UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C. 20549





FORM
10-Q





x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934


For
the Quarterly Period Ended August 31, 2010





OR





 ̈
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934


For
the transition period from ____ to ___





Commission
File Number 1-13436





TELETOUCH
COMMUNICATIONS, INC.


(Exact
name of registrant in its charter)





Delaware
            
            75-2556090(State
      or other jurisdiction of
              Incorporation
      or Organization)
            
            (I.R.S.
      Employer Identification No.)




5718
Airport Freeway, Fort Worth, Texas  76117   (800)
232-3888


(Address
and telephone number of principal executive offices)









Indicate by check mark whether the
registrant (1) has filed all reports required to be filed by Section 13 or 15(d)
of the Securities Exchange Act of 1934 during the preceding 12 months (or for
such shorter period that the registrant was required to file such reports), and
(2) has been subject to such filing requirements for the past 90
days.





Yes  x 
No  ̈





Indicate
by check mark whether the registrant has submitted electronically and posted on
its corporate website, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding
12 months (or for such shorter period that the registrant was required to submit
and post such files).





Yes   ̈ 
No  ̈





Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer, or a smaller reporting
company.  See definitions of “large accelerated filer,” “accelerated
filer” and “smaller reporting company” in Rule 12b-2 of the Exchange
Act.





Large
accelerated filer   ̈    
Accelerated filer   ̈    Non-accelerated
filer   ̈    Smaller
reporting company  x





Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Act).  Yes  ̈  No
x





Indicate
the number of shares outstanding of each of the Registrant’s classes of Common
Stock, as of the latest practicable date:  Common Stock, $0.001 par
value, 48,739,002 shares at October 5, 2010.








TELETOUCH
COMMUNICATIONS, INC.





TABLE OF
CONTENTS




Page No.Part
      I.  Financial InformationItem
      1.
                    Financial
      Statements - Teletouch Communications, Inc
                    4Consolidated
      Balance Sheets as of August 31, 2010 (unaudited) and May 31, 2010
      (unaudited)
                    4Consolidated
      Statements of Operations – Three Months Ended August 31, 2010 (unaudited)
      and August 31, 2009 (unaudited)
                    6Consolidated
      Statements of Cash Flows - Three Months Ended August 31, 2010 (unaudited)
      and August 31, 2009 (unaudited)
                    7Notes
      to Consolidated Financial Statements (unaudited)
                    8Item
      2.
                    Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations
                    27Item
      3.
                    Quantitative
      and Qualitative Disclosures About Market Risk
                    45Item
      4.
                    Controls
      and Procedures
                    46Part
      II.  Other InformationItem
      1.
                    Legal
      Proceedings
                    47Item 1A.
                    Risk
      Factors
                    48Item
      2.
                    Unregistered
      Sales of Equity Securities and Use of Proceeds
                    50Item
      3.
                    Defaults
      Upon Senior Securities
                    50Item
      4.
                    Removed
      and Reserved
                    50Item
      5.
                    Other
      Information
                    50Item
      6.
                    Exhibits
                    50Signatures
                    51




2


Forward-Looking
Statements





This
Quarterly Report on Form 10-Q contains forward-looking statements and
information relating to Teletouch Communications, Inc. and its subsidiaries that
are based on management’s beliefs as well as assumptions made by and information
currently available to management. These statements are made pursuant to the
safe harbor provisions of the Private Securities Litigation Reform Act of 1995.
Statements that are predictive in nature, that depend upon or refer to future
events or conditions, or that include words such as “anticipate,” “believe,”
“estimate,” “expect,” “intend” and similar expressions, as they relate to
Teletouch Communications, Inc. or its management, are forward-looking
statements. Although these statements are based upon assumptions management
considers reasonable, they are subject to certain risks, uncertainties and
assumptions, including, but not limited to, those factors set forth below under
the caption  “Management’s Discussion and Analysis of Financial Condition
and Results of Operations” and “Risk Factors.” Should one or more of these risks
or uncertainties materialize, or should underlying assumptions prove incorrect,
actual results or outcomes may vary materially from those described herein as
anticipated, believed, estimated, expected or intended. Investors are cautioned
not to place undue reliance on these forward-looking statements, which speak
only as of their respective dates. We undertake no obligation to update or
revise any forward-looking statements. All subsequent written or oral
forward-looking statements attributable to us or persons acting on our behalf
are expressly qualified in their entirety by the discussion included in this
report.


3





PART
1 – FINANCIAL INFORMATION




Item
1.   Financial Statements





TELETOUCH
COMMUNICATIONS, INC.


CONSOLIDATED
BALANCE SHEETS


(unaudited)


(in
thousands, except share data)





ASSETS





August 31,
                
                
                May 31,2010
                
                
                2010CURRENT
      ASSETS:Cash
                
                $
                4,187
                
                
                $
                4,932Certificates
      of deposit-restricted
                
                
                50
                
                
                
                150Accounts
      receivable, net of allowance of $363 at August 31, 2010 and $407 at May
      31, 2010
                
                
                3,754
                
                
                
                3,967Unbilled
      accounts receivable
                
                
                2,466
                
                
                
                2,592Inventories,
      net of reserve of $218 at August 31, 2010 and $232 at May 31,
      2010
                
                
                1,310
                
                
                
                1,049Notes
      receivable
                
                
                2
                
                
                
                15Prepaid
      expenses and other current assets
                
                
                1,055
                
                
                
                1,288Patent
      held for sale
                
                
                257
                
                
                
                257Total
      Current Assets
                
                
                13,081
                
                
                
                14,250PROPERTY
      AND EQUIPMENT, net of accumulated depreciation of $6,112 at August 31,
      2010 and $6,039 at May 31, 2010
                
                
                2,769
                
                
                
                2,749GOODWILL
                
                
                343
                
                
                
                343INTANGIBLE
      ASSETS, net of accumulated amortization of $9,195 at August 31, 2010 and
      $8,964 at May 31, 2010
                
                
                4,136
                
                
                
                4,342TOTAL
      ASSETS
                
                $
                20,329
                
                
                $
                21,684





See
Accompanying Notes to Consolidated Financial Statements


4




TELETOUCH
COMMUNICATIONS, INC.


CONSOLIDATED
BALANCE SHEETS


(unaudited)


(in
thousands, except share data)





LIABILITIES
AND SHAREHOLDERS’ DEFICIT





August 31,
                
                
                May 31,2010
                
                
                2010CURRENT
      LIABILITIES:Accounts
      payable
                
                $
                8,135
                
                
                $
                7,964Accounts
      payable-related party
                
                
                24
                
                
                
                111Accrued
      expenses and other current liabilities
                
                
                4,676
                
                
                
                5,517Current
      portion of long-term debt
                
                
                1,559
                
                
                
                1,412Current
      portion of trademark purchase obligation
                
                
                150
                
                
                
                150Deferred
      revenue
                
                
                516
                
                
                
                336Total
      Current Liabilities
                
                
                15,060
                
                
                
                15,490LONG-TERM
      LIABILITIES:Long-term
      debt, net of current portion
                
                
                13,678
                
                
                
                14,487Long-term
      trademark purchase obligation, net of current portion
                
                
                200
                
                
                
                350Total
      Long Term Liabilities
                
                
                13,878
                
                
                
                14,837TOTAL
      LIABILITIES
                
                
                28,938
                
                
                
                30,327COMMITMENTS
      AND CONTINGENCIES
                
                
                -
                
                
                
                -SHAREHOLDERS'
      DEFICIT:Common
      stock, $.001 par value, 70,000,000 shares authorized, 49,916,189 shares
      issued and 48,739,002 shares outstanding at August 31, 2010 and May 31,
      2010
                
                
                50
                
                
                
                50Additional
      paid-in capital
                
                
                51,450
                
                
                
                51,186Treasury
      stock, 1,177,187 shares held at August 31, 2010 and May 31,
      2010
                
                
                (216
                )
                
                
                (216
                )Accumulated
      deficit
                
                
                (59,893
                )
                
                
                (59,663
                )Total
      Shareholders' Deficit
                
                
                (8,609
                )
                
                
                (8,643
                )TOTAL
      LIABILITIES AND SHAREHOLDERS' DEFICIT
                
                $
                20,329
                
                
                $
                21,684





See
Accompanying Notes to Consolidated Financial Statements


5





TELETOUCH
COMMUNICATIONS, INC.


CONSOLIDATED
STATEMENTS OF OPERATIONS


(in
thousands, except shares and per share amounts)


(unaudited)





Three Months EndedAugust 31,2010
                
                
                2009Operating
      revenues:Service
      and installation revenue
                
                $
                5,737
                
                
                $
                6,659Product
      sales revenue
                
                
                3,241
                
                
                
                4,800Total
      operating revenues
                
                
                8,978
                
                
                
                11,459Operating
      expenses:Cost
      of service and installation (exclusive of depreciation and amortization
      included below)
                
                
                1,527
                
                
                
                1,967Cost
      of products sold
                
                
                2,862
                
                
                
                4,404Selling
      and general and administrative
                
                
                3,916
                
                
                
                4,197Depreciation
      and amortization
                
                
                279
                
                
                
                327Total
      operating expenses
                
                
                8,584
                
                
                
                10,895Income
      from operations
                
                
                394
                
                
                
                564Interest
      expense, net
                
                
                (568
                )
                
                
                (502
                )Income
      (loss) before income tax expense
                
                
                (174
                )
                
                
                62Income
      tax expense
                
                
                56
                
                
                
                62Net
      income (loss)
                
                $
                (230
                )
                
                $
                -Income
      (loss) per share applicable to common shareholders - basic and
      diluted
                
                $
                -
                
                
                $
                -Weighted
      average basic and diluted shares outstanding
                
                
                48,739,002
                
                
                
                48,895,491





See
Accompanying Notes to Consolidated Financial Statements


6




TELETOUCH
COMMUNICATIONS, INC.


CONSOLIDATED
STATEMENTS OF CASH FLOWS


(in
thousands)


(unaudited)





Three
      Months EndedAugust 31,2010
                
                
                2009Operating
      Activities:Net
      income (loss)
                
                $
                (230
                )
                
                $
                -Adjustments
      to reconcile net income (loss) to net cash provided by (used in) operating
      activities:Depreciation
      and amortization
                
                
                279
                
                
                
                327Non-cash
      compensation expense
                
                
                264
                
                
                
                131Non-cash
      interest expense (income)
                
                
                24
                
                
                
                (19
                )Provision
      for losses on accounts receivable
                
                
                115
                
                
                
                216Provision
      for inventory obsolescence
                
                
                18
                
                
                
                15Changes
      in operating assets and liabilities:Accounts
      receivable
                
                
                220
                
                
                
                68Inventories
                
                
                (279
                )
                
                
                350Prepaid
      expenses and other assets
                
                
                233
                
                
                
                94Accounts
      payable
                
                
                84
                
                
                
                (1,437
                )Accrued
      expenses and other current liabilities
                
                
                (841
                )
                
                
                (484
                )Deferred
      revenue
                
                
                180
                
                
                
                (23
                )Net
      cash provided by (used in) operating activities
                
                
                67
                
                
                
                (762
                )Investing
      Activities:Capital
      expenditures
                
                
                (93
                )
                
                
                (12
                )Purchase
      of intangible asset
                
                
                (10
                )
                
                
                -Redemption
      of certificates of deposit
                
                
                100
                
                
                
                -Purchase
      of trademark license
                
                
                (150
                )Receipts
      from notes receivable
                
                
                3
                
                
                
                594Net
      cash (used in) provided by investing activities
                
                
                (150
                )
                
                
                582Financing
      Activities:Payments
      on long-term debt
                
                
                (662
                )
                
                
                (675
                )Purchase
      of treasury stock
                
                
                -
                
                
                
                (31
                )Net
      cash used in financing activities
                
                
                (662
                )
                
                
                (706
                )Net
      decrease in cash
                
                
                (745
                )
                
                
                (886
                )Cash
      at beginning of period
                
                
                4,932
                
                
                
                4,642Cash
      at end of period
                
                $
                4,187
                
                
                $
                3,756Supplemental
      Cash Flow Data:Cash
      payments for interest
                
                $
                568
                
                
                $
                525Cash
      payments for income taxes
                
                $
                41
                
                
                $
                241Non-Cash
      Transactions:Capitalization
      of loan origination fees
                
                $
                -
                
                
                $
                244Intangible
      asset received for payment of note receivable
                
                $
                10
                
                
                $
                257Intangible
      asset received for payment of account receivable
                
                $
                4
                
                
                $
                -Fixed
      assets received for payment of note receivable
                
                $
                -
                
                
                $
                25





See
Accompanying Notes to Consolidated Financial Statements


7


TELETOUCH COMMUNICATIONS,
INC.





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
46 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. Teletouch
operates 24 retail and agent locations in Texas. Locations include both
“Teletouch” and “Hawk Electronics” branded in-line and free-standing stores and
service centers. The Teletouch branded locations offer the Company’s two-way
radio products and services as well as public safety equipment to state, city
and local entities as well as commercial businesses. Teletouch’s wholly-owned
subsidiary, Progressive Concepts, Inc. (“PCI”) is a Master Distributor and
Authorized Provider 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 26
years, PCI has offered various communication services on a direct bill basis and
today services approximately 57,000 cellular subscribers. PCI sells consumer
electronics products and cellular services through its stores, its own 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 electronics and automotive 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. Teletouch also sells public safety equipment and services
under the brand “Teletouch PSE” (Public Safety Equipment).





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. 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.


8




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
standby letters of credit to it suppliers to secure purchases made under the
credit terms provided by these suppliers. The Company deposits funds into a
certificate of deposit and instructs that bank to issue the standby letter of
credit to the benefit of the supplier. All such funds are reported as restricted
funds until such time as the supplier releases the letter of credit requirement.
As of August 31, 2010 and May 31, 2010, the Company had $50,000 and $150,000
deposited in certificate of deposits, respectively, securing standby letter of
credits with one of its suppliers and a credit card merchant.




Allowance for Doubtful
Accounts: The Company performs periodic credit evaluations of its
customer base and extends credit to virtually all of its customers on an
uncollateralized basis.




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 an account receivable past due when
customers exceed the terms of payment granted to them by the Company. The
Company writes-off its fully reserved accounts receivable when it has exhausted
all internal 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 $363,000
and $407,000 at August 31, 2010 and May 31, 2010, respectively. Based on the
information available to the Company, 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.




9




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 channels, 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 $218,000 and $232,000 at August
31, 2010 and May 31, 2010, respectively. Actual obsolescence could differ from
those estimates.




Property and Equipment:
Property and equipment are 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
      yearsTwo-way
      network infrastructure
            5-15
      yearsOffice
      and computer equipment
            3-5
      yearsSigns
      and displays
            5-10
      yearsOther
      equipment
            3-5 yearsLeasehold
      improvements
            Shorter
      of estimated usefullife
      or term of lease





Intangible Assets:The
Company’s intangible assets are comprised of certain definite lived assets as
well as two 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, including
capitalized loan origination costs, the purchase and development of key
distribution agreements, purchased subscriber bases and FCC license acquisition
costs are amortized over the estimated useful life of the asset and reviewed for
impairment upon any triggering event that gives rise to any question as to the
assets’ ultimate recoverability as prescribed under ASC 360, Property, Plant and
Equipment, (“ASC 360”).




Indefinite
Lived Intangible Assets: The Company has two indefinite lived intangible
assets, goodwill and a purchased perpetual trademark license. Goodwill acquired
in a business combination and intangible assets determined to have an indefinite
useful life are not amortized but instead tested for impairment at least
annually in accordance with the provisions of ASC 350. The ASC 350 goodwill
impairment model is a two-step process. The first step compares the fair value
of a reporting unit that has goodwill assigned to its carrying value. The fair
value of a reporting unit using discounted cash flow analysis is estimated. If
the fair value of the reporting unit is determined to be less than its carrying
value, a second step is performed to compute the amount of goodwill impairment,
if any. Step two allocates the fair value of the reporting unit to the reporting
unit’s net assets other than goodwill. The excess of the reporting unit’s fair
value over the amounts assigned to its net assets other than goodwill is
considered the implied fair value of the reporting unit’s goodwill. The implied
fair value of the reporting unit’s goodwill is then compared to the carrying
value of its goodwill. Any shortfall represents the amount of goodwill
impairment. The goodwill recorded in the Company’s consolidated balance sheet
was acquired in January 2004 as part of the purchase of the two-way radio assets
of Delta Communications, Inc. The Company tests this goodwill annually on March
1st,
the first day of its fourth fiscal quarter, of each year unless an event occurs
that would cause the Company to believe the value is impaired at an interim
date.


10




In May
2010, Progressive Concepts, Inc., purchased a perpetual trademark license to use
the trademark “Hawk Electronics” (see Note – 6 “Goodwill and Other Intangible
Assets” for additional discussion). In accordance with ASC 350, an entity shall
evaluate the remaining useful life of an intangible asset that is not being
amortized each reporting period to determine whether events and circumstances
continue to support an indefinite useful life. As mentioned above, the guidance
under ASC 350 also states an intangible asset that is not subject to
amortization shall be tested for impairment annually or more frequently if
events or changes in circumstances indicate the asset might be impaired. The
impairment test shall consist of a comparison of the fair value of an intangible
asset with its carrying amount. If the carrying amount of an intangible asset
exceeds its fair value, an impairment loss shall be recognized in an amount
equal to the excess.





The
Company evaluated PCI’s perpetual trademark license asset at May 31, 2010, 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. 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
cellular distribution agreements with AT&T, purchased subscriber bases, FCC
licenses, internally developed software 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 wireless contracts is computed using the straight-line
method over the contract’s expected life. The estimated useful lives for the
intangible assets are as follows:





AT&T
      distribution agreements and subscriber bases
              1-13
      yearsFCC
      licenses
              9
      yearsInternally
      developed software
              3
      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 follows:





Loan
      origination costs
              2-5
      years





As of
August 31, 2010, the most significant intangible assets remaining that continue
to be amortized are the AT&T distribution agreements and subscriber bases.
The DFW and San Antonio AT&T cellular distribution agreements will continue
to be amortized through August 31, 2014 and December 31, 2013, respectively, or
for approximately 4.0 and 3.3 years, respectively.





The
wireless contract intangible assets represent certain cellular distribution
contracts that the Company has with AT&T, under which the Company is allowed
to provide cellular services to its customers. Although the Company has
sustained losses in recent years, management has evaluated this asset in light
of the fair value of each of the cellular subscribers that the Company services.
Included in the provisions of the primary contract with AT&T (DFW market) is
a liquidated damages provision, which defines a value of $1,000 per subscriber
(number) to be paid to the Company if AT&T were to solicit or take any or
all of the cellular subscribers from PCI. Under the terms of the DFW market
distribution agreement with AT&T, which expired on August 31, 2009, AT&T
must continue to provide airtime to the Company as long as the subscribers
choose to remain on service, or at AT&T’s option, AT&T could “buy-back”
the subscribers from the Company for the $1,000 liquidated damages per
subscriber line provided for by the agreement. The total value of the cellular
subscriber base provided for by the liquidated damages provision contained in
the contract exceeds the carrying value of the asset at all periods presented
herein. The Company regularly forecasts the expected cash flows to be derived
from this cellular subscriber base and as of the date of this Report those
expected cash flows exceed the carrying value of the asset.




11




Amortization
of the distribution agreements, subscriber bases, FCC licenses and internally
developed software is considered an operating expense and included in
“Depreciation and Amortization” in the accompanying consolidated statements of
operations. The Company periodically reviews the estimated useful lives of its
identifiable 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 Tangible
Assets: In accordance with ASC 360, the Company evaluates the
recoverability of the carrying value of its tangible long-lived assets based on
estimated undiscounted cash flows to be generated from such assets. If the
undiscounted cash flows indicate an 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. Projected revenues assume a declining
cellular service revenue while projected operating expenses are based upon
historic experience and expected market conditions adjusted to reflect an
expected decrease in expenses resulting from cost saving
initiatives.





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, and in each
instance the appraised value exceeds the carrying value of the
property.




Asset Held for Sale: In
accordance with ASC 360, the Company will reclassify certain long-lived assets
as a current asset held for sale on the Company’s consolidated balance sheets if
certain requirements are met. In order for an asset to be held for sale
under the provisions of ASC 360, management must determine the asset is to be
held for sale in its current condition, an active plan to complete the sale of
the asset has been initiated and the sale of the asset is probable within one
year. The Company evaluated the hotspot network patent it acquired during the
public auction of Air-bank, Inc.’s assets in July 2009 and has determined this
asset met all the criteria for an asset held for sale under ASC 360. At August
31, 2010, the patent is recorded as a current asset held for sale on the
Company’s consolidated balance sheet for approximately $257,000 as the Company
is actively pursuing the sale of this patent through a broker. The Company has
received no formal offers to purchase the patent from potential buyers but has
received several expressions of interest from qualified buyers who have
indicated the market value of the patent exceeds the carrying value as of August
31, 2010. The Company is attempting to sell the patent by the end of the second
quarter in fiscal year 2011.




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, 2010 and May 31, 2010,
the Company has recorded a valuation allowance against the full amount of its
net deferred tax assets. Although the Company had taxable income for fiscal year
2010, it is currently unable to reasonably forecast taxable income beyond fiscal
year 2010. The inability to foresee taxable income in future years makes it
more likely than not that the Company will not realize its recorded deferred tax
assets in future periods.




12




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 and two-way radio equipment through
the Company’s retail, wholesale and two-way 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, PCI offers customers a 30
day return/ exchange program for new cellular subscribers in order to match
programs put in place by most of the other cellular carriers. During the 30
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 30 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 revenues 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 have no impact on our consolidated financial
statements.


13




Deferred
revenue represents monthly service fees primarily access charges for cellular
services that are billed in advance by the Company.




Concentration of Credit Risk:
Teletouch provides cellular and other wireless telecommunications 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 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 its financial instruments approximates fair value due to the short
maturity of the current assets and liability and the reasonableness of the
interest rates on the Company’s debt.





Advertising and Pre-opening Costs:Labor costs, costs of hiring and training personnel and certain other
costs relating to the opening of new retail locations are expensed as incurred.
Additionally, advertising costs are expensed as incurred although the Company is
partially reimbursed based on various vendor agreements. 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, 2010 the
Company had two stock-based compensation plans for employees and nonemployee
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, 2010 and
2009 because the Company provided for a full valuation allowance against all
accrued future tax benefits for all periods presented until its operations
improve and the Company is able to forecast taxable income in the future
sufficient to utilize its deferred tax assets.


14




For the
three months ended August 31, 2010 and 2009, the Company has elected to use 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 the historical daily volatility of the Company’s common
stock. Historical volatility factors utilized in the Company’s Black-Scholes
computations for options issued in the three months ended August 31, 2010 ranged
from 127.22% to 135.33% and was 240.4% for the options issued in the three
months ended August 31, 2009. 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, 2010 ranged from 5.0 years to 6.0 years and was 5.0 years for the
options issued in the three months ended August 31, 2009. 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,
2010 ranged from 2.05% to 2.42% and was 2.55% for the options issued in the
three months ended August 31, 2009. 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, 2010 and 2009. 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, 2010 and May 31, 2010 totaled 4,652,098 and 3,054,545,
respectively. The weighted-average exercise price per share of options
exercisable at August 31, 2010 and May 31, 2010 was $0.27 with remaining
weighted-average contractual terms of approximately 7.5 years and 7.0 years,
respectively.





The
weighted-average grant date fair value of options granted during the three
months ended August 31, 2010 and 2009 was $0.33 and $0.12,
respectively.





At August
31, 2010, the total remaining unrecognized compensation cost related to unvested
stock options amounted to approximately $190,000, which will be amortized over
the weighted-average remaining requisite service period of 1.37
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, 2010, the Company’s outstanding common stock options
totaled 5,656,483 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
during the three months ended August 31, 2010. At August 31, 2009, the Company’s
outstanding common stock options totaled 4,603,982 and were excluded from the
diluted earnings per share calculation because the options were not dilutive due
to their exercise price exceeding the Company’s market price of its common stock
at August 31, 2009.





Recently
Issued Accounting Standards:





In
October 2009, the FASB issued ASU No. 2009-13, Revenue Recognition (Topic 605) –
Multiple-Deliverable Revenue Arrangements, (“ASU 2009-13”). ASU 2009-13
impacts the determination of when the individual deliverables included in a
multiple-element arrangement may be treated as separate units of accounting.
Additionally, these new standards modify the manner in which the transaction
consideration is allocated across the separately identified deliverables by no
longer permitting the residual method of allocating arrangement consideration.
These new standards are effective for the Company beginning June 1, 2011. The
Company does not expect the adoption of this guidance to have a material impact
on its consolidated financial positions or results of operations.




15




NOTE
3 – 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. During fiscal year
2010 and following the Company’s commencement of an arbitration proceeding
against AT&T (discussed further below), AT&T notified the Company it is
cancelling or not renewing three of the six distribution agreements including
those agreements that cover the Austin, Texas MSA, Houston, Texas MSA and
Arkansas. The Company is disputing these cancellations and is attempting to have
these matters included and resolved in the arbitration hearing related to the
DFW Agreement. The distribution agreements permit 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.





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. 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’s largest
distribution agreement with AT&T for the Dallas / Fort Worth, Texas MSA was
amended effective September 1, 1999 with an initial term of 10 years (the
“DFW Agreement”). The DFW Agreement provided for two 5-year extensions unless
either party provides written notice to the other party at least six months
prior to the expiration of the initial term or the additional renewal term.
Specifically, under the terms of its distribution agreement with AT&T, the
Company is allowed to continue to service its existing subscribers (each
telephone number assigned to a customer is deemed to be a separate subscriber)
at the time of expiration until the subscribers, of their own free will,
independently and without any form of encouragement or inducement from AT&T,
have their services terminated with the Company. The initial term of the DFW
Agreement expired on August 31, 2009, and the Company received the required six
month notice from AT&T in February 2009 stating it would not extend the DFW
Agreement. As a result of the expiration of the initial term of the DFW
Agreement, the exclusivity requirements under this agreement terminated in
August 2009, which allows the Company to expand its cellular offerings in the
previously AT&T exclusive areas, under new agreements with one or more
carriers.





On
September 30, 2009, Teletouch’s subsidiary, PCI, commenced an arbitration
proceeding against AT&T seeking at least $100 million in damages. The
binding arbitration was commenced to seek relief for damages incurred as
AT&T has prevented the Company from selling the popular iPhone and other
“AT&T exclusive” products and services that PCI believes it is contractually
entitled to provide to its customers.  In addition, the Company’s
initial statement of claim alleges, among other things, that AT&T has
violated the longstanding non-solicitation provisions under the DFW Agreement by
and between the companies by actively inducing customers to leave PCI for
AT&T. While PCI has attempted to negotiate with AT&T for the purpose of
obviating the need for legal action, such attempts have failed. Accordingly, PCI
has initiated this arbitration.


16




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 EndedAugust 31,2010
                      
                      
                      2009Gross
      service and installation billings
                      
                      $
                      11,374
                      
                      
                      $
                      14,396Less:
      Direct costs paid to AT&T
                      
                      
                      (5,637
                      )
                      
                      
                      (7,737
                      )Net
      service and installation revenue
                      
                      $
                      5,737
                      
                      
                      $
                      6,659





Gross
service and installation billings include gross cellular subscription
billings, which are measured as the total recurring monthly cellular service
charges invoiced to PCI’s wireless subscribers for which a fixed percentage of
the dollars invoiced are retained by PCI as compensation for the services it
provides to these subscribers and for which PCI takes full (100%) accounts
receivable risk before deducting certain revenue sharing amounts that are
payable to AT&T under PCI’s current billing and customer service agreements
with AT&T.




NOTE
4 – INVENTORY





The
following table reflects the components of inventory (in
thousands):





August 31, 2010
                        
                        
                        May 31, 2010Cost
                        
                        
                        Reserve
                        
                        
                        Net Value
                        
                        
                        Cost
                        
                        
                        Reserve
                        
                        
                        Net ValuePhones
      and related accessories
                        
                        $
                        728
                        
                        
                        $
                        (60
                        )
                        
                        $
                        668
                        
                        
                        $
                        557
                        
                        
                        $
                        (69
                        )
                        
                        $
                        488Automotive
      products
                        
                        
                        300
                        
                        
                        
                        (36
                        )
                        
                        
                        264
                        
                        
                        
                        284
                        
                        
                        
                        (42
                        )
                        
                        
                        242Satellite
      products
                        
                        
                        19
                        
                        
                        
                        (4
                        )
                        
                        
                        15
                        
                        
                        
                        18
                        
                        
                        
                        (4
                        )
                        
                        
                        14Two-way
      products
                        
                        
                        476
                        
                        
                        
                        (116
                        )
                        
                        
                        360
                        
                        
                        
                        418
                        
                        
                        
                        (115
                        )
                        
                        
                        303Other
                        
                        
                        5
                        
                        
                        
                        (2
                        )
                        
                        
                        3
                        
                        
                        
                        4
                        
                        
                        
                        (2
                        )
                        
                        
                        2Total
      inventory and reserves
                        
                        $
                        1,528
                        
                        
                        $
                        (218
                        )
                        
                        $
                        1,310
                        
                        
                        $
                        1,281
                        
                        
                        $
                        (232
                        )
                        
                        $
                        1,049





NOTE
5 – PROPERTY AND EQUIPMENT




Property
and equipment consisted of the following (in thousands):




August 31, 2010
                  
                  
                  May 31, 2010Land
                  
                  $
                  774
                  
                  
                  $
                  774Buildings
      and leasehold improvements
                  
                  
                  3,102
                  
                  
                  
                  3,056Two-way
      network infrastructure
                  
                  
                  1,055
                  
                  
                  
                  1,055Office
      and computer equipment
                  
                  
                  2,778
                  
                  
                  
                  2,716Signs
      and displays
                  
                  
                  790
                  
                  
                  
                  790Other
      equipment
                  
                  
                  382
                  
                  
                  
                  397$
                  8,881
                  
                  
                  $
                  8,788Less:Accumulated
      depreciation and amortization
                  
                  
                  (6,112
                  )
                  
                  
                  (6,039
                  )$
                  2,769
                  
                  
                  $
                  2,749





Depreciation
and amortization expense related to property and equipment was approximately
$73,000 and $103,000 for the three months ended August 31, 2010 and 2009,
respectively.





Property
and equipment are recorded at cost. Depreciation and amortization is computed
using the straight-line method. The following table contains the property, plant
and equipment by estimated useful life, net of accumulated depreciation and
amortization as of August 31, 2010 (in thousands):




17




Less than
                  
                  
                  3 to 4
                  
                  
                  5 to 9
                  
                  
                  10 to 14
                  
                  
                  15 to 19
                  
                  
                  20 years
                  
                  
                  Total Net3 years
                  
                  
                  years
                  
                  
                  years
                  
                  
                  years
                  
                  
                  years
                  
                  
                  and greater
                  
                  
                  ValueBuildings
      and leasehold improvements
                  
                  $
                  15
                  
                  
                  $
                  67
                  
                  
                  $
                  113
                  
                  
                  $
                  -
                  
                  
                  $
                  10
                  
                  
                  $
                  1,184
                  
                  
                  $
                  1,389Two-way
      network infrastructure
                  
                  
                  11
                  
                  
                  
                  127
                  
                  
                  
                  115
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  253Office
      and computer equipment
                  
                  
                  162
                  
                  
                  
                  101
                  
                  
                  
                  6
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  269Signs
      and displays
                  
                  
                  47
                  
                  
                  
                  9
                  
                  
                  
                  6
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  62Other
                  
                  
                  22
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  22Land
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  774
                  
                  
                  
                  774$
                  257
                  
                  
                  $
                  304
                  
                  
                  $
                  240
                  
                  
                  $
                  -
                  
                  
                  $
                  10
                  
                  
                  $
                  1,958
                  
                  
                  $
                  2,769





NOTE
6 – GOODWILL AND OTHER INTANGIBLE ASSETS





Goodwill:  The reported
goodwill of the Company at August 31, 2010 and May 31, 2010 relates entirely to
the two-way radio segment and was purchased in the acquisition of the assets of
DCAE, Inc., which was completed in January 2004. The Company reported
goodwill of $343,000 on its consolidated balance sheet at August 31, 2010 and
May 31, 2010.





Other intangible assets: The following is a
summary of the Company’s intangible assets as of August 31, 2010 and May 31,
2010 excluding goodwill (in thousands):





August 31, 2010
                  
                  
                  May 31, 2010Gross
                  
                  
                  
                  
                  
                  Net
                  
                  
                  Gross
                  
                  
                  
                  
                  
                  NetCarrying
                  
                  
                  Accumulated
                  
                  
                  Carrying
                  
                  
                  Carrying
                  
                  
                  Accumulated
                  
                  
                  CarryingAmount
                  
                  
                  Amortization
                  
                  
                  Value
                  
                  
                  Amount
                  
                  
                  Amortization
                  
                  
                  ValueDefinite
      lived intangible assets:Wireless
      contracts and subscriber bases
                  
                  $
                  10,284
                  
                  
                  $
                  (7,285
                  )
                  
                  $
                  2,999
                  
                  
                  $
                  10,258
                  
                  
                  $
                  (7,091
                  )
                  
                  $
                  3,167FCC
      licenses
                  
                  
                  104
                  
                  
                  
                  (76
                  )
                  
                  
                  28
                  
                  
                  
                  104
                  
                  
                  
                  (73
                  )
                  
                  
                  31PCI
      marketing list
                  
                  
                  1,235
                  
                  
                  
                  (1,235
                  )
                  
                  
                  -
                  
                  
                  
                  1,235
                  
                  
                  
                  (1,235
                  )
                  
                  
                  -Loan
      origination fees
                  
                  
                  639
                  
                  
                  
                  (430
                  )
                  
                  
                  209
                  
                  
                  
                  639
                  
                  
                  
                  (395
                  )
                  
                  
                  244Internally
      developed software
                  
                  
                  170
                  
                  
                  
                  (170
                  )
                  
                  
                  -
                  
                  
                  
                  170
                  
                  
                  
                  (170
                  )
                  
                  
                  -Total
      amortizable intangible assets
                  
                  
                  12,432
                  
                  
                  
                  (9,196
                  )
                  
                  
                  3,236
                  
                  
                  
                  12,406
                  
                  
                  
                  (8,964
                  )
                  
                  
                  3,442Indefinite
      lived intangible assets:Perpetual
      trademark license agreement
                  
                  
                  900
                  
                  
                  
                  -
                  
                  
                  
                  900
                  
                  
                  
                  900
                  
                  
                  
                  -
                  
                  
                  
                  900Total
      intangible assets
                  
                  $
                  13,332
                  
                  
                  $
                  (9,196
                  )
                  
                  $
                  4,136
                  
                  
                  $
                  13,306
                  
                  
                  $
                  (8,964
                  )
                  
                  $
                  4,342





Amortization
is computed using the straight-line method based on the following estimated
useful lives:





Wireless
      contracts and subscriber bases
                1-13
      yearsFCC
      licenses
                9
      yearsLoan
      origination fees
                2-5
      yearsInternally-developed
      software
                3
      years








18




NOTE
7 – ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES





Accrued
expenses and other current liabilities consist of (in thousands):





August 31,
                  
                  
                  May 31,2010
                  
                  
                  2010Accrued
      payroll and other personnel expense
                  
                  $
                  1,377
                  
                  
                  $
                  1,957Accrued
      state and local taxes
                  
                  
                  579
                  
                  
                  
                  527Unvouchered
      accounts payable
                  
                  
                  2,030
                  
                  
                  
                  1,953Customer
      deposits payable
                  
                  
                  392
                  
                  
                  
                  427Other
                  
                  
                  298
                  
                  
                  
                  653Total
                  
                  $
                  4,676
                  
                  
                  $
                  5,517





NOTE
8 – LONG-TERM DEBT





Long-term
debt at August 31, 2010 and May 31, 2010 consists of the following (in
thousands):





August 31,
                  
                  
                  May 31,2010
                  
                  
                  2010Thermo
      revolving credit facility
                  
                  $
                  11,630
                  
                  
                  $
                  12,189East
      West Bank (formerly United Commerical Bank)
                  
                  
                  2,336
                  
                  
                  
                  2,361Jardine
      Capital Corporation bank debt
                  
                  
                  582
                  
                  
                  
                  585Warrant
      redemption notes payable
                  
                  
                  689
                  
                  
                  
                  764Total
      long-term debt
                  
                  
                  15,237
                  
                  
                  
                  15,899Less:
      Current portion
                  
                  
                  (1,559
                  )
                  
                  
                  (1,412
                  )Long-term
      debt, net
                  
                  $
                  13,678
                  
                  
                  $
                  14,487





Current
portion of long-term debt at August 31, 2010 and May 31, 2010 consists of the
following (in thousands):





August 31,
                  
                  
                  May 31,2010
                  
                  
                  2010Thermo
      revolving credit facility
                  
                  $
                  747
                  
                  
                  $
                  1,016East
      West Bank (formerly United Commerical Bank)
                  
                  
                  106
                  
                  
                  
                  105Jardine
      Capital Corporation bank debt
                  
                  
                  17
                  
                  
                  
                  16Warrant
      redemption notes payable
                  
                  
                  689
                  
                  
                  
                  275Total
      current portion of long-term debt
                  
                  $
                  1,559
                  
                  
                  $
                  1,412





Thermo Revolving Credit Facility:On August 28, 2009, Teletouch finalized amending, effective August 1,
2009, the terms of its $5,250,000 revolving credit facility with Thermo Credit,
LLC, resulting in, among other changes, the availability under the revolving
credit facility being increased from $5,250,000 to $18,000,000 and the maturity
of the revolver being extended from April 30, 2010 to January 31, 2012 (the
“Second Amended Thermo Revolver”).




The
Second Amended Thermo Revolver provides for the Company to obtain revolving
credit loans from Thermo from time to time up to $18,000,000. Borrowings against
the Second Amended Thermo Revolver are limited to specific advance rates against
the aggregate fair value of the Company’s assets, as defined in the amendment,
including real estate, equipment, infrastructure assets, inventory, accounts
receivable, intangible assets and notes receivable (collectively, the “Borrowing
Base”). The Company is allowed to borrow the lesser of the borrowing base amount
or the initial commitment amount of $18,000,000, less a monthly step down
amount. If the Company were to maximize its credit line, beginning in December
31, 2009, the availability under the Second Amended Thermo Revolver would be
reduced monthly by an amount equal to the average principal balance of loans
outstanding against the non-accounts receivable assets in the Borrowing Base for
that month divided by sixty (60) (the “Monthly Step Down”). The loans
outstanding on the accounts receivable component of the Borrowing Base will be
increased or decreased through periodic reporting of the Borrowing Base to
Thermo. The balance of all principal and interest outstanding under the Second
Amended Thermo Revolver is due January 31, 2012. The annual interest rate on the
Second Amended Thermo Revolver is 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%). Under the terms of the Second Amended Thermo Revolver, the Company must
maintain certain financial covenants including a net worth of at least
$5,000,000, computed on a fair value basis, at each fiscal quarter, a debt
service coverage ratio that ranges between 1.10 and 1.20 over the remaining life
of the revolver and an operating income no less than zero at any fiscal quarter.
The purpose of the Second Amended Thermo Revolver was to retire the former
factoring debt facility with Thermo and to provide additional availability to
the Company for its ongoing working capital needs. As of August 31, 2010, the
Company has a current repayment liability under the Second Amended Thermo
Revolver related to a loan commitment fee obligation of approximately
$68,000.




19




Under the
Company’s former debt facility with Thermo (the “Thermo Factoring Debt”), the
Company had adequate credit availability under the facility but was limited in
its ability to borrow additional funds due to declining levels of accounts
receivable. With the Second Amended Thermo Revolver, the Company can finance
other non-accounts receivable asset purchases by including them in the Borrowing
Base. Borrowings by the Company against non-accounts receivable assets are
limited to 33.3% of the total amount of loans outstanding under the terms of the
Second Amended Thermo Revolver. As of August 31, 2010, the Company had a maximum
availability of $5,870,000 against non-accounts receivable assets and
$11,739,000 against accounts receivable for a total maximum availability of
$17,609,000. Additionally, the Company had approximately $11,630,000 in loans
outstanding under the Second Amended Thermo Revolver as of August 31, 2010 which
included an obligation of approximately $68,000 related to loan commitment fees
under the Second Amended Thermo Revolver and is due on August 1, 2011. As of
August 31, 2010, $7,082,000 was advanced against accounts receivable and
$4,548,000 was advanced against non-accounts receivable assets. The availability
to the Company as of August 31, 2010 under the Second Amended Thermo Revolver is
approximately $4,657,000 to be borrowed against future accounts receivable and
$1,322,000 to be borrowed against non-accounts receivable asset future
purchases.




In
February 2010, the Company began making principal payments on the Second Amended
Thermo Revolver due to the Company’s having borrowings outstanding against the
non-accounts receivable assets in excess of the 33.3% limit on such borrowings
as measured against the total borrowings outstanding. This situation resulted
due to a decline in the Company’s accounts receivable and its related borrowings
against these receivables in 2010. 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 and as of August 31, 2010, the
maximum potential borrowings available under the revolver are
$17,609,000.




The lien
and security interest in substantially all of the Company’s assets, properties,
accounts, inventory, goods and the like granted to Thermo under the Thermo
Revolver and all other provisions remain the same under the Second Amended
Thermo Revolver.




NOTE
9 – 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 styledProgressive 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 nameHawk Electronics, as well as
counterclaims by Hawk against the Company of, among other things, trademark
infringement and dilution.


20




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
paid $400,000 by May 31, 2010 and $150,000 by July 1, 2010, and is obligated to
pay $150,000 by July 1, 2011, $100,000 by July 1, 2012 and $100,000 by July 1,
2013.




As of
August 31, 2010, the Company has recorded $150,000 as current portion of
trademark purchase obligation (July 1, 2011 payment) as a current liability and
has recorded $200,000 (payments due thereafter) under long-term trademark
purchase obligation as a long-term liability.





NOTE
10 - INCOME TAXES




Teletouch
uses the liability method to account for income taxes. Under this method,
deferred income tax assets and liabilities are determined based on differences
between the financial reporting and tax bases of assets and liabilities and are
measured using the enacted tax rates that are expected to be in effect when the
differences reverse.




Significant components of the Company’s
deferred taxes are as
follows(in
thousands):


August 31, 2010
                  
                  
                  May 31, 2010Deferred
      Tax Assets:Current
      deferred tax assets:Accrued
      liabilities
                  
                  $
                  827
                  
                  
                  $
                  826Deferred
      revenue
                  
                  
                  121
                  
                  
                  
                  55Inventories
                  
                  
                  79
                  
                  
                  
                  83Allowance
      for doubtful accounts
                  
                  
                  124
                  
                  
                  
                  1381,151
                  
                  
                  
                  1,102Valuation
      allowance
                  
                  
                  (1,151
                  )
                  
                  
                  (1,102
                  )Current
      deferred tax assets, net of valuation allowance
                  
                  
                  -
                  
                  
                  
                  -Non-current
      deferred tax assets:Net
      operating loss
                  
                  
                  9,797
                  
                  
                  
                  9,769Intangible
      assets
                  
                  
                  229
                  
                  
                  
                  228Fixed
      assets
                  
                  
                  189
                  
                  
                  
                  174Licenses
                  
                  
                  15
                  
                  
                  
                  15Other
                  
                  
                  35
                  
                  
                  
                  4710,265
                  
                  
                  
                  10,233Valuation
      allowance
                  
                  
                  (10,265
                  )
                  
                  
                  (10,233
                  )Non-current
      deferred tax assets, net of valuation allowance
                  
                  $
                  -
                  
                  
                  $
                  -





NOTE
11 – COMMITMENTS AND CONTINGENCIES





Teletouch
leases buildings, transmission towers, and equipment under non-cancelable
operating leases 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. Future minimum rental commitments under
non-cancelable leases are as follows (in thousands):





Twelve Months Ending August 31,Total
                    
                    
                    2011
                    
                    
                    2012
                    
                    
                    2013
                    
                    
                    2014
                    
                    
                    ThereafterOperating leases
                    
                    $
                    5,220
                    
                    
                    $
                    805
                    
                    
                    $
                    452
                    
                    
                    $
                    359
                    
                    
                    $
                    319
                    
                    
                    $
                    3,285




21




Teletouch
is party to various legal proceedings arising in the ordinary course of
business. The Company believes there is no proceeding, either threatened or
pending, against it that will result in a material adverse effect on its results
of operations or financial condition.




NOTE
12 – SHAREHOLDERS’ EQUITY





Capital Structure: Teletouch’s
authorized capital structure allows for the issuance of 70,000,000 shares of
common stock with a $0.001 par value and 5,000,000 shares of preferred stock
with a $0.001 par value.




Series C Preferred Stock:At
August 31, 2010, no shares of Series C Preferred Stock with a par value of
$0.001 are issued and outstanding.





NOTE
13 - STOCK OPTIONS





Teletouch’s
1994 Stock Option and Stock Appreciation Rights Plan (the “1994 Plan”) was
adopted in July 1994 and provides for the granting of incentive and
non-incentive stock options and stock appreciation rights to officers,
directors, employees and consultants to purchase not more than an aggregate of
400,000 shares of common stock. The Compensation Committee or the Board of
Directors administers the 1994 Plan and has authority to determine the optionees
to whom awards will be made, the terms of vesting and forfeiture, the amount of
the awards, and other terms. Under the terms of the 1994 Plan, the option
price approved by the Board of Directors shall not be less than the fair market
value of the common stock at date of grant. Exercise prices in the
following table have been adjusted to give effect to the repricing that took
effect in December 1999 and November 2001.




On
November 7, 2002, the Company’s common shareholders voted to adopt and ratify
the Teletouch 2002 Stock Option and Appreciation Rights Plan (the “2002 Plan”).
Under the 2002 Plan, Teletouch may issue options, which will result in the
issuance of up to an aggregate of 10,000,000 shares of Teletouch’s common stock.
The 2002 Plan provides for options, which qualify as incentive stock options
(Incentive Options) under Section 422 of the Code, as well as the issuance of
non-qualified options (Non-Qualified Options). The shares issued by Teletouch
under the 2002 Plan may be either treasury shares or authorized but unissued
shares as Teletouch’s Board of Directors may determine from time to time.
Pursuant to the terms of the 2002 Plan, Teletouch may grant Non-Qualified
Options and Stock Appreciation Rights (SARs) only to officers, directors,
employees and consultants of Teletouch or any of Teletouch’s subsidiaries as
selected by the Board of Directors or the Compensation Committee. The 2002 Plan
also provides that the Incentive Options shall be available only to officers or
employees of Teletouch or any of Teletouch’s subsidiaries as selected by the
Board of Directors or Compensation Committee. The price at which shares of
common stock covered by the option can be purchased is determined by Teletouch’s
Compensation Committee or Board of Directors; however, in all instances the
exercise price is never less than the fair market value of Teletouch’s common
stock on the date the option is granted. To the extent that an Incentive Option
or Non-Qualified Option is not exercised within the period in which it may be
exercised in accordance with the terms and provisions of the 2002 Plan described
above, the Incentive Option or Non-Qualified Option will expire as to the then
unexercised portion. In addition, employees that cease their services with the
Company and hold vested options will have the ability to exercise their vested
options for a period three months after their termination date with the
Company.





As of
August 31, 2010, approximately 27,995 Non-Qualified Options and 12,000 Incentive
Options are outstanding under the 1994 Plan, and approximately 496,998
Non-Qualified Options and 5,119,490 Incentive Options are outstanding under the
2002 Plan.


22




A summary
of option activity for the three months ended August 31, 2010 is as
follows:





WeightedWeighted
                  
                  
                  AverageAverage
                  
                  
                  Remaining
                  
                  
                  AggregateExercise
                  
                  
                  Contractual
                  
                  
                  IntrinsicShares
                  
                  
                  Price
                  
                  
                  Term
                  
                  
                  ValueOutstanding
      at June 1, 2010
                  
                  
                  4,563,316
                  
                  
                  $
                  0.25
                  
                  
                  
                  7.36
                  
                  
                  $
                  401,150Three
      months ended August 31, 2010Granted
                  
                  
                  1,093,167
                  
                  
                  
                  0.33Exercised
                  
                  
                  -
                  
                  
                  
                  -Forfeited
                  
                  
                  -
                  
                  
                  
                  -Outstanding
      at August 31, 2010
                  
                  
                  5,656,483
                  
                  
                  
                  0.26
                  
                  
                  
                  7.62
                  
                  
                  $
                  1,140,645Options
      exercisable at August 31, 2010
                  
                  
                  4,652,098
                  
                  
                  $
                  0.27
                  
                  
                  
                  7.46
                  
                  
                  $
                  903,462





The
following table summarizes the status of the Company’s non-vested stock options
since June 1, 2010:





Non-vested OptionsWeighted-Number of
                    
                    
                    Average FairShares
                    
                    
                    ValueNon-vested
      at June 1, 2010
                    
                    
                    1,508,771
                    
                    
                    $
                    0.18Granted
                    
                    
                    1,093,167
                    
                    
                    
                    0.30Vested
                    
                    
                    (1,597,553
                    )
                    
                    
                    0.25Forfeited
                    
                    
                    -
                    
                    
                    
                    -Non-vested
      at August 31, 2010
                    
                    
                    1,004,385
                    
                    
                    $
                    0.21





The
Company estimates the fair value of employee stock options on the date of grant
using the Black-Scholes model. The determination of fair value of stock-based
payment awards on the date of grant using an option-pricing model is affected by
the stock price as well as assumptions regarding a number of highly complex and
subjective variables. These variables include, but are not limited to the
expected stock price volatility over the term of the awards and the actual and
projected employee stock option exercise behaviors. The Company has elected to
estimate the expected life of an award based on the SEC approved “simplified
method.” The Company calculated its expected volatility assumption required in
the Black-Scholes model based on the historical volatility of its
stock. The Company recorded approximately $264,000 and $131,000 in stock
based compensation expense in the consolidated financial statements for the
three months ended August 31, 2010 and 2009, respectively.




NOTE
14 – RELATED PARTY TRANSACTIONS




The
commonly controlled companies owning or affiliated with Teletouch are as
follows:




Progressive
Concepts Communications, Inc., a Delaware corporation (“PCCI”) – PCCI has
no operations and is a holding company formed to acquire the stock of PCI
(Teletouch’s subsidiary as of August 2006) in 2001. Robert McMurrey, Chairman
and Chief Executive Officer of Teletouch, controls approximately 94% of the
stock of PCCI. In 2004, PCCI acquired 100% of the outstanding common units of
TLL Partners, LLC (see below).





TLL
Partners, LLC, a Delaware LLC (“TLLP”) – TLLP has no operations and is a
holding company formed in 2001 to acquire certain outstanding Series A Preferred
stock and subordinated debt obligations of Teletouch. The purchased subordinated
debt obligations were forgiven, and in November 2002, all of the outstanding
Series A Preferred stock was redeemed by Teletouch by the issuance of 1,000,000
shares of Teletouch’s convertible Series C Preferred stock. In November 2005,
TLLP converted all of its shares of Series C Preferred stock into 44,000,000
shares of Teletouch’s common stock gaining approximately 80% ownership of
Teletouch’s outstanding common stock.




23




The
Company received certain dividend payments from investments belonging to TLLP in
the periods presented in this Report and as of August 31, 2010, approximately
$24,000 remains payable to TLLP by the Company.




NOTE
15 – SEGMENT INFORMATION





ASC 280,
Segment Reporting,
establishes standards for reporting information about operating segments.
Operating segments are defined as components of an enterprise about which
separate financial information is available that is regularly evaluated by the
chief operating decision maker, or decision making group, in deciding how to
allocate resources and in assessing performance.





Using
this criteria, the Company's three reportable segments are cellular services,
wholesale distribution and two-way radio services.




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 25 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 a master distributor for AT&T wireless services,
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.
Furthermore, in January 2009, Teletouch entered into a new distribution
agreement with T-Mobile USA, Inc. (“T-Mobile”). The Company closed its last two
Oklahoma retail locations selling T-Mobile branded cellular services and
products in October 2009. Subsequent to these closings, in January 2010, the
T-Mobile agreement was cancelled.




On
January 19, 2010, the Company signed a new two-year, national distribution
agreement with Clearwire Communications (NASDAQ: CLWR) to sell its 4G service
called CLEAR. On January 26, 2010, the Company announced that it had recently
entered into a two-year, Authorized Representative Agreement with Sprint
(NYSE:S) subsidiary, Sprint Solutions, Inc.





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.




The
two-way business segment includes radio services provided on the Company’s Logic
Trunked Radio (“LTR”) system and the related radio equipment sales as well as
radio equipment sales to customers operating their own two-way radio system.
Public safety equipment sales and services are also included in the two-way
business segment.





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 of May
31, 2010, the Company combined its car dealer expediter business which was
previously reported as other operations with its wholesale segment operations
for segment presentation purposes. The segment information presented for the
three months ended August 31, 2009 in this Report has been conformed to be
comparable to the current year’s segment information.


24




The
following tables summarize the Company’s operating financial information by each
segment for the three months ended August 31, 2010 and 2009 (in
thousands):




Three Months Ended August 31, 2010Cellular
                          
                          
                          Wholesale
                          
                          
                          Two-Way
                          
                          
                          Corporate
                          
                          
                          TotalOperating
      revenues:Service
      and installation revenue
                          
                          $
                          5,264
                          
                          
                          $
                          30
                          
                          
                          $
                          426
                          
                          
                          $
                          17
                          
                          
                          $
                          5,737Product
      sales revenue
                          
                          
                          893
                          
                          
                          
                          1,662
                          
                          
                          
                          684
                          
                          
                          
                          2
                          
                          
                          
                          3,241Total
      operating revenues
                          
                          
                          6,157
                          
                          
                          
                          1,692
                          
                          
                          
                          1,110
                          
                          
                          
                          19
                          
                          
                          
                          8,978Operating
      expenses:Cost
      of service and installation revenue (exclusive of depreciation and
      amortization included below)
                          
                          
                          1,144
                          
                          
                          
                          16
                          
                          
                          
                          367
                          
                          
                          
                          -
                          
                          
                          
                          1,527Cost
      of products sold
                          
                          
                          1,078
                          
                          
                          
                          1,261
                          
                          
                          
                          524
                          
                          
                          
                          (1
                          )
                          
                          
                          2,862Selling
      and general and administrative
                          
                          
                          910
                          
                          
                          
                          411
                          
                          
                          
                          150
                          
                          
                          
                          2,445
                          
                          
                          
                          3,916Depreciation
      and amortization
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          21
                          
                          
                          
                          258
                          
                          
                          
                          2793,132
                          
                          
                          
                          1,688
                          
                          
                          
                          1,062
                          
                          
                          
                          2,702
                          
                          
                          
                          8,584Income
      (loss) from operations
                          
                          
                          3,025
                          
                          
                          
                          4
                          
                          
                          
                          48
                          
                          
                          
                          (2,683
                          )
                          
                          
                          394Interest
      expense, net
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          (568
                          )
                          
                          
                          (568
                          )Income
      (loss) before income tax expense
                          
                          
                          3,025
                          
                          
                          
                          4
                          
                          
                          
                          48
                          
                          
                          
                          (3,251
                          )
                          
                          
                          (174
                          )Income
      tax expense
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          56
                          
                          
                          
                          56Net
      income (loss)
                          
                          $
                          3,025
                          
                          
                          $
                          4
                          
                          
                          $
                          48
                          
                          
                          $
                          (3,307
                          )
                          
                          $
                          (230
                          )




Three Months Ended August 31, 2009Cellular
                          
                          
                          Wholesale
                          
                          
                          Two-Way
                          
                          
                          Corporate
                          
                          
                          TotalOperating revenues:Service and installation revenue
                          
                          $
                          6,195
                          
                          
                          $
                          17
                          
                          
                          $
                          406
                          
                          
                          $
                          41
                          
                          
                          $
                          6,659Product
      sales revenue
                          
                          
                          1,569
                          
                          
                          
                          2,667
                          
                          
                          
                          562
                          
                          
                          
                          2
                          
                          
                          
                          4,800Total
      operating revenues
                          
                          
                          7,764
                          
                          
                          
                          2,684
                          
                          
                          
                          968
                          
                          
                          
                          43
                          
                          
                          
                          11,459Operating
      expenses:Cost
      of service and installation (exclusive of depreciation and amortization
      included below)
                          
                          
                          1,555
                          
                          
                          
                          10
                          
                          
                          
                          402
                          
                          
                          
                          -
                          
                          
                          
                          1,967Cost
      of products sold
                          
                          
                          1,588
                          
                          
                          
                          2,378
                          
                          
                          
                          442
                          
                          
                          
                          (4
                          )
                          
                          
                          4,404Selling
      and general and administrative
                          
                          
                          1,326
                          
                          
                          
                          339
                          
                          
                          
                          128
                          
                          
                          
                          2,404
                          
                          
                          
                          4,197Depreciation
      and amortization
                          
                          
                          1
                          
                          
                          
                          
                          
                          
                          
                          32
                          
                          
                          
                          294
                          
                          
                          
                          3274,470
                          
                          
                          
                          2,727
                          
                          
                          
                          1,004
                          
                          
                          
                          2,694
                          
                          
                          
                          10,895Income
      (loss) from operations
                          
                          
                          3,294
                          
                          
                          
                          (43
                          )
                          
                          
                          (36
                          )
                          
                          
                          (2,651
                          )
                          
                          
                          564Interest
      expense, net
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          (502
                          )
                          
                          
                          (502
                          )Income
      (loss) before income tax expense
                          
                          
                          3,294
                          
                          
                          
                          (43
                          )
                          
                          
                          (36
                          )
                          
                          
                          (3,153
                          )
                          
                          
                          62Income
      tax expense
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          62
                          
                          
                          
                          62Net
      income (loss)
                          
                          $
                          3,294
                          
                          
                          $
                          (43
                          )
                          
                          $
                          (36
                          )
                          
                          $
                          (3,215
                          )
                          
                          $
                          -





The
Company identifies its assets by segment. Significant assets of the Company’s
corporate offices include cash, property and equipment, loan origination costs
and the patent held for sale. The Company’s assets by segment as of August 31,
2010 and May 31, 2010 are as follows:


25




August 31, 2010
                        
                        
                        May 31, 2010Total Assets
                        
                        
                        Property and
                          Equipment, net
                        
                        
                        IntangibleAssets,
                          net
                        
                        
                        Total Assets
                        
                        
                        Property and
                          Equipment, net
                        
                        
                        IntangibleAssets,
                          netSegmentCellular
                        
                        $
                        9,448
                        
                        
                        $
                        110
                        
                        
                        $
                        3,901
                        
                        
                        $
                        10,362
                        
                        
                        $
                        124
                        
                        
                        $
                        4,068Wholesale
                        
                        
                        1,154
                        
                        
                        
                        19
                        
                        
                        
                        -
                        
                        
                        
                        837
                        
                        
                        
                        2
                        
                        
                        
                        -Two-way
                        
                        
                        1,946
                        
                        
                        
                        400
                        
                        
                        
                        370
                        
                        
                        
                        1,599
                        
                        
                        
                        401
                        
                        
                        
                        373Corporate
                        
                        
                        7,781
                        
                        
                        
                        2,240
                        
                        
                        
                        208
                        
                        
                        
                        8,886
                        
                        
                        
                        2,222
                        
                        
                        
                        244Totals
                        
                        $
                        20,329
                        
                        
                        $
                        2,769
                        
                        
                        $
                        4,479
                        
                        
                        $
                        21,684
                        
                        
                        $
                        2,749
                        
                        
                        $
                        4,685





During
the three months ended August 31, 2010 and 2009, the Company did not have a
single customer that represented more than 10% of total segment
revenues.





NOTE
16 – SUBSEQUENT EVENT





In
September 2010, Teletouch was awarded a multi-year contract with the General
Services Administration (“GSA”) for the Company's comprehensive product line of
public safety, emergency vehicle lighting and siren equipment. The contract
allows the Company the opportunity to compete in the public and emergency
products category nationwide, allowing any federal, state and / or local
government agencies to purchase items from the Company’s public safety product
line quickly and cost effectively. In addition, the contract enables the Company
to streamline its purchasing process for its current government customers and
will allow the Company to serve new customers around the country in the same
manner. Furthermore, in the near future, the Company will offer additional
products and services from its different businesses through the
GSA.




The GSA
Schedule is a government-wide procurement system. Teletouch will be providing
all government agencies with the contracted "best value" pricing, as well as
simplifying procurement for its products and services. When government agencies
place orders with Teletouch, it will allow the agencies to fulfill their bidding
and quote comparison requirements, without having to prepare new bids, which
will increase overall purchasing efficiency and lower costs. The GSA contract
award criteria were stringent and Teletouch was evaluated on its overall
quality, pricing, financial, corporate stability and customer
references.




Teletouch's
public safety products will fall under Schedule 84 which includes Total
Solutions for Law Enforcement, Security, Facilities Management, Fire, Rescue,
Clothing, Marine Craft and Emergency/Disaster Response.





The
Company’s contract with the GSA was effective on October 1, 2010, for an initial
period of five years, with the GSA having the option to extend the contract for
three additional 5-year periods.


26




Item
2.  Management’s Discussion and Analysis of Financial Condition and
Results of Operations





The
following discussion and analysis of the results of operations and financial
condition of the Company should be read in conjunction with the consolidated
financial statements and the related notes and the discussions under “Critical
Accounting Estimates,” which describes key estimates and assumptions we make in
the preparation of our financial statements.





Overview





For over
46 years, Teletouch has offered a comprehensive suite of telecommunications
products and services, including cellular, two-way radio, GPS-telemetry,
wireless messaging and public safety equipment. Teletouch operates 24 cellular
retail and agent locations, under the “Teletouch” and “Hawk Electronics” brand
names.




Teletouch’s
core-business is acquiring, billing and supporting cellular subscribers under a
long-term recurring revenue relationship with AT&T. The distribution
agreements with AT&T and its predecessor companies have been in place for
over 26 years. Through its subsidiary, Progressive Concepts Inc., (“PCI”), the
Company provides AT&T cellular services (voice, data and entertainment), as
well as other mobile, portable and personal electronics products and services to
individuals, businesses and government agencies. PCI operates a chain of retail
stores and sells cellular and other products and services under the “Hawk
Electronics” brand, through Hawk-branded sub-agents, its own direct sales force,
call center and the Internet. As a master distributor and Authorized Services
Provider for AT&T, the Company controls the entire customer relationship,
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. PCI also operates a national wholesale distribution business, known
as PCI Wholesale that serves major carrier agents, rural cellular carriers,
smaller consumer and electronic retailers and automotive dealers throughout the
United States. The Company also maintains certain international customer
relationships, primarily in Asia, Europe and Latin America for its cellular
related wholesale equipment sales business. Teletouch’s original business is
maintained as an integral component of the Company’s wireless solutions, by
providing two-way radio products and services on its own network in North and
East Texas. In its first attempt at expanding the Company’s cellular related
business, in January 2009, Teletouch entered into an Exclusive Retailer
Agreement with T-Mobile USA, Inc. (“T-Mobile”) for markets outside its AT&T
exclusive territories. The initial agreement provided for Teletouch to open,
operate and manage mall locations, with the Company's first locations opening in
major markets in Oklahoma in February 2009. After opening five (5) new mall
locations under the T-Mobile brand banner, the Company found that long-term
customer traffic for T-Mobile products and services to be inadequate and the
Company closed its last two Oklahoma retail locations in October 2009.
Subsequent to these closings, in January 2010, the T-Mobile agreement was
cancelled. On January 19, 2010, the Company signed a new two-year, national
distribution agreement with Clearwire Communications (NASDAQ: CLWR) to sell its
4G service called CLEAR. On January 26, 2010, the Company announced that it had
also entered into a two-year, Authorized Representative Agreement with Sprint
(NYSE:S) subsidiary, Sprint Solutions, Inc. In late 2007, Teletouch began
selling public safety equipment and services under the brand Teletouch PSE
(“PSE”). The PSE business is a complementary offering to the Company’s two-way
radio business, and the Company has expanded its product lines to include light
bars, sirens and other accessories used in or on emergency response vehicles
through a number of distribution agreements with manufacturers of these
products. In September 2010, Teletouch was awarded a multi-year contract with
the General Services Administration (“GSA”) to sell its public safety equipment
to federal, state and local government agencies.




27




During
the three months ended August 31, 2010, Teletouch focused its efforts on
producing documents and other evidence to support its litigation against
AT&T in preparation for the hearing scheduled for March 2011 with AT&T,
maximizing its profitability in its existing cellular and other business units
and pursuing new business acquisitions. In addition, the Company restructured
its existing sales personnel by creating new sales teams, regional sales
managers and product managers in an effort to promote the cross-training of all
products lines sold within the Company. The product managers will focus on
growing the Company’s product lines with the development of new sales strategies
and continually analyzing the Company’s product mix for increased sales. They
product managers will also assist the sales teams and managers with back-end
support such as creating and updating price lists, quoting specialty jobs and
supplying technical knowledge of the products sold within the
Company.




Throughout
the remainder of fiscal year 2011, the Company will focus on resolving its
dispute with AT&T.


In
September 2009, PCI commenced an arbitration proceeding against AT&T to seek
relief for damages the Company incurred because it was prohibited to sell the
iPhone as well as other “AT&T exclusive” products and services (see Item 1.
Legal Proceedings for discussion of the action brought against AT&T related
to the iPhone and other matters). The Arbitration hearing is currently scheduled
for March 2011. Until the arbitration is complete, the Company will focus on
retaining and preserving its existing subscriber base in the DFW and San Antonio
markets while expanding its cellular subscriber base in available markets
covered by the Company’s various other AT&T distribution agreements. In
addition, during fiscal year 2011, the Company will focus on finding one or more
direct relationships with cellular handset manufacturers in an effort to grow
its wholesale cellular distribution business. The Company was successful in
significantly increasing sales from its wholesale distribution business during
fiscal year 2010 and is anticipating that sales will continue to grow once more
reliable suppliers are found. Although the Company believes it can maintain a
profitable, but declining cellular business in the future with its existing
subscriber base, organic growth in its other business units or new business
acquisitions will be necessary to offset expected losses of revenue and profits
from its core legacy cellular business. There is no assurance that any of the
acquisitions will be concluded or the AT&T arbitration will be resolved
quickly. Throughout the remainder of fiscal year 2011, the Company will focus on
expanding its wholesale, two-way radio and public safety equipment businesses
and leveraging its existing customer relationships from each of its business
units to sell multiple product lines to existing and new customers.





Discussion
of Business Strategy by Operating Segment





During
fiscal year 2010, the Company was successful in initiating new national and
international wholesale distribution channels, increasing the Company’s product
sales by over 40% when compared to fiscal year 2009. This additional sales
volume, in addition to ongoing management of operating expenses, contributed to
the Company’s achieving net income in fiscal year 2010 for the first time in
many years. Throughout fiscal year 2010, Teletouch better positioned itself for
future growth by optimizing the efficiency of its operations by re-allocating
resources to business units capable of achieving meaningful growth for the
Company versus supporting many of the Company’s prior smaller businesses and
product lines with limited potential for growth. Key to this strategy in fiscal
year 2011 will be to focus on leveraging the Company’s various customer
relationships, including PCI’s approximately 57,000 cellular subscribers, and
previous customers which are generally comprised of individuals and businesses
of higher than average credit worthiness (due to PCI’s stringent credit
standards).




28





The
Company’s primary business for over 26 years has been distributing cellular
services under several exclusive master distributor agreements with AT&T and
its predecessor companies. During fiscal year 2010, certain changes to the
Company’s relationship with AT&T occurred, including the expiration of the
initial term of its primary DFW distribution agreement and the commencement of
legal action against AT&T by the Company.  Following the August
2009 expiration of the DFW distribution agreement, the Company maintains the
right to continue servicing its cellular subscriber base in perpetuity, i.e.,
until the last subscriber terminates service.  Since the launch of the
iPhone in June 2007 and following AT&T’s refusal to allow the Company to
offer the iPhone to its subscriber base, the Company has experienced higher
rates of attrition in its cellular subscriber base due to subscribers
transferring their service to AT&T to purchase an iPhone.  The iPhone
and certain other products and services withheld from the Company by AT&T
were the primary reasons the Company commenced the legal action against AT&T
in September 2009. Following expiration of the DFW agreement and the
commencement of the legal action, the Company has experienced a predicted
decline in cellular subscribers and cellular revenues due to AT&T
subscribers no longer being allowed to transfer their service to PCI. Subscriber
attrition rates have remained flat following the August 2009 expiration of the
DFW agreement, but the inability to replace these subscribers has resulted in a
declining subscriber base and declining cellular service revenues. The Company
is currently negotiating new cellular carrier distribution relationships and
began offering cellular services with Sprint and Clearwire in the later part of
fiscal year 2010 with the intent of offsetting some of the losses of its
AT&T cellular service revenues.





During
fiscal year 2010, the Company was successful in improving its operating results
through aggressive cost management and improved product sales from its wholesale
and two-way businesses.  During fiscal year 2011, the Company will
continue to manage its costs closely and will focus on developing new sources of
revenue for its wholesale distribution and its two-way radio business units and
on retaining its recurring cellular subscriber base.  These new
revenue sources are expected from several product distribution agreements and,
potentially, the acquisition of one or more complementary businesses. There is
no assurance that any new distribution agreements or any of the acquisitions
will be finalized.





Certain
non-recurring expenses are expected to be incurred in fiscal year 2011 related
to the arbitration proceeding against AT&T and the startup and expansion
costs related to the new products and services.  The Company believes
that these non-recurring expenses will be manageable and will not materially
impair its operating results during fiscal year 2011. In addition, on July 21,
2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act was signed
into law and a permanent delay of the implementation of section 404(b) of the
Sarbanes Oxley Act of 2002 (“SOX”) for companies with non-affiliated public
float under $75,000,000 (“non-accelerated filer”). Section 404(b) under SOX is
the requirement to have an independent accounting firm audit and attest to the
effectiveness of a Company’s internal controls. As Teletouch currently qualifies
as a non-accelerated filer under the SEC rules and expects to remain one through
fiscal year 2011, there are no additional costs anticipated for complying with
Section 404(b) under SOX.





In the
first quarter of fiscal year 2011, the Company restructured its existing sales
personnel in an effort to increase sales in all of its business units by
promoting the cross-training of all products and services sold throughout the
Company.  The Company anticipates the restructuring of its sales
personnel to be complete by the end of the second quarter of fiscal year 2011.
This will include the hiring of additional sales personnel for the Company’s
sales teams and product manager positions.  The Company anticipates a
growth in sales from its wholesale, two-way radio and public safety equipment
businesses due to the restructuring of its sales personnel and expects to expand
its businesses into new geographic areas as well as introducing new products and
services within its existing businesses throughout the remainder of fiscal year
2011 compared to the three months ending August 30, 2010.





In
September 2010, the Company was successful in obtaining a contract with United
States General Services Administration (“GSA”) which allows the Company to list
and sell its catalog of products to all Federal agencies and many state and
local entities by passing the traditional, lengthy bidding
process.  The contract became effective for the Company on October 1,
2010 and has an initial 5 year term (see Note 16 – “Subsequent Event” for
additional information on the GSA contract).


29




Cellular
Operations




In August
2009, the initial term of the primary distribution agreement between Teletouch’s
subsidiary, PCI and AT&T expired.  Under this agreement, PCI
distributes AT&T cellular services and serves as billing agent for AT&T
in the DFW market.  With the expiration of this agreement, the Company
is no longer exclusive to AT&T in DFW, which allows the Company to expand it
cellular service offerings in this market for the first time in over 26
years.  The expiration of the DFW distribution agreement also
restricts PCI from growing its subscriber base in DFW by limiting new
activations and prohibiting AT&T subscribers from moving their service to
PCI, but the majority of the provisions of the agreement remained intact at the
option of PCI, including the right for PCI to continue servicing its existing
DFW subscribers until there are no more subscribers remaining as customers of
PCI.  Based on its current subscriber attrition rates, the Company
estimates that it will maintain Subscribers in DFW for at least the next five
years. The Company has historically had five distribution agreements with
AT&T in addition to the distribution agreement covering the DFW market
discussed above. Under these other distribution agreements, the Company is
allowed to distribute AT&T wireless services, on an exclusive basis, in
certain major markets in Texas and Arkansas, including the San Antonio, Texas
Metropolitan Statistical Area (“MSA”), Austin, Texas MSA, Houston, Texas MSA,
East Texas Regional MSA and Arkansas, including primarily the Little Rock,
Arkansas MSA. These distribution agreements have varying terms with the longest
extending through October 2013.





In August
2009, the Company received notice from AT&T of its intent not to renew the
Houston distribution agreement, but let it naturally expire in February 2010,
which would allow the Company to continue servicing its small subscriber base in
the Houston area through February 2011. In September 2009, the Company received
notice from AT&T of its intent to terminate the Arkansas distribution
agreement substantially on the grounds the Company did not maintain a sufficient
number of retail outlets in that market. The Arkansas agreement would otherwise
expire in July 2012. Additionally, AT&T has claimed the San Antonio
distribution agreement should have been previously conformed to an agreement
similar to the Houston agreement in accordance with a related agreement reached
between the parties in connection with a settlement agreement completed in June
2007. In January 2008, the Company elected to renew its legacy San Antonio
distribution agreement with AT&T through August 2009, which provided rights
to the Company to enter into a reseller agreement with AT&T and purchase the
subscriber base at the expiration of the agreement. To date, neither AT&T
nor the Company have been able to agree on the value for the subscriber base and
the next steps following the August 2009 expiration of the San Antonio
agreement, so the Company has continued to service this customer base and
operates under the terms of the legacy agreement. The Company is aggressively
disputing the contract matters with AT&T and expects that these matters will
all be resolved through the arbitration in process over matters related to its
DFW distribution agreement (see discussion below).  With the exception
of the San Antonio and DFW distribution agreements, none of the other
distribution agreements are deemed material to the current operations of the
Company. The Company cannot provide any assurance that it will be successful in
maintaining its Houston, Arkansas or San Antonio distribution agreements beyond
their contractual expiration dates.





On
September 30, 2009, the Company commenced an arbitration proceeding against
AT&T seeking at least $100 million in damages. The binding arbitration was
commenced to seek relief for damages incurred as AT&T has prevented the
Company from selling the popular iPhone and other “AT&T exclusive” products
and services that PCI is and has been contractually entitled to provide to its
customers under the distribution agreements. While PCI has attempted to
negotiate with AT&T for the purpose of obviating the need for legal action,
such attempts have failed. Accordingly, PCI has initiated this
arbitration.   The Company expects this arbitration process to take
ten months before a final outcome is determined unless this matter is able to be
settled sooner with AT&T outside of this venue.





With
PCI’s exclusivity to AT&T in the DFW market lifted in August 2009 and after
being unable to reach an alternate form of agreement with AT&T, the Company
began actively negotiating final terms under a variety of new cellular carriers,
WiFi, WiMax and related wireless communications relationships. The Company began
launching these new cellular carrier services and products in the latter part of
fiscal year 2010. On January 19, 2010, the Company signed a new two-year,
national distribution agreement with Clearwire Communications (NASDAQ: CLWR) to
sell its 4G service called CLEAR.  On January 26, 2010, the Company
announced that it had entered into a two-year, Authorized Representative
Agreement with Sprint (NYSE:S) subsidiary, Sprint Solutions,
Inc.


30




Throughout
fiscal year 2011, the Company will focus on the retention of its approximately
57,000 cellular subscribers, which primarily reside in the DFW and San Antonio
markets in Texas.  In addition, the Company will focus on developing
the other markets covered by its existing AT&T distribution agreements,
starting with the East Texas market where Teletouch currently has personnel and
existing infrastructure in place. Through new carrier relationships, the Company
will offer its customers a choice in services and additional products which it
expects will help in its efforts to retain its cellular customers in DFW and San
Antonio.





Wholesale
Business





During
fiscal year 2010, the Company’s focus in the wholesale business was managing
credit exposure on sales, pricing methodology, improving margins and increasing
inventory turnover. The extensive re-evaluation of the wholesale business in
2009 resulted in certain sustainable operating changes to the business,
including office staff reductions, new sales hiring, re-pricing of new and
non-current inventory, as well as identified the necessity to grow market share
and focus on more exclusive product offerings. In October 2009, the Company
materially increased its cellular handset brokerage business selling to volume
buyers both domestically and internationally.  Initially the Company
primarily brokered phones manufactured by Research In Motion, better known as
the manufacturer of Blackberry® cellular handsets. This brokerage business
contributed to the increase in product sales for the Company’s wholesale
business during the second and third quarter of fiscal year 2010, which
correspond to the traditional holiday selling season. The Company’s handset
brokerage business declined throughout the remainder of fiscal year 2010 because
the Company has been unsuccessful to date in locating a stable volume supplier
of cellular handsets following the purchasing restrictions imposed on the
Company by AT&T in December 2009. The Company is pursuing new suppliers of
cellular handsets to support the wholesale brokerage business and anticipates it
will ramp up this business quickly once a supplier agreement is in place. Based
on its current negotiations with cellular handset manufacturers, the Company
expects it will have at least one material new supplier agreement in place by
mid-fiscal year 2011. The Company will continue to focus on expanding its
distributor relationships and expand its product line with a focus on products
that it can offer exclusively for wholesale distribution in fiscal year
2011.





Two-Way
Radio Operations





In fiscal
year 2010, the Company’s two way division secured a contract in support of the
re-banding efforts undertaken nationally to migrate public safety communications
to frequencies that will not experience interference from certain radio channels
operated by Sprint/Nextel.  This project covers the East Texas market
and generated approximately $406,000 in installation revenues during fiscal year
2010. The Company expects to generate at least an additional $200,000 in
installation revenues in fiscal year 2011 from the re-banding
project.  Teletouch’s long-term relationships and reputation with the
various governmental entities over its  roughly 46 year presence in
East Texas has allowed the Company to procure this business to date. In fiscal
year 2011, the Company believes it will be successful in expanding its two-way
business in different markets by focusing on government entities and business
customers in the DFW area that are long-term cellular customers of
PCI.  During the last quarter of fiscal year 2010, PCI’s direct
business cellular salespeople began promoting two-way products to new and
existing business customers in an effort to offer a wider range of wireless
products to fit their customer’s needs.




31


As a
complement to and embedded in its two-way radio segment, the Company began
selling public safety equipment in late 2007 under several master distributor
agreements with its suppliers. The product lines include various aftermarket
accessories that are added to vehicles in the public safety industry, but
primarily includes light bars, sirens and computer equipment supports mounted
in-vehicle. During fiscal year 2011, the Company will be focusing on expanding
the distribution of these product lines to other markets by cross-training of
existing sales personnel in those other markets as well as by opening new
distribution points in those markets. In addition, the Company is working with
its manufacturers to secure approval to sell these products into other protected
markets and to potentially acquire other existing distribution in these
markets.





In
September 2010, Teletouch was awarded a multi-year contract with the General
Services Administration (“GSA”) for the Company's comprehensive product line of
public safety, emergency vehicle lighting and siren equipment. The contract
allows the Company the opportunity to compete in the public and emergency
products category nationwide, allowing any federal, state and / or local
government agencies to purchase items from the Company’s public safety product
line quickly and cost effectively. In addition, the contract enables the Company
to streamline its purchasing process for its current government customers and
will allow the Company to serve new customers around the country in the same
manner.  Furthermore, in the near future, the Company will offer additional
products and services from its different businesses through the GSA. The GSA
Schedule is a government-wide procurement system. Teletouch will be providing
all government agencies with the contracted "best value" pricing, as well as
simplifying procurement for its products and services. When government agencies
place orders with Teletouch, it will allow the agencies to fulfill their bidding
and quote comparison requirements, without having to prepare new bids, which
will increase overall purchasing efficiency and lower costs. The GSA contract
award criteria were stringent and Teletouch was evaluated on its overall
quality, pricing, financial, corporate stability and customer references.
Teletouch's public safety products will fall under Schedule 84 which includes
Total Solutions for Law Enforcement, Security, Facilities Management, Fire,
Rescue, Clothing, Marine Craft and Emergency/Disaster Response. The Company’s
contract with the GSA was effective on October 1, 2010, for an initial period of
five years, with the GSA having the option to extend the contract for three
additional 5-year periods.





Results
of Operations for the three months ended August 31, 2010 and 2009





Overview of Operating
Results for the Three Months ended August 31, 2010 and 2009





The
consolidated operating results for the three months ended August 31, 2010 and
2009 are as follows:




(dollars in thousands)
                  
                  Three Months Ended August 31,
                  
                  
                  2010 vs 20092010
                  
                  
                  2009
                  
                  
                  Change
                  
                  
                  % ChangeOperating
      resultsService
      and installation revenue
                  
                  $
                  5,737
                  
                  
                  $
                  6,659
                  
                  
                  $
                  (922
                  )
                  
                  
                  -14
                  %Product
      sales revenue
                  
                  
                  3,241
                  
                  
                  
                  4,800
                  
                  
                  
                  (1,559
                  )
                  
                  
                  -32
                  %Total
      operating revenues
                  
                  
                  8,978
                  
                  
                  
                  11,459
                  
                  
                  
                  (2,481
                  )
                  
                  
                  -22
                  %Cost
      of service and installation (exclusive of depreciation and
      amortization)
                  
                  
                  1,527
                  
                  
                  
                  1,967
                  
                  
                  
                  (440
                  )
                  
                  
                  -22
                  %Cost
      of products sold
                  
                  
                  2,862
                  
                  
                  
                  4,404
                  
                  
                  
                  (1,542
                  )
                  
                  
                  -35
                  %Other
      operating expenses
                  
                  
                  4,195
                  
                  
                  
                  4,524
                  
                  
                  
                  (329
                  )
                  
                  
                  -7
                  %Income
      from operations
                  
                  $
                  394
                  
                  
                  $
                  564
                  
                  
                  $
                  (170
                  )
                  
                  
                  -30
                  %Net
      income (loss)
                  
                  $
                  (230
                  )
                  
                  $
                  -
                  
                  
                  $
                  (230
                  )
                  
                  
                  -100
                  %





32


The
$230,000 decrease in net income for the three months ended August 31, 2010
compared to the three months ended August 31, 2009 is primarily attributable to
the reduction in net income in its cellular operating segment of $269,000 as
compared to the same quarter last year.  In spite of a loss of
approximately 13,000 cellular subscribers since August 31, 2009, the Company has
not realized the full impact of this loss of subscribers on its earnings as a
result of improving its profit margins on its cellular service revenues by
selling more profitable cellular features provided by PCI to its remaining
subscriber base and by controlling expenses in this business unit.  Of
the 13,000 cellular subscribers lost since August 31, 2009, approximately, 8,200
of those subscribers were lost to AT&T and of these, approximately 4,500
subscribers transferred to AT&T to purchase the iPhone.  These
significant losses of cellular subscribers to AT&T are the basis for our
ongoing litigation against AT&T.     Although the
Company’s cellular service revenues decreased period over period, the Company
was able to improve net earnings in its wholesale business unit by $47,000 and
its two way radio business unit by $84,000 during this quarter as compared to
the same quarter last year.  These improvements were the result of
additional sales efforts combined with continued management of
expenses.  Additionally, during the first quarter of fiscal 2011, the
Company issued stock options to the Company’s executive management and board of
directors resulting in non-cash stock compensation charges of $264,000 during
the quarter which is an increase of $133,000 over similar charges recorded
during the same quarter last year.   Excluding the $264,000 in
non-cash stock compensation charges for the quarter, the Company’s operations
were slightly positive for the first quarter of fiscal 2011 but lower than
targeted by management.  The Company expected to be awarded its GSA
contract and have one of its supply agreements in place with a cellular
manufacturer during the quarter, both of which were expected to contribute to
earnings in the first quarter.  In September 2010, the GSA contract
was awarded and the Company is continuing to work toward finalizing a supply
agreement for cellular equipment for its wholesale business needs.





Significant Components of
Operating Revenues and Expenses





Operating
revenues are primarily generated from the Company’s cellular, wholesale and
two-way radio operations and are comprised of a mix of service and installation
revenues as well as product revenues.  Service and installation
revenues are generated primarily from the Company’s cellular and two-way radio
operations.  Within the cellular operations, the primary service
revenues are generated by PCI from the sale of recurring cellular subscription
services under several master distributor agreements with AT&T. Since 1984,
the Company’s subsidiary, PCI, has held agreements with AT&T and its
predecessor companies, which allowed PCI to offer cellular service and customer
service to AT&T customers in exchange for certain compensation and
fees.  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. Within the two-way radio operations, service revenues are
generated by the sale of subscription radio services on the Company’s own radio
network as well as from the sale of maintenance services on customer owned radio
equipment.  The Company’s wholesale business generates service
revenues from its car dealer expediter operations.





The
majority of the Company’s product sales are generated by PCI’s wholesale
operations and are comprised of cellular telephones, cellular accessories and
12-volt (automotive) mobile electronics, which are sold to smaller dealers and
carriers throughout the United States. In addition, the wholesale business
includes product sales from its car dealer expeditor business, which primarily
consists of vehicle parts and accessories. Within the cellular operations of the
Company, product sales are comprised primarily of cellular telephones and
accessories sold through PCI’s retail stores, outside salespeople and agents to
generate recurring cellular subscription revenues. The two-way radio operations’
products are comprised of radios and service parts for radio communication
systems and public safety equipment.





Cost of
providing service and installation consists primarily of costs related to
supporting PCI’s cellular subscriber base under the master distributor agreement
with AT&T including:





§
            Costs
      of recurring revenue features that are added to the cellular subscribers’
      accounts by PCI which are not subject to the revenue sharing arrangement
      with AT&T; such features include roadside and emergency assistance
      program, handset and accessory warranty programs and certain custom
      billing services.


33





§
            Cost
      of third-party roaming charges that are passed through to PCI by
      AT&T.  Roaming charges are incurred when a cellular
      subscriber leaves the designated calling area and utilizes a carrier,
      other than AT&T, to complete the cellular call.  PCI is
      charged by AT&T for 100% of these “off-network” roaming charges
      incurred by its customer base.


§
            Costs
      to operate and maintain PCI’s customer service department to provide
      billing support and facilitate account changes for cellular service
      subscribers.  These costs primarily include the related payroll
      and benefits costs as well as telecommunication charges for inbound
      toll-free numbers and outbound long
distance.


§
            Costs
      of the Company’s retail stores including personnel, rents and
      utilities.


§
            Costs
      of bad debt related to the cellular service
  billings.





Cost of
products sold consists of the net book value of items sold from the Company’s
operating segments, which are cellular telephones, accessories, two-way radio,
public safety equipment and 12-volt mobile electronics and their related
accessories as well as the expenses and write-downs of equipment and accessory
inventory for shrinkage and obsolescence.  We recognize cost of
products sold, other than costs related to write-downs of equipment and
accessory inventory for shrinkage and obsolescence, when title passes to the
customer.  In PCI’s wholesale operations, products and accessories are
sold to customers at pricing above PCI’s cost. However, PCI will generally sell
cellular telephones below cost to new and existing cellular service customers as
an inducement to enter into one-year and two-year subscription contracts, to
upgrade service and extend existing subscription contracts or in connection with
other promotions.  The resulting equipment subsidy to the majority of
PCI’s cellular customers is consistent with the cellular industry and is treated
as an acquisition cost of the related recurring cellular subscription
revenues.  This acquisition cost is expensed by the Company when the
cellular equipment is sold with the expectation that the subsidy will be
recovered through margins on the cellular subscription revenues over the
contract term with the customer.





Selling
and general and administrative costs primarily consist of customer acquisition
costs, including the costs of our retail stores, sales commissions paid to
internal salespeople and agents, payroll costs associated with our retail and
direct sales force, marketing expenses, billing costs, information technology
operations, bad debt expense and back office support activities, including
customer retention, legal, finance, marketing, human resources, strategic
planning and technology and product development, along with the related payroll
and facilities costs.  Also included in selling and general and
administrative costs are the ongoing costs of maintaining Teletouch as a public
company, which include audit, legal, other professional and regulatory
fees.





Service and Installation
Revenue for the Three Months Ended August 31, 2010 and 2009





The
service and installation revenues shown below have been grouped and are
discussed by the Company’s reportable operating segments as defined under GAAP.
The corporate category includes the service revenues that are not generated by
the business operations of the Company that meet the quantitative requirements
for segment reporting under GAAP.  The corporate service revenues
primarily consist of revenues earned from a mineral rights lease the Company
executed with Chesapeake Exploration, LLC, in June 2008.


34





(dollars in thousands)
                  
                  Three Months Ended August 31,
                  
                  
                  2010 vs 20092010
                  
                  
                  2009
                  
                  
                  $ Change
                  
                  
                  % ChangeService
      and installation revenueCellular
      operationsGross
      cellular subscription billings
                  
                  $
                  10,901
                  
                  
                  $
                  13,932
                  
                  
                  $
                  (3,031
                  )
                  
                  
                  -22
                  %Net
      revenue adjustment (revenue share due AT&T)
                  
                  
                  (5,637
                  )
                  
                  
                  (7,737
                  )
                  
                  
                  2,100
                  
                  
                  
                  -27
                  %Cellular
      operations total service revenues:
                  
                  
                  5,264
                  
                  
                  
                  6,195
                  
                  
                  
                  (931
                  )
                  
                  
                  -15
                  %Wholesale
                  
                  
                  30
                  
                  
                  
                  17
                  
                  
                  
                  13
                  
                  
                  
                  76
                  %Two-way
      radio operations
                  
                  
                  426
                  
                  
                  
                  406
                  
                  
                  
                  20
                  
                  
                  
                  5
                  %Corporate
                  
                  
                  17
                  
                  
                  
                  41
                  
                  
                  
                  (24
                  )
                  
                  
                  -59
                  %Service
      and installation revenue
                  
                  $
                  5,737
                  
                  
                  $
                  6,659
                  
                  
                  $
                  (922
                  )
                  
                  
                  -14
                  %





Gross cellular subscription
billings are measured as the total recurring monthly cellular
service charges invoiced to PCI’s wireless subscribers for which a fixed
percentage of the dollars invoiced are retained by PCI as compensation for the
services it provides to these subscribers and for which PCI takes full
(100%) accounts receivable risk before deducting certain revenue sharing
amounts that are payable to AT&T under PCI’s master distributor agreements
with AT&T. The Company uses the calculation of gross cellular subscription
billings to measure the overall growth of its cellular business and to project
its future cash receipts from the subscriber base.





The 22%
decrease in the cellular operation’s gross cellular subscriptions billings for
the three months ended August 31, 2010 compared to the same period in the prior
fiscal year was due to a decrease in monthly access charges of approximately
$1,656,000 which is a direct result of the Company’s declining cellular
subscriber base.  The reduction in subscribers is largely due to the
Company’s inability to offer the iPhone to its cellular customers resulting in
PCI’s cellular subscribers being forced to transfer their service to AT&T in
order to purchase the iPhone.  The Company had approximately 57,000
cellular subscribers as of August 31, 2010 compared to approximately 70,000
cellular subscribers as of August 31, 2009. Of the 13,000 subscribers lost since
August 31, 2009, approximately 8,200 of these subscribers were lost to AT&T
and of these, approximately 4,500 subscribers transferred to AT&T to
purchase the iPhone.  In addition, the Company had a decrease in
cellular service revenues related to custom feature, data and toll charges
of  $453,000, $298,000 and $169,000, respectively, period over
period.





Cost of Service and
Installation for the Three Months Ended August 31, 2010 and
2009





Cost of
service and installation expense consists of the following significant
components:


35





(dollars in thousands)Three Months Ended August 31,
                    
                    
                    2010 vs 20092010
                    
                    
                    2009
                    
                    
                    Change
                    
                    
                    % ChangeCost
      of service and installation(exclusive
      of depreciation and amortization)Cellular
      operations
                    
                    $
                    1,144
                    
                    
                    $
                    1,555
                    
                    
                    $
                    (411
                    )
                    
                    
                    -26
                    %Wholesale
      operations
                    
                    
                    16
                    
                    
                    
                    10
                    
                    
                    
                    6
                    
                    
                    
                    60
                    %Two-way
      radio operations
                    
                    
                    367
                    
                    
                    
                    402
                    
                    
                    
                    (35
                    )
                    
                    
                    -9
                    %Total
      cost of service and installation
                    
                    $
                    1,527
                    
                    
                    $
                    1,967
                    
                    
                    $
                    (440
                    )
                    
                    
                    -22
                    %





The 26%
decrease in cost of service and installation related to the Company’s cellular
operations for  the three months ended August 31, 2010 compared to the
same period in the prior fiscal year corresponds with the decrease in cellular
service revenues, which is a result of the Company’s declining cellular
subscriber base. Significant cost reductions from the Company’s cellular
operations period over period includes a decrease in bad debt expense of
approximately $131,000 and a decrease in costs associated with the Company’s
phone warranty program of approximately $118,000.  In addition,
salaries and other personnel benefits decreased by approximately $50,000 period
over period due to a reduction in the cellular operations
personnel.  The cellular customer service department had 50 employees
as of August 31, 2010 compared to 58 employees as of August 31,
2009.





The 9%
decrease in cost of service and installation related to the Company’s two-way
operations for the three months ended August 31, 2010 compared to the same
period in the prior fiscal year is primarily due to a decrease in network
repairs related to the Company’s logic trunk radio (“LTR”) system of
approximately $20,000.  In addition, the Company reduced personnel at
its Garland two-way service location in the first quarter of fiscal year 2010,
which resulted in a decrease of salaries and other personnel benefits of
approximately $12,000 period over period.


36





Sales Revenue and Cost of
Products Sold for the Three Months ended August 31, 2010 and
2009





(dollars in thousands)
                  
                  Three Months Ended August 31,
                  
                  
                  2010 vs 20092010
                  
                  
                  2009
                  
                  
                  $ Change
                  
                  
                  %
                    ChangeProduct
      Sales RevenueCellular
      operations
                  
                  $
                  893
                  
                  
                  $
                  1,569
                  
                  
                  $
                  (676
                  )
                  
                  
                  -43
                  %Wholesale
      operations
                  
                  
                  1,662
                  
                  
                  
                  2,667
                  
                  
                  
                  (1,005
                  )
                  
                  
                  -38
                  %Two-way
      radio operations
                  
                  
                  684
                  
                  
                  
                  562
                  
                  
                  
                  122
                  
                  
                  
                  22
                  %Corporate
      operations
                  
                  
                  2
                  
                  
                  
                  2
                  
                  
                  
                  -
                  
                  
                  
                  0
                  %Total
      product sales revenue
                  
                  $
                  3,241
                  
                  
                  $
                  4,800
                  
                  
                  $
                  (1,559
                  )
                  
                  
                  -32
                  %Cost
      of products soldCellular
      operations
                  
                  
                  1,078
                  
                  
                  
                  1,588
                  
                  
                  
                  (510
                  )
                  
                  
                  -32
                  %Wholesale
      operations
                  
                  
                  1,261
                  
                  
                  
                  2,378
                  
                  
                  
                  (1,117
                  )
                  
                  
                  -47
                  %Two-way
      radio operations
                  
                  
                  524
                  
                  
                  
                  442
                  
                  
                  
                  82
                  
                  
                  
                  19
                  %Corporate
      operations
                  
                  
                  (1
                  )
                  
                  
                  (4
                  )
                  
                  
                  3
                  
                  
                  
                  -75
                  %Cost
      of products sold
                  
                  $
                  2,862
                  
                  
                  $
                  4,404
                  
                  
                  $
                  (1,542
                  )
                  
                  
                  -35
                  %





Product sales revenue: The
43% decrease in product sales from the Company’s cellular operations for the
three months ended August 31, 2010 compared to the same period in the prior
fiscal year is primarily due to a decrease in cellular phone activations and
upgrades. The Company activated 957 phones during the three months ended August
31, 2010 compared to 2,138 cellular phone activations during the three months
ended August 31, 2009.  The reduction is primarily attributable to the
termination of the Company’s Dallas / Fort Worth distribution agreement with
AT&T on August 31, 2009. Subsequent to that date, the Company was prohibited
from adding new customers to its Dallas / Fort Worth subscriber base.In addition, the Company had
839 fewer cellular phone upgrade transactions in the three months ended August
31, 2010 compared to  the three months ended August 31, 2009.
Furthermore, product sales from the cellular operations decreased by
approximately $249,000 period over period due to Company’s closing its Oklahoma
T-Mobile locations during the second quarter of fiscal year 2010.





The 38%
decrease in product sales from the Company’s wholesale operations for the three
months ended August 31, 2010 compared to the same period in the prior fiscal
year is primarily related to a decrease in  brokering cellular
handsets to domestic and international cellular distributors. Sales of cellular
handsets from the Company’s wholesale business decreased by approximately
$687,000 for the three months ended August 31, 2010 compared to the three months
ended August 31, 2009.  The Company is currently pursuing new
suppliers of cellular handsets to support the wholesale brokerage business and
anticipates it will ramp up this business quickly once a supplier agreement is
in place. In addition, sales of car audio equipment from the Company’s wholesale
business decreased by approximately $351,000 period over period due to the
Company experiencing a weak demand for aftermarket car audio products due to a
saturated market and fewer small to mid-size electronic retailers.





The 22%
increase in product sales from the Company’s two-way radio operations for the
three months ended August 31, 2010 compared to the same period in the prior
fiscal year is primarily due to an  increase in sales of public safety
equipment (“PSE”).  Product sales from the Company’s PSE business
increased by approximately $75,000 period over period. In addition, two-way
radio and parts sales increased by approximately $47,000 period over
period.


37





Cost of products
sold:  The 35% decrease in total cost of products sold is a
direct result of a decrease in product sales revenues from the cellular and
wholesale operations offset by an increase in sales and cost of products sold
from the two-way operations.  The decrease in product costs from the
Company’s cellular operations is a direct result of fewer cellular product sales
due to the Company’s declining cellular subscriber base. Due to the pricing
established across the cellular industry and the Company’s efforts to retain its
existing cellular subscribers, cellular equipment sold in conjunction with a new
service activation or the renewal of a service contract results in the Company’s
subsidizing a substantial portion of the cost of the handset. Although the
Company’s wholesale operations experienced a decrease in sales period over
period, wholesale profit margins improved in the three months ended August 31,
2010 compared to the same period in the prior fiscal year due to the wholesale
brokerage sales transactions in the three months ended August 31, 2009. These
were primarily high volume, low margin sales. The increase in two-way cost of
products corresponds with the increase in two-way radio and parts
sales.





Selling and General and
Administrative Expenses for the Three Months ended August 31, 2010 and
2009





Selling
and general and administrative expenses consist of the following significant
components:





(dollars in thousands)
                  
                  Three Months Ended August 31,
                  
                  
                  2010 vs 20092010
                  
                  
                  2009
                  
                  
                  $ Change
                  
                  
                  % ChangeSelling
      and general and administrativeSalaries
      and other personnel expenses
                  
                  $
                  2,235
                  
                  
                  $
                  2,521
                  
                  
                  $
                  (286
                  )
                  
                  
                  -11
                  %Office
      expense
                  
                  
                  445
                  
                  
                  
                  517
                  
                  
                  
                  (72
                  )
                  
                  
                  -14
                  %Advertising
      expense
                  
                  
                  148
                  
                  
                  
                  113
                  
                  
                  
                  35
                  
                  
                  
                  31
                  %Professional
      fees
                  
                  
                  430
                  
                  
                  
                  573
                  
                  
                  
                  (143
                  )
                  
                  
                  -25
                  %Taxes
      and licenses fees
                  
                  
                  46
                  
                  
                  
                  53
                  
                  
                  
                  (7
                  )
                  
                  
                  -13
                  %Stock-based
      compensation expense
                  
                  
                  264
                  
                  
                  
                  131
                  
                  
                  
                  133
                  
                  
                  
                  102
                  %Other
      expenses
                  
                  
                  348
                  
                  
                  
                  289
                  
                  
                  
                  59
                  
                  
                  
                  20
                  %Total
      selling and general and administrative
                  
                  $
                  3,916
                  
                  
                  $
                  4,197
                  
                  
                  $
                  (281
                  )
                  
                  
                  -7
                  %





The 11%
decrease in salaries and other personnel expenses for the three months ended
August 31, 2010 compared to the same period in the prior fiscal year is
attributable to a decrease in personnel primarily due to the Company closing its
Oklahoma T-Mobile locations in the second quarter of fiscal year
2010.  A reduction in the Company’s accruals related to the
executive’s annual incentive bonus plans partially contributed to the decrease
in salaries and other personnel benefits expense period over period. The
executive bonus plan is based upon the Company’s financial performance and
whether certain targets are met during the fiscal year. The executive bonus
accrual is monitored throughout the fiscal year and adjusted
quarterly.





The 14%
decrease in office expense for the three months ended August 31, 2010 compared
to the same period in the prior fiscal year is primarily related to a reduction
in lease expenses.  The Company had lease expenses of approximately
$46,000 related to the Oklahoma T-Mobile locations in the three months ended
August 31, 2009 with no similar occurring transactions in the three months ended
August 31, 2010 since the  locations were closed in the second quarter
of fiscal year 2010. In addition, the Company decreased telecommunication
expenses of approximately $28,000 period over period due to consolidating its
corporate phone lines.





The 31%
increase in advertising expense for the three months ended August 31, 2010
compared to the same period in the prior fiscal year is due to the Company
receiving advertising reimbursements from certain vendors for achieving sales
based objectives.  During the three months ended August 31, 2010, the
Company received approximately $38,000 in advertising reimbursements compared to
no similar occurring transactions in the three months ended August 31,
2009.


38





The 25%
decrease in professional fees for the three months ended August 31, 2010
compared to the same period in the prior fiscal year is due to a reduction in
legal fees of approximately $233,000 primarily due to legal costs associated
with defending the Company in a trademark infringement litigation in fiscal year
2010. The Company settled the trademark litigation in the fourth quarter of
fiscal year 2010.  The decrease in legal expenses are partially offset
by an increase in investor relation expenses of approximately $91,000 period
over period. These fees are primarily related to the Company hiring a public
relations firm to help promote the Company within the investment
community.





The 102%
increase in stock-based compensation expense for the three months ended August
31, 2010 compared to the same period in the prior fiscal year is due to
an  increase in the number of stock options granted to the Company’s
executive management and Board of Directors in June 2010 as well as an increase
in the market value of the underlying common stock since the prior year which
drove an increase in the computed fair value of the options. During the first
quarter of fiscal year 2011, the Company granted an additional 1,093,167 in
stock options which contributed to the increase in stock compensation
expense quarter over quarter.





The 20%
increase in other expenses for the three months ended August 31, 2010 compared
to the same period in the prior fiscal year is attributable to an increase in
corporate travel expenses of approximately $37,000.  In addition, the
Company experienced an increase dues and subscription costs of approximately
$17,000 period over period primarily related to monthly fees incurred for a
sales software  program.





Other Operating Expenses for
the Three Months Ended August 31, 2010 and 2009





(dollars in thousands)
                  
                  Three Months Ended August 31,
                  
                  
                  2010 vs 20092010
                  
                  
                  2009
                  
                  
                  $ Change
                  
                  
                  % ChangeOther
      Operating ExpensesDepreciation
      and amortization
                  
                  $
                  279
                  
                  
                  $
                  327
                  
                  
                  $
                  (48
                  )
                  
                  
                  -15
                  %




Depreciation and
amortization:  Depreciation and amortization expense as
reported is comprised of the following:





(dollars in thousands)
                  
                  Three Months Ended August 31,
                  
                  
                  2010 vs 20092010
                  
                  
                  2009
                  
                  
                  $ Change
                  
                  
                  % ChangeOther
      Operating ExpensesDepreciation
                  
                  $
                  73
                  
                  
                  $
                  103
                  
                  
                  $
                  (30
                  )
                  
                  
                  -29
                  %Amortization
                  
                  
                  206
                  
                  
                  
                  224
                  
                  
                  
                  (18
                  )
                  
                  
                  -8
                  %Total
      other operating expenses
                  
                  $
                  279
                  
                  
                  $
                  327
                  
                  
                  $
                  (48
                  )
                  
                  
                  -15
                  %





The 29%
decrease in depreciation expense for the three months ended August 31, 2010
compared to the same period in the prior fiscal year is attributable to the
Company’s minimal purchases of fixed assets for its corporate offices and retail
locations. In addition, the age of certain existing capital assets also
contributed to the decrease in depreciation expense period over period. The 8%
decrease in amortization expense for the three months ended August 31, 2010
compared to the three months ended August 31, 2009 is due to certain loan
origination fees that became fully amortized in fiscal year
2010.


39





Interest Expense, Net of
Interest Income for the Three Months Ended August 31, 2010 and
2009





(dollars in thousands)
                  
                  Three Months Ended August 31,
                  
                  
                  2010 vs 20092010
                  
                  
                  2009
                  
                  
                  $ Change
                  
                  
                  % ChangeInterest
      Expense (Income)Mortgage
      debt
                  
                  $
                  39
                  
                  
                  $
                  42
                  
                  
                  $
                  (3
                  )
                  
                  
                  -7
                  %Thermo
      factoring debt
                  
                  
                  -
                  
                  
                  
                  306
                  
                  
                  
                  (306
                  )
                  
                  
                  -100
                  %Thermo
      revolving credit facility
                  
                  
                  502
                  
                  
                  
                  140
                  
                  
                  
                  362
                  
                  
                  
                  259
                  %Warrant
      redemption notes payable
                  
                  
                  26
                  
                  
                  
                  35
                  
                  
                  
                  (9
                  )
                  
                  
                  -26
                  %Other
                  
                  
                  1
                  
                  
                  
                  (21
                  )
                  
                  
                  22
                  
                  
                  
                  -105
                  %Total
      interest expense, net
                  
                  $
                  568
                  
                  
                  $
                  502
                  
                  
                  $
                  66
                  
                  
                  
                  13
                  %





The 13%
increase in interest expense, net for the three months ended August 31, 2010
compared to the same period in the prior fiscal year is due to an increase in
interest expense related to the Thermo revolving credit facility.  In
August 2009, the Company combined its Thermo factoring debt facility and the
Thermo revolving credit facility into a single debt facility by expanding the
revolving credit facility to allow the Company to retire the Thermo factoring
debt.  The debt restructure included a change in the calculation of
interest related to the Company’s debt balance with Thermo and increased
interest expense by approximately $56,000 period over period.





Income Tax Expense for the
Three Months Ended August 31, 2010 and 2009





In the
two periods presented, the combined operations of the Company did not generate a
federal tax liability.  In the three months ended August 31, 2010 and
2009, the Company recorded $56,000 and $62,000 in state tax expenses,
respectively. The state tax expense relates primarily to the Texas margin tax,
which was initially implemented by the state effective January 1,
2008.  The margin tax is calculated by using the Company’s gross
receipts from business conducted in Texas each fiscal year less a cost of goods
sold deduction.  Due to a reduction in the Company’s gross receipts in
Texas, the Texas state tax expense decreased in the three months ended August
31, 2010 compared to the three months ended August 31, 2009.




Financial
Condition as of August 31, 2010





(dollars in thousands)
                  
                  Three Months Ended August 31,
                  
                  
                  2010 vs 20092010
                  
                  
                  2009
                  
                  
                  $ ChangeCash
      provided by (used in) operating activities
                  
                  $
                  67
                  
                  
                  $
                  (762
                  )
                  
                  $
                  829Cash
      (used in) provided by investing activities
                  
                  
                  (150
                  )
                  
                  
                  582
                  
                  
                  
                  (732
                  )Cash
      used in financing activities
                  
                  
                  (662
                  )
                  
                  
                  (706
                  )
                  
                  
                  44Net
      decrease in cash
                  
                  $
                  (745
                  )
                  
                  $
                  (886
                  )
                  
                  $
                  141





Liquidity
and Capital Resources





As of
August 31, 2010, the Company had approximately $4,200,000 cash on hand and a
working capital deficit of approximately $2,000,000 as of August 31,
2010 compared to a deficit of approximately $1,200,000 as of May 31,
2010. Although the Company recorded a net loss in the first quarter of
fiscal year 2010, it had positive operating results and generated sufficient
cash to service its liabilities, including its fiscal year 2010 accrued bonuses
as well as increase its investment in inventory to support its growth
initiatives in the three months ended August, 31, 2010.


40





During
fiscal year 2011, the Company expects its wholesale and two-way operations to
continue to improve through the restructuring of its sales personnel and expects
increased sales since the Company was awarded the GSA contract in September 2010
(see Note 16 – “Subsequent Event” for additional information on the GSA
contract). In addition, the Company believes it can maintain a profitable
cellular business although its cellular subscriber base continues to decline.
Through the remainder of the fiscal year, the Company will continue to focus on
providing superior customer service to its existing cellular subscriber base
while maximizing revenues through the cellular services offered by PCI and
adding additional subscribers in the markets where permitted by AT&T. In
addition, the Company is actively pursuing business acquisitions and believes
those businesses, once acquired, will add additional revenue and profits to the
Company’s existing operations.  The Company believes it has sufficient
cash and cash availability under its current financing facilities to meet its
obligations during the upcoming 12 months.   Historically, the
Company has demonstrated its ability to manage expenses to drive material
results to the Company.  During fiscal year 2011, the Company
anticipates seeking further cost reduction initiatives for selling and general
and administrative expenses as it continues to maximize profitability in all its
business units by closely monitoring overhead expenses.  For the
remainder of fiscal year 2011, the total debt service obligations for the
Company are approximately $2,400,000.  Considering the cash on hand,
cash availability under the Thermo loan facility to fund the expansion of the
business, cash generated on a monthly basis from the billable subscriber base
under the continuing portion of the AT&T distribution agreements and the
payment terms available for obligations owing to AT&T, the Company believes
it will have sufficient cash to meet its obligations for at least the 12 months
following the date of this Report.





Operating
Activities





The
increase in cash provided by the Company’s operating activities during the three
months ended August 31, 2010 compared to the three months ended August 31, 2009
is attributable to additional payments made against the Company’s accounts
payable of approximately $1,400,000 during the first quarter of fiscal year
2010. The payments primarily related to revenue share invoices payable to
AT&T. The increase in cash is offset by the Company decreasing its accrued
liabilities period over period primarily related to fiscal year 2010 bonus
payments of approximately $591,000 in the first quarter of fiscal year
2011.





Investing
Activities





The
decrease in cash provided by the Company’s investing activities for the three
months ended August 31, 2010 compared to three months ended August 31, 2009 is
due to cash receipts received during the first quarter of fiscal year 2010
against former notes receivable. In addition, the Company increased its capital
expenditures by approximately $81,000 and made a payment of $150,000 related to
the trademark license (see Note 9 – “Trademark Purchase Obligation” for addition
information on the trademark license) in the three months ended August 31, 2010
compared to the three months ended August 31, 2009.  The decrease in
cash was partially offset by the redemption of a $100,000 certificate of deposit
in the first quarter of fiscal year 2011.





Financing
Activities





The
decrease in cash used by the Company’s financing activities for the three months
ended August 31, 2010 compared to the three months ended August 31, 2009 is
primarily attributable to the purchase of treasury stock of approximately
$31,000 in the first quarter of fiscal year 2010.





Off-Balance
Sheet Transactions




The
Company does not engage in off-balance sheet transactions.




41




Critical
Accounting Estimates





The
preceding discussion and analysis of financial condition and results of
operations are based upon Teletouch's consolidated financial statements, which
have been prepared in conformity with accounting principles generally accepted
in the United States. The preparation of these financial statements requires
management to make estimates and judgments that affect the reported amounts of
assets, liabilities, revenues, expenses and related disclosures. On an on-going
basis, Teletouch evaluates its estimates and assumptions, including but not
limited to those related to the impairment of long-lived assets, reserves for
doubtful accounts, provision for income taxes, revenue recognition and certain
accrued liabilities. Teletouch bases its estimates on historical experience and
various other assumptions that are believed to be reasonable under the
circumstances, the results of which form the basis for making judgments about
the carrying values of assets and liabilities that are not readily apparent from
other sources. Actual results may differ from these estimates under different
assumptions or conditions.





Allowance
for Doubtful Accounts: The Company performs periodic credit evaluations
of its customer base and extends credit to virtually all of its customers on an
uncollateralized basis.





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 an account receivable past due when
customers exceed the terms of payment granted to them by the
Company.  The Company writes off its fully reserved accounts
receivable when it has exhausted all collection efforts, which is typically 90
days following the last payment received from the customer.





Accounts
receivable are presented net of an allowance for doubtful accounts of $363,000
and $407,000 at August 31, 2010 and May 31, 2010, respectively.  Based
on the information available to the Company, 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 balance.





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 purchase of the inventory by
the Company.  In addition, management establishes specific valuation
allowances for discontinued inventory based on its prior experience of
liquidating this type of inventory.  Through the Company’s wholesale
and Internet distribution channels, it is successful in liquidating the majority
of any inventory that becomes obsolete.  The Company has many
different electronics suppliers, all of which provide reasonable notification of
model changes, which allows the Company to minimize its level of discontinued or
obsolete inventory. Actual results could differ from those
estimates.  Inventories are stated on the Company’s consolidated
balance sheet net of a reserve for obsolescence of $218,000 and $232,000 at
August 31, 2010 and May 31, 2010, respectively.


42





Impairment
of Long-Lived Assets:In accordance with ASC
360, Property, Plant and
Equipment, (“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
an impairment, then the carrying value of the assets being 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. Projected revenues assume a continued
decline in cellular service revenue while projected operating expenses are based
upon historic experience and expected market conditions adjusted to reflect an
expected decrease in expenses resulting from cost saving
initiatives.





The
Company’s review of the carrying value of its tangible long-lived assets at May
31, 2010 indicated the carrying value of these assets were recoverable through
estimated future cash flows.  Because of the sustained losses the
Company has incurred during the past several years, the Company also reviewed
the market values of these assets.  The review indicated the market
value exceeded the carrying value at May 31, 2010.  However, if the
cash flow estimates or the significant operating assumptions upon which they are
based change in the future, Teletouch may be required to record impairment
charges related to its long-lived assets.





The most
significant long-lived tangible 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. In each
instance, the appraised value exceeded the carrying value of the
property.





In
accordance with ASC 360, Teletouch evaluates the recoverability of the carrying
value of its long-lived assets and certain intangible assets based on estimated
undiscounted cash flows to be generated from such assets.





The
evaluation of the Company’s long-lived intangible assets is discussed in Note 2
under “Intangible Assets.” Under the same premise as the long-lived tangible
assets, their market values were also evaluated at May 31, 2010, and the Company
determined that based primarily on the market value and supported by the
Company’s cash flow projections, there was no impairment of these assets. If the
cash flow estimates or the significant operating assumptions upon which they are
based change in the future, Teletouch may be required to record impairment
charges related to its long-lived assets.





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 and 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.  On November 1,
2005, the Company became a member of the consolidated tax group of Progressive
Concepts Communications, Inc. (“PCCI”) as a result of PCCI’s gaining control of
over 80% of the outstanding common stock of Teletouch on that
date.  PCCI gained control of Teletouch’s common stock through the
conversion by TLL Partners, LLC (“TLLP”), PCCI’s wholly-owned subsidiary, of all
of its shares of the Company’s outstanding Series C Preferred Stock into
43,500,000 shares of common stock on November 1, 2005.  As of November
1, 2005, TLLP was a disregarded entity for federal tax purposes since it was at
that time a single member limited liability company (“LLC”). Therefore, the
parent company of Teletouch for federal tax purposes was deemed to be
PCCI.   The Company continued to account for its taxes under ASC
740 and record its deferred taxes on a stand-alone basis while part of PCCI’s
consolidated tax group.  In August 2006 as a result certain debt
restructuring activities involving TLLP, Teletouch’s direct parent and PCCI’s
wholly-owned subsidiary, the Company broke from the PCCI tax group due to new
TLLP shares that were issued as part of this restructuring, which resulted in
TLLP no longer being disregarded for tax purposes.  Beginning in
August 2006, TLLP is taxed as a partnership, and the Company is again separately
liable for its federal income taxes.


43





Goodwill:
Goodwill represents the excess of costs over fair value of assets of businesses
acquired.  Goodwill and intangible assets acquired in a business
combination and determined to have an indefinite useful life are not amortized
but instead are tested for impairment at least annually in accordance with the
provisions of ASC 350, Intangibles-Goodwill and
Other, (“ASC 350”). Teletouch’s goodwill was recorded in January 2004 as
part of the purchase of the two-way radio assets of Delta Communications,
Inc.  The Company decided to test this goodwill annually on March
1st,
the first day of its fourth fiscal quarter, of each year unless an event occurs
that would cause the Company to believe the value is impaired at an interim
date.





At March
1, 2010, the Company evaluated the carrying value of its goodwill associated
with its two-way business and concluded that no impairment of its goodwill was
required in fiscal year 2010.  The Company estimates the fair value of
its two-way business using a discounted cash flow method. The Company
continually evaluates whether events and circumstances have occurred that
indicate the remaining balance of goodwill may not be recoverable. In evaluating
impairment the Company estimates the sum of the expected future cash flows
derived from such goodwill. Such evaluations for impairment are significantly
impacted by estimates of future revenues, costs and expenses and other factors.
A significant change in cash flows in the future could result in an additional
impairment of goodwill. No changes occurred in the two-way business during the
current quarter that warranted an impairment to goodwill.





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 and billing recurring cellular
services and 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 services and two-way
radio equipment through the Company’s retail, wholesale and two-way radio
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
when delivery occurs, the customer takes title and assumes risk of loss, terms
are fixed and determinable and collectability is reasonably
assured.  The Company does not generally grant rights of
return.  However, PCI offers customers a 30 day return/exchange
program for new cellular subscribers in order to match programs in place by most
of the other cellular carriers.  During the 30 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 30 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.  In addition, it is typical to incur
losses on the sale of the cellular phone equipment related to signing up
customers under a cellular airtime contract; therefore, any reserves recorded
for customer returns would be an accrual of gains via reversing the losses
incurred on the original cellular phone sale transaction.  The Company
does not believe accruing for the potential gains would be in accordance with
GAAP but rather records this gain in the period that it is actually
realized.


44





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
customer service to its subscribers.  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
PCI’s 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.





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 have no impact on our
consolidated financial statements.





Deferred
revenue represents prepaid monthly service fees billed to customers, primarily
monthly access charges for cellular services that are billed in advance by the
Company.





Stock-Based
Compensation:We account 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. The Company estimates the
fair value of employee stock options on the date of grant using the
Black-Scholes model. The determination of fair value of stock-based payment
awards on the date of grant using an option-pricing model is affected by our
stock price as well as assumptions regarding a number of highly complex and
subjective variables. These variables include, but are not limited to the
expected stock price volatility over the term of the awards and the actual and
projected employee stock option exercise behaviors. The Company has elected to
estimate the expected life of an award based on the SEC approved “simplified
method”. We calculated our expected volatility assumption required in the
Black-Scholes model based on the historical volatility of our stock. We will
update these assumptions on at least an annual basis and on an interim basis if
significant changes to the assumptions are warranted.





Item
3.  Quantitative and Qualitative Disclosures About Market
Risk





The
Company did not have any foreign currency hedges or other derivative financial
instruments as of August 31, 2010.  We do not enter into financial
instruments for trading or speculative purposes and do not currently utilize
derivative financial instruments.  Our operations are conducted
primarily in the United States and as such are not subject to material foreign
currency exchange rate risk.


45





Item
4. Controls and Procedures





Controls
and procedures




As of the
end of the period covered by this report, the Company conducted an evaluation,
under the supervision and with the participation of our management, including
the Chief Executive Officer, President and Chief Operating Officer and Chief
Financial Officer (the “Certifying Officers”) of our disclosure controls and
procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act).
Based on this evaluation, the Certifying Officers concluded that, as of
August 31, 2010, our disclosure controls and procedures were effective to
ensure that information required to be disclosed by us in reports that we file
or submit under the Exchange Act is recorded, processed, summarized and
reported, within the time periods specified in the Commission’s rules and forms
and to ensure that information required to be disclosed by us in the reports
that we file or submit under the Exchange Act is accumulated and communicated to
us, including our principal executive and principal financial officers, as
appropriate to allow timely decisions regarding required
disclosure.




Change
in internal control over financial reporting




There
were no changes in our internal control over financial reporting during our most
recently completed fiscal quarter that have materially affected or are
reasonably likely to materially affect our internal control over financial
reporting.




46





Part
II.  Other Information





Item
1.     Legal Proceedings





Teletouch
is subject to various legal proceedings arising in the ordinary course of
business. Except as set forth below, the Company believes there is no
proceeding, either threatened or pending, against it that could result in a
material adverse effect on its results of operations or financial
condition.





AT&T Binding Arbitration:
In late June 2007, Apple, Inc. introduced the iPhone to the United States in an
exclusive distribution and wireless services partnership with AT&T. AT&T
was at the time, and remains today, the only authorized carrier provider for the
iPhone. Since that time, AT&T has refused to allow the Company to sell the
iPhone as well as other products and services, despite AT&T’s contractual
obligation to do so under its previously executed distribution agreements
between AT&T and the Company. Furthermore, the Company asserts that AT&T
has continued to make direct contact with Company customers and aggressively
markets, advertises and promotes the iPhone and other AT&T exclusive
products and services to Company customers in an attempt to induce them to
switch to AT&T.





In June
2007, the Company serviced approximately 83,000 cellular subscribers. As of May
31, 2010, more than 18,700 subscribers have transferred their accounts to
AT&T, with a significant percentage of these solely due to the exclusive
availability of the iPhone through AT&T and Apple designated retail outlets
only.





Since
July 2007, the Company had attempted to negotiate with AT&T for the purpose
of obviating the need for legal action. However, such attempts failed.
Therefore, on September 30, 2009, the Company, through the legal entity
Progressive Concepts, Inc. (“PCI”), commenced an arbitration proceeding against
New Cingular Wireless PCS, LLC and AT&T Mobility Texas LLC (collectively,
“AT&T”) seeking a minimum $100 million in damages. The binding arbitration
was commenced to seek relief for damages incurred as AT&T has prevented PCI
from selling the popular iPhone and other AT&T exclusive products and
services that PCI is and has been contractually entitled to provide to its
customers under distribution agreements between PCI and AT&T. The action
further asserts that AT&T violated the longstanding non-solicitation
provisions of the DFW market distribution agreement by and between the companies
by actively inducing customers to leave PCI for AT&T. PCI is represented in
the matter by the Company’s legal counsel, Bracewell & Giuliani,
LLP.





On
February 28, 2010, Teletouch and its wholly-owned subsidiary, PCI, as Claimant
and AT&T as Respondent received the Agreed Scheduling Order from the
Judicial Arbitration and Mediation Services, Inc. (“JAMS”) Arbitrator assigned
to the binding arbitration. Among other matters, including the provision of the
Rules and Law governing the arbitration, the Agreed Scheduling Order set out the
proposed completion dates for Discovery, Depositions, Dispositive Motions and
Briefing Deadlines, culminating in an Arbitration hearing period scheduled for
November 8, 2010 through November 12, 2010.





On August
10, 2010, the Agreed Scheduling Order was amended by the JAMS Arbitrator after
being petitioned by AT&T for additional time to prepare for the
hearing.  As a result, all interim completion dates to prepare for the
hearing have been extended with the Arbitration hearing period re-scheduled for
March 21, 2011 through March 25, 2011.





For a
detailed description of the Company’s legal proceedings and legal action Notice
and Initial Statement of Claim, please refer to the related Form 8-K, filed with
the SEC October 1, 2009, which is incorporated by reference
herein.


47





Item
1A.   Risk Factors





Except as
set forth below, there were no material changes from the risk factors as
previously disclosed in our Annual Report for the fiscal year ended May 31, 2010
filed with the SEC on August 30, 2010.





Amounts
due under the Company’s revolving credit facility with its senior lender could
accelerate as a result of a continued decline in the Company’s cellular
subscriber base and the related assets that have been borrowed against which
could  result in an operating cash deficiency and an inability to
continue servicing the debt obligation.





The
Company historically relied upon Thermo Credit, LLC (“Thermo”) to provide cash
availability under its revolving credit facility to fund its working capital
needs including purchasing inventory when vendor credit terms are not available
and for financing sales made by the Company on extended credit terms. This
facility was designed to provide sufficient cash availability for the Company in
times when the underlying assets pledged as collateral were
growing.  The primary asset pledged as collateral is the Company’s
customer accounts receivable.  The launch of the iPhone in June 2007
and AT&T’s refusal to allow the Company to sell the iPhone has resulted in a
steady decline in the Company’s subscriber base, the related billings and
accounts receivable.  This decline in the subscriber base and related
billings was accelerated as a result of the expiration of the Company’s primary
DFW distribution agreement with AT&T in August 2009, which ended the
Company’s ability to add new subscribers and further prevented the Company from
allowing any AT&T subscribers in the DFW market desiring to change their
billing services to the Company from transferring their cellular service to the
Company.  Prior to August 2009, transfers of customers from AT&T
had partially offset some of the losses of customers leaving to purchase the
iPhone elsewhere.  This decline in cellular billings and accounts
receivable has directly reduced the borrowings available against accounts
receivable under the credit facility and has had the indirect effect of reducing
the borrowings available against other assets, including inventory, intangibles,
property and equipment, because borrowings on non-accounts receivable assets are
limited to a fixed percentage of the total borrowings
outstanding.  The losses of cellular subscribers coupled with periodic
declines in accounts receivable in the wholesale distribution business has
resulted in the Company’s being periodically over-advanced on its facility. The
Company had previously borrowed the maximum amount available against its assets
for certain debt restructuring transactions in addition to its working capital
needs so a portion of the borrowed funds are not held in cash or other short
term assets for servicing any potential accelerated repayment obligations it may
encounter.  To date, Thermo has allowed the Company to remain
over-advanced on the facility from time-to-time, extended certain repayment
terms, modified scheduled debt amortization and has continued to allow the
inclusion of certain assets in the computation of its borrowing base, which in
turn has allowed the Company to meet its obligations under the facility. If
Thermo were to have difficulty with the terms of the existing facility or
exclude or modify certain advances allowed against assets currently included in
the borrowing, the Company could potentially experience operating cash
deficiencies up to and including being unable to meet its obligations under this
revolving credit facility. In addition, if Thermo does not renew the Company’s
debt agreement in January 2012, the Company would have to secure new financing
to re-finance its current obligation due to Thermo and meet its ongoing cash
needs. Assuming the Company were able to find a new senior lender, it can
provide no assurance the terms of the new financing would be as favorable as
these provided by Thermo or that a new lender would be as accommodating to the
varying cash needs of the Company during the term of the loan.  We can
provide no assurance that Thermo will renew the current facility, but do note
that the initial loans with Thermo from August 2006, have been modified,
expanded and extended on several occasions to date. To the extent that the
Company was unable to refinance this debt, it would likely not have the means to
fully repay Thermo from the cash on hand or generated from operations resulting
in the possibility of a foreclosure on all of the assets of the
Company.


48





An
accelerated reduction in our cellular subscriber base could have a material
adverse effect on our business.





The
launch of the iPhone in June 2007 and AT&T’s refusal to allow the Company to
sell the iPhone has resulted in a steady decline in the Company’s subscriber
base (see Item 1. Legal Proceedings for discussion of the action brought against
AT&T related to the iPhone and other matters). This decline in the Company’s
customer base was accelerated as a result of the expiration of the Company’s
primary DFW distribution agreement with AT&T in August 2009. The Company
continues to battle the losses of subscribers to AT&T and is currently
seeking relief through a binding arbitration process that it initiated in
September 2009. As AT&T continues to release new products or services that
are not made available to the Company, losses of cellular subscribers will
continue. If any of these products or services become in extraordinary demand or
are required by consumers or businesses, the result could be an acceleration of
cellular subscriber losses to AT&T.  Although the Company does
maintain contracts varying from one to two years with its current customer base
for cellular service, the customer may voluntarily elect to transfer to another
carrier, including AT&T, at any time and incur a penalty fee. If expenses
related to the Company’s cellular operations are not adjusted accordingly due to
a declining subscriber base, the Company will rely upon its other business units
to replace the revenue and income loss from its cellular operations. We can
provide no assurance that any of our other existing business units could
generate enough revenue in a timely manner to cover the losses sustained from a
rapidly declining cellular subscriber base. We also can provide no assurance
that our customers will continue to purchase products or services from us or
that their purchases will be at the same or greater levels than in prior
periods.




Teletouch
may be unsuccessful in the arbitration with AT&T and could incur a
significant obligation from the outcome of the arbitration or an unfavorable
outcome from the arbitration could have a material adverse effect on the
Company’s business.





Since
July 2007, the Company has attempted to negotiate with AT&T for the purpose
of obviating the need for legal action. However, such attempts have failed.
Therefore, on September 30, 2009, the Company, through the legal entity
Progressive Concepts, Inc. commenced an arbitration proceeding against New
Cingular Wireless PCS, LLC and AT&T Mobility Texas LLC (collectively,
“AT&T”) seeking at least $100 million in damages. The binding arbitration
was commenced to seek relief for damages incurred as AT&T has prevented PCI
from selling the popular iPhone and other “AT&T exclusive” products and
services that PCI is and has been contractually entitled to provide to its
customers under distribution agreements between PCI and AT&T. In response to
PCI’s initiating its legal action, AT&T filed certain counterclaims in the
arbitration, including seeking monetary damages for equipment transactions
between the parties and certain alleged breaches of the distribution agreement
by the Company. If the Company does not prevail in its claim against AT&T,
then the expected result is that the Company would continue to service its
subscribers under the distribution agreement and would not be awarded any
monetary damages. While the Company believes that the counterclaims are
baseless, if AT&T prevails in its counterclaims during the arbitration, the
Company could potentially be held liable for certain payments to AT&T or it
could be ruled that the Company had defaulted on certain terms and conditions of
the distribution agreement as a result of actions alleged in these
counterclaims. We can provide no assurance that the Company will prevail in its
arbitration against AT&T or be able to defend against the counterclaims
raised by AT&T or pay any obligations due to AT&T in the event they were
to prevail in any of their counterclaims.


49





Teletouch’s
parent company may be unable to meet its future financial
obligations.





Prior to
the acquisition of PCI in August 2006, TLLP, Teletouch’s parent company, assumed
all of the remaining institutional debt of PCI, whereby the senior debt
obligations formerly at PCI were transferred to TLLP as senior debt obligations
and the subordinated debt obligations of PCI were partially settled by the
issuance of Teletouch’s common stock owned by TLLP with the balance converted to
redeemable Series A preferred units of TLLP. To secure the senior debt
obligation, TLLP pledged all of its assets, which consist primarily of its
holding of approximately 80% of the outstanding common stock of Teletouch. When
the senior debt originally matured in August 11, 2007, TLLP did not have
sufficient cash or other means to repay this debt and was successful in
negotiating an initial extension of the maturity date through October 11,
2007. Subsequent extensions were granted by the senior debt holder to TLLP
extending the maturity date through December 15, 2010. TLLP is a holding company
with no operations with a minimal amount of cash on hand and may be dependent
upon selling a sufficient number of shares it owns in Teletouch common stock or
upon the cash flows of Teletouch through the receipt of future cash dividends to
service its outstanding debt obligations. The Company has no current
agreements with TLLP to fund cash obligations nor does it have any current plans
to declare dividends in order to allow TLLP to meet the debt obligations. TLLP’s
management has represented to the Company that it is working to refinance this
debt to allow additional time for the value of its Teletouch common stock to
appreciate in order for it to be able to sell a sufficient number of shares to
repay its debt obligations. If TLLP is unsuccessful in repaying its obligations
and its lenders foreclose on Teletouch’s common stock owned by TLLP and become
the majority shareholders of Teletouch, then there is a risk that these lenders
could vote through matters that may not be in the best interest of the
shareholders of Teletouch as a whole.





Item
2.     Unregistered Sales of Equity Securities and Use
of Proceeds





None





Item
3.     Defaults Upon Senior Securities





None





Item
4.     Removed and Reserved





Item
5.     Other Information





None





Item
6.     Exhibits





ExhibitNumber
              
              Title of Exhibit31.1
              
              Certification
      pursuant to Rule 13a-14(a) and Rule 15d-14(a)31.2
              
              Certification
      pursuant to Rule 13a-14(a) and Rule 15d-14(a)32.1
              
              Certification
      pursuant to 1350, Chapter 63, Title 18 of United States
    Code32.2
              
              Certification
      pursuant to 1350, Chapter 63, Title 18 of United States
    Code




50





SIGNATURES





Pursuant
to the requirements of the Securities Exchange Act of 1934, the registrant has
duly caused this Report to be signed on its behalf by the undersigned thereunto
duly authorized.





Date:
      October 14, 2010
              TELETOUCH
      COMMUNICATIONS, INC.RegistrantBy:
              /s/
      Robert M. McMurreyRobert
      M. McMurrey
                Chief
      Executive Officer(Principal
      Executive Officer)By:
              /s/
      Douglas E. SloanDouglas
      E. Sloan
                Chief
      Financial Officer
                (Principal
      Financial and Accounting
Officer)




51