealer of cellular voice, data and entertainment services though AT&T Mobility (“AT&T”) to consumers, businesses
and government agencies and markets these services under the Hawk Electronics brand name. For over 28 years, PCI has offered various
communication services on a direct bill basis and services 35,338 cellular subscribers as of August 31, 2012. PCI sells consumer
electronics products and cellular services through its stores, its network of Hawk-branded sub-agents stores, its own direct sales
force and on the Internet at various sites, including its primary consumer-facing sites:
www.hawkelectronics.com
,
www.hawkwireless.com
and
www.hawkexpress.com
.
The Company handles all aspects of the wireless customer relationship, including:
|
·
|
Initiating and maintaining all subscribers’ cellular, two-way radio and other service agreements;
|
|
·
|
Determining credit scoring standards and underwriting new account acquisitions;
|
|
·
|
Handling all billing, collections, and related credit risk through its own proprietary billing systems;
|
|
·
|
Providing all facets of real-time customer support, using a proprietary, fully integrated Customer Relationship Management (CRM) system through its own 24x7x365 capable call centers and the Internet.
|
In addition, PCI operates a national wholesale distribution
business, “PCI Wholesale,” which serves major carrier agents, rural cellular carriers, smaller consumer and automotive
electronics retailers and auto dealers throughout the country and internationally, with ongoing product and sales support through
its direct sales representatives, call center, and the Internet through
www.pciwholesale.com
and
www.pcidropship.com
, among other sites.
Discontinued Two-Way Operations:
On August 11, 2012,
the Company sold its legacy two-way business, which offered two-way radio products and services as well as public safety equipment
to state, city and local entities as well as commercial businesses. The Company sold the public safety equipment and services under
the brand “Teletouch PSE” (Public Safety Equipment), through direct sales and distribution including the United States
General Services Administration (“GSA”), BuyBoard (a State of Texas website operated by the Local Government Purchasing
Cooperative), and a Texas multiple awards contract (“TXMAS”) facility also run by the State of Texas, which allowed
products to be sold to all State agencies and authorized local public entities. The Company operated its two-way business in four
Teletouch branded service center locations.
The Company has applied retrospective adjustments for the three
months ended August 31, 2011 to reflect the effects of the discontinued two-way operations that occurred during the three months
ended August 31, 2012; therefore, revenue, costs and expenses of the discontinued two-way operations have been excluded from those
respective captions and reported separately as discontinued operations in the Company’s consolidated statement of operations.
Additionally, the assets and liabilities of the discontinued two-way operations have been classified as assets and liabilities
held for sale and removed from specific line items on the consolidated balance sheets as of August 31, 2012 and May 31, 2012 (see
Note 3 – “Discontinued Two-Way Operations” for more information on the sale of the Company’s two-way business).
Basis of Presentation:
The consolidated financial statements
include the consolidated accounts of Teletouch Communications, Inc. and our wholly-owned subsidiaries (collectively, the “Company”
or “Teletouch”). Teletouch Communications, Inc. owns all of the shares of Progressive Concepts, Inc., a Texas corporation
(“PCI”), Teletouch Licenses, Inc., a Delaware corporation (“TLI”), Visao Systems, Inc., a Delaware corporation
(“Visao”) and TLL Georgia, Inc., a Delaware corporation (“TLLG”). PCI is the primary operating business
of Teletouch. TLI is a company formed for the express purpose of owning all of the FCC licenses utilized by Teletouch to operate
its two-way radio network. Following the sale of the two-way radio business on August 11, 2012 and the related transfer of all
of the Company’s remaining FCC licenses to the buyer, TLI remains a shell company with no other operations. Visao is a company
formed to develop and distribute the Company’s telemetry products, which as of the date of this Report are no longer being
sold. Currently Visao is maintained as a shell company with no operations. TLLG was formed for the express purpose of entering
into an asset purchase agreement with Preferred Networks, Inc. in May 2004 and ceased operations following the sale of the Company’s
paging business in August 2006. TLLG is currently a shell company. All significant intercompany accounts and transactions have
been eliminated in consolidation.
Financial Condition and Going Concern Discussion:
As
of August 31, 2012, the Company has approximately $1,666,000 cash on hand, a working capital deficit of approximately $10,941,000
(primarily due to all of the Company’s debt being current at the close of the period, as further described herein below)
and a related shareholders’ deficit of approximately $6,333,000. Included in the working capital deficit are debt obligations
of approximately $9,740,000, including senior revolving credit debt of approximately $7,075,000 with Thermo Credit, LLC (“Thermo”)
and real estate loans totaling approximately $2,665,000. Also included in this working capital deficit is approximately $1,818,000
of accrued sales and use tax obligations related to the results of a State of Texas (the “State”) tax audit of the
Company’s wholly owned subsidiary, PCI, for the period January 2006 through October 2009, as well as an additional $323,000
of estimated tax liability related to similar tax issues that are believed to have continued beyond the current tax audit period
(see Note 8 – “Accrued Expenses and Other Current Liabilities” and Note 9 – “Texas Sales and Use
Tax Obligation” for further discussion of this sales tax liability). As discussed further below, the Company is dependent
on raising additional debt and / or equity financing to resolve its current debt obligations and on receiving certain payment relief
from the State related to the sales tax liability to maintain sufficient cash to continue operations over the next twelve months.
The Company’s debt with Thermo
was originally set to mature in January 2013. However, o
n February 21, 2012, the Company received a Notice of Borrowing
Base Redetermination (the “Notice”) from Thermo, stating that it planned to revise the elements that comprised the
Company’s Borrowing Base, and that the Company would then be significantly over-advanced on its loan facility. On March 8,
2012, Thermo withdrew and rescinded the Notice and the parties negotiated a compromise solution by entering into
Waiver and Amendment No. 5 to the Loan and Security Agreement (“Amendment No. 5”) effective February 29, 2012.
Thermo
agreed to enter into Amendment No. 5, provided that the Company made a payment on the outstanding balance of the loan in the amount
of $2,000,000 by March 14, 2012. Under the terms of Amendment No. 5, Thermo agreed to waive
certain
financial covenants and not accelerate collection of the Note through August 31, 2012, provided that certain financial performance
targets were met by the Company for its fourth fiscal quarter ending May 31, 2012, and that the Company refinanced or was substantially
through the process of refinancing its existing real estate loans, thereby providing Thermo with an additional $1,400,000 payment
on the loan on or before July 15, 2012. Amendment No. 5 also terminated Thermo’s obligation to lend or advance any additional
funds under the Loan Agreement.
Although the Company made the required
$2,000,000 cash payment on March 14, 2012, the Company did not meet all of the requirements under Amendment No. 5 during its fourth
fiscal quarter ending May 31, 2012 and was not able to refinance its existing real estate loans and pay Thermo an additional $1,400,000
by July 15, 2012. However, on July 23, 2012, Thermo notified the Company that the August 31, 2012 maturity date was being accepted,
but that no further extensions would be provided beyond this date. As a result of the recent sale of the Company’s two-way
business (see Note 3 – “Discontinued Two-Way Operations” for more information on the sale of the two-way business),
the Company was able to pay Thermo approximately $1,001,000 on August 14, 2012 in exchange for Thermo releasing its liens on the
assets related to the two-way business.
On September 10, 2012, the Company received a Formal Notice of Maturity (the “Letter”)
from Thermo which notified the Company the revolving credit facility had matured by its terms on August 31, 2012, and therefore
under the terms of the facility, Thermo had the right to demand payment for all obligations due and payable under the credit revolving
facility by September 17, 2012. Thermo further reserved all rights and remedies available to it under the documents and agreements
in connection with the revolving credit facility. Even though Thermo was reserving its rights under the agreement and revolving
credit facility, the Letter did not constitute a notification to the Company that Thermo was commencing the exercise of any of
its rights and remedies.
As of the date of this Report, Thermo has not commenced any actions
against the Company and is
negotiating terms of settling this obligation with the Company and its prospective
new senior lender. The Company executed a term sheet with a prospective new lender on August 1, 2012 and is currently working with
the lender through the due diligence process and the ongoing negotiations with Thermo. As of the date of this Report, the Company’s
outstanding balance on the Thermo loan is approximately $7,022,000.
Additionally, the Company’s real estate loans with East
West Bank, a wholly owned subsidiary of East West Bancorp, and Jardine Capital Corporation initially matured on May 3, 2012. As
of the date of this Report, East West Bank and Jardine Capital Corporation granted extensions through November 3, 2012 and October
15, 2012, respectively. The Company can provide no assurance that further extensions will be granted by either lender, but through
the date of this Report neither lender has exercised any of its rights and remedies upon prior maturity dates. As of the date of
this Report, the outstanding balance of the East West Bank and Jardine Capital Corporation debt totaled approximately, $2,101,000
and $542,000, respectively.
The total debt outstanding combined with the Company’s
previously reported fiscal year 2012 operating results and the issues identified in the sales tax audit of PCI have created challenges
in securing new financing. The Company has been told by its prospective new senior lender that the new loan can be closed by late
October 2012, if no additional matters are identified during diligence. The Company is not aware of any matters that would prevent
it from closing on this new loan and anticipates this loan will provide sufficient proceeds to settle its debt with Thermo. The
terms of this new loan, as outlined in the term sheet, contemplate a slightly higher cost of financing under the new loan as compared
to the Company’s current loan with Thermo, but these terms will continue to be negotiated through the final loan documents.
The Company can provide no assurance that it will be able to close this new loan or that it would be able to find an alternate
lender to provide a similar amount of financing against the Company’s assets or that such financing will be sufficient to
settle its obligation to Thermo. No assurance can be provided that Thermo will not take action against the Company and the underlying
collateral until the Company can execute a new debt facility to pay off the Thermo debt. Further, it is unlikely the Company will
be able to refinance its current real estate debt until such time as its senior debt obligation with Thermo is settled and a new
senior loan facility is in place, and no assurance can be provided that these lenders will not take action against the Company
and the underlying real estate collateral. Further acceleration or collection actions taken by Thermo, either real estate lender
or the State of Texas prior to the Company being able to secure the new financing would likely result in the Company being forced
to seek protection from its creditors or turn over its collateral, which in the case of Thermo, collectively comprises all of the
assets of the Company.
During fiscal year 2012 and through
the date of this Report, the Company has recorded total sales tax, interest and penalty charges of approximately $2,216,000 as
a result of the State of Texas (the “State”) sales and use tax audit of PCI, as discussed above. In June 2012, the
audit was completed and the Company was noticed that its sales and use tax obligation to the State, which was due and payable on
July 23, 2012. Since the Company did not have the means to pay the entire tax obligation by that date, the Company petitioned the
State for a redetermination hearing related to the PCI sales and use tax audit on July 9, 2012. The redetermination letter submitted
to the State included a request for a re-payment agreement and a waiver of penalty and interest among other items. In addition,
on September 20, 2012, the Company submitted a formal compromise and payment agreement request to the State in an effort to forego
the lengthy redetermination process and settle the sales tax obligation expeditiously. In this most recent request, the Company
proposed the State to agree to reduce the total tax assessment including interest and penalty to $1,250,000 and grant thirty-six
month repayment terms. As of the date of this Report, a final hearing date has not been set by the State, and the Company is awaiting
a response from the State related to its payment agreement request.
The Company can provide no assurance the sales and use
tax obligation will be reduced, a re-payment agreement will be executed or a waiver of penalty and interest will be granted by
the State. Specifically, if a payment plan is not granted by the State as a result of the redetermination hearing or the payment
agreement request, the Company would be unable to pay the tax obligation without securing additional debt financing which cannot
be assured
(see Note 8 – “Accrued Expenses and Other Current Liabilities” and Note
9 – “Texas Sales and Use Tax Obligation” for further discussion on the Texas sales and use tax audit accruals)
.
The Company has been advised by counsel that it can seek recovery
of taxes that were not billed or collected from its customers and suppliers beginning in January 2006 and intends to make every
reasonable effort to pursue the collection of such taxes. The underlying unbilled and uncollected sales tax due and legally recoverable
from all of PCI’s customers and suppliers is approximately $1,270,000. Based on a detailed review of all currently available
cellular billings from August 2006 through October 2009, and a review of certain equipment sales invoices from January 2006 through
October 2009, the Company has determined that its top 50 customers comprise approximately $450,000 of the unbilled sales taxes
that the Company will pursue for recovery. There can be no assurance that the Company’s recovery efforts will be successful,
nor can the Company estimate an amount of recovery expected from such efforts at this time.
The Company has been focused on improving its operating results
to attract new lenders to the Company since it became aware of Thermo’s intent to accelerate the Company’s senior debt
earlier in calendar year 2012. The Company improved its operating results from continuing operations in the three months ended
August 31, 2012 compared to the same period from the prior fiscal year. This is primarily the result of price increases implemented
on certain services and fees billed to the Company’s cellular subscriber base in the fourth quarter of fiscal year 2012,
intentional cost reduction measures taken in all areas of the Company and limits imposed on the number of subsidized handsets sold
to new and existing cellular subscribers. Along with the closing of four Hawk branded stores in June 2012 and the sale of the two-way
business in August 2012, these actions are part of the Company’s overall strategic plan to transition the business away from
its declining cellular services business to a focus on large scale wholesale distribution of cellular phones and accessories. This
transition to a new business model has been slowed by the Company’s lack of available working capital to invest in the additional
inventory and other resources required to improve sales and margins in the wholesale business. The current focus has been on improving
short term profitability to provide comfort to the various lenders that have been approached about providing the needed new financing.
The Company is continuing to see erosion in cellular services revenues and profits due to continued losses of subscribers while,
although limited, it is incurring the added costs of activating new cellular subscribers and upgrading existing subscribers to
new phones to keep them as customers to maintain as many cellular subscribers as it can during the remaining term of its distribution
agreement with AT&T (agreement expires November 2014). Due to the greatly increased subsidies required by offering the iPhone,
subscribers choosing to activate an iPhone have a higher cost of acquisition, requiring a longer time to become profitable to the
Company.
The Company’s plan is to enhance and expand its wholesale
distribution business to improve profitability of the Company and believes that securing a variety of key supplier relationships
over the past several months, including the agreement with TCT Mobile Multinational, Limited to sell and distribute their Alcatel
One Touch branded cellular phones and Unimax Communications, Inc. to sell and distribute their UMX® branded cellular handsets.
In addition, the hiring of key personnel with experience in large scale cellular equipment distribution in the first quarter of
fiscal 2013 is providing a solid foundation upon which to expand the Company’s wholesale business. However, to be successful,
the Company must solve its current liquidity issues and secure a new lender that is capable of providing the necessary continuing
financing to fund this growth. No assurance can be provided the Company will be able to increase sales or margins in its wholesale
business as a result of any of the distribution agreements it has secured even if the appropriate working capital is made available
to the Company. Nor can there be any assurance provided that the wholesale business units can be grown quickly enough to provide
sufficient earnings to offset the expected loss of earnings from the cellular business. Therefore, with new financing in place,
the Company will be prepared to continue to reduce costs to the levels necessary to meet its financial obligations as they come
due. Without new financing, the Company cannot meet its current financial obligations.
As a result of the above conditions and in accordance with generally
accepted accounting principles in the United States, there exists substantial doubt about the Company’s ability to continue
as a going concern.
NOTE 2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Use of Estimates:
The consolidated financial statements
have been prepared using the accrual basis of accounting in accordance with accounting principles generally accepted in the United
States of America. Preparing financial statements in conformity with generally accepted accounting principles (“GAAP”)
requires management to make estimates and assumptions. Those assumptions affect the reported amounts of assets and liabilities,
disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and
expenses during the reporting period.
Actual results could materially differ from those estimates.
Cash:
We deposit our cash with high credit quality institutions.
Periodically, such balances may exceed applicable FDIC insurance limits. Management has assessed the financial condition of these
institutions and believes the possibility of credit loss is minimal.
Certificates of Deposit-Restricted:
From time to time,
the Company is required to issue a standby letter of credit to a supplier to secure a credit line extended to the Company. In these
instances, funds are deposited into a certificate of deposit and the bank to issues a standby letter of credit to the supplier’s
benefit. All such funds are reported as restricted funds until such time as the supplier releases its rights under the letter of
credit. As of August 31, 2012, the Company had $25,000 of cash certificates of deposit securing standby letters of credit with
its suppliers.
Allowance for Doubtful Accounts:
The Company performs
credit evaluations of its customers prior to extending open credit terms. The Company does not perfect a security in any of the
goods it sells causing all credit lines extended to be unsecured.
In determining the adequacy of the allowance for doubtful accounts,
management considers a number of factors, including historical collections experience, aging of the receivable portfolio, financial
condition of the customer and industry conditions. The Company considers accounts receivable past due when the customer’s
payment in full is not received within payment terms. The Company writes-off accounts receivable when it has exhausted all collection
efforts, which is generally within 90 days following the last payment received on the account.
Accounts receivable are presented net of an allowance for doubtful
accounts of $176,000 and $150,000 at August 31, 2012 and May 31, 2012, respectively. Based on the information available, management
believes the allowance for doubtful accounts as of those periods are adequate; however, actual write-offs may exceed the recorded
allowance.
The Company evaluates its write-offs on
a monthly basis. The Company determines which accounts are uncollectible, and those balances are written-off against the Company’s
allowance for doubtful accounts.
For the quarter ended August 31, 2012,
the Company was unable to process its accounts receivable write-offs for July and August 2012 totaling approximately $37,000; therefore,
the reported allowance at August 31, 2012, includes $37,000 for these previously identified accounts to be written off and approximately
$139,000 as an allowance against the balance of the accounts receivable.
As of May 31, 2012, the Company had written
off all known uncollectible accounts and the approximately $150,000 allowance was an estimate based on the accounts receivable
outstanding at that date.
Reserve for Inventory Obsolescence:
Inventories are stated
at the lower of cost (primarily on a moving average basis), which approximates actual cost determined on a first-in, first-out
(“FIFO”) basis, or fair market value and are comprised of finished goods. In determining the adequacy of the reserve
for inventory obsolescence, management considers a number of factors including recent sales trends, industry market conditions
and economic conditions. In assessing the reserve, management also considers price protection credits the Company expects to recover
from its vendors when the vendor cost on certain inventory items is reduced shortly after the purchase of the inventory by the
Company. In addition, management establishes specific valuation allowances for discontinued inventory based on its prior experience
liquidating this type of inventory. Through the Company’s wholesale and internet distribution channel, it is successful in
liquidating the majority of any inventory that becomes obsolete. The Company has many different cellular handset, radio and other
electronics suppliers, all of which provide reasonable notification of model changes, which allows the Company to minimize its
level of discontinued or obsolete inventory. Inventories are presented net of a reserve for obsolescence of $168,000 and $155,000
at August 31, 2012 and May 31, 2012, respectively. Actual results could differ from those estimates.
Property and Equipment:
Property and equipment is recorded
at cost. Depreciation is computed using the straight-line method. Expenditures for major renewals and betterments that extend the
useful lives of property and equipment are capitalized. Expenditures for maintenance and repairs are charged to expense as incurred.
Upon the sale or abandonment of an asset, the cost and related accumulated depreciation are removed from the Company’s balance
sheet, and any gains or losses on those assets are reflected in the accompanying consolidated statement of operations of the respective
period. The straight-line method with estimated useful lives is as follows:
Buildings and improvements
|
5-30 years
|
Office and computer equipment
|
3- 5 years
|
Signs and displays
|
5-10 years
|
Other equipment
|
3-5 years
|
Leasehold improvements
|
Shorter of estimated useful
|
|
life or term of lease
|
Intangible Assets:
The Company’s intangible assets
include both definite and indefinite lived assets. Indefinite lived intangible assets are not amortized but evaluated annually
(or more frequently) for impairment under ASC 350,
Intangibles-Goodwill and Other
, (“ASC 350”). Definite lived
intangible assets are amortized over the estimated useful life of the asset and reviewed for impairment upon any event that raises
a question as to the asset’s ultimate recoverability as prescribed under ASC 360,
Property, Plant and Equipment
, (“ASC
360”).
Indefinite Lived Intangible Assets:
The Company’s
indefinite lived intangible asset is a purchased perpetual trademark license. In May 2010, Progressive Concepts, Inc., purchased
a perpetual trademark license to use the trademark “Hawk Electronics” (see Note – 11 “Trademark Purchase
Obligation” for additional discussion). Since it has been determined the trademark license has an indefinite useful life,
the carrying value of the trademark license is not amortized over a specific period of time but instead is tested for impairment
at least annually in accordance with the provisions of ASC 350.
The Company evaluated PCI’s perpetual trademark license
asset at May 31, 2012, in accordance with ASC 350 and determined the fair value of the license exceeded its carrying value; therefore,
no impairment was recorded. The fair value of the perpetual trademark license was based upon the discounted estimated future cash
flows of the Company’s cellular business which is the primary beneficiary of the Hawk brand. No changes have occurred in
the business during the three months ended August 31, 2012 that indicated any impairment of the perpetual trademark license. The
Company will continually evaluate whether events and circumstances occur that would no longer support an indefinite life for its
perpetual trademark license.
Definite Lived Intangible Assets:
Definite lived
intangible assets consist of the capitalized cost associated with acquiring the AT&T distribution agreements, purchased subscriber
bases, GSA contract, TXMAS contract and loan origination costs. The Company does not capitalize customer acquisition costs in the
normal course of business but would capitalize the purchase costs of acquiring customers from a third party. Intangible assets
are carried at cost less accumulated amortization. Amortization on the AT&T distribution agreements is computed using the straight-line
method over the contract’s remaining term through November 2014. The estimated useful lives for the intangible assets are
as follows:
AT&T distribution agreements and subscriber bases
|
1-13 years
|
GSA and TXMAS contracts
|
5 years
|
The Company defers certain direct costs in obtaining loans and
amortizes such amounts using the straight-line method over the expected life of the loan, which approximates the effective interest
method.
As of August 31, 2012, the most significant intangible asset
remaining is the AT&T distribution agreement and subscriber base. The AT&T cellular distribution agreement subscriber base
asset will be amortized through November 30, 2014, which is the expiration of the distribution agreement under the terms of the
Third Amendment to the Distribution Agreement (see Note 4 – “Relationship With Cellular Carrier” for further
discussion on the settlement of the litigation with AT&T and the resulting amended distribution agreement). Amortization expense
over the 27 months remaining under the current term of the AT&T distribution agreement will be approximately $57,000 per month.
The AT&T distribution agreement assets represent contracts
the Company has with AT&T, under which the Company is allowed to provide cellular services to its customers. The Company regularly
forecasts the expected cash flows to be derived from the cellular subscriber base and the Company anticipates the future cash flows
generated from its cellular subscriber base to exceed the carrying value of this asset.
Amortization of the AT&T distribution agreements, subscriber
bases, GSA and TXMAS contracts is recorded as an operating expense under the caption “Depreciation and Amortization”
in the accompanying consolidated statements of operations. The Company periodically reviews the estimated useful lives of its intangible
assets, taking into consideration any events or circumstances that might result in a lack of recoverability or revised useful life.
Impairment of Long-lived Assets:
In accordance with ASC
360, the Company evaluates the recoverability of the carrying value of its long-lived assets based on estimated undiscounted cash
flows to be generated from such assets. If the undiscounted cash flows indicate impairment, then the carrying value of the assets
evaluated is written-down to the estimated fair value of those assets. In assessing the recoverability of these assets, the Company
must project estimated cash flows, which are based on various operating assumptions, such as average revenue per unit in service,
disconnect rates, sales productivity ratios and expenses. Management develops these cash flow projections on a periodic basis and
reviews the projections based on actual operating trends. The projections assume that general economic conditions will continue
unchanged throughout the projection period and that their potential impact on capital spending and revenues will not fluctuate.
Projected revenues are based on the Company’s estimate of units in service and average revenue per unit as well as revenue
from various new product initiatives.
The most significant tangible long-lived asset owned by the
Company is the Fort Worth, Texas corporate office building and the associated land. The Company has received periodic appraisals
of the fair value of this property, with the most recent appraisal completed in February 2012, and in each instance the appraised
value exceeds the carrying value of the property.
The Company’s review of the carrying value of its tangible
long-lived assets at August 31, 2012 and May 31, 2012 indicates the carrying value of these assets will be recoverable through
estimated future cash flows. If the cash flow estimates, or the significant operating assumptions upon which they are based change
in the future, the Company may be required to record impairment charges related to its long-lived assets.
Prepaid expenses and other current assets:
The Company
records certain expenses that are paid for in advance of their use or consumption as a current asset on the Company’s consolidated
balance sheets.
The components of prepaid expenses and other current assets
at August 31, 2012 and May 31, 2012 are as follows (in thousands):
|
|
August 31,
|
|
|
May 31,
|
|
|
|
2012
|
|
|
2012
|
|
|
|
|
|
|
|
|
Prepaid Dallas Cowboy's suite lease expense
|
|
$
|
135
|
|
|
$
|
185
|
|
Prepaid legal fees
|
|
|
36
|
|
|
|
42
|
|
Prepaid insurance premiums
|
|
|
162
|
|
|
|
201
|
|
Investor relations expense
|
|
|
34
|
|
|
|
86
|
|
Security deposits
|
|
|
79
|
|
|
|
79
|
|
Other
|
|
|
142
|
|
|
|
145
|
|
Total prepaid expenses and other current assets
|
|
$
|
588
|
|
|
$
|
738
|
|
Contingencies:
The Company accounts for contingencies
in accordance with ASC 450,
Contingencies
(“ASC 450”). ASC 450 requires that an estimated loss from a loss contingency
shall be accrued when information available prior to issuance of the financial statements indicates that it is probable that an
asset has been impaired or a liability has been incurred at the date of the financial statements and when the amount of the loss
can be reasonably estimated. Accounting for contingencies such as legal and contract dispute matters requires us to use our judgment.
We believe that our accruals or disclosures related to these matters are adequate. Nevertheless, the actual loss from a loss contingency
might differ from our estimates.
Provision for Income Taxes:
The
Company accounts for income taxes in accordance with ASC 740,
Income Taxes
, (“ASC 740”) using the asset and
liability approach, which requires recognition of deferred tax liabilities and assets for the expected future tax consequences
of temporary differences between the carrying amounts and the tax basis of such assets and liabilities. This method utilizes enacted
statutory tax rates in effect for the year in which the temporary differences are expected to reverse and gives immediate effect
to changes in income tax rates upon enactment. Deferred tax assets are recognized, net of any valuation allowance, for temporary
differences, net operating loss and tax credit carry forwards. Deferred income tax expense represents the change in net deferred
assets and liability balances. Deferred income taxes result from temporary differences between the basis of assets and liabilities
recognized for differences between the financial statement and tax basis thereon and for the expected future tax benefits to be
derived from net operating losses and tax credit carry forwards. A valuation allowance is recorded when it is more likely than
not that deferred tax assets will be unrealizable in future periods.
As of August 31, 2012 and May 31,
2012, the Company has recorded a valuation allowance against the full amount of its net deferred tax assets. The Company will continue
to evaluate its financial forecast to determine if a portion of its deferred tax assets can be realized in future periods. When
the Company is charged interest or penalties related to income tax matters, the Company records such interest and penalties as
interest expense in the consolidated statement of operations.
The Company’s most significant deferred tax asset is its
accumulated net operating losses. These net operating losses are subject to limitations as a result of a change in control that
took place during August 2011, as defined by Section 382 of the Internal Revenue Code.
Revenue Recognition:
Teletouch recognizes revenue over
the period the service is performed in accordance with SEC Staff Accounting Bulletin No. 104, “Revenue Recognition in Financial
Statements” and ASC 605,
Revenue Recognition
, (“ASC 605”). In general, ASC 605 requires that four basic
criteria must be met before revenue can be recognized: (1) persuasive evidence of an arrangement exists, (2) delivery has occurred
or services rendered, (3) the fee is fixed and determinable and (4) collectability is reasonably assured. Teletouch believes, relative
to sales of products, that all of these conditions are met; therefore, product revenue is recognized at the time of shipment.
The Company primarily generates revenues by providing recurring
cellular services and through product sales. Cellular services include cellular airtime and other recurring services provided through
a master distributor agreement with AT&T. Product sales include sales of cellular telephones, accessories, car and home audio
products and other services through the Company’s retail and wholesale operations.
Cellular and other service revenues and related costs are recognized
during the period in which the service is rendered. Associated subscriber acquisition costs are expensed as incurred. Product sales
revenue is recognized at the time of shipment, when the customer takes title and assumes risk of loss, when terms are fixed and
determinable and collectability is reasonably assured. The Company does not generally grant rights of return. However, to be competitive
with AT&T’s programs, PCI offers customers a 15 day return / exchange program for new cellular subscribers. During the
15 days, a customer may return all cellular equipment and cancel service with no penalty. Reserves for returns, price discounts
and rebates are estimated using historical averages, open return requests, recent product sell-through activity and market conditions.
No reserves have been recorded for the 15 day cellular return program since only a very small number of customers utilize this
return program and many fail to meet all of the requirements of the program, which include returning the phone equipment in new
condition with no visible damage.
Since 1984, Teletouch’s subsidiary, PCI, has held agreements
with AT&T or one of its predecessor companies, which allowed PCI to offer cellular service and provide the billing and customer
services to its subscribers. PCI is compensated for the services it provides based upon sharing a portion of the monthly billings
of AT&T cellular services with AT&T. PCI is responsible for the billing and collection of cellular charges from these customers
and remits a percentage of the cellular billings generated to AT&T. Based on its relationship with AT&T, the Company has
evaluated its reporting of revenues under ASC 605-45,
Revenue Recognition, Principal Agent Considerations
(“ASC 605-45”)
associated with its services attached to the AT&T agreements. Included in ASC 605-45 are eight indicators that must be evaluated
to support reporting gross revenue. These indicators are (i) the entity is the primary obligor in the arrangement, (ii) the entity
has general inventory risk before customer order is placed or upon customer return, (iii) the entity has latitude in establishing
price, (iv) the entity changes the product or performs part of the service, (v) the entity has discretion in supplier selection,
(vi) the entity is involved in the determination of product or service specifications, (vii) the entity has physical loss inventory
risk after customer order or during shipment and (viii) the entity has credit risk. In addition, ASC 605-45 includes three additional
indicators that support reporting net revenue. These indicators are (i) the entity’s supplier is the primary obligor in the
arrangement, (ii) the amount the entity earns is fixed and (iii) the supplier has credit risk. Based on its assessment of the indicators
listed in ASC 605-45, the Company has concluded that the AT&T services provided by PCI should be reported on a net basis. Also
in accordance with ASC 605-45, sales tax amounts invoiced to our customers have been recorded on a net basis and are not included
in our operating revenues.
Deferred revenue primarily represents monthly cellular service
access charges that are billed in advance by the Company.
Concentration of Credit Risk:
Teletouch provides cellular
services to a diversified customer base of small to mid-size businesses and individual consumers, primarily in the DFW and San
Antonio markets in Texas. In addition, the Company sells cellular equipment and consumer electronics products to a large base of
small to mid-size cellular carriers, agents and resellers as well as a large group of smaller electronics and car audio dealers
throughout the United States. As a result, no significant concentration of credit risk exists. The Company performs periodic credit
evaluations of its customers to determine individual customer credit risks and promptly terminates services or ceases shipping
products for nonpayment.
Financial Instruments:
The Company’s financial
instruments consists of certificates of deposit-restricted, accounts receivable, accounts payable and debt. Management believes
the carrying value of the certificates of deposit-restricted, accounts receivable and accounts payable are considered to be representative
of their respective fair values due to the short-term nature of these instruments. Since the borrowing rates associated with the
Company’s current debt do not differ from market rates used for similar bank borrowings, managements also believes its current
debt approximates its fair value. At August 31, 2012, the Company’s current debt was $9,740,000. Current debt is classified
as a Level 2 item within the fair value hierarchy found under the guidance of ASC 820
Fair Value Measurements and Disclosures.
Advertising and Pre-opening Costs:
Labor costs, costs
of hiring and training personnel and certain other costs relating to the opening of any new retail or service center locations
are expensed as incurred. Additionally, advertising costs are expensed as incurred and are occasionally partially reimbursed based
on various vendor agreements. Advertising and promotion costs were $45,000 and $78,000 for the three months ended August 31, 2012
and August 31, 2011, respectively. Advertising reimbursements are accrued when earned and committed to by the Company’s vendor
and are recorded as a reduction to advertising cost in that period.
Stock-based Compensation:
At August 31, 2012, the Company
had two stock-based compensation plans (both of which were expired) for employees and non-employee directors, which authorize the
granting of various equity-based incentives including stock options and stock appreciation rights.
The Company accounts for stock-based awards to employees in
accordance with ASC 718,
Compensation-Stock Compensation
, (“ASC 718”) and for stock based awards to non-employees
in accordance with ASC 505-50,
Equity, Equity-Based Payments to Non-Employees
(“ASC 505-50”). Under both ASC
718 and ASC 505-50, we use a fair value based method to determine compensation for all arrangements where shares of stock or equity
instruments are issued for compensation. For share option instruments issued, compensation cost is recognized ratably using the
straight-line method over the expected vesting period.
Cash flows resulting from excess tax benefits are classified
as a financing activity. Excess tax benefits are realized from tax deductions for exercised options in excess of the deferred tax
asset attributable to stock compensation costs for such options. The Company did not record any excess tax benefits as a result
of any exercises of stock options in the three months ended August 31, 2012 and August 31, 2011.
To estimate the fair value of its stock options, the Company
uses the Black-Scholes option-pricing model, which incorporates various assumptions including volatility, expected life and interest
rates. The Company is required to make various assumptions in the application of the Black-Scholes option pricing model. The Company
has determined that the best measure of expected volatility is based on an average of the previous two fiscal year’s historical
daily volatility of the Company’s common stock adjusted to exclude the top 10% high and low closing trading prices during
each period measured. Historical volatility factors utilized in the Company’s Black-Scholes computations for options issued
in the three months ended August 31, 2012 was 63.45% and was 72.58% for the options issued in the three months ended August 31,
2011. The Company has elected to estimate the expected life of an award based upon the SEC approved “simplified method”
noted under the provisions of Staff Accounting Bulletin No. 107 with the continued use of this method extended under the provisions
of Staff Accounting Bulletin No. 110. Under this formula, the expected term is equal to: ((weighted-average vesting term + original
contractual term)/2). The expected term used by the Company as computed by this method for options issued in the three months ended
August 31, 2012 and 2011 was 5.0 years. The interest rate used is the risk free interest rate and is based upon U.S. Treasury rates
appropriate for the expected term. Interest rates used in the Company’s Black-Scholes calculations for options issued in
the three months ended August 31, 2012 was 0.62% and was 1.60% for the options issued in the three months ended August 31, 2011.
Dividend yield is zero for these options as the Company does not expect to declare any dividends on its common shares in the foreseeable
future.
In addition to the key assumptions used in the Black-Scholes
model, the estimated forfeiture rate at the time of valuation is a critical assumption. The Company has estimated an annualized
forfeiture rate of 0.0% for the stock options granted to senior management and the Company’s directors in the three months
ended August 31, 2012 and August 31, 2011. The Company reviews the expected forfeiture rate annually to determine if that percent
is still reasonable based on historical experience.
Options exercisable at August 31, 2012 and May 31, 2012 totaled
7,091,486 and 6,234,986, respectively. The weighted-average exercise price per share of options exercisable at August 31, 2012
and May 31, 2012 was $0.31 and $0.29, respectively with remaining weighted-average contractual terms of approximately 6.4 years
and 6.3 years as of August 31, 2012 and May 31, 2012, respectively.
The weighted-average grant date fair value of options granted
during the three months ended August 31, 2012 and August 31, 2011 was $0.20 and $0.30, respectively.
At August 31, 2012, the total remaining unrecognized compensation
cost related to unvested stock options amounted to approximately $17,000, which will be amortized over the weighted-average remaining
requisite service period of 2.3 years.
Income (loss) Per Share:
In accordance with ASC 260,
Earnings Per Share
, basic income (loss) per share (“EPS”) is calculated by dividing net income (loss) by the
weighted average number of common shares outstanding. Diluted EPS is calculated by dividing net income available to common shareholders
by the weighted average number of common shares outstanding including any dilutive securities outstanding. At August 31, 2012 and
2011, the Company’s outstanding common stock options totaled 7,174,820 and 6,348,984, respectively and were not included
in the computation of diluted earnings per share due to their antidilutive effect as a result of the net loss incurred for the
three months ended August 31, 2012 and 2011.
Recently Issued Accounting Standards:
The
Company has reviewed all recently issued, but not yet effective, accounting pronouncements and does not believe the future adoption
of any such pronouncements may be expected to cause a material impact on its consolidated financial condition or the consolidated
results of its operations.
In July 2012, the Financial Accounting Standards Board (“FASB”)
issued Accounting Standards Update (“ASU”) No. 2012-02,
Intangibles-Goodwill and Other (Topic 350): Testing Indefinite-Lived
Intangible Assets for Impairment
. To be consistent with the guidance found under ASU 2011-08,
Intangibles-Goodwill and Other
(Topic 350): Testing Goodwill for Impairment,
ASU 2012-02 is intended to simplify impairment testing for indefinite-lived intangible
assets other than goodwill by adding a qualitative review step to assess whether the required quantitative impairment analysis
that exists today is necessary. Under the amended rule, a company will not be required to calculate the fair value of a business
that contains recorded indefinite-lived intangible assets other than goodwill unless it concludes, based on the qualitative assessment,
that it is more likely than not that the fair value of that business is less than its book value. If such a decline in fair value
is deemed more likely than not to have occurred, then the quantitative impairment test that exists under current GAAP must be completed;
otherwise, the indefinite-lived assets other than goodwill are deemed to be not impaired and no further testing is required until
the next annual test date (or sooner if conditions or events before that date raise concerns of potential impairment in the business).
The amended impairment guidance does not affect the manner in which a company estimates fair value. This new standard is effective
for the Company beginning June 1, 2013.
NOTE 3 – DISCONTINUED TWO-WAY OPERATIONS
On August 11, 2012, Teletouch and DFW Communications,
Inc. (“DFW”) entered into an Asset Purchase Agreement (the “APA”), where the Company agreed to sell, assign,
transfer and convey to DFW substantially all of the assets of the Company associated with the two-way radio and public safety equipment
business, such assets including, among other things, certain related accounts receivable; inventory; fixed assets (e.g. fixtures,
equipment, machinery, appliances, etc.); supplies used in connection with the business; the Company’s leases, permits and
titles, including certain FCC licenses held by the Company; and DFW also assumed certain obligations, permits and contracts related
to the Company’s business. Subject to certain working capital adjustments, DFW agreed to pay, at closing, as consideration
for the assets of the Company an amount in cash equal to approximately $1,469,000, $168,000 of which was allocated to certain designated
suppliers’ payments and $300,000 of which was allocated to real estate and goodwill. The parties to the APA further designated
approximately $767,000 for working capital purposes, such amount consisting of, among other things, aged accounts receivable and
inventory as of the effective date of the APA. This includes a working capital adjustment provision that provides for no more than
$200,000 of post-close working capital adjustments to be charged to the Company in the event of any material accounts receivable
or inventory deficits. The foregoing disposition of the Company’s assets, excluding the sale of the real estate, closed on
August 14, 2012, having been reviewed and approved by the Company’s Board of Directors on August 10, 2012. On the August
14, 2012 closing, the Company received approximately $1,169,000 in cash consideration from DFW for all of the assets of the two-way
radio and public safety equipment business, excluding the building and land located in Tyler, Texas.
Summary results for the two-way operations
are reflected as discontinued operations in the Company’s consolidated statement of operations for the three months ended
August 31, 2012 and 2011 and are as follows:
(dollars in thousands)
|
|
Three months ended
|
|
|
|
August 31,
|
|
|
|
2012
|
|
|
2011
|
|
Operating revenues
|
|
$
|
679
|
|
|
$
|
2,934
|
|
Loss on sale of assets related to discontinued two-way operations
|
|
$
|
(110
|
)
|
|
$
|
-
|
|
Income (loss) from discontinued two-way operations
|
|
|
28
|
|
|
|
(50
|
)
|
Income tax expense form discontinued two-way operations
|
|
|
15
|
|
|
|
7
|
|
|
|
|
|
|
|
|
|
|
Net loss from discontinued two-way operations
|
|
$
|
(97
|
)
|
|
$
|
(57
|
)
|
As of August 31, 2012, the Company’s real estate located
in Tyler, Texas related to the discontinued two-way operations is classified as a current asset held for sale on the Company’s
consolidated balance sheet. The Company anticipates the sale of the real estate to be finalized by November 30, 2012. The carrying
value of the real estate held for sale at August 31, 2012 is approximately $116,000.
A summary of the assets and liabilities sold in conjunction
with the sale of the two-way business as determined at May 31, 2012 is as follows:
(dollars in thousands)
|
|
May 31,
|
|
|
|
2012
|
|
Assets
|
|
|
|
|
Current Assets:
|
|
|
|
|
Accounts receivable, net of allowance of $26
|
|
$
|
746
|
|
Inventory, net of reserve of $176
|
|
|
395
|
|
Prepaid expenses and other current assests
|
|
|
20
|
|
Total current assets
|
|
|
1,161
|
|
Long-term assets:
|
|
|
|
|
Property and equipment, net of accumulated depreciation and amortization of $1,459
|
|
|
386
|
|
Goodwill
|
|
|
343
|
|
Intangible assets, net of accumulated amortization of $217
|
|
|
7
|
|
Total long-term assets
|
|
|
736
|
|
Total Assets
|
|
$
|
1,897
|
|
Liabilities
|
|
|
|
|
Current Liabilities:
|
|
|
|
|
Accrued expenses and other current liabilites
|
|
$
|
48
|
|
Deferred revenue
|
|
|
69
|
|
Total Liabilities
|
|
$
|
117
|
|
The assets and liabilities associated with the two-way business,
as of May 31, 2012, are recorded under the captions “Current assets held for sale,” “Assets Held for Sale”
and “Current liabilities held for sale” in the Company’s consolidated balance sheet.
Restricted Cash:
The restricted cash related to the sale
of the discontinued two-way operations is a result of cash received subsequent to sale the two-way business on August 11, 2012
for the payment of certain accounts receivables DFW purchased under the APA. The cash the Company received against DFW’s
accounts receivables was partially offset by operating expenses the Company paid on behalf of DFW subsequent to the sale transaction.
Under the APA, the Company is obligated to reimburse DFW for such amounts and as of August 31, 2012, the restricted cash associated
with the sale of the discontinued two-way business is approximately $241,000.
NOTE 4 – SETTLEMENT AND RELEASE AGREEMENT WITH AT&T
From September 2009 to November 2011, Teletouch, through its
wholly-owned subsidiary, PCI, was involved in an arbitration proceeding with and against New Cingular Wireless PCS, LLC and AT&T
Mobility Texas LLC (collectively, “AT&T”) relating to, among other things, certain distribution and related agreements
by and between the parties. On November 23, 2011, PCI and AT&T entered into a settlement and release agreement (the “Agreement”)
pursuant to which the parties agreed to settle all of their disputes subject to the foregoing arbitration.
Material terms and provisions under of the Agreement included
that:
|
(i)
|
The parties entered into the Third Amendment to the Distribution Agreement which amended and renewed three year distribution agreements for all of PCI’s current and prior market areas, including the DFW, San Antonio, Houston/South Texas, Austin/Central Texas, Tyler/East Texas and Arkansas service areas; and
|
|
(ii)
|
The parties agreed to enter into a six year Exclusive Dealer Agreement, the first half of which runs co-terminously with the amended and renewed Distribution Agreement, then continuing for three years thereafter; and
|
|
(iii)
|
PCI was allowed the right and authorization to sell, activate and provide services to Apple iPhone and iPad models as a distributor and to sell and activate such models as a Dealer, subject to the terms set forth in supplements to each agreement respectively, and from the locations described therein; and
|
|
(iv)
|
PCI received cash and other consideration including $5,000,000 in cash and $5,000,000 credit against PCI’s outstanding accounts payable to AT&T at closing, and agreement for the transfer of all remaining subscribers to AT&T by the end of the three year Distribution Agreement term for a maximum cash payment of $8,500,000, subject to certain terms and conditions, at which point, such Distribution Agreement ends, and PCI then acts solely as a Dealer for the remaining three year term of the Dealer Agreement; and
|
|
(v)
|
Parties agreed to mutual releases from and against any and all claims, demands, obligations, liabilities and causes of action, of any nature whatsoever, at law or in equity, known or unknown, whether or not arising out of or related to Claims, Counterclaims, DFW Distribution Agreements, Other Marketing Agreements or Arbitration, as of the Effective Date.
|
The $5,000,000 cash payment was received from AT&T on December
1, 2011. The entire $10,000,000 of initial consideration comprised of the $5,000,000 cash payment and $5,000,000 forgiveness of
PCI’s oldest unpaid obligations to AT&T related to AT&T’s percentage of PCI’s monthly cellular billings
was recorded in operating income on the Company’s consolidated statement of operations for the fiscal year ended May 31,
2012 under the caption “Gain on settlement with AT&T.” In addition, for the cellular subscribers that transferred
from PCI to AT&T since the agreement was executed in November 2011, the Company recorded the fees it earned for those lost
subscribers under the caption “Gain on the settlement with AT&T” for the three months ended August 31, 2012 (see
Part II, Item. 1 Legal Proceedings – “AT&T Binding Arbitration” for details of the settlement and release
agreement with AT&T).
NOTE 5 – RELATIONSHIP WITH CELLULAR CARRIER
The Company has historically had six distribution agreements
with AT&T which provide for the Company to distribute AT&T wireless services, on an exclusive basis, in major markets in
Texas and Arkansas, including the Dallas-Fort Worth, Texas Metropolitan Statistical Area (“MSA”), San Antonio, Texas
MSA, Austin, Texas MSA, Houston, Texas MSA, East Texas Regional MSA and Arkansas, including primarily the Little Rock, Arkansas
MSA.
As a result of the settlement and release agreement and the
execution of the Third Amendment to the Distribution Agreement on November 23, 2011, the Company’s current and prior distribution
agreements with AT&T were consolidated and renewed or extended for three (3) years allowing PCI to again activate new subscribers
and provide many of the previously withheld wireless services and products, including the iPhone. The distribution agreement permits
the Company to offer AT&T cellular phone service with identical pricing characteristics to AT&T and provide billing customer
services to its customers on behalf of AT&T in exchange for certain predetermined compensation and fees, which are primarily
in the form of a revenue sharing of the core wireless services the Company bills on behalf of AT&T. In addition, the Company
bills the same subscribers several additional features and products that it offers and retains all revenues and gross margins related
to those certain services and products. Under the distribution agreement, the Company is responsible for all of the billing and
collection of cellular charges from its customers and remains liable to AT&T for pre-set percentages of all AT&T related
cellular service customer billings. The current distribution agreement expires on November 30, 2014.
Because of the volume of business transacted with AT&T,
as well as the revenue generated from AT&T services, there is a significant concentration of credit and business risk involved
with having AT&T as a primary vendor.
The Company reports its revenues related to the AT&T services
on a net basis in accordance with ASC 605-45 as follows (in thousands):
|
|
Three Months Ended
|
|
|
|
August 31,
|
|
|
August 31,
|
|
|
|
2012
|
|
|
2011
|
|
|
|
|
|
|
|
|
Gross billings
|
|
$
|
7,388
|
|
|
$
|
8,612
|
|
Net revenue adjustment (revenue share due to AT&T)
|
|
|
(3,665
|
)
|
|
|
(4,487
|
)
|
Service revenue, as reported
|
|
$
|
3,723
|
|
|
$
|
4,125
|
|
Gross billings include gross cellular subscription billings,
which are measured as the total recurring monthly cellular service charges invoiced to PCI’s cellular subscribers from which
a fixed percentage of the dollars invoiced are retained by PCI as compensation for the billing and support services it provides
to these subscribers. PCI remits a fixed percentage of the gross cellular subscription billings to AT&T and absorbs 100% of
any bad debt associated with the gross cellular subscription billings under the terms of its distribution agreement with AT&T.
NOTE 6 – INVENTORY
The following table lists the cost basis of inventory by major
product category and the related reserves for inventory obsolescence at August 31, 2012 and May 31, 2012 (in thousands):
|
|
August 31, 2012
|
|
|
May 31, 2012
|
|
|
|
Cost
|
|
|
Reserve
|
|
|
Net Value
|
|
|
Cost
|
|
|
Reserve
|
|
|
Net Value
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Phones and related accessories
|
|
$
|
566
|
|
|
$
|
(117
|
)
|
|
$
|
449
|
|
|
$
|
700
|
|
|
$
|
(94
|
)
|
|
$
|
606
|
|
Automotive products
|
|
|
274
|
|
|
|
(46
|
)
|
|
|
228
|
|
|
|
273
|
|
|
|
(55
|
)
|
|
|
218
|
|
Other
|
|
|
14
|
|
|
|
(5
|
)
|
|
|
9
|
|
|
|
18
|
|
|
|
(6
|
)
|
|
|
12
|
|
Total inventory and reserves
|
|
$
|
854
|
|
|
$
|
(168
|
)
|
|
$
|
686
|
|
|
$
|
991
|
|
|
$
|
(155
|
)
|
|
$
|
836
|
|
NOTE 7 – PROPERTY AND EQUIPMENT
Property and equipment at August 31, 2012 and May 31, 2012 consisted
of the following (in thousands):
|
|
August 31, 2012
|
|
|
May 31, 2012
|
|
|
|
|
|
|
|
|
Land
|
|
$
|
774
|
|
|
$
|
774
|
|
Buildings and leasehold improvements
|
|
|
2,721
|
|
|
|
2,848
|
|
Office and computer equipment
|
|
|
2,770
|
|
|
|
2,766
|
|
Signs and displays
|
|
|
707
|
|
|
|
712
|
|
Other
|
|
|
35
|
|
|
|
62
|
|
|
|
$
|
7,007
|
|
|
$
|
7,162
|
|
Less:
|
|
|
|
|
|
|
|
|
Accumulated depreciation
|
|
|
(4,892
|
)
|
|
|
(5,038
|
)
|
|
|
|
|
|
|
|
|
|
Total property and equipment
|
|
$
|
2,115
|
|
|
$
|
2,124
|
|
Depreciation expense related to property and equipment was $52,000
and $52,000 for the three months ended August 31, 2012 and August 31, 2011, respectively.
Property and equipment are recorded at cost. Depreciation is
computed using the straight-line method. The following table contains the property and equipment by estimated useful life, net
of accumulated depreciation as of August 31, 2012 (in thousands):
|
|
Less than
|
|
|
3 to 4
|
|
|
5 to 9
|
|
|
10 to 14
|
|
|
15 to 19
|
|
|
20 years
|
|
|
Total Net
|
|
|
|
3 years
|
|
|
years
|
|
|
years
|
|
|
years
|
|
|
years
|
|
|
and greater
|
|
|
Value
|
|
Buildings and leasehold improvements
|
|
$
|
34
|
|
|
$
|
35
|
|
|
$
|
54
|
|
|
$
|
1
|
|
|
$
|
986
|
|
|
$
|
-
|
|
|
$
|
1,110
|
|
Office and computer equipment
|
|
|
154
|
|
|
|
28
|
|
|
|
17
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
199
|
|
Signs and displays
|
|
|
8
|
|
|
|
3
|
|
|
|
4
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
15
|
|
Other
|
|
|
3
|
|
|
|
14
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
17
|
|
Land (no depreciation)
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
774
|
|
|
|
774
|
|
|
|
$
|
199
|
|
|
$
|
80
|
|
|
$
|
75
|
|
|
$
|
1
|
|
|
$
|
986
|
|
|
$
|
774
|
|
|
$
|
2,115
|
|
NOTE 8 – INTANGIBLE ASSETS
The following is a summary of the Company’s intangible
assets as of August 31, 2012 and May 31, 2012, excluding goodwill (in thousands):
|
|
August 31, 2012
|
|
|
May 31, 2012
|
|
|
|
Gross
|
|
|
|
|
|
Net
|
|
|
Gross
|
|
|
|
|
|
Net
|
|
|
|
Carrying
|
|
|
Accumulated
|
|
|
Carrying
|
|
|
Carrying
|
|
|
Accumulated
|
|
|
Carrying
|
|
|
|
Amount
|
|
|
Amortization
|
|
|
Value
|
|
|
Amount
|
|
|
Amortization
|
|
|
Value
|
|
Definite lived intangible assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Wireless contracts and subscriber bases
|
|
$
|
10,277
|
|
|
$
|
(8,748
|
)
|
|
$
|
1,529
|
|
|
$
|
10,277
|
|
|
$
|
(8,575
|
)
|
|
$
|
1,702
|
|
PCI marketing list
|
|
|
1,235
|
|
|
|
(1,235
|
)
|
|
|
-
|
|
|
|
1,235
|
|
|
|
(1,235
|
)
|
|
|
-
|
|
Loan origination fees
|
|
|
668
|
|
|
|
(616
|
)
|
|
|
52
|
|
|
|
616
|
|
|
|
(616
|
)
|
|
|
-
|
|
Government Services Administration contract
|
|
|
15
|
|
|
|
(6
|
)
|
|
|
9
|
|
|
|
15
|
|
|
|
(5
|
)
|
|
|
10
|
|
Texas Multiple Award Schedule contract
|
|
|
4
|
|
|
|
(1
|
)
|
|
|
3
|
|
|
|
4
|
|
|
|
(1
|
)
|
|
|
3
|
|
Internally developed software
|
|
|
170
|
|
|
|
(170
|
)
|
|
|
-
|
|
|
|
170
|
|
|
|
(170
|
)
|
|
|
-
|
|
Total amortizable intangible assets
|
|
|
12,369
|
|
|
|
(10,776
|
)
|
|
|
1,593
|
|
|
|
12,317
|
|
|
|
(10,602
|
)
|
|
|
1,715
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Indefinite lived intangible assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Perpetual trademark license agreement
|
|
|
900
|
|
|
|
-
|
|
|
|
900
|
|
|
|
900
|
|
|
|
-
|
|
|
|
900
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total intangible assets
|
|
$
|
13,269
|
|
|
$
|
(10,776
|
)
|
|
$
|
2,493
|
|
|
$
|
13,217
|
|
|
$
|
(10,602
|
)
|
|
$
|
2,615
|
|
Total amortization expense for the three months ended August
31, 2012, and August 31, 2011 was approximately $172,000 and $228,000.
NOTE 9 – ACCRUED EXPENSES AND
OTHER CURRENT LIABILITIES
Accrued expenses and other current liabilities
consist of (in thousands):
|
|
August 31,
|
|
|
May 31,
|
|
|
|
2012
|
|
|
2012
|
|
|
|
|
|
|
|
|
Accrued payroll and other personnel expense
|
|
$
|
342
|
|
|
$
|
449
|
|
Accrued state and local taxes
|
|
|
507
|
|
|
|
551
|
|
Texas sales and use tax audit accrual
|
|
|
323
|
|
|
|
311
|
|
Unvouchered accounts payable
|
|
|
1,316
|
|
|
|
1,003
|
|
Customer deposits payable
|
|
|
202
|
|
|
|
218
|
|
Other
|
|
|
431
|
|
|
|
396
|
|
Total
|
|
$
|
3,121
|
|
|
$
|
2,928
|
|
Texas Sales and Use Tax Audit Accrual
Based on the results of the current Texas sales tax audit of
PCI (see Note 9 – “Texas Sales and Use Tax Obligation” for further discussion), the Company believes it has additional
financial exposure for certain periods following October 2009, the last month covered under the current sales tax audit, in the
likely event that PCI is audited in the future by the State. Similar tax computations were applied to the Company’s cellular
billings through November 2010, the point at which PCI made substantial system and process changes to correct these tax computations.
Other sales and use tax issues which were identified during the course of the current sales tax audit and have either been fully
corrected or are in the process of being corrected by the Company.
In accordance with ASC 450, the Company has determined that
the potential outcome of a subsequent sales tax audit represents a loss contingency, as the Company believes it is probable that
it will be audited by the State for the periods after the recently completed sales tax audit and will likely be assessed additional
taxes for that audit period. It is common practice for the State to audit a subsequent period after the discovery of a material
liability in a prior audit period.
Under the guidance of ASC 450, an estimated loss from a loss
contingency shall be accrued by a charge to income if both the following conditions are met: (i) information is available before
the next most current financial statements are issued or are available to be issued indicates that it is probable that an asset
had been impaired or a liability had been incurred as of the date of the financial statements, and (ii) the amount of such loss
can be reasonably estimated. In addition, from the guidance of ASC 450, a potential loss range should be estimated and the lower
end of the range should be accrued when no other amount within the range appears to be a better estimate.
The Company has estimated its potential sales and use tax exposure
for the periods that have not been audited by the State to be between $322,000 and $448,000, including estimated penalties and
interest of approximately $48,000 and $63,000, respectively, through August 31, 2012. This estimate covers all periods following
the completed sales tax audit period through the date that each identified tax issue was substantially corrected by the Company.
Since the Company cannot predict the outcome of a future sales tax audit, it has recorded the low end of the estimated loss in
its consolidated financials as of August 31, 2012. The Company’s estimate of the low end of the range of potential liability
considered only the errors identified in the current sales tax audit whereas the high end of the range was estimated using a conservative
application of sales tax rates on the majority of the cellular services billed from November 2009, the end of the current audit
period, through October 2010, the month that the identified tax issues were remediated by the Company. The actual liability, as
a result of a future tax audit, could fall outside of our estimated range due to items that could be identified during an audit
but not considered by us.
NOTE 10 – TEXAS SALES AND USE TAX OBLIGATION
From October 2010 through June 2012, the State of Texas (the
“State”) conducted a sales and use tax audit of the Company’s subsidiary, PCI, covering the period from January
2006 to October 2009. During the second fiscal quarter of 2011, while undergoing standard preparations for the tax audit, the Company
identified that there could be certain issues in connection with the prior application and interpretation of sales tax rates assessed
on various services and products billed and received by PCI. However, multiple prior sales tax audits of PCI conducted by the State
did not identify or determine that there were any such issues, even though PCI’s methodology for computing sales taxes was
virtually identical during the prior periods. As a result, prior to receiving a final determination from the State on these sales
tax matters, the Company could not accurately predict the probable outcome of this audit or any related material liability to the
State. In accordance with Accounting Standard Codification 450,
Contingencies
(“ASC 450”), the Company reported
an estimated range for this potential liability of between $22,000 and $2,400,000. The lower end of the range was based on the
actual results of PCI’s prior State tax audits, with the higher end of the range based on the Company’s internal review
and most conservative analysis, which indicated a potential estimated liability of up to $1,900,000, plus an additional estimated
potential liability of up to $500,000 for related penalties and interest on the Company’s highest possible estimated amount.
On March 27, 2012, the Company received a summary of the errors
identified by the State auditor on selected billing statements and invoices, which further included computations of these errors
extrapolated over the respective total billings and purchases for the audit period. Based on the information provided by the State,
the Company initially recorded a sales and use tax liability related to the tax audit of approximately $1,850,000 during the quarter
ended February 29, 2012, including approximately $443,000 in penalties and interest that was expected to be assessed by the State.
On June 11, 2012, the Company received notice from the State
the sales and use tax audit was complete. As a result of the final audit assessments provided by the State, the Company adjusted
its sales and use tax liability related to the tax audit to reflect a total obligation at May 31, 2012, of approximately $1,880,000,
including approximately $466,000 in assessed penalties and interest. The sales and use tax assessed by the State, before penalties
and interest, totaled approximately $1,414,000 for the tax audit period, and was comprised of approximately $6,000 of use tax related
to fixed asset purchases, $126,000 of use tax due on various services purchased by the Company, $637,000 of under billed sales
taxes related to cellular services billings and $645,000 of under billed sales taxes related to other billings. In addition, the
State noticed the Company the final audit assessment was due and payable on July 23, 2012.
Since the Company could not pay the entire tax obligation by
July 23, 2012, the Company petitioned the State on July 9, 2012 for a redetermination hearing related to PCI’s sale sales
and use tax audit. In the redetermination letter submitted to the State, the Company has requested the State to review questionable
audit transactions where the Company believes it is due a possible tax refund or credit adjustment. In addition, the Company has
requested the State to provide repayment assistance due to the Company’s current financial condition and limited working
capital. Furthermore, the Company has requested a waiver of penalty and interest that has been imposed by the State.
On
September 20, 2012, the Company submitted a formal compromise and payment agreement request to the State in an effort to forego
the lengthy redetermination process and settle the sales tax obligation expeditiously. The Company requested that the State reduce
the total tax assessment including interest and penalty to $1,250,000 and grant thirty-six month repayment terms for this obligation.
As of the date of this Report, the State has not set a redetermination hearing for PCI or responded to the Company formal payment
agreement request. Until the hearing is completed, a payment plan can be negotiated or this liability can be settled in another
manner. Beginning in June 2012, the Company has been voluntarily paying $25,000 a month against its sales and use tax obligation.
There can be no assurance that that any of the relief requested will be granted by the State as a result of this determination
hearing.
As of August 31, 2012, the Company’s sales and use tax
liability related to PCI’s sales tax audit is approximately $1,818,000, including assessed interest and penalties of approximately
$479,000.
NOTE 11 – CURRENT DEBT
Current debt at August 31, 2012 and May
31, 2012 consists of the following (in thousands):
|
|
August 31,
|
|
|
May 31,
|
|
|
|
2012
|
|
|
2012
|
|
Thermo revolving credit facility
|
|
$
|
7,075
|
|
|
$
|
8,233
|
|
East West Bank (formerly United Commerical Bank)
|
|
|
2,119
|
|
|
|
2,147
|
|
Jardine Capital Corporation bank debt
|
|
|
546
|
|
|
|
552
|
|
Total current debt
|
|
$
|
9,740
|
|
|
$
|
10,932
|
|
Thermo Revolving Credit Facility:
On August 28, 2009,
the Company entered into Amendment No. 2 to the Loan and Security Agreement with Thermo Credit, LLC (“Thermo”), effective
August 1, 2009, which amended the terms of its initial $5,250,000 Loan and Security Agreement dated April 30, 2008, and resulted
in, among other changes, the availability under the revolving credit facility being increased to $18,000,000 and the maturity of
the revolver being extended from April 30, 2010 to January 31, 2012 (“Amendment No. 2”).
Under the terms of Amendment No. 2, the revolver provided for
the Company to obtain loans from Thermo from time to time up to approximately $18,000,000, but following Amendment No. 4 discussed
below, the commitment was reduced to $12,000,000 meaning outstanding borrowings could not to exceed this amount. Borrowings under
the revolver are limited to specific advance rates against the aggregate fair value of the Company’s assets, as defined in
the Loan and Security Agreement, as amended, including real estate, equipment, infrastructure assets, inventory, accounts receivable,
intangible assets and notes receivable (collectively, the “Borrowing Base”). The annual interest rate on the revolver
under the terms of Amendment No. 2 remained at the lesser of: (a) the maximum non-usurious rate of interest per annum permitted
by applicable Louisiana law or (b) the greater of (i) the prime rate plus 8% or (ii) fourteen percent (14%).
In February 2010, the Company began making principal payments
on the revolver due to the Company’s having borrowings outstanding against the non-accounts receivable assets in excess of
the limit on such borrowings as measured against the total borrowings outstanding. In March 2010, Thermo agreed to let the Company
begin making monthly principal payments of approximately $53,000 through the remainder of the term of the loan to reduce the outstanding
loan balance against the non-accounts receivable assets. The monthly principal payments reduce the commitment amount under the
revolver.
On March 9, 2011, the Company entered into Amendment No. 3 to
the Loan and Security Agreement, effective December 31, 2010, which resulted in (i) extending the maturity date of the revolver
from January 31, 2012 to January 31, 2013, (ii) an additional commitment fee of $135,000 due and payable on or before January 31,
2012, (iii) the deferral of monthly principal payments for the period December 2010 to June 2011 to be due and payable on or before
August 31, 2011 and (iv) the deferral of an over advance of $433,747 as of December 31, 2010 to be due and payable on or before
August 31, 2011 after consideration of the Company’s borrowing base as of that date. All other terms of the revolver remained
unchanged.
On October 11, 2011, the Company entered into Amendment No.
4 to the Loan and Security Agreement whereby the loan commitment amount was reduced from $18,000,000 to $12,000,000 as of October
11, 2011. As a result of the reduced loan commitment amount, the loan commitment fee of $68,000 payable on August 1, 2011, as required
under Amendment No. 2, was reduced to $45,000. The Company paid the amended commitment fee amount in August 2011. All other terms
of the Thermo Revolver remained unchanged.
On March 14, 2012, effective February 29, 2012, Teletouch and
Thermo entered into Waiver and Amendment No. 5 (“Amendment No. 5”) to the Loan and Security Agreement, as amended to
date (the “Loan Agreement”). Under the terms of the Amendment No. 5, the Company made a payment on the outstanding
balance of the loan in the amount of $2,000,000. In consideration for such payment, Thermo agreed, among other things, to (i) waive
any and all Events of Default (as the term is defined under the Loan Agreement), and all financial covenants for the third fiscal
quarter ended February 29, 2012, (ii) waive any and all Financial Covenant Defaults (as defined under the Loan Agreement) for the
fourth fiscal quarter ended May 31, 2012, and not to accelerate collection of the Note for any reason under the Loan Agreement
through May 31, 2012, and (iii) not to take any action to exclude, reevaluate or make any redetermination of any property currently
included in the Borrowing Base through at least May 31, 2012. In addition, Thermo agreed to grant a conditional future waiver of
any and all Financial Covenant Defaults (as defined under the Loan Agreement) and not to accelerate the collection of the Note
through August 31, 2012, provided that certain financial performance targets are met by the Company during its fourth fiscal quarter
ending May 31, 2012, and that the Company, among other things, refinances certain of its existing loans encumbering the Eligible
Real Estate (as defined under the Loan Agreement), thereby providing Thermo with additional proceeds of $1,400,000 on or before
July 15, 2012. Additional provisions of Amendment No. 5 included accelerating the Revolving Credit Maturity Date from January 31,
2013, to August 31, 2012, with the parties’ agreement that Thermo will have no further obligation to lend or advance any
additional funds that may be or become available under the Loan Agreement, and, a modification of the commitment fee due under
the Loan Agreement from the $90,000 earned commitment fee for the final twelve month term of the loan that was to end on January
31, 2013, to a monthly commitment fee of $7,500 (based on 0.0625% of the original $12,000,000 loan commitment), earned by and payable
to Thermo on the first day of each month beginning February 1, 2012 and through each month thereafter until the loan is paid in
full, or the August 31, 2012, maturity date, whichever was sooner.
Although the Company made the required $2,000,000 cash payment
on March 14, 2012, the Company did not meet all of the requirements under Amendment No. 5 during its fourth fiscal quarter ending
May 31, 2012 and was not able to refinance its existing real estate loans and pay Thermo an additional $1,400,000 by July 15, 2012.
However, as a result of the recent sale of the Company’s two-way business (see Note 3 – “Discontinued Two-Way
Operations” for more information on the sale of the two-way business), the Company was able to pay Thermo approximately $1,001,000
on August 14, 2012.
On August 1, 2012, the Company executed a term sheet with a
potential new debt lender and is currently working with the lender through the due diligence process. The Company is targeting
to close on this new senior debt facility by the end of October 2012.
On September 10, 2012 the Company received a Formal Notice of
Maturity (the “Letter”) from Thermo which notified the Company the revolving credit facility had matured by its terms
on August 31, 2012, and therefore under the terms of the facility, Thermo had the right to demand payment for all obligations due
and payable under the credit revolving facility by September 17, 2012. Thermo further reserved all rights and remedies available
to it under the documents and agreements in connection with the revolving credit facility. Even though Thermo was reserving its
rights under the agreement and revolving credit facility, the Letter did not constitute a notification to the Company that Thermo
was commencing the exercise of any of its rights and remedies. As of the date of this Report, Thermo has not commenced any actions
against the Company and is willing
to work with the Company as it seeks new financing to settle the
amount due under the revolving credit facility. The Company can provide no assurance it will be successful in obtaining new debt
funding or Thermo will not take any action against the Company and the underlying collateral against the revolving credit facility.
As of August 31, 2012, the Company’s outstanding balance
on the Thermo loan was approximately $7,075,000.
East West Bank Debt (formerly
United Commercial Bank):
Effective May 3, 2007, the Company entered into a loan agreement with United Commercial Bank, which
was subsequently acquired by East West Bank, (the “East West Debt”) to refinance previous debt in the amount of $2,850,000
at May 31, 2007.
As of August 31, 2012, $2,650,000 continued to be funded under the agreement with East West Bank, and
approximately $2,119,000 was outstanding.
The East West Debt requires monthly payments of $15,131 and
bears interest at the prime rate as published in the Wall Street Journal and adjusted from time to time (3.25% at August 31, 2012).
The East West Debt is collateralized by a first lien on the Company’s corporate office building, the excess land adjacent
to that building and a billboard in Fort Worth, Texas owned by the Company. The East West Debt matured on May 3, 2012 and the Company
was noticed in the second quarter of fiscal year 2012 the East West Debt would not be renewed. Subsequently, East West Bank granted
an initial extension of the debt maturity through August 3, 2012 and granted a second extension through November 3, 2012. The Company
has not been able to secure new financing against its real estate and believes that this will not be possible until it secures
new senior debt financing and settles its debt with Thermo. The Company cannot assure such financing can be secured or that any
new financing will be on terms favorable to the Company. In addition, the Company can provide no assurance that East West Bank
will extend the current maturity date or that any such extensions will allow a sufficient amount of time for the Company to secure
the new real estate financing.
Jardine Bank Debt:
Effective May 3, 2007, the Company
entered into a loan agreement with Jardine Capital Corp. (the “Jardine Bank Debt”) to refinance previous debt in the
amount of $650,000. The Jardine Bank Debt is collateralized by a second lien on the Company’s corporate office building,
the excess land adjacent to that building and a billboard in Fort Worth, Texas owned by the Company. The Jardine Bank Debt requires
monthly payments of $7,705, bears interest at 13% and matured on May 3, 2012. The Company was noticed in the second quarter of
fiscal year 2012 the Jardine Bank Debt would not be renewed. Subsequently, Jardine Capital granted an initial extension of the
debt maturity through August 3, 2012 and granted a second extension through October 15, 2012. As of August 31, 2012, a total of
approximately $546,000 was outstanding under this agreement. The Company has not been able to secure new financing against its
real estate and believes that this will not be possible until it secures new senior debt financing and settles its debt with Thermo.
The Company cannot assure such financing can be secured or that any new financing will be on terms favorable to the Company. In
addition, the Company can provide no assurance that Jardine Bank will extend the current maturity date or that any such extensions
will allow a sufficient amount of time for the Company to secure the new real estate financing.
NOTE 12 – TRADEMARK PURCHASE OBLIGATION
On May 4, 2010, Progressive Concepts, Inc., entered in a certain
Mutual Release and Settlement Agreement (the “Agreement”) with Hawk Electronics, Inc. (“Hawk”). The settlement
followed a litigation matter styled
Progressive Concepts, Inc. d/b/a Hawk Electronics v. Hawk Electronics, Inc
. Case No.
4-08CV-438-Y, by the Company against Hawk in the US District Court for the Northern District of Texas which alleged, among other
things, infringement on the trade name
Hawk Electronics
, as well as counterclaims by Hawk against the Company of, among
other things, trademark infringement and dilution.
Under terms of the Agreement, the parties executed mutual releases
of claims against each other and agreed to file a stipulation of dismissal in connection with the pending litigation matter. The
Company agreed to, among other things, the purchase a perpetual license from Hawk to use the trademark “Hawk Electronics”
for $900,000. Under the terms of the license agreement, the Company made a payment of $550,000 on June 1, 2010 and a payment of
$150,000 on July 1, 2011, and a payment of $100,000 on June 29, 2012 and is obligated to pay $100,000 by July 1, 2013.
As of August 31, 2012, the Company has recorded $100,000 as
a current liability under current portion of trademark purchase obligation (July 1, 2013 payment).
In addition, under the terms of the agreement, the Company can
continue to use the domain name
www.hawkelectronics.com
but will be required to pay Hawk a monthly royalty fee to use the
domain name beginning August 1, 2013. A monthly royalty payment of $2,000 will be due during the first year of use with a 10% increase
to the monthly fee each subsequent year the domain name is used by the Company.
NOTE 13 - INCOME TAXES
Significant components of the Company’s deferred taxes
as of August 31, 2012 and May 31, 2012 are as follows (in thousands):
|
|
August 31,
|
|
|
May 31,
|
|
|
|
2012
|
|
|
2012
|
|
|
|
|
|
|
|
|
Deferred Tax Assets:
|
|
|
|
|
|
|
|
|
Current deferred tax assets:
|
|
|
|
|
|
|
|
|
Accrued liabilities
|
|
$
|
796
|
|
|
$
|
841
|
|
Deferred revenue
|
|
|
-
|
|
|
|
28
|
|
Inventories
|
|
|
62
|
|
|
|
118
|
|
Allowance for doubtful accounts
|
|
|
60
|
|
|
|
60
|
|
|
|
|
918
|
|
|
|
1,047
|
|
Valuation allowance
|
|
|
(918
|
)
|
|
|
(1,047
|
)
|
Current deferred tax assets, net of valuation allowance
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
Non-current deferred tax assets:
|
|
|
|
|
|
|
|
|
Net operating loss
|
|
|
8,480
|
|
|
|
8,547
|
|
Accrued liabilities
|
|
|
566
|
|
|
|
511
|
|
Intangible assets
|
|
|
289
|
|
|
|
316
|
|
Fixed assets
|
|
|
230
|
|
|
|
207
|
|
Licenses
|
|
|
-
|
|
|
|
9
|
|
Other
|
|
|
180
|
|
|
|
178
|
|
|
|
|
9,745
|
|
|
|
9,768
|
|
Valuation allowance
|
|
|
(9,745
|
)
|
|
|
(9,768
|
)
|
Non-current deferred tax assets, net of valuation allowance
|
|
|
-
|
|
|
|
-
|
|
The Company has approximately $24,943,000 of Net Operating Losses
(“NOL’s”) at August 31, 2012, which are subject to expiration in various amounts from 2022 through 2031. In fiscal
year 2013, these net operating losses are subject to limitations as a result of a change in ownership that took place during August
2011, as defined by Section 382 of the Internal Revenue Code. For fiscal year 2013, the Company has approximately $2,274,000 in
NOL’s available to offset taxable income for the year. Realization of deferred tax assets associated with the net operating
losses is dependent upon generating sufficient taxable income prior to their expiration and to the limitations imposed by Section
382. Management has determined that it is unlikely that the deferred tax assets will be realized; therefore, a full valuation allowance
has been established as of August 31, 2012 and May 31, 2012.
The current Company policy classifies any
interest recognized on an underpayment of income taxes and any statutory penalties recognized on a tax position taken as interest
and penalty expense in its consolidated statements of operations. There was an insignificant amount of interest and penalties recognized
and accrued as of August 31, 2012. The Company has not taken a tax position that, if challenged, would have a material effect on
the financial statements or the effective tax rate for fiscal year ended August 31, 2012 and has not recognized any additional
liabilities for uncertain tax positions under the guidance of ASC 740. The Company’s tax years 2005 through 2011 for federal
returns and 2009 through 2012 for state returns remain open to major taxing jurisdictions in which we operate, although no material
changes to unrecognized tax positions are expected within the next year.
NOTE 14 – COMMITMENTS AND CONTINGENCIES
Teletouch leases building and equipment
under non-cancelable operating leases with initial lease terms ranging from one to twenty years. These leases contain various renewal
terms and restrictions as to use of the property. Some of the leases contain provisions for future rent increases. The total amount
of rental payments due over the lease terms is charged to rent expense on the straight-line method over the term of the leases.
The difference between rent expense recorded and the amount paid is recorded as deferred rental expense, which is included in accrued
expenses and other liabilities in the accompanying consolidated balance sheets. The Company’s most significant lease obligation
is for a suite at the Dallas Cowboys Stadium in Arlington, Texas, which is used for customer, supplier, investor relations and
other corporate events. Due to the significance of this lease compared to the Company’s other operating leases, it is separately
identified in the table below. Total rent expense recorded against all operating leases, including the Dallas Cowboy’s suite
lease was
$207,000
, and $261,000 in the three months ended August 31, 2012 and August 31, 2011,
respectively. Future minimum rental commitments under non-cancelable leases are as follows (in thousands):
|
|
(in thousands)
|
|
|
|
Twelve Months Ending August 31,
|
|
|
|
Total
|
|
|
2013
|
|
|
2014
|
|
|
2015
|
|
|
2016
|
|
|
2017
|
|
|
Thereafter
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other Operating Leases
|
|
$
|
659
|
|
|
$
|
328
|
|
|
$
|
207
|
|
|
$
|
59
|
|
|
$
|
46
|
|
|
$
|
19
|
|
|
$
|
-
|
|
Dallas Cowboys Suite Lease
|
|
|
3,694
|
|
|
|
205
|
|
|
|
205
|
|
|
|
205
|
|
|
|
205
|
|
|
|
205
|
|
|
|
2,669
|
|
Total Operating Leases
|
|
$
|
4,353
|
|
|
$
|
533
|
|
|
$
|
412
|
|
|
$
|
264
|
|
|
$
|
251
|
|
|
$
|
224
|
|
|
$
|
2,669
|
|
Additionally, as of August 31, 2012, the Company has a commitment
to purchase 4,080 Alcatel branded cellular handsets from TCT Mobile Multinational, Limited (“TCT”) for approximately
$402,000 under its recently executed distribution agreement with TCT. To date, approximately 1,000 cellular handsets have been
received and the Company expects to receive the remaining product in late October 2012.
Sales and Use Tax Audit Contingency
Due to the results of PCI’s recent sales and use tax audit,
the Company has identified a sales and use tax contingency for the period subsequent to the recent audit period which is November
1, 2009 through May 31, 2012 (see Note 8 – “Accrued Expenses and Other Current Liabilities” for more information
on the sales and use tax accrual for this period).
The Company recorded approximately $162,000 and $251,000 in
stock based compensation expense in the consolidated financial statements for the three months ended August 31, 2012 and August
31, 2011, respectively.
The commonly controlled companies owning or affiliated with
Teletouch are as follows:
On August 17, 2011, TLLP closed on a transaction
to settle certain of its debt obligations and retire its outstanding redeemable Series A Preferred Units. The result of this transaction
was that TLLP transferred a total of 27,000,000 shares of Teletouch’s common stock to settle these obligations leaving it
with 3,650,999 shares of Teletouch’s common stock or approximately 7.5% ownership of Teletouch (see “Change of Ownership
and Voting Control of Teletouch” in Note 14 – “Stockholders Equity” for further discussion on this transaction).
On November 29, 2011, TLLP sold an additional
600,000 shares of Teletouch common stock leaving TLLP with a 6.3% ownership of Teletouch.
Using these criteria, the Company's two
reportable segments are cellular services and wholesale distribution. The Company’s former two-way radio services business
was sold on August 11, 2012 and is reported as discontinued operations for the three months ended August 31, 2012 and 2011 (see
Note 3 – “Two-Way Discontinued Operations” for more information on the sale of the two-way business).
The Company’s cellular business segment represents its
core business, which has been acquiring, billing, and supporting cellular subscribers under a revenue sharing relationship with
AT&T and its predecessor companies for over 28 years. The consumer services and retail business within the cellular segment
is operated primarily under the Hawk Electronics brand name, with additional business and government sales provided by a direct
sales group operating throughout all of the Company’s markets. As an Authorized Service Provider and billing agent, the Company
controls the entire customer experience, including initiating and maintaining the cellular service agreements, rating the cellular
plans, providing complete customer care, underwriting new account acquisitions and providing multi-service billing, collections,
and account maintenance.
The Company’s wholesale business
segment represents its distribution of cellular telephones, accessories, car audio and car security products to major carrier agents,
rural cellular carriers, smaller consumer electronics and automotive retailers and auto dealers throughout the United States.
Corporate overhead is reported separate
from the Company’s identified segments. The Corporate overhead costs include expenses for the Company’s accounting,
information technology, human resources, marketing and executive management functions, as well as all direct costs associated with
public company compliance matters including legal, audit and other professional services costs.
Beginning in the quarter ended November
30, 2011, the Company began combining the insignificant amounts previously reported as corporate product sales, with the product
sales reported for its cellular segment. These product sales previously reported as corporate sales related to an insignificant
amount of product sales that were generated through various corporate departments, primarily related to cellular products. The
segment information for the three months ended August 31, 2011 in this Report has been conformed to be comparable to the current
year’s segment presentation.
The following tables summarize the Company’s
operating financial information by each segment for the three months ended August 31, 2012 and August 31, 2011 (in thousands):
The Company identifies its assets by segment. Significant assets
of the Company’s corporate offices include all of the Company’s cash, property and equipment, loan origination costs
and the patent held for sale. The Company’s assets by segment as of August 31, 2012 and May 31, 2012 are as follows:
(1) “Other” includes
assets, property and equipment, net and goodwill and intangible assets, net associated with the Company’s discontinued two-way
operations.
During the three months ended August 31,
2012 and August 31, 2011, the Company did not have a single customer that represented more than 10% of total segment revenues.
Management’s discussion and analysis of results of operations
and financial condition is intended to assist the reader in the understanding and assessment of significant changes and trends
related to the results of operations and financial position of the Company. This discussion and analysis should be read in conjunction
with the consolidated financial statements and the related notes and the discussions under “Critical Accounting Estimates,”
which describes key estimates and assumptions we make in the preparation of our financial statements. The Company’s first
fiscal quarter begins on Junefirst and ends on August 3first.