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 February 29, 2008





OR





o 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   ̈ 
No  x





Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, 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, 49,051,980 shares at April 14, 2008.








TELETOUCH
COMMUNICATIONS, INC.





TABLE OF
CONTENTS





Page No.Part
      I.  Financial InformationItem
      1.
                                                            Financial
      Statements - Teletouch Communications, Inc .
                                                            4Consolidated
      Balance Sheets as of February 29, 2008 (unaudited)and May 31, 2007
      (unaudited)
                                                            4Consolidated
      Statements of Operations – Three and Nine Months Ended February 29, 2008
      (unaudited) and February 28, 2007 (unaudited)
                                                            6Consolidated
      Statements of Cash Flows - Three and Nine Months Ended February 29, 2008
      (unaudited) and February 28, 2007 (unaudited)
                                                            7Notes
      to Consolidated Financial Statements (unaudited)
                                                            8Item
      2.
                                                            Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations
                                                            34Item
      3.
                                                            Quantitative
      and Qualitative Disclosures About Market Risk
                                                            54Item
      4.
                                                            Controls
      and Procedures
                                                            54Part
      II.  Other InformationItem
      1.
                                                            Legal
      Proceedings
                                                            57Item
      1A.
                                                            Risk
      Factors
                                                            57Item
      2.
                                                            Unregistered
      Sales of Equity Securities and Use of Proceeds
                                                            63Item
      3.
                                                            Defaults
      Upon Senior Securities
                                                            63Item
      4.
                                                            Submission
      of Matters to a Vote of Security Holders
                                                            63Item
      5.
                                                            Other
      Information
                                                            63Item
      6.
                                                            Exhibits
                                                            64Signatures
                                                            65




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 captions “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 under “Risk
Factors”.


3





PART
1 – FINANCIAL INFORMATION





Item
1.   Financial Statements





TELETOUCH
COMMUNICATIONS, INC.


CONSOLIDATED
BALANCE SHEETS


(unaudited)


(in
thousands, except share data)




ASSETS





February 29,
                      
                      
                      May
      31,2008
                      
                      
                      2007CURRENT
      ASSETS:Cash
                      
                      $
                      2,740
                      
                      
                      $
                      7,824Certificates
      of deposit-restricted
                      
                      
                      424
                      
                      
                      
                      411Accounts
      receivable, net of allowance of $626 at February 29, 2008 and $527 at May
      31, 2007
                      
                      
                      7,872
                      
                      
                      
                      7,127Accounts
      receivable-related party
                      
                      
                      250
                      
                      
                      
                      250Unbilled
      accounts receivable
                      
                      
                      3,167
                      
                      
                      
                      3,144Inventories,
      net of reserve of $223 at February 29, 2008 and $518 at May 31,
      2007
                      
                      
                      2,305
                      
                      
                      
                      2,858Prepaid
      expenses and other current assets
                      
                      
                      877
                      
                      
                      
                      826Total
      Current Assets
                      
                      
                      17,635
                      
                      
                      
                      22,440PROPERTY,
      PLANT AND EQUIPMENT, net of accumulated depreciationof $7,200 at
      February 29, 2008 and $6,807 at May 31, 2007
                      
                      
                      3,294
                      
                      
                      
                      3,621GOODWILL
                      
                      
                      343
                      
                      
                      
                      343INTANGIBLE
      ASSETS, net of accumulated amortizationof $6,955 at February 29, 2008
      and $6,291 at May 31, 2007
                      
                      
                      5,259
                      
                      
                      
                      5,898TOTAL
      ASSETS
                      
                      $
                      26,531
                      
                      
                      $
                      32,302





See
Accompanying Notes to Consolidated Financial Statements


4





TELETOUCH
COMMUNICATIONS, INC.


CONSOLIDATED
BALANCE SHEETS


(unaudited)


(in
thousands, except share data)




LIABILITIES
AND SHAREHOLDERS’ DEFICIT





February 29,
                      
                      
                      May
      31,2008
                      
                      
                      2007CURRENT
      LIABILITIES:Accounts
      payable
                      
                      $
                      9,664
                      
                      
                      $
                      15,208Accounts
      payable-related party
                      
                      
                      63
                      
                      
                      
                      63Accrued
      expenses and other current liabilities
                      
                      
                      6,900
                      
                      
                      
                      9,387Current
      portion of long-term debt
                      
                      
                      20,337
                      
                      
                      
                      18,358Deferred
      revenue
                      
                      
                      431
                      
                      
                      
                      453Current
      portion of redeemable common stock purchase warrants
                      
                      
                      3,000
                      
                      
                      
                      3,000Total
      Current Liabilities
                      
                      
                      40,395
                      
                      
                      
                      46,469LONG-TERM
      DEBT, net of current portion
                      
                      
                      3,151
                      
                      
                      
                      3,220TOTAL
      LIABILITIES
                      
                      
                      43,546
                      
                      
                      
                      49,689COMMITMENTS
      AND CONTINGENCIES
                      
                      
                      -
                      
                      
                      
                      -SHAREHOLDERS'
      DEFICIT:Common
      stock, $.001 par value, 70,000,000 shares authorized, 49,916,189 and
      49,416,189 shares issued and 49,051,980 and 48,551,980 shares outstanding
      at February 29, 2008 and May 31, 2007
                      
                      
                      50
                      
                      
                      
                      49Additional
      paid-in capital
                      
                      
                      39,163
                      
                      
                      
                      39,015Treasury
      stock, 864,209 shares held at February 29, 2008 and May 31,
      2007
                      
                      
                      (185
                      )
                      
                      
                      (185
                      )Accumulated
      deficit
                      
                      
                      (56,043
                      )
                      
                      
                      (56,266
                      )Total
      Shareholders' Deficit
                      
                      
                      (17,015
                      )
                      
                      
                      (17,387
                      )TOTAL
      LIABILITIES AND SHAREHOLDERS' DEFICIT
                      
                      $
                      26,531
                      
                      
                      $
                      32,302





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
                    Ended
                  
                  
                  Three Months
                    Ended
                  
                  
                  Nine Months
                    Ended
                  
                  
                  Nine Months
                    EndedFebruary 29,
                  
                  
                  February 28,
                  
                  
                  February 29,
                  
                  
                  February 28,2008
                  
                  
                  2007
                  
                  
                  2008
                  
                  
                  2007Operating
      revenues:Service,
      rent, and maintenance revenue
                  
                  $
                  7,253
                  
                  
                  $
                  6,632
                  
                  
                  $
                  21,994
                  
                  
                  $
                  20,439Product
      sales revenue
                  
                  
                  6,116
                  
                  
                  
                  6,931
                  
                  
                  
                  19,475
                  
                  
                  
                  21,265Total
      operating revenues
                  
                  
                  13,369
                  
                  
                  
                  13,563
                  
                  
                  
                  41,469
                  
                  
                  
                  41,704Operating
      expenses:Cost
      of service, rent and maintenance (exclusive of depreciation and
      amortization included below)
                  
                  
                  2,495
                  
                  
                  
                  3,075
                  
                  
                  
                  8,213
                  
                  
                  
                  9,901Cost
      of products sold
                  
                  
                  5,520
                  
                  
                  
                  6,173
                  
                  
                  
                  17,235
                  
                  
                  
                  18,429Selling
      and general and administrative
                  
                  
                  4,696
                  
                  
                  
                  5,117
                  
                  
                  
                  15,280
                  
                  
                  
                  15,309Depreciation
      and amortization
                  
                  
                  367
                  
                  
                  
                  451
                  
                  
                  
                  1,170
                  
                  
                  
                  1,420Gain
      on forgiveness of trade payable obligation to AT&T
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  (3,824
                  )
                  
                  
                  -Loss
      (gain) on disposal of assets
                  
                  
                  (17
                  )
                  
                  
                  1
                  
                  
                  
                  (34
                  )
                  
                  
                  15Total
      operating expenses
                  
                  
                  13,061
                  
                  
                  
                  14,817
                  
                  
                  
                  38,040
                  
                  
                  
                  45,074Operating
      income (loss) from continuing operations
                  
                  
                  308
                  
                  
                  
                  (1,254
                  )
                  
                  
                  3,429
                  
                  
                  
                  (3,370
                  )Interest
      expense, net
                  
                  
                  (1,014
                  )
                  
                  
                  (720
                  )
                  
                  
                  (3,027
                  )
                  
                  
                  (2,726
                  )Income
      (loss) from continuing operations before income tax
expense
                  
                  
                  (706
                  )
                  
                  
                  (1,974
                  )
                  
                  
                  402
                  
                  
                  
                  (6,096
                  )Income
      tax expense
                  
                  
                  60
                  
                  
                  
                  62
                  
                  
                  
                  179
                  
                  
                  
                  88Net
      income (loss) from continuing operations
                  
                  
                  (766
                  )
                  
                  
                  (2,036
                  )
                  
                  
                  223
                  
                  
                  
                  (6,184
                  )Gain
      on sale of assets related to discontinued paging
operations
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  163Income
      from discontinued paging operations
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  449Loss
      on sale of assets related to discontinued security monitoring
      operations
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  (78
                  )Net
      income from discontinued operations
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  534Net
      income (loss)
                  
                  
                  (766
                  )
                  
                  
                  (2,036
                  )
                  
                  
                  223
                  
                  
                  
                  (5,650
                  )Participation
      rights of common stock purchase warrants in undistributed
      earnings
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  (24
                  )
                  
                  
                  -Net
      income (loss) applicable to common shareholders
                  
                  $
                  (766
                  )
                  
                  $
                  (2,036
                  )
                  
                  $
                  199
                  
                  
                  $
                  (5,650
                  )Basic
      income (loss) per share applicable to common shareholders:Continuing
      operations
                  
                  $
                  (0.02
                  )
                  
                  $
                  (0.04
                  )
                  
                  $
                  0.00
                  
                  
                  $
                  (0.13
                  )Discontinued
      operations
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  0.01Total
                  
                  $
                  (0.02
                  )
                  
                  $
                  (0.04
                  )
                  
                  $
                  0.00
                  
                  
                  $
                  (0.12
                  )Diluted
      income (loss) per share applicable to common shareholders:Continuing
      operations
                  
                  $
                  (0.02
                  )
                  
                  $
                  (0.04
                  )
                  
                  $
                  0.00
                  
                  
                  $
                  (0.13
                  )Discontinued
      operations
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  0.01Total
                  
                  $
                  (0.02
                  )
                  
                  $
                  (0.04
                  )
                  
                  $
                  0.00
                  
                  
                  $
                  (0.12
                  )Weighted
      average shares outstanding:Basic
                  
                  
                  49,051,980
                  
                  
                  
                  48,575,206
                  
                  
                  
                  48,810,954
                  
                  
                  
                  48,622,941Diluted
                  
                  
                  49,051,980
                  
                  
                  
                  48,575,206
                  
                  
                  
                  54,961,483
                  
                  
                  
                  48,622,941





See
Accompanying Notes to Consolidated Financial Statements


6





TELETOUCH
COMMUNICATIONS, INC.


CONSOLIDATED
STATEMENTS OF CASH FLOWS


(in
thousands)


(unaudited)





Nine Months Ended
                  
                  
                  Nine Months EndedFebruary 29,
                  
                  
                  February 28,2008
                  
                  
                  2007Operating
      Activities:Net
      income (loss)
                  
                  $
                  223
                  
                  
                  $
                  (5,650
                  )Adjustments
      to reconcile net income (loss) to net cash provided by (used in)
      operating activities:Depreciation
      and amortization
                  
                  
                  1,170
                  
                  
                  
                  1,614Non-cash
      compensation expense
                  
                  
                  88
                  
                  
                  
                  40Non-cash
      interest expense
                  
                  
                  1,281
                  
                  
                  
                  1,583Non-cash
      gain on forgiveness of a trade payable obligation to
    AT&T
                  
                  
                  (3,824
                  )
                  
                  
                  -Provision
      for losses on accounts receivable
                  
                  
                  787
                  
                  
                  
                  330Provision
      for inventory obsolescence
                  
                  
                  25
                  
                  
                  
                  323Gain
      on disposal of assets
                  
                  
                  (34
                  )
                  
                  
                  (108
                  )Amortization
      of unearned sale/leaseback profit
                  
                  
                  -
                  
                  
                  
                  (71
                  )Changes
      in operating assets and liabilities, net of acquisitions:Accounts
      receivable
                  
                  
                  (1,535
                  )
                  
                  
                  (281
                  )Inventories
                  
                  
                  529
                  
                  
                  
                  (123
                  )Prepaid
      expenses and other assets
                  
                  
                  (51
                  )
                  
                  
                  (209
                  )Accounts
      payable
                  
                  
                  (5,544
                  )
                  
                  
                  6,041Accrued
      expenses and other current liabilities
                  
                  
                  1,318
                  
                  
                  
                  1,192Deferred
      revenue
                  
                  
                  (16
                  )
                  
                  
                  270Net
      cash provided by (used in) operating activities
                  
                  
                  (5,583
                  )
                  
                  
                  4,951Investing
      Activities:Purchases
      of property and equipment
                  
                  
                  (188
                  )
                  
                  
                  (262
                  )Redemption
      of certificates of deposit
                  
                  
                  -
                  
                  
                  
                  310Proceeds
      from sale of paging operations
                  
                  
                  -
                  
                  
                  
                  3,083Net
      proceeds from sale of assets
                  
                  
                  16
                  
                  
                  
                  14Net
      cash provided by (used in) investing activities
                  
                  
                  (172
                  )
                  
                  
                  3,145Financing
      Activities:Deferred
      financing costs
                  
                  
                  (24
                  )
                  
                  
                  (40
                  )Distribution
      to related entity
                  
                  
                  -
                  
                  
                  
                  (150
                  )Net
      proceeds from borrowings
                  
                  
                  798
                  
                  
                  
                  4,572Payments
      on short-term debt
                  
                  
                  (82
                  )
                  
                  
                  -Payments
      on long-term debt
                  
                  
                  (81
                  )
                  
                  
                  (11,140
                  )Proceeds
      from stock issuance
                  
                  
                  60
                  
                  
                  
                  -Net
      cash provided by (used in) financing activities
                  
                  
                  671
                  
                  
                  
                  (6,758
                  )Net
      increase (decrease) in cash
                  
                  
                  (5,084
                  )
                  
                  
                  1,338Cash
      at beginning of period
                  
                  
                  7,824
                  
                  
                  
                  2,604Cash
      at end of period
                  
                  $
                  2,740
                  
                  
                  $
                  3,942Supplemental
      Cash Flow Data:Cash
      payments for interest
                  
                  $
                  1,748
                  
                  
                  $
                  1,195Non-Cash
      Transactions:Payment
      of debt through capital contribution
                  
                  $
                  -
                  
                  
                  $
                  9,782





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:During the fiscal year ended May 31, 2007,
Teletouch Communications, Inc., a Delaware corporation, (“Teletouch” or the
“Company”) finalized two significant transactions. On August 11, 2006, the
Company completed the acquisition of Progressive Concepts, Inc., a Texas
corporation (“PCI”) and on August 14, 2006, the Company finalized the sale
of its paging business. This discussion on the business of Teletouch should be
read considering the discussion below under “Principles of Consolidation,” which
discusses the accounting treatment for the acquisition of PCI and in Note 3 -
“Acquisition of Progressive Concepts, Inc.,” which discusses the terms of the
acquisition of PCI and Note 4 - “Discontinued Paging Operations,” which
discusses the sale of all of the assets and operations related to its paging
business.




Teletouch
Communications, Inc. was incorporated under the laws of the State of Delaware in
July 1994 and in 2006 relocated its corporate headquarters from Tyler, Texas to
Fort Worth, Texas in conjunction with the acquisition of PCI. References to
Teletouch or the Company as used throughout this document means Teletouch
Communications, Inc. or Teletouch Communications, Inc. and its subsidiaries, as
the context requires.




Teletouch
has been a provider of telecommunications services for over 40 years, providing
two-way radio services in Texas, GPS-telemetry and public safety/emergency
response vehicle products and services throughout the U.S. Until the sale of its
paging business in August 2006, it also provided paging services in non-major
metropolitan areas and communities in the Southeast United States. The Company
provided paging services in Alabama, Arkansas, Florida, Georgia, Louisiana,
Mississippi, Missouri, Oklahoma, Texas and Tennessee. Late in 2007, Teletouch
began selling safety/emergency response vehicle products and services business
under the brand Teletouch EVP (emergency vehicle products). The EVP business is
complementary offering to the Company’s existing two-way radio
business.




Following
the sale of the paging business and the acquisition of PCI in August 2006,
Teletouch’s core-business has been acquiring, billing and supporting cellular
subscribers under a recurring revenue relationship with AT&T Wireless,
formerly Cingular Wireless (“AT&T”). The original distribution agreement
between PCI and AT&T had been in place for more than 20 years. Teletouch,
through its subsidiary, PCI, is a provider of 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. The Company operates a chain of retail stores and sells under the
“Hawk Electronics” brand, through Hawk-branded sub-agents and its own direct
sales force and through the Internet at various sites. As a master distributor
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. Also
acquired as part of the PCI acquisition, Teletouch now operates a national
wholesale distribution business, known as PCI Wholesale that serves smaller
cellular and automotive retailers, car dealers and rural cellular carriers
throughout the country.





Delinquent Financial
Reporting: Following the acquisition of PCI in August 2006, the Company
had significant difficulty completing the required stand alone audits of PCI
which resulted in significant delays in completing the consolidated audits of
Teletouch and preparing the required filings with the Securities and Exchange
Commission (“SEC”) since the acquisition of PCI was accounted for in a manner
similar to a pooling of interests.


8





The
Company completed a conversion of PCI’s accounting system to a new platform,
which included the rebuilding of PCI’s internal accounting records from 2001 and
all periods thereafter.  PCI had historically completed annual audits
of it financial statement but did not prepare quarterly financial
statements.  Because of the significant delays encountered in
compiling the PCI records, the Company chose to focus first on compiling the
financial records necessary to complete Teletouch’s delinquent Annual Report on
Form 10-K for the years ended May 31, 2007 and 2008.  These reports
were filed on November 25, 2008 and January 16, 2009, respectively, and prior to
the completion of any of the required Quarterly Reports on Form 10-Q for these
periods.





Since the
Annual Reports for both fiscal years ending May 31, 2007 and 2008 were filed
prior to the filing of the Quarterly Report on Form 10-Q for the quarter ended
February 29, 2008, the Company believes this Report should be read in
conjunction with all filings covering periods subsequent to and including this
quarter.





Further,
the Company prepared this Quarterly Report on Form 10-Q for its quarter ended
February 29, 2008 as if this Report had been completed and filed within the
statutory timeframe allowed.  Under the SEC’s rules, this Report would
have been due to be filed by April 14, 2008.  Therefore, certain
transactions which were completed following April 14, 2008 are only disclosed in
the subsequent, but already filed, financial reports of the
Company.





Principles of Consolidation:
The accompanying unaudited interim consolidated financial statements included
herein as of February 29, 2008 and for each of the three and nine months ended
February 29, 2008 and February 28, 2007, have been prepared by the Company
without an audit, pursuant to accounting principles generally accepted in the
United States and in accordance with the rules and regulations of the SEC. The
interim condensed 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., 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 and was acquired in August 2006 (see
Note 3 “Acquisition of Progressive Concepts, Inc.” for additional information).
TLI is a company formed for the express purpose of owning all of the FCC
licenses utilized by Teletouch in its two-way network as well as those paging
licenses that were sold in conjunction with paging business in August 2006.
Visao Systems, Inc. is a company formed to develop and distribute the Company’s
telemetry products. TLL Georgia, Inc. was formed for the express purpose of
entering into an asset purchase agreement with Preferred Networks, Inc. in May
2004. All significant intercompany accounts and transactions have been
eliminated in consolidation. In the opinion of management, all adjustments
(consisting of normal recurring adjustments) necessary for a fair statement of
financial position, results of operations and cash flows for the interim periods
presented have been made.  The results of operations for the three and
nine months ended February 29, 2008, are not necessarily indicative of the
results which will be realized for the year ending May 31, 2008.




The
acquisition of PCI was completed on August 11, 2006 through the
contribution of the stock of PCI to Teletouch by TLL Partners, LLC, a Delaware
LLC (“TLLP”). This transaction was considered a reorganization of entities under
common control since both PCI and Teletouch were under the common control of
TLLP prior to the reorganization. Prior to the reorganization, TLLP controlled
100% of the outstanding common stock of PCI, and approximately 80% of the
outstanding common stock of Teletouch. In accordance with the accounting
guidance under Emerging Issues Task Force Issue No. 90-5, “Exchanges of
Ownership Interests Between Entities Under Common Control” and Appendix D of
Statement of Financial Accounting Standards No. 141, “Business
Combinations,” the PCI contribution is accounted for in a manner similar to a
pooling of interests which means that the historical basis of the net assets of
PCI are combined with those of Teletouch. As a result of this reorganization and
because PCI is consolidated with Teletouch, PCI’s year end was changed from a
calendar year ending December 31 to a fiscal year ending May 31 for
financial reporting purposes.


9





Some
information and footnote disclosures normally included in financial statements
or notes thereto prepared in accordance with generally accepted accounting
principles have been condensed or omitted pursuant to such SEC rules and
regulations. We believe, however, that our disclosures are adequate to make the
information presented not misleading. These interim consolidated financial
statements should be read in conjunction with the consolidated financial
statements and notes thereto included in Teletouch’s 2007 Annual Report on Form
10-K.




Financial Condition and Going
Concern:  The Company had a working capital deficit of
approximately $22,760,000 and $24,029,000 at February 29, 2008 and May 31, 2007,
respectively, and a shareholders’ deficit of approximately $17,015,000 and
$17,387,000 at February 29, 2008 and May 31, 2007, respectively.  The
Company’s senior debt (the “Senior Debt”) payable to Fortress totaled
approximately $11,154,000 and $9,878,000 at February 29, 2008 and May 31,
2007, respectively. The Senior Debt was due and payable in full on
April 14, 2006. In September 2005, the Company executed amendments with its
senior and subordinated debt holders under, which they agreed to waive the
existing events of default and defer interest payments on the subordinated debt
until after the maturity of the Senior Debt on April 14, 2006. In August
2006, prior to the acquisition by Teletouch, PCI was successful in negotiating a
restructuring of its debt obligations with both its senior and subordinated
lenders under which it was fully released from the balance of $9,782,000 in
subordinated debt which was converted to redeemable equity at Teletouch’s parent
company, TLL Partners, LLC (“TLLP”). TLLP also assumed the full balance
remaining on PCI’s senior debt obligations (after a $10,000,000 cash payment to
the lender by the PCI) and PCI was conditionally released from having any future
payment obligations under the Senior Debt and all liens on the assets of PCI
were conditionally released as long as certain terms of a Transaction Party
Agreement (“TPA”) by and among PCI, Teletouch, TLLP and the senior lender,
Fortress Credit Corp. (“Fortress”) were not violated (see Note 3 “Acquisition of
Progressive Concepts, Inc.” for further information on the Company’s debt
restructuring). The TPA provided Fortress with certain control over the ongoing
operations of Teletouch and PCI as well as provided for the contingent
re-instatement of the liens on PCI assets if certain conditions were not
maintained by either Teletouch or PCI. A TPA was required by Fortress in order
to assure that PCI or Teletouch would not take actions which in Fortress’ view
could reduce the value of Fortress’ security. Under the terms of the TPA both
PCI and Teletouch are bound to comply with certain negative covenants. If either
PCI or Teletouch breaches the TPA or violates any of the negative covenants then
Fortress can reinstate the Senior Debt at PCI to the fullest extent available
under the law as if the debt restructuring had never occurred. PCI is
conditionally released from having any future payment obligations under the
Senior Debt as long as the terms of the TPA are not violated. However, in
accordance with Statement of Financial Accounting Standard No. 140,
“Accounting for the Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities” (“SFAS 140”), PCI must be legally released from
being the primary obligor under the Senior Debt in order to de-recognize this
liability. Because of the existence of the TPA which allows Fortress limited
control of PCI and Teletouch and a contingent ability to reinstate the debt at
PCI, we believe that PCI has not been fully released from being the primary
obligor under the Senior Debt as contemplated by SFAS 140 as of February 29,
2008. In addition, 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
nor does it have any current plans to declare dividends in order to allow TLLP
to meet the debt obligations. Therefore, PCI and Teletouch will continue to
report the senior debt obligation payable to Fortress as a liability on its
balance sheet until such time as the debt is fully satisfied by TLLP or when PCI
and Teletouch are released from the TPA.


10




Beginning
in June 2007, the Company has experienced higher than normal cellular subscriber
attrition due primarily to the launch of the iPhone. Although the iPhone is
offered to customers by AT&T, PCI has been denied the approval to sell or
activate the iPhone for customers by AT&T. The Company reviews its staffing
levels on a quarterly basis and continues to seek ways to consolidate and
automate necessary functions in order to control personnel and other operating
costs. In addition the Company is focused on seeking additional distribution for
existing products lines including an emphasis on internet marketing. There can
be no assurance the Company’s current efforts to increase revenues or continue
to reduce costs will be successful nor is there any assurance that the trade
credit that is currently extended to the Company will be maintained or expanded
for fiscal 2008 to facilitate this growth. The Company is continuing to seek
additional debt and equity financing to ensure it is able to meet its remaining
trade and debt obligations as well as provide sufficient working capital to
continue and grow its operations. If it is unsuccessful in its efforts to secure
additional financing, the Company may be unable to meet its obligations and
might be forced to seek protection from its creditors.





In
addition the Company’s factoring debt obligation with Thermo has been presented
as a current liability on the Company’s consolidated balance sheet at
February 29, 2008 and May 31, 2007, in accordance with EITF 95-22, because
the factoring agreement requires a lockbox agreement under which customer
payments on accounts are directed to a lockbox controlled by Thermo and because
certain subjective acceleration rights are retained by Thermo under the
agreement. However, the stated maturity date of the obligation is February 2010.
The factoring debt obligations at February 29, 2008 and May 31, 2007, were
approximately $9,079,000 and $8,352,000, respectively.





As a
result of the above conditions, there exists substantial doubt about the
Company’s ability to continue as a going concern.  No adjustments have
been made to the Company’s financial statements as a result of this
uncertainty.





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 February 29, 2008 and May 31, 2007, the Company had $424,000
and $411,000 respectively, of cash certificates of deposit securing two standby
letters of credit with its suppliers.





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.


11





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.





Accounts
receivable are presented net of an allowance for doubtful accounts of $626,000
and $527,000 at February 29, 2008 and May 31, 2007,
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.





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 has
received from the vendor. 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 distribution
channel, 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.
Inventories are stated on the Company’s consolidated balance sheet net of a
reserve for obsolescence of $223,000 and $518,000 at February 29, 2008 and May
31, 2007, respectively. Actual results could differ from those
estimates.





Property, Plant and
Equipment:  Property and equipment is recorded at cost.
Depreciation is computed using the straight-line method. Expenditures for major
renewals and betterments that extend the useful lives of property and equipment
are capitalized. Expenditures for maintenance and repairs are charged to expense
as incurred. Upon the sale or abandonment of an asset, the cost and related
accumulated depreciation are removed from the Company’s balance sheet, and any
gains or losses on those assets are reflected in the accompanying consolidated
statement of operations of the respective period. The straight-line method
estimated useful lives are as follows:





Buildings
      and improvements
                
                5-30
      yearsTwo-way
      infrastructure
                
                5-15
      yearsSigns
      and displays
                
                5-10
      yearsOther
      equipment
                
                3-5
      yearsLeasehold
      improvements
                
                Shorter
      of estimated usefullife
      or term of lease





Intangible
Assets:Intangible assets are comprised of certain definite
lived assets as well as a single indefinite lived asset which is
goodwill.  Indefinite lived intangible assets are not amortized but
evaluated annually (or more frequently) for impairment under Statement of
Financial Accounting Standards (“SFAS”) No. 142, “Goodwill and Other Intangible
Assets” (“SFAS 142”).   Definite lived intangible assets,
including capitalized loan origination costs, wireless contract acquisition
costs 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 SFAS 144, “Accounting for the Impairment or Disposal of
Long-Lived Assets” (“SFAS 144”).


12





Indefinite
Lived Intangible Assets: The Company only has one category of indefinite
lived intangible asset, which is 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 tested for impairment at least annually in accordance with the
provisions of SFAS 142.  The SFAS 142 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.  Under the guidance of SFAS 142, companies are required to
test for impairment of intangible assets with indefinite lives at least
annually.  Teletouch’s only intangible asset with an indefinite life
is goodwill, which was initially recorded 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.





Definite
Lived Intangible Assets:Definite lived
intangible assets consist of the capitalized costs 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 life.  The estimated useful lives for the
intangible assets are as follows:





AT&T
      distribution agreements and subscriber bases
                1-13 yearsFCC
      licenses
                9
      yearsNon-compete
      agreements
                5
      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





The
distribution agreements intangible assets represent certain contracts that the
Company has with its cellular carrier, AT&T, under which the Company is
allowed to provide cellular services to its customers. Although the Company has
sustained losses over the past several 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 (Dallas/Fort Worth market) is a buy-back/penalty provision, which
quantifies a value of the subscriber base as if AT&T were to terminate the
contracts with the Company and buy back the subscribers from
PCI.  Under the terms of the Dallas/Fort Worth market distribution
agreement with AT&T, following the expiration of the initial term of the
agreement in August 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 can buy-back the subscribers from the Company for $1,000 per
subscriber line. This buy-back value contained in the contract significantly
exceeds the carrying value of the asset at all periods presented herein.
Additionally, in August 2007 the Company obtained an independent valuation of
the customer base, which also exceeds the carrying value of this asset at all
periods presented herein.




13





Amortization
of the distribution agreements, subscriber bases, FCC licenses and internally
developed software is considered 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
Assets: In accordance with SFAS 144, 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
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 stable
to slightly 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 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 and in each
instance the appraised value continues to exceed the carrying value of the
property.





Provision for Income Taxes:The Company accounts for income taxes in accordance with SFAS No. 109,
“Accounting for Income Taxes,”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 February 29, 2008 and May 31, 2007, the Company
has recorded a valuation allowance against the full amount of its net deferred
tax assets since it does not forecast taxable income for fiscal year 2008, nor
is the Company able to reasonably forecast taxable income beyond next
year.  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.





The
Company adopted the provisions of Financial Standards Accounting Board
Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (“FIN 48”)
an interpretation SFAS No. 109, on June 1, 2007.  No material
adjustment in the liability for unrecognized income tax benefits was recognized
as a result of the adoption of FIN 48.  At February 29, 2008 and May
31, 2007 the Company’s unrecognized income tax benefits, primarily the result of
loss carryforwards, had a full valuation allowance recorded against
them.




14





On
November 1, 2005, the Company became a member of the consolidated tax group of
PCCI as a result of PCCI 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 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 of Teletouch for federal tax purposes
was deemed to be PCCI.   The Company continued to account for its
taxes under SFAS 109 and record its deferred taxes on a stand-alone basis while
part of PCCI’s consolidated tax group.  In August 2006, as a result of
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 and through the date of this
report, TLLP is taxed as a partnership and the Company is again separately
liable for its federal income taxes.





Discontinued Operations:
Assets and liabilities expected to be sold or disposed of are presented
separately on the consolidated balance sheets as assets or liabilities held for
sale. When components of the Company are classified as held for sale, the
results of operations of the components are presented separately as income
(loss) from discontinued operations, net, for current and prior periods. See
Note 4 “Discontinued Paging Operations” and Note 5 “Discontinued Security
Operations” in the notes to consolidated financial statements for further
discussion of our discontinued operations.





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” (“SAB 104”). SAB 104 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) collectibility 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 billing services and through
product sales.  Billing services include customer billings for
cellular airtime and other recurring services under a master distributor
agreement with AT&T.  Product sales include sales of cellular
telephones, accessories, and car and home audio products through the Company’s
retail and wholesale operations.





Revenues
and related costs generated through the Company’s billing services are
recognized during the period in which the service is
rendered.  Associated acquisition costs are expensed as
incurred.  For the Company’s product sales, revenue is recognized at
the time of shipment, the customer takes title and assumes risk of loss, terms
are fixed and determinable and collectibility 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
1987, the Company, through its subsidiary, PCI, has held agreements with
AT&T, which allowed PCI to offer cellular service and provide the billing
and customer services to AT&T 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 Emerging Issues Task Force Issue 99-19, “Reporting Revenue Gross
as a Principal versus Net as an Agent,” (“EITF 99-19”) associated with its
services attached to the AT&T agreements.  Based on its assessment
of the indicators listed in EITF 99-19, the Company has concluded that the
AT&T services provided by PCI should be reported on a net
basis.




15





Deferred
revenue represents prepaid monthly service fees paid by customers.





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 Dallas/Fort Worth and San
Antonio markets in Texas.  In addition, the Company sells cellular
equipment and consumer electronics products to 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 for nonpayment.





Financial
Instruments:  The Company’s financial instruments consists of
certificates of deposit-restricted, accounts receivable, accounts payable, debt
and redeemable common stock purchase warrants. 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.





Stock-based Compensation:At
February 29, 2008 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.





On June
1, 2006, the Company adopted the provisions of SFAS 123(R), “Share Based
Payment” (“SFAS 123(R)”) using the modified prospective transition method. 
SFAS 123(R) requires companies to measure and recognize the cost of employee
services received in exchange for awards of equity instruments based on the
grant date fair value of those awards. For share option instruments issued
subsequent to the adoption of SFAS 123(R), compensation cost is recognized
ratably using the straight-line method over the expected vesting period. For
equity options issued prior to the adoption of SFAS 123(R), compensation cost is
recognized using a graded vesting method. In addition, pursuant to SFAS 123(R),
the Company is required to estimate the amount of expected forfeitures when
calculating compensation costs instead of accounting for forfeitures as
incurred, which was the previous method. Prior periods are not restated under
this transition method. Options previously awarded and classified as equity
instruments continue to maintain their equity classification under SFAS
123(R).





SFAS No.
123(R) requires cash flows resulting from excess tax benefits to be 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 adopting SFAS 123(R) in the three and nine months ended
February 29, 2008 and February 28, 2007 because the Company provided for a
full valuation allowance against all accrued future tax benefits  for
both years until its operations improve and the Company is able to forecast
taxable income in the future sufficient to utilize its deferred tax
assets.




16





SFAS No.
123(R) requires the use of a valuation model to calculate the fair value of
stock-based awards. For the nine months ended February 29, 2008 and February 28,
2007, 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 nine months ended February 29, 2008 and February 28, 2007 was 140.8%
and 163.1%, respectively.  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 nine months ended
February 29, 2008 was 5.5 years and ranged from 5.5 years to 6.0 years for the
options issued in the nine months ended February 28, 2007. 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 nine months ended February
29, 2008 was 3.35% and ranged from 4.66% to 4.72% for the options issued in the
nine months ended February 28, 2007. 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.





Options
exercisable at February 29, 2008 and May 31, 2007 totaled 1,404,488 and
1,714,071, respectively.  The weighted-average exercise price per
share of options exercisable at February 29, 2008 and May 31, 2007 was $0.34 and
$0.35, respectively, with remaining weighted-average contractual terms of
approximately 7.3 years and 8.2 years, respectively.





At
February 29, 2008, the total remaining unrecognized compensation cost
related to unvested stock options amounted to approximately $131,000, which will
be amortized over the weighted-average remaining requisite service period of
1.10 years.





Income (loss) Per
Share:Basic income (loss) per share (“EPS”) is calculated by
dividing net income (loss) available to common shareholders 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 shares outstanding and potential shares
outstanding.  During 2002, the Company issued 6,000,000 redeemable
common stock purchase warrants, which remained outstanding through February 29,
2008.  These securities are considered to be “Participating
Securities” under SFAS No. 128, “Earnings Per Share”(“SFAS 128”) for diluted EPS
calculations.  The redeemable common stock purchase warrants are
considered Participating Securities because the common stock underlying these
securities participates in dividends (if declared) at the same rate as the
common shareholders. Because the Company reported net income for the nine months
ended February 29, 2008, a portion of the net income has been allocated to the
participating warrants as if dividends were declared leaving net income
applicable to common shareholders for the computation of basic
EPS.  Due to the factthere is no contractual
obligation for the security holders of the warrants to share in losses of the
Company, they have not been included in the basic loss per share calculations
for the quarter ended February 29, 2008 and February 28, 2007 and the nine
months ended February 28, 2007.





The
following table provides a reconciliation of the numerators and the denominators
used to calculate the basic and diluted income and loss per share as disclosed
in our Consolidated Statement of Operations for the three and nine months ended
February 29, 2008 and February 28, 2007 (in thousands per share
amounts):




17





Three Months Ended
                    
                    
                    Nine Months EndedFebruary
      29,
                    
                    
                    February
      28,
                    
                    
                    February
      29,
                    
                    
                    February
      28,2008
                    
                    
                    2007
                    
                    
                    2008
                    
                    
                    2007Numerator:Net
      income (loss)
                    
                    $
                    (766
                    )
                    
                    $
                    (2,036
                    )
                    
                    $
                    223
                    
                    
                    $
                    (5,650
                    )Participation
      rights of preferred stock in undistributed earnings (see percentage
      calculation below)
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    (24
                    )
                    
                    
                    -Numerator
      for basic net income (loss) per common share - income (loss) available to
      common shareholders under the two-class method
                    
                    $
                    (766
                    )
                    
                    $
                    (2,036
                    )
                    
                    $
                    199
                    
                    
                    $
                    (5,650
                    )Participation
      rights of preferred stock in undistributed earnings
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    24
                    
                    
                    
                    -Numerator
      for diluted net income (loss) per common share - income (loss) available
      to common shareholders under the two-class method
                    
                    $
                    (766
                    )
                    
                    $
                    (2,036
                    )
                    
                    $
                    223
                    
                    
                    $
                    (5,650
                    )Denominator:Denominator
      for basic net income (loss) per common share - weighted-average
      shares
                    
                    
                    49,052
                    
                    
                    
                    48,575
                    
                    
                    
                    48,811
                    
                    
                    
                    48,623Effect
      of dilution due to common stock purchase warrants
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    5,763
                    
                    
                    
                    -Subtotal
                    
                    
                    49,052
                    
                    
                    
                    48,575
                    
                    
                    
                    54,574
                    
                    
                    
                    48,623Percentage
      of undistributed earnings allocated to common stock purchase
      warrants
                    
                    
                    0.0
                    %
                    
                    
                    0.0
                    %
                    
                    
                    10.6
                    %
                    
                    
                    0.0
                    %Effect
      of dilution due to stock options
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    387
                    
                    
                    
                    -Denominator
      for diluted net income (loss) per common share - adjusted weighted-average
      shares
                    
                    
                    49,052
                    
                    
                    
                    48,575
                    
                    
                    
                    54,961
                    
                    
                    
                    48,623Basic
      income (loss) per share applicable to common shareholdersContinuing
      operations
                    
                    $
                    (0.02
                    )
                    
                    $
                    (0.04
                    )
                    
                    $
                    0.00
                    
                    
                    $
                    (0.13
                    )Discontinued
      operations
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    0.01Total
                    
                    $
                    (0.02
                    )
                    
                    $
                    (0.04
                    )
                    
                    $
                    0.00
                    
                    
                    $
                    (0.12
                    )Diluted
      income (loss) per share applicable to common shareholders:Continuing
      operations
                    
                    $
                    (0.02
                    )
                    
                    $
                    (0.04
                    )
                    
                    $
                    0.00
                    
                    
                    $
                    (0.13
                    )Discontinued
      operations
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    0.01Total
                    
                    $
                    (0.02
                    )
                    
                    $
                    (0.04
                    )
                    
                    $
                    0.00
                    
                    
                    $
                    (0.12
                    )





Recently
Issued Accounting Pronouncements





In
February 2007, FASB issued SFAS 159, “The Fair Value Option for Financial
Assets and Financial Liabilities. SFAS 159 expands the use of fair value
accounting but does not affect existing standards, which require assets or
liabilities to be carried at fair value. Under SFAS 159, a company may elect to
use fair value to measure financial instruments and certain other items, which
may reduce the need to apply complex hedge accounting provisions in order to
mitigate volatility in reported earnings. The fair value election is irrevocable
and is generally made on an instrument-by-instrument basis, even if a company
has similar instruments that it elects not to measure based on fair value. At
the adoption date, unrealized gains and losses on existing items for which fair
value has been elected are reported as a cumulative adjustment to beginning
retained earnings. Subsequent to the adoption of SFAS 159, changes in fair value
are recognized in earnings. The provisions of SFAS 159 are effective for the
Company on June 1, 2008. The Company does not expect the adoption of SFAS 159 to
have a material impact on its financial statements.





In
December 2007, the FASB issued SFAS 160, “Noncontrolling Interests in
Consolidated Financial Statements — An Amendment of ARB No. 51.” This
Statement amends ARB 51 to establish accounting and reporting standards for the
noncontrolling interest in a subsidiary and for the deconsolidation of a
subsidiary. It clarifies that a noncontrolling interest in a subsidiary is an
ownership interest in the consolidated entity that should be reported as equity
in the consolidated financial statements. The provisions of SFAS 160 are
effective for the Company on June 1, 2009. The Company does not expect the
adoption of SFAS 160 to have a material impact on its financial
statements.





In
December 2007, the FASB issued SFAS 141(R). This statement amends SFAS 141,
“Business Combinations,” and provides revised guidance for recognizing and
measuring identifiable assets and goodwill acquired, liabilities assumed, and
any noncontrolling interest in the acquiree. It also provides disclosure
requirements to enable users of the financial statements to evaluate the nature
and financial effects of the business combination. The provisions of SFAS 141(R)
are effective for the Company on June 1, 2009. The Company does not expect the
adoption of SFAS 141(R) to have a material impact on its financial
statements.




18





In
September 2006, FASB issued SFAS 157, “Fair Value Measurements” (“SFAS
157”). This Statement defines fair value and provides guidance for how to
measure fair value. SFAS 157 applies to assets and liabilities required or
permitted to be measured at fair value under other accounting pronouncements;
however, this statement does not provide guidance whether assets and liabilities
are required or permitted to be measured at fair value. The provisions of SFAS
157 are effective for the Company on June 1, 2008. The Company does not expect
the adoption of SFAS 157 to have a material impact on the Company’s financial
position, results of operations or cash flows.





In
July 2006, the FASB issued FASB Interpretation No. 48, “Accounting for
Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109,”
(“FIN 48”) which clarifies the accounting for uncertainty in tax positions. This
interpretation requires the recognition of a tax position when it is more likely
than not that the tax position will be sustained upon examination by relevant
taxing authorities, based on the technical merits of the position. The
provisions of FIN 48 went into effect for the Company on June 1, 2007. The
adoption of FIN 48 did not have a material impact on the Company’s financial
statements.





NOTE
3 – ACQUISITION OF PROGRESSIVE CONCEPTS, INC.





On
August 11, 2006, Teletouch became the owner of all of the issued and
outstanding equity securities of PCI, by virtue of the contribution of 100% of
the issued and outstanding equity securities of PCI to Teletouch by TLLP,
without the issuance of any monetary or stock consideration by Teletouch (the
“PCI Acquisition”). Teletouch and TLLP entered into a certain Contribution
Agreement (the “CA”). Prior to the CA, TLLP was the beneficial owner of 4,200
shares of common stock, $0.10 par value per share, of PCI, which represented
100% of PCI’s outstanding securities. Under the terms and provisions of the CA,
TLLP contributed and Teletouch accepted all such outstanding equity securities
of PCI. Upon the closing of the CA, PCI became a wholly-owned subsidiary of
Teletouch. Because of the common control of both Teletouch and PCI by TLLP
immediately prior to the transaction, the acquisition of PCI is accounted for in
a manner similar to a pooling of interests (See Note 1). As a result of the
pooling of interests accounting, all intercompany transactions were determined
to be insignificant; however they have been eliminated from all the periods
presented.





Immediately
preceding the PCI Acquisition, PCI and certain of its affiliates entered into a
debt restructuring, pursuant to which (i) PCI paid $10,000,000 of its
outstanding senior debt balance to Fortress Credit Corp. (the “Senior Debt”),
PCI’s senior lender (“Fortress”); (ii) PCI was conditionally released from
all of its remaining prior institutional debt, and its assets were conditionally
released from all related liens; (iii) PCI entered into a new accounts
receivable factoring and security facility (secured by its accounts receivable)
with Thermo Credit, LLC (“Thermo”) and (iv) certain prior debt obligations
of PCI were assumed by TLLP.





Concurrent
with the PCI Acquisition, PCI, Teletouch and Fortress entered into a Transaction
Party Agreement (“TPA”), which provided Fortress with certain control over the
ongoing operations of Teletouch and PCI as well as provided for the contingent
re-instatement of the liens on PCI assets if certain conditions were not
maintained by either Teletouch or PCI (see “Transaction Party Agreement”
discussion included in Note 10 “Long-Term Debt” for more information). A TPA was
required by Fortress in order to assure that PCI or Teletouch would not take
actions which in Fortress’ view could reduce the value of Fortress’ security.
Under the terms of the TPA both PCI and Teletouch are bound to comply with
certain negative covenants. If either PCI or Teletouch breaches the TPA or
violates any of the negative covenants then Fortress can reinstate the Senior
Debt at PCI to the fullest extent available under the law as if the debt
restructuring had never occurred. PCI is conditionally released from having any
future payment obligations under the Senior Debt as long as the terms of the TPA
are not violated. However, in accordance with SFAS 140, Accounting for the
Transfers and Servicing of Financial Assets and Extinguishments of Liabilities
PCI must be legally released from being the primary obligor under the Senior
Debt in order to de-recognize this liability. Because of the existence of the
TPA which allows Fortress limited control of PCI and Teletouch and a contingent
ability to reinstate the debt at PCI, we believe that PCI has not been fully
released from being the primary obligor under the Senior Debt as contemplated by
SFAS 140 as of February 29, 2008. In addition, 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 nor does it have any current plans to declare
dividends in order to allow TLLP to meet the debt obligations. Therefore, the
Company will continue to report the Senior Debt as a liability on its balance
sheet until such time as the debt is fully satisfied by TLLP or when PCI and
Teletouch are released from the TPA.




19




In order
raise sufficient cash to make the $10,000,000 payment to Fortress, PCI entered
into a new factoring facility with Thermo secured by PCI’s accounts receivable
which provides up to approximately $10,000,000 of available advances against
PCI’s accounts receivable. On August 11, 2006 approximately $6,200,000 was
advanced to PCI under the factoring facility, which was primarily used to make
the required payment to Fortress.




In
addition, prior to the acquisition of PCI by Teletouch, PCI’s previous
subordinated lenders, Stratford Capital Partners, L.P., a Delaware limited
partnership (“Stratford”), Retail & Restaurant Growth Capital, L.P., a
Delaware limited partnership (“RRGC”), agreed to exchange their approximately
$9,782,000 of debt in PCI into 4,350,000 shares of Teletouch Common Stock owned
by TLLP and a Preferred A Membership Interest by TLLP (see “Subordinated Debt”
discussion in Note 11 “Long-Term Debt” for more information). PCI accounted for
the assumption of the subordinated debt on its balance sheet as a contribution
of capital from its parent, TLLP.




As part
of the exchange transaction, Teletouch, Stratford and RRCG (Stratford and RRGC
collectively, the “Holders”) entered into a certain Registration Rights
Agreement (the “RRA”). In connection with this exchange, Teletouch agreed to
grant to the Holders certain registration rights under the federal securities
laws with respect to the securities received by the Holders pursuant to the
foregoing arrangement. Namely, the Holders were granted piggy-back registration
rights to participate in any underwritten offering and registration of
Teletouch’s equity securities under the Securities Act of 1933, as amended (the
“Securities Act”), including a shelf registration statement pursuant to Rule 415
under the Securities Act, through August 10, 2010. See additional
discussion under “Registration Rights Agreement” in Note 14 “Shareholders’
Equity.”





NOTE
4 – DISCONTINUED PAGING OPERATIONS





At the recommendation of
management, on August 19, 2005, the Board of Directors of the Company (the
“Board”) approved and authorized the Company’s management to enter into an Asset
Purchase Agreement (“APA”) with the Teletouch Paging, LP, a limited partnership,
wholly-owned by an unrelated, private Fort Worth, Texas investment group, (the
“Buyer”), to sell substantially all of the assets related to the paging
business. On August 22, 2005, the Company executed the APA with Teletouch
Paging, LP.





On
August 14, 2006, Teletouch completed the sale of its paging business
assets. Prior to closing the Company and the Buyer agreed to compute the EBITDA
of the paging business through July 31, 2006 and add to that amount any
subsequent collections on accounts receivable through the closing date to arrive
at the total reductions to the purchase price. Further, it was agreed that the
Company would have no obligation for expenses incurred related to the paging
business from August 1, 2006 through the closing date. The total cash
consideration of approximately $3,100,000 received by Teletouch at the closing
for the acquired assets included a $1,900,000 cash payment and a $1,200,000
prepayment of the promissory note resulting in a gain of $163,000 on the sale of
the paging business.




20





Summary
results for the paging business are reflected as discontinued operations in the
accompanying consolidated statements of operations for the nine months ended
February 29, 2008 and February 28, 2007 are as follows:





Three Months Ended
                
                
                Nine Months EndedFebruary 29,
                
                
                February 28,
                
                
                February 29,
                
                
                February 28,2008
                
                
                2007
                
                
                2008
                
                
                2007Gross
      revenue
                
                $
                -
                
                
                $
                -
                
                
                $
                -
                
                
                $
                2,230Income
      from discontinued paging operations
                
                $
                -
                
                
                $
                -
                
                
                $
                -
                
                
                $
                449Gain
      on sale of assets related to discontinued paging
operations
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                163Net
      income from discontinued paging operations
                
                $
                -
                
                
                $
                -
                
                
                $
                -
                
                
                $
                612





NOTE
5 – DISCONTINUED SECURITY MONITORING OPERATIONS





On
September 21, 2005, the Company sold substantially all of its security
monitoring operations. During the quarter ended November 30, 2007, the Company
recorded a post-closing adjustment on the sale of the assets of the security
monitoring operations which resulted in a $78,000 loss. Accordingly, the
operating results of the security monitoring business are reflected as
discontinued operations in our consolidated statements of operations for the
nine months ended February 28, 2007.





NOTE
6 – RELATIONSHIP WITH CELLULAR CARRIER





The
Company is party to 6 distribution agreements with AT&T Mobility, its
successors and assigns, 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. The distribution agreements permit the Company to offer AT&T cellular
phone service with identical pricing characteristics and provide billing
customer services to its customers on behalf of AT&T in exchange for certain
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’ additional features and products it
offers and retains all revenues 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 a set percentage
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 provides for two 5 year extensions
unless either party provides written notice to the other party at least 6 months
prior to the expiration of the initial term or the additional renewal term,
although certain billing services and other obligations continue for many years
after the initial term expires. Specifically, under the terms of its
distribution agreement with AT&T, the Company is allowed to continue to
service its existing subscriber base until these subscribers terminate service
with the Company. The initial term of the DFW Agreement will expire in August
2009. If the DFW Agreement is not extended beyond its natural expiration date,
the exclusivity requirements under this agreement will also terminate in August
2009. Since the launch of the iPhone in the first quarter of fiscal year 2008,
the Company has experienced higher subscriber attrition rates due to customers
wanting to acquire the iPhone. AT&T has prohibited the Company from selling
the iPhone or servicing any subscribers with an iPhone and has required any of
the Company’s customers desiring an iPhone to move their Company provided
service to AT&T’s billing services platform. The Company believes these
restrictions on the Company and the requirement to make the Company’s customers
change their billing services provider are in direct violation of its agreements
with AT&T, including specifically the bilateral non-solicitation provision
contained in such agreements which provides for a $1,000 per subscriber penalty
for these actions. The remaining distribution agreements with AT&T have
varying expiration dates through October 31, 2012. The Company reports its
revenues related to the AT&T services on a net basis in accordance with
Emerging Issues Task Force Issue 99-19, “Reporting Revenue Gross as a Principal
versus Net as an Agent” (“EITF 99-19”) as follows (in thousands):




21





Three Months Ended
                    
                    
                    Nine Months EndedFebruary 29,
                    
                    
                    February 28,
                    
                    
                    February 29,
                    
                    
                    February 28,2008
                    
                    
                    2007
                    
                    
                    2008
                    
                    
                    2007Gross
      service, rent and maintenance billings
                    
                    $
                    16,332
                    
                    
                    $
                    15,939
                    
                    
                    $
                    49,263
                    
                    
                    $
                    47,414Less:
      Direct costs paid to AT&T
                    
                    
                    (9,079
                    )
                    
                    
                    (9,307
                    )
                    
                    
                    (27,269
                    )
                    
                    
                    (26,975
                    )Net
      service, rent and maintenance revenue
                    
                    $
                    7,253
                    
                    
                    $
                    6,632
                    
                    
                    $
                    21,994
                    
                    
                    $
                    20,439





Gross
service, rent and maintenance 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.





Settlement
of Dispute with AT&T





On
June 1, 2007, the Company entered into a Compromise Settlement and Release
Agreement (the “Settlement”) with New Cingular Wireless PCS, LLC (successor in
interest to Southwestern Bell Wireless Inc.) as General Partner of the Houston
Cellular Telephone Company L.P., successor to Dallas SMSA Limited Partnership
(referred to as “AT&T”).





In its
claim, the Company had asserted that it had incurred damages in connection with
alleged actions of AT&T in connection with the Distribution Agreement
between both parties effective September 1, 1999, as amended by the
Amendment to Distribution Agreement effective November 12, 1999 (the “DFW
Agreement”). The Company’s claims related to the recovery of amounts previously
remitted and/or owed to AT&T with respect to intracompany roaming costs
and/or charges. These intracompany roaming charges were being assessed as the
Company’s customers were traveling outside their home calling area but still
remained in an area covered by cellular systems owned by AT&T. In connection
with the allegation, the Company had asserted claims with regard to
reimbursement of amounts previously remitted and disputed the amounts owed with
respect to such intracompany roaming costs and/or charges. In addition to the
claims related to intracompany roaming costs and/or charges, the Company had
asserted claims related to various other actions, including but not limited to
equipment and availability, rate plan disclosures, additional distribution, the
provisions of billing and usage information, claims related to the customers
billed by the Company, along with other dealings and transactions between both
parties and those arising out of and in connections with the DFW Agreement (the
“Dispute”). Also in the Settlement, AT&T denied liability with respect to
the Dispute.





As part
of the Settlement, both parties agreed to compromise and settle all disputes,
claims or causes of action of any kind asserted or which could have been
asserted regarding the Dispute, each without admitting any liability to the
other.





The
parties agreed to the following:




22





(1)
            Upon
      execution of the Settlement, both parties entered into a Second Amendment
      to the DistributionAgreement dated June 1, 2007 (the “Second
      Amendment”).


(2)
            As
      part of the terms of the Second Amendment, AT&T agreed to apply
      certain sections as identified in the Second Amendment that relate to
      amounts to be remitted to AT&T for intracompany roamer airtime
      retroactively back to November 1,
2005.


(3)
            The
      parties agreed that upon payment of approximately $4,661,000 by the
      Company to AT&T on or before June 8, 2007 to settle outstanding
      payables owed by the Company, net of what the Company had previously made
      deductions from remittances with respect to certain amounts previously
      remitted to AT&T, no further amount will be due by either party to the
      other with respect to such intracompany roaming costs or other charges for
      the period up to the effective date of the Settlement, except for payments
      due by the Company for April and May 2007 billing cycles, which were
      calculated and remitted in accordance with the Second
      Amendment.




As a
result, the Company recognized a gain of $3,824,000 in June 2007 associated with
the reversal of previously recognized accrued liabilities. The gain is recorded
separately as an offset to Operating Expenses and reported on the Company’s
Consolidated Statement of Operations as “Gain on forgiveness of trade payable
obligation to AT&T” in the Company’s consolidated statements of
operations.





The
Settlement also contained other provisions customary for agreements of this
nature.





NOTE
7 – INVENTORY





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





February 29, 2008
                
                
                May 31, 2007Cost
                
                
                Reserve
                
                
                Net Value
                
                
                Cost
                
                
                Reserve
                
                
                Net ValuePhones
      and related accessories
                
                $
                1,153
                
                
                $
                -
                
                
                $
                1,153
                
                
                $
                1,308
                
                
                $
                -
                
                
                $
                1,308Automotive
      products
                
                
                646
                
                
                
                -
                
                
                
                646
                
                
                
                1,389
                
                
                
                -
                
                
                
                1,389Satellite
      products
                
                
                33
                
                
                
                -
                
                
                
                33
                
                
                
                98
                
                
                
                -
                
                
                
                98Two-way
      products
                
                
                533
                
                
                
                -
                
                
                
                533
                
                
                
                352
                
                
                
                -
                
                
                
                352Other
                
                
                163
                
                
                
                (87
                )
                
                
                76
                
                
                
                229
                
                
                
                (111
                )
                
                
                118Total
      inventory and reserves
                
                $
                2,528
                
                
                $
                (87
                )
                
                $
                2,441
                
                
                $
                3,376
                
                
                $
                (111
                )
                
                $
                3,265General
      obsolescence reserve
                
                
                -
                
                
                
                (136
                )
                
                
                (136
                )
                
                
                -
                
                
                
                (407
                )
                
                
                (407
                )Total
      inventory and reserves
                
                $
                2,528
                
                
                $
                (223
                )
                
                $
                2,305
                
                
                $
                3,376
                
                
                $
                (518
                )
                
                $
                2,858





NOTE
8 – PROPERTY, PLANT AND EQUIPMENT





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





February 29, 2008
                  
                  
                  May 31, 2007Land
                  
                  $
                  774
                  
                  
                  $
                  774Buildings
      and leasehold improvements
                  
                  
                  3,227
                  
                  
                  
                  3,217Two-way
      network infrastructure
                  
                  
                  1,066
                  
                  
                  
                  3,321Office
      and computer equipment
                  
                  
                  3,286
                  
                  
                  
                  850Signs
      and displays
                  
                  
                  1,737
                  
                  
                  
                  1,826Other
                  
                  
                  404
                  
                  
                  
                  440$
                  10,494
                  
                  
                  $
                  10,428Accumulated
      depreciation
                  
                  
                  (7,200
                  )
                  
                  
                  (6,807
                  )$
                  3,294
                  
                  
                  $
                  3,621




23




Depreciation
expense was approximately $146,000 and $238,000 for the three months ended
February 29, 2008 and February 28, 2007, respectively and $507,000 and $773,000
for the nine months ended February 29, 2008 and February 28, 2007,
respectively.





Property,
plant and equipment are recorded at cost. Depreciation is computed using the
straight-line method. The following table contains the property, plant and
equipment by estimated useful life, net of accumulated depreciation as of
February 29, 2008 (in thousands):





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
                
                
                ValueLand
                
                $
                -
                
                
                $
                -
                
                
                $
                -
                
                
                $
                -
                
                
                $
                -
                
                
                $
                774
                
                
                $
                774Buildings
      and leasehold improvements
                
                
                146
                
                
                
                35
                
                
                
                193
                
                
                
                -
                
                
                
                7
                
                
                
                1,218
                
                
                
                1,599Two-way
      network infrastructure
                
                
                99
                
                
                
                16
                
                
                
                276
                
                
                
                3
                
                
                
                -
                
                
                
                -
                
                
                
                394Office
      and computer equipment
                
                
                123
                
                
                
                159
                
                
                
                3
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                285Signs
      and displays
                
                
                65
                
                
                
                65
                
                
                
                2
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                132Other
                
                
                77
                
                
                
                33
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                110$
                510
                
                
                $
                308
                
                
                $
                474
                
                
                $
                3
                
                
                $
                7
                
                
                $
                1,992
                
                
                $
                3,294




NOTE
9 – GOODWILL AND OTHER INTANGIBLE ASSETS





Intangible Assets with Indefinite
Lives: In accordance with SFAS No. 142,Goodwill and Other Intangible
Assets, the Company performs an annual impairment test of goodwill as
well as evaluates this goodwill for recoverability upon any significant change
in the business. There were no changes in the carrying amount of intangible
assets with indefinite lives for the three and nine months ended February 29,
2008.





The
reported goodwill of the Company at February 29, 2008 and May 31, 2007 relates
entirely to the two-way radio segment and was recorded in conjunction with the
acquisition of the assets of Delta Communications and Electronics, Inc. which
was completed in January 2004. The Company evaluates the recoverability of this
goodwill at least once annually on March 1st of each year. There have been no
changes in the two-way radio segment during the current quarter that would
indicate to the Company that the carrying value of its goodwill may have been
impaired during the period.





Intangible Assets with Definite
Lives:The following is a
summary of the Company’s intangible assets that are subject to amortization (in
thousands):





February 29, 2008
                                        
                                        
                                        May 31, 2007Gross
                                        
                                        
                                        
                                        
                                        
                                        Net
                                        
                                        
                                        Gross
                                        
                                        
                                        
                                        
                                        
                                        NetCarrying
                                        
                                        
                                        Accumulated
                                        
                                        
                                        Carrying
                                        
                                        
                                        Carrying
                                        
                                        
                                        Accumulated
                                        
                                        
                                        CarryingAmount
                                        
                                        
                                        Amortization
                                        
                                        
                                        Value
                                        
                                        
                                        Amount
                                        
                                        
                                        Amortization
                                        
                                        
                                        ValueAT&T
      distribution agreements and subscriber bases
                                        
                                        $
                                        10,258
                                        
                                        
                                        $
                                        (5,347
                                        )
                                        
                                        $
                                        4,911
                                        
                                        
                                        $
                                        10,257
                                        
                                        
                                        $
                                        (4,764
                                        )
                                        
                                        $
                                        5,493FCC
      licenses
                                        
                                        
                                        104
                                        
                                        
                                        
                                        (47
                                        )
                                        
                                        
                                        57
                                        
                                        
                                        
                                        104
                                        
                                        
                                        
                                        (39
                                        )
                                        
                                        
                                        65PCI
      marketing list
                                        
                                        
                                        1,235
                                        
                                        
                                        
                                        (1,235
                                        )
                                        
                                        
                                        -
                                        
                                        
                                        
                                        1,235
                                        
                                        
                                        
                                        (1,235
                                        )
                                        
                                        
                                        -Loan
      origination fees
                                        
                                        
                                        352
                                        
                                        
                                        
                                        (78
                                        )
                                        
                                        
                                        274
                                        
                                        
                                        
                                        328
                                        
                                        
                                        
                                        (20
                                        )
                                        
                                        
                                        308Non-compete
      agreements
                                        
                                        
                                        95
                                        
                                        
                                        
                                        (78
                                        )
                                        
                                        
                                        17
                                        
                                        
                                        
                                        95
                                        
                                        
                                        
                                        (63
                                        )
                                        
                                        
                                        32Internally-developed
      software
                                        
                                        
                                        170
                                        
                                        
                                        
                                        (170
                                        )
                                        
                                        
                                        -
                                        
                                        
                                        
                                        170
                                        
                                        
                                        
                                        (170
                                        )
                                        
                                        
                                        -Balance
      at February 29, 2008 and May 31, 2007
                                        
                                        $
                                        12,214
                                        
                                        
                                        $
                                        (6,955
                                        )
                                        
                                        $
                                        5,259
                                        
                                        
                                        $
                                        12,189
                                        
                                        
                                        $
                                        (6,291
                                        )
                                        
                                        $
                                        5,898





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





AT&T
      distribution agreements and subscriber bases
                    1-13 yearsFCC
      licenses
                    9 yearsLoan
      origination fees
                    2-5 yearsNon-compete
      agreements
                    5 yearsInternally-developed
      software
                    3 years




24


Total
amortization expense for the three months ended February 29, 2008 and February
28, 2007 was approximately $221,000 and $213,000, respectively and $663,000 and
$647,000 for the nine months ended February 29, 2008 and February 28, 2007,
respectively.





NOTE
10 – ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES





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





February
      29,
                  
                  
                  May
      31,2008
                  
                  
                  2007Accrued
      payroll and other personnel expense
                  
                  $
                  1,752
                  
                  
                  $
                  1,528Accrued
      state and local taxes
                  
                  
                  826
                  
                  
                  
                  766Unvouchered
      accounts payable
                  
                  
                  3,089
                  
                  
                  
                  1,977Customer
      deposits payable
                  
                  
                  659
                  
                  
                  
                  640Accrued
      AT&T roamer charges
                  
                  
                  -
                  
                  
                  
                  3,790Other
                  
                  
                  574
                  
                  
                  
                  686Total
                  
                  $
                  6,900
                  
                  
                  $
                  9,387





NOTE
11 – LONG-TERM DEBT





Long-term
debt at February 29, 2008 and May 31, 2007 consists of the following (in
thousands):





February
      29,
                  
                  
                  May
      31,2008
                  
                  
                  2007Senior
      debt
                  
                  $
                  11,154
                  
                  
                  $
                  9,878Vehicle
      notes
                  
                  
                  19
                  
                  
                  
                  48United
      Commercial Bank debt
                  
                  
                  2,591
                  
                  
                  
                  2,650Jardine
      Capital Corporation bank debt
                  
                  
                  645
                  
                  
                  
                  650Thermo
      factoring debt
                  
                  
                  9,079
                  
                  
                  
                  8,352Total
      long-term debt
                  
                  
                  23,488
                  
                  
                  
                  21,578Less:
      Current portion
                  
                  
                  (20,337
                  )
                  
                  
                  (18,358
                  )Long-term
      debt, net
                  
                  $
                  3,151
                  
                  
                  $
                  3,220





Current
portion of long-term debt at February 29, 2008 and May 31, 2007 consists of the
following (in thousands):





February
      29,
                  
                  
                  May
      31,2008
                  
                  
                  2007Senior
      debt
                  
                  $
                  11,154
                  
                  
                  $
                  9,878Vehicle
      notes
                  
                  
                  16
                  
                  
                  
                  36United
      Commercial Bank debt
                  
                  
                  80
                  
                  
                  
                  85Jardine
      Capital Corporation bank debt
                  
                  
                  8
                  
                  
                  
                  7Thermo
      factoring debt
                  
                  
                  9,079
                  
                  
                  
                  8,352Total
      current portion of  long-term debt
                  
                  $
                  20,337
                  
                  
                  $
                  18,358




Senior Debt: Effective
April 15, 2004, Fortress Credit Corporation (“Fortress”) purchased the
Original Senior Debt Agreement from LINC. The terms of the loan did not change
when Fortress purchased the Original Senior Debt; therefore, the change in debt
ownership was accounted for as a debt modification. Fortress simultaneously
entered into an Amended and Restated Loan and Security Agreement with PCCI for
the purpose of refinancing its Original Senior Debt Agreement and to provide
working capital for PCI (the “Senior Debt Agreement”). The Senior Debt Agreement
cancelled the existing revolver and replaced it with a new $15,000,000 revolving
line-of-credit, which was fully funded on April 15, 2005 (“First Fortress
Note”).


25




PCCI paid
a non-refundable commitment fee of 2.50% of the loan to Fortress to enter into
the amendment. The First Fortress Note had a maturity date of April 14,
2006, and bore interest at a rate of 16% annually, requiring monthly cash
interest payments at an interest rate of 10% per annum and allowing accrued
interest exceeding 10% (the 6% differential) to be rolled into the principal
balance of the loan and its payment to be deferred until the maturity date of
the loan.




Effective
January 6, 2005, PCCI executed the Second Amended and Restated Loan
Agreement allowing for additional borrowings up to $5,000,000 under a separate
note agreement (“Second Fortress Note”), thereby raising the aggregate credit
line available under the revolving line or credit to $20,000,000. Additionally,
under the terms of the Amended Senior Debt Agreement, PCCI was granted a
deferral of all cash interest payments under the loan until after March 2005.
All other terms of the Senior Debt Agreement remained the same. The purpose of
this additional loan was primarily to pay a portion of PCI’s outstanding balance
to AT&T as of December 31, 2004. On the date of the amendment,
$3,000,000 was funded against the Second Fortress Note. Additional fundings
could be requested by PCCI in writing but the total borrowings outstanding under
the Second Fortress Note could not exceed $5,000,000. The Second Fortress Note
bears interest at a rate of 16% per annum (in an event of default as
defined by the Amended Senior Debt Agreement, the interest rate will increase to
20% per annum) and had an original maturity date of January 31, 2005
subject to automatic extensions. However, in no event would the maturity date of
the Second Fortress Note be automatically extended beyond the First Fortress
Note maturity date of April 14, 2006. The First and Second Notes under the
Senior Debt Agreement are collectively hereafter referred to as the Senior
Debt.




From the
maturity date of the Senior debt in April 2006 through August 2006, the Company
was in default under the Fortress loan agreement and was in continuing
negotiations with Fortress to resolve the payment obligation. As part of the
debt restructuring of PCI and the acquisition of PCI by Teletouch, PCI made a
payment of $10,000,000 to Fortress and the $8,700,000 balance of the PCI’s debt
obligation to Fortress was assumed by TLLP and secured by shares of Teletouch’s
common stock owned by TLLP (the “Senior Debt Restructuring”). As part of the
Senior Debt Restructuring, Fortress required that Teletouch and PCI enter into a
Transaction Party Agreement (“TPA”) as discussed further below. The Senior Debt
was to be repaid by TLLP in full within 12 months or Fortress would have the
right to foreclose and convert the outstanding principal and accrued interest
into shares of Teletouch’s common stock held by TLLP.




TLLP was
unable to repay the senior debt obligations that came due on August 15, 2007 but
was successful in negotiating extensions through April 17, 2008. The
Company was able to extend the maturity date of the obligation on behalf of TLLP
through December 11, 2007, by paying Fortress extension fees of approximately
$206,000 during the nine months ended February 29, 2008.


26


Current Presentation of Senior Debt:Concurrent with the PCI Acquisition, PCI, Teletouch and Fortress entered
into a Transaction Party Agreement (“TPA”), which provided Fortress with certain
control over the ongoing operations of Teletouch and PCI as well as provided for
the contingent re-instatement of the liens on PCI assets if certain conditions
were not maintained by either Teletouch or PCI (see “Transaction Party
Agreement” discussion below for more information). A TPA was required by
Fortress in order to assure that PCI or Teletouch would not take actions which
in Fortress’ view could reduce the value of Fortress’ security. Under the terms
of the TPA both PCI and Teletouch are bound to comply with certain negative
covenants. If either PCI or Teletouch breaches the TPA or violates any of the
negative covenants then Fortress can reinstate the Senior Debt at PCI to the
fullest extent available under the law as if the debt restructuring had never
occurred. PCI is conditionally released from having any future payment
obligations under the Senior Debt as long as the terms of the TPA are not
violated. However, in accordance with SFAS 140, Accounting for the Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities PCI must be
legally released from being the primary obligor under the Senior Debt in order
to de-recognize this liability. Because of the existence of the TPA which allows
Fortress limited control of PCI and Teletouch and a contingent ability to
reinstate the debt at PCI, we believe that PCI has not been fully released from
being the primary obligor under the Senior Debt as contemplated by SFAS 140 as
of February 29, 2008. In addition, Teletouch’s parent, TLLP, assumed the Senior
Debt from PCI in August 2006 and 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 nor does it have any current plans to declare dividends in
order to allow TLLP to meet the debt obligations. Therefore, PCI and Teletouch
will continue to report the senior debt obligation payable to Fortress as a
liability on their balance sheet until such time as the debt is fully satisfied
by TLLP or when PCI and Teletouch are released from the TPA.





Thermo Factoring Debt: On
February 26, 2008, Teletouch entered into a second amendment to the
factoring facility with Thermo Credit, LLC (“Thermo”) to provide for, among
other items, (i) an increase to the gross amount of pledged accounts
receivable to $15,000,000 with a continuance of the cash advance rate of 85%;
(ii) a one time 1.05% discount fee on the gross amount of pledged
receivables; (iii) a 0.95% monthly discount fee on the outstanding gross
value of in-process billings that have been advanced against and (iv) the
extension of the termination date to February 26, 2010 (the “Second Amended
Factoring Agreement”).





NOTE
12 - 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.





In June
2006, the FASB issued interpretation No. 48, “Accounting for Uncertainty in
Income Taxes – an Interpretation of FASB Statement No. 109” (“FIN
48”).  FIN 48 seeks to reduce the diversity in practice associated
with certain aspects of measurement and recognition in accounting for income
taxes.  In addition, FIN 48 provides guidance on derecognition,
classification, interest and penalties and accounting in interim periods and
requires expanded disclosures with respect to uncertainty in income
taxes.  The Company adopted FIN 48 effective June 1,
2007.


27


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





February 29, 2008
                  
                  
                  May 31, 2007Deferred
      Tax Assets:Current
      deferred tax assets:Accrued
      liabilities
                  
                  $
                  555
                  
                  
                  $
                  296Deferred
      revenue
                  
                  
                  33
                  
                  
                  
                  20Inventories
                  
                  
                  75
                  
                  
                  
                  184Bad
      debt reserve
                  
                  
                  391
                  
                  
                  
                  1741,054
                  
                  
                  
                  674Valuation
      allowance
                  
                  
                  (1,037
                  )
                  
                  
                  (674
                  )Current
      deferred tax assets, net of valuation allowance
                  
                  
                  17
                  
                  
                  
                  -Non-current
      deferred tax assets:Net
      operating loss
                  
                  
                  9,689
                  
                  
                  
                  10,154Intangible
      assets
                  
                  
                  150
                  
                  
                  
                  105Fixed
      assets
                  
                  
                  314
                  
                  
                  
                  192Licenses
                  
                  
                  22
                  
                  
                  
                  24Other
                  
                  
                  2
                  
                  
                  
                  210,177
                  
                  
                  
                  10,477Valuation
      allowance
                  
                  
                  (10,069
                  )
                  
                  
                  (10,477
                  )Non-current
      deferred tax assets, net of valuation allowance
                  
                  
                  108
                  
                  
                  
                  -Deferred
      Tax Liabilities:Current
      deferred tax liabilities:Other
                  
                  
                  17
                  
                  
                  
                  -Non-current
      deferred tax liabilities:Intangible
      assets
                  
                  
                  12
                  
                  
                  
                  -Fixed
      assets
                  
                  
                  96
                  
                  
                  
                  -108
                  
                  
                  
                  -Net
      Current Deferred Tax Asset
                  
                  $
                  -
                  
                  
                  $
                  -Net
      Non-Current Deferred Tax Asset
                  
                  $
                  -
                  
                  
                  $
                  -





NOTE
13 – COMMITMENTS AND CONTINGENCIES





Teletouch
leases office space, 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.  Minimum rental commitments under non-cancelable leases are as
follows (in thousands):





Twelve Months Ending February 28 or February
      29,Total
                        
                        
                        2009
                        
                        
                        2010
                        
                        
                        2011
                        
                        
                        2012
                        
                        
                        ThereafterOperating
      leases
                        
                        $
                        6,890
                        
                        
                        $
                        1,103
                        
                        
                        $
                        755
                        
                        
                        $
                        576
                        
                        
                        $
                        408
                        
                        
                        $
                        4,048





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.





In
addition to the contractual obligations mentioned above, the Company has the
following contingency:


28





Claim by Former Employee:In
March 2008, the Company received a demand letter from Keith Cole, former CFO of
PCI and General Counsel for the Company.  Mr. Cole was terminated in
January 2008.  Mr. Cole has made a demand for certain compensation
that he believed was due prior to his termination.  The basis for this
claim is certain alleged verbal conversations with management of the
Company.  The total alleged unpaid compensation amount claimed by Mr.
Cole is approximately $455,000. The Company has submitted this claim to its
Employee Practices Liability carrier and intends to vigorously defend itself in
this matter.  The Company cannot predict the outcome of this matter at
this time.





NOTE
14 – SHAREHOLDERS’ EQUITY





Common Stock Purchase
Warrants: In November 2002, the Company issued 6,000,000 redeemable
common stock purchase warrants as part of a debt restructuring transaction
completed in fiscal year 2003 (the “GM Warrants”).  At February 29,
2008 and May 31, 2007, the Company had 6,000,000 GM Warrants issued and
outstanding. The GM Warrants were exercisable beginning in December of 2005 and
terminating in December of 2010.  In December of 2007 or earlier upon
specific events, the holder of the GM Warrants may require the Company to redeem
the warrants at $0.50 per warrant.  Because of this mandatory
redemption feature, the Company initially recorded the estimated fair value of
the GM Warrants as a long-term liability on its consolidated balance sheet and
adjusted the amount to reflect changes in the fair value of the warrants,
including accretion in value due to the passage of time, with such changes
charged or credited to interest expense through the exercise date of the
warrants.  There have been no changes in the fair value of the
warrants in the nine months ended February 29, 2008.





At
February 29, 2008 and May 31, 2007, the market value of the 6,000,000
redeemable common stock warrants was approximately $1,400,000 and $2,300,000,
respectively based on the market closing price of Teletouch’s stock of $0.24 and
$0.38 per share as of those dates respectively; therefore, the redemption value
of $3,000,000 more closely approximates the fair value of the GM Warrants at
February 29, 2008 and May 31, 2007. As of February 29, 2008 and
May 31, 2007, $3,000,000 is recorded as a current liability on the
Company’s consolidated balance sheet related to these obligations. Due to
certain conflicting dates in the May 17, 2002 restructuring agreement that
provided for the redeemable warrants and the actual warrant agreements issued to
the GM Warrant holders in December 2002, the warrants could have become
exercisable on the fifth anniversary of the restructuring agreement, which would
have caused these warrants to become fully exercisable on May 17, 2007. Due
to this possibility, the Company has recorded the full $3,000,000 liability as
of February 29, 2008 and May 31, 2007.





In
December, 2007, the 12 holders of the collective 6,000,000 outstanding GM
Warrants (collectively, the “GM Warrant Holders”) sent notices to the Company to
redeem the warrants. The Company is currently in negotiations with the GM
Warrant Holders related to a new payment arrangement.





Registration Rights Agreement:In conjunction with the August 2006 acquisition of PCI and the related
exchange of certain subordinated debt at PCI for 4,350,000 shares of Teletouch’s
common stock owned by TLLP and Series A Preferred membership units of TLLP,
Teletouch, Stratford and RRCG (Stratford and RRGC collectively, the “Holders”)
entered into a certain Registration Rights Agreement (the “RRA”). In connection
with this exchange, Teletouch agreed to grant to the Holders certain
registration rights under the federal securities laws with respect to the
securities received by the Holders pursuant to the foregoing arrangement.
Namely, the Holders were granted piggy-back registration rights to participate
in any underwritten offering and registration of Teletouch’s equity securities
under the Securities Act of 1933, as amended (the “Securities Act”), including a
shelf registration statement pursuant to Rule 415 under the Securities Act,
through August 10, 2010. The RRA excludes a number of different types of
registration statements from the piggy-back registration rights provided by the
RRA, including but not limited to, any registration statement (i) on Form
S-8 or any similar successor form, (ii) filed in connection with the
acquisition of or combination with another entity, (iii) required pursuant
to an agreement executed between Teletouch, TLLP or Fortress with a purchaser in
a so-called “PIPE” private placement transaction for the resale by the investors
in the PIPE of securities of the Registrant (a “PIPE Agreement”), to the extent
such PIPE Agreement does not provide for the Holders to have registration
rights, or (iv) relating to securities offered for the account of Teletouch
that is filed prior to August 10, 2008, provided that at least 50% of the
securities registered are offered for the account of Teletouch.


29




The
Holders also agreed not to affect any public sale or private offer or
distribution of any equity securities of Teletouch during the 10 business days
prior to the effectiveness under the Securities Act of any underwritten
registration with respect to any of Teletouch’s equity securities or any
securities convertible into or exercisable or exchangeable for such equity
securities and during such time period after the effectiveness under the
Securities Act of any underwritten registration (not to exceed 180 days) as
Teletouch and the managing underwriter may agree. To evidence these obligations,
each Investor (or its future transferee) agreed to execute and deliver to
Teletouch and the underwriters in an underwriting offering such lock-up
agreements as may be required.





NOTE
15 - 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
1,000,000 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 February 29, 2008, approximately
30,659 Non-Qualified Options and 52,000 Incentive Options are outstanding under
the 1994 Plan, and approximately 172,664 Non-Qualified Options and 1,798,750
Incentive Options are outstanding under the 2002 Plan.


30


A summary
of option activity for the nine months ended February 29, 2008 is as
follows:





WeightedWeighted
                  
                  
                  AverageAverage
                  
                  
                  Remaining
                  
                  
                  AggregateExercise
                  
                  
                  Contractual
                  
                  
                  IntrinsicShares
                  
                  
                  Price
                  
                  
                  Term
                  
                  
                  ValueOutstanding
      at June 1, 2007
                  
                  
                  2,749,905
                  
                  
                  $
                  0.33
                  
                  
                  
                  8.66
                  
                  
                  $
                  307,951Nine
      months ended February 29, 2008Granted
                  
                  
                  40,000
                  
                  
                  
                  0.24
                  
                  
                  
                  -Exercised
                  
                  
                  (500,000
                  )
                  
                  
                  0.12
                  
                  
                  
                  -Forfeited
                  
                  
                  (235,832
                  )
                  
                  
                  0.79
                  
                  
                  
                  -Outstanding
      at February 29, 2008
                  
                  
                  2,054,073
                  
                  
                  
                  0.33
                  
                  
                  
                  7.80
                  
                  
                  $
                  59,250Options
      exercisable at February 29, 2008
                  
                  
                  1,404,488
                  
                  
                  $
                  0.34
                  
                  
                  
                  7.34
                  
                  
                  $
                  39,700





The
following table summarizes the status of the Company’s non-vested stock options
since June 1, 2007:





Non-vested OptionsWeighted-Number
      of
                  
                  
                  Average
      FairShares
                  
                  
                  ValueNon-vested
      at June 1, 2007
                  
                  
                  1,035,834
                  
                  
                  $
                  0.29Granted
                  
                  
                  40,000
                  
                  
                  
                  0.22Vested
                  
                  
                  (426,249
                  )
                  
                  
                  0.26Forfeited
                  
                  
                  -
                  
                  
                  
                  -Non-vested
      at February 29, 2008
                  
                  
                  649,585
                  
                  
                  $
                  0.30





Upon
adoption of SFAS 123(R) on June 1, 2006, the Company began estimating the value
of employee stock options on the date of grant using the Black-Scholes model.
Prior to the adoption of SFAS 123(R), the value of each employee stock option
was estimated on the date of grant using the Black-Scholes model for the purpose
of the pro forma financial disclosure in accordance with SFAS 123. 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 $28,000 and $23,000 in stock based compensation expense in the
consolidated financial statements for the three months ended February 29, 2008
and February 28, 2007, respectively. The Company recorded approximately $88,000
and $40,000 in stock based compensation expense in the consolidated financial
statements for the nine months ended February 29, 2008 and February 28, 2007,
respectively.





NOTE
16 – RELATED PARTY TRANSACTIONS





Following
the acquisition of PCI in August 2006 (as discussed in Note 3), 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 acquired 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.  See Note 3 “Acquisition of Progressive Concepts, Inc.” for
discussions on TLLP’s contribution of the stock of PCI to Teletouch in August
2006 and the assumption by TLLP of certain of PCI’s debt obligations prior to
the contribution of PCI’s stock to Teletouch.


31





The
Company entered into certain related party transactions during the three and
nine months ended February 29, 2008 and February 28, 2007 with PCCI and TLLP,
both companies controlled by Robert McMurrey, Chairman and Chief Executive
Officer of Teletouch, as follows:





In June
2006, the Company loaned $250,000 to PCCI for the purpose of allowing PCCI to
enter into an option agreement with Air-bank, Inc., a non-affiliated prepaid
cellular technology company (“Air-bank”).  The $250,000 was to be used
to secure a management and option agreement with Air-bank providing PCCI the
option to acquire up to 55% interest in Air-bank.  As of the date of
this report, the loan balance remains at $250,000 with no interest accruing and
continues to be the largest amount the Company has loaned to PCCI to
date.  The Company also provided certain leased office space to
Air-bank beginning in June 2006 and continuing through February 29,
2008.  The Company receives less than $1,000 per month from Air-bank
related to the leased office space.





In August
2006, TLLP paid certain legal fees on behalf of the Company related to the debt
restructuring and the reorganization of its commonly controlled
companies.  The Company has recorded this $63,000 expense in the three
months ended August 31, 2006.  As of February 29, 2008, $63,000
remains payable to TLLP by the Company.





NOTE
17 – SEGMENT INFORMATION





The
Company's consolidated financial statements include three reportable segments:
cellular services, wholesale distribution and two-way radio services. The
Company determines its reportable segments based on the aggregation criteria of
Financial Accounting Standards No. 131 “Disclosures about Segments of an
Enterprise and Related Information” (“SFAS No. 131”).





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 for over 20 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.





The
Company’s wholesale business segment represents its distribution of cellular
telephones, accessories, car audio and car security products to other third
party customers and distributors.





Two-way
radio services represent 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.  Safety
and emergency response vehicle products are also included in the two-way
business segment.





Corporate
overhead is reported separate from the Company’s identified segments and this
indirect cost is not allocated to the operating segments. The Corporate overhead
costs include expenses from the Company’s cost centers for accounting,
information technology, human resources, marketing and executive
management.





The
following tables summarize the Company’s operating financial information by each
segment for the three and nine months ended February 29, 2008 and February 28,
2007 (in thousands):


32





Three Months Ended
                  
                  
                  Nine Months EndedFebruary
      29,
                  
                  
                  February
      28,
                  
                  
                  February
      29,
                  
                  
                  February
      28,2008
                  
                  
                  2007
                  
                  
                  2008
                  
                  
                  2007Operating
      revenues:Service,
      rent and maintenance revenueCellular
                  
                  $
                  6,634
                  
                  
                  $
                  5,944
                  
                  
                  $
                  20,208
                  
                  
                  $
                  18,371Two-way
                  
                  
                  526
                  
                  
                  
                  510
                  
                  
                  
                  1,410
                  
                  
                  
                  1,451Other
                  
                  
                  93
                  
                  
                  
                  178
                  
                  
                  
                  376
                  
                  
                  
                  617Total
                  
                  
                  7,253
                  
                  
                  
                  6,632
                  
                  
                  
                  21,994
                  
                  
                  
                  20,439Product
      sales revenueCellular
                  
                  
                  1,915
                  
                  
                  
                  2,343
                  
                  
                  
                  5,806
                  
                  
                  
                  6,983Wholesale
                  
                  
                  3,200
                  
                  
                  
                  3,178
                  
                  
                  
                  10,260
                  
                  
                  
                  9,779Two-way
                  
                  
                  562
                  
                  
                  
                  742
                  
                  
                  
                  1,843
                  
                  
                  
                  2,469Other
                  
                  
                  439
                  
                  
                  
                  668
                  
                  
                  
                  1,566
                  
                  
                  
                  2,034Total
                  
                  
                  6,116
                  
                  
                  
                  6,931
                  
                  
                  
                  19,475
                  
                  
                  
                  21,265Operating
      revenueCellular
                  
                  
                  8,549
                  
                  
                  
                  8,287
                  
                  
                  
                  26,014
                  
                  
                  
                  25,354Wholesale
                  
                  
                  3,200
                  
                  
                  
                  3,178
                  
                  
                  
                  10,260
                  
                  
                  
                  9,779Two-way
                  
                  
                  1,088
                  
                  
                  
                  1,252
                  
                  
                  
                  3,253
                  
                  
                  
                  3,920Other
                  
                  
                  532
                  
                  
                  
                  846
                  
                  
                  
                  1,942
                  
                  
                  
                  2,651Total
                  
                  
                  13,369
                  
                  
                  
                  13,563
                  
                  
                  
                  41,469
                  
                  
                  
                  41,704Operating
      expenses:Cost
      of service, rent and maintenance(exclusive
      of depreciation and amortization included below)Cellular
                  
                  
                  1,981
                  
                  
                  
                  2,326
                  
                  
                  
                  6,529
                  
                  
                  
                  7,509Two-way
                  
                  
                  463
                  
                  
                  
                  567
                  
                  
                  
                  1,443
                  
                  
                  
                  1,683Other
                  
                  
                  51
                  
                  
                  
                  182
                  
                  
                  
                  241
                  
                  
                  
                  709Total
                  
                  
                  2,495
                  
                  
                  
                  3,075
                  
                  
                  
                  8,213
                  
                  
                  
                  9,901Cost
      of products soldCellular
                  
                  
                  1,970
                  
                  
                  
                  2,454
                  
                  
                  
                  5,732
                  
                  
                  
                  6,994Wholesale
                  
                  
                  2,789
                  
                  
                  
                  2,843
                  
                  
                  
                  9,028
                  
                  
                  
                  8,637Two-way
                  
                  
                  446
                  
                  
                  
                  461
                  
                  
                  
                  1,337
                  
                  
                  
                  1,677Other
                  
                  
                  315
                  
                  
                  
                  415
                  
                  
                  
                  1,138
                  
                  
                  
                  1,121Total
                  
                  
                  5,520
                  
                  
                  
                  6,173
                  
                  
                  
                  17,235
                  
                  
                  
                  18,429Selling
      and general and administrativeCellular
                  
                  
                  1,475
                  
                  
                  
                  1,758
                  
                  
                  
                  4,976
                  
                  
                  
                  5,334Wholesale
                  
                  
                  365
                  
                  
                  
                  340
                  
                  
                  
                  1,165
                  
                  
                  
                  1,079Two-way
                  
                  
                  153
                  
                  
                  
                  173
                  
                  
                  
                  392
                  
                  
                  
                  493Corporate
                  
                  
                  2,486
                  
                  
                  
                  2,542
                  
                  
                  
                  8,074
                  
                  
                  
                  7,492Other
                  
                  
                  217
                  
                  
                  
                  304
                  
                  
                  
                  673
                  
                  
                  
                  911Total
                  
                  
                  4,696
                  
                  
                  
                  5,117
                  
                  
                  
                  15,280
                  
                  
                  
                  15,309Depreciation
      and amortizationTwo-way
                  
                  
                  61
                  
                  
                  
                  59
                  
                  
                  
                  181
                  
                  
                  
                  181Corporate
                  
                  
                  306
                  
                  
                  
                  392
                  
                  
                  
                  989
                  
                  
                  
                  1,239Total
                  
                  
                  367
                  
                  
                  
                  451
                  
                  
                  
                  1,170
                  
                  
                  
                  1,420Gain
      on forgiveness of trade payable obligation to AT&TCorporate
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  (3,824
                  )
                  
                  
                  -Loss
      (gain) on disposal of assetsTwo-Way
                  
                  
                  -
                  
                  
                  
                  1
                  
                  
                  
                  -
                  
                  
                  
                  (4
                  )Corporate
                  
                  
                  (17
                  )
                  
                  
                  -
                  
                  
                  
                  (34
                  )
                  
                  
                  19Total
      Operating expenses
                  
                  
                  13,061
                  
                  
                  
                  14,817
                  
                  
                  
                  38,040
                  
                  
                  
                  45,074Operating
      income (loss) from continuing operationsCellular
                  
                  
                  3,123
                  
                  
                  
                  1,749
                  
                  
                  
                  8,777
                  
                  
                  
                  5,517Wholesale
                  
                  
                  46
                  
                  
                  
                  (5
                  )
                  
                  
                  67
                  
                  
                  
                  63Two-way
                  
                  
                  (35
                  )
                  
                  
                  (9
                  )
                  
                  
                  (100
                  )
                  
                  
                  (110
                  )Corporate
                  
                  
                  (2,775
                  )
                  
                  
                  (2,934
                  )
                  
                  
                  (5,205
                  )
                  
                  
                  (8,750
                  )Other
                  
                  
                  (51
                  )
                  
                  
                  (55
                  )
                  
                  
                  (110
                  )
                  
                  
                  (90
                  )Total
                  
                  
                  308
                  
                  
                  
                  (1,254
                  )
                  
                  
                  3,429
                  
                  
                  
                  (3,370
                  )Interest
      expense, netTwo-way
                  
                  
                  -
                  
                  
                  
                  (1
                  )
                  
                  
                  (2
                  )
                  
                  
                  (14
                  )Corporate
                  
                  
                  (1,014
                  )
                  
                  
                  (719
                  )
                  
                  
                  (3,025
                  )
                  
                  
                  (2,712
                  )Total
                  
                  
                  (1,014
                  )
                  
                  
                  (720
                  )
                  
                  
                  (3,027
                  )
                  
                  
                  (2,726
                  )Income
      (loss) from continuing operations before income tax
expense
                  
                  
                  (706
                  )
                  
                  
                  (1,974
                  )
                  
                  
                  402
                  
                  
                  
                  (6,096
                  )Income
      tax expenseCorporate
                  
                  
                  60
                  
                  
                  
                  62
                  
                  
                  
                  179
                  
                  
                  
                  88Net
      income (loss) from continuing operations
                  
                  
                  (766
                  )
                  
                  
                  (2,036
                  )
                  
                  
                  223
                  
                  
                  
                  (6,184
                  )Gain
      on sale of assets related to discontinued paging
operations
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  163Income
      from discontinued paging operations
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  449Loss
      on sale of assets related to discontinued security monitoring
      operations
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  (78
                  )Net
      income from discontinued operations
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  534Net
      income (loss)
                  
                  
                  (766
                  )
                  
                  
                  (2,036
                  )
                  
                  
                  223
                  
                  
                  
                  (5,650
                  )Participation
      rights of common stock purchase warrants in undistributed
      earnings
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  (24
                  )
                  
                  
                  -Net
      income (loss) applicable to common shareholders
                  
                  $
                  (766
                  )
                  
                  $
                  (2,036
                  )
                  
                  $
                  199
                  
                  
                  $
                  (5,650
                  )


33





The
Company identifies its assets by segment. Significant assets of the Company’s
corporate offices include cash, property and equipment and loan origination
costs.  The Company’s assets by segment as of February 29, 2008 and
May 31, 2007 are as follows:





February
      29, 2008
                      
                      
                      May
      31, 2007Total Assets
                      
                      
                      Property and
                        Equipment, net
                      
                      
                      Goodwill, Net
                      
                      
                      Intangible Assets,
                        net
                      
                      
                      Total Assets
                      
                      
                      Property and
                        Equipment, net
                      
                      
                      Goodwill, Net
                      
                      
                      Intangible Assets,
                        netSegmentCellular
                      
                      $
                      16,062
                      
                      
                      $
                      376
                      
                      
                      $
                      -
                      
                      
                      $
                      4,891
                      
                      
                      $
                      15,807
                      
                      
                      $
                      553
                      
                      
                      $
                      -
                      
                      
                      $
                      5,456Two-way
                      
                      
                      2,034
                      
                      
                      
                      541
                      
                      
                      
                      343
                      
                      
                      
                      94
                      
                      
                      
                      1,937
                      
                      
                      
                      637
                      
                      
                      
                      343
                      
                      
                      
                      134Wholesale
                      
                      
                      1,880
                      
                      
                      
                      18
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      2,885
                      
                      
                      
                      1
                      
                      
                      
                      -
                      
                      
                      
                      -Corporate
                      
                      
                      6,291
                      
                      
                      
                      2,336
                      
                      
                      
                      -
                      
                      
                      
                      274
                      
                      
                      
                      11,242
                      
                      
                      
                      2,376
                      
                      
                      
                      -
                      
                      
                      
                      308Other
                      
                      
                      264
                      
                      
                      
                      23
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      431
                      
                      
                      
                      54
                      
                      
                      
                      -
                      
                      
                      
                      -Totals
                      
                      $
                      26,531
                      
                      
                      $
                      3,294
                      
                      
                      $
                      343
                      
                      
                      $
                      5,259
                      
                      
                      $
                      32,302
                      
                      
                      $
                      3,621
                      
                      
                      $
                      343
                      
                      
                      $
                      5,898





During
the three and nine months ended February 29, 2008 and February 28, 2007, the
Company did not have a single customer that represented more than 10% of total
segment revenues.





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





Overview




Teletouch
has been a provider of telecommunications services for over 40 years, providing
two-way radio services in Texas, GPS-telemetry and public safety/emergency
response vehicle products and services throughout the U.S. Until the sale of its
paging business in August 2006, it also provided paging services in non-major
metropolitan areas and communities in the Southeast United States. The Company
provided paging services in Alabama, Arkansas, Florida, Georgia, Louisiana,
Mississippi, Missouri, Oklahoma, Texas and Tennessee. Late in 2007, Teletouch
began selling safety/emergency response vehicle products and services business
under the brand Teletouch EVP (emergency vehicle products). The EVP business is
complementary offering to the Company’s existing two-way radio
business.




Following
the sale of the paging business and the acquisition of PCI in August 2006,
Teletouch’s core-business has been acquiring, billing and supporting cellular
subscribers under a recurring revenue relationship with AT&T Wireless,
formerly Cingular Wireless (“AT&T”). The original distribution agreement
between PCI and AT&T had been in place for more than 20 years. Teletouch,
through its subsidiary, PCI, is a provider of 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. The Company operates a chain of retail stores and sells under the
“Hawk Electronics” brand, through Hawk-branded sub-agents and its own direct
sales force and through the Internet at various sites. As a master distributor
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. Also
acquired as part of the PCI acquisition, Teletouch now operates a national
wholesale distribution business, known as PCI Wholesale that serves smaller
cellular and automotive retailers, car dealers and rural cellular carriers
throughout the country.





2008
Business Strategy





Most of
the efforts in fiscal year 2008 will continue to focus on the integration issues
related to the acquisition of PCI as well as securing financing to complete one
or more acquisitions to provide revenue growth for the Company. PCI had
historically been a privately held company which presented challenges of
migrating the systems and processes of PCI to those required of a public
company. During the remainder of fiscal year 2008, the management team will work
on implementing a series of basic internal controls and processes along with
authorization levels, which were lacking while PCI was a privately held company.
Beginning with the year ending May 31, 2008, the Company’s management will
be required to internally assess and report on its internal controls over
financial reporting under the rules of Section 404 of the Sarbanes-Oxley
Act of 2002.


34




Another
equally as important focus at PCI is improving profitability. PCI has generated
net losses in several of its recent years, and our focus is on implementing cost
control initiatives at PCI while seeking additional opportunities to grow
revenues. The Company continues to evaluate new electronic products to introduce
in its retail and website outlets that could be marketed to its existing
customer base. PCI’s 80,000 cellular subscribers are comprised of individuals
and businesses of higher than average credit worthiness due to PCI’s stringent
credit standards.





For
fiscal year 2008, a large part of Teletouch’s efforts will be on timeliness in
its financial reporting. The Company’s financial reporting delays were caused
primarily by the acquisition of PCI in August 2006. Since that time its
inability to complete its audits and file the required financials has hindered
the Company’s ability to secure additional financing to grow the business. Until
these financial reporting and audit matters are concluded, the Company will
continue to manage closely its operating expenses to improve profitability.
Since the August 2006 acquisition of PCI, many personnel and process changes
have been completed to allow for and promote organic growth in its current
business units. In order to realize this organic growth, the Company has added
additional sales personnel and locations, increased its internet marketing
activities and enhanced its systems and processes to allow for the timely
integration of new product lines.





The core
business of Teletouch is providing cellular services to customers through PCI’s
distribution agreements with AT&T. The primary distribution agreement with
AT&T expires in August 2009. The Company cannot guarantee this agreement
with AT&T will be extended beyond its expiration date. Under the terms of
the current distribution agreement, if the agreement is not renewed by AT&T,
the Company would be allowed to continue to provide services to its existing
subscribers until these subscribers terminate service. Under this scenario the
Company could experience accelerated reductions in its cellular service revenues
beginning in September 2009 due to its inability to replace customers that
disconnect service in the normal course of business. Because of the potential
change in the Company’s cellular services business, the Company is aggressively
working to develop its other business units as well as evaluating its
alternatives to maintain the recurring revenues generated by its current
cellular subscriber base.





RESULTS
OF OPERATIONS





Operating
revenues are primarily generated from the Company’s cellular, wholesale and
two-way radio operations and are comprised of a mix of service, rent and
maintenance revenues as well as product revenues.  Service, rent and
maintenance 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.  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 generates other service revenues from some of
its ancillary and smaller operations, including internet services and satellite
television services.





The
majority of the Company’s product sales is generated by PCI’s wholesale
operations and is comprised of cellular telephones, cellular accessories and 12
volt mobile electronics, which are sold to smaller dealers and carriers
throughout the United States.  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. Two-way radio operations’
products are comprised of radios and service parts for radio communication
systems.





35


Service,
rent and maintenance revenues and related costs are recognized during the period
in which the service is rendered.  Associated 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 collectibility 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.





Since
1987, the Company’s subsidiary, PCI, has held agreements with AT&T, 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.  Based on
PCI’s relationship with AT&T, the Company has evaluated its reporting of
revenues, under Emerging Issues Task Force Issue 99-19, “Reporting Revenue Gross
as a Principal versus Net as an Agent,” (“EITF 99-19”) associated with its
services attached to the AT&T agreements.





Based on
its assessment of the indicators listed in EITF 99-19, the Company has concluded
that the AT&T services provided by PCI should be reported on a net
basis.  PCI does bill and assume the collections risk on 100% of the
cellular services used by its customers. However, under a net basis of reporting
these revenues, only the excess of the gross customer billings over the
contractual percentage of these billed amounts paid to AT&T is reported as
revenue on the Company’s consolidated financials.





Cost of
providing service, rent and maintenance consists primarily of costs related to
supporting the 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
      programs and handset and accessory warranty
  programs.


§
            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 100% of these charges incurred by its customer base
      under all of its distribution agreements with the exception of the
      agreement covering the San Antonio market. Under the San Antonio
      agreement, the Company remits 100% of any billings related to roaming to
      AT&T and is not responsible for the actual roaming charges incurred by
      the subscriber.


§
            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


36


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
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 subscribers as an inducement to
customers to agree to 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, 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, Rent and
Maintenance Revenue for the Three and Nine Months Ended February 29, 2008 and
February 28, 2007





The
service, rent and maintenance revenues shown below have been grouped and are
discussed by the Company’s reportable operating segments as defined under GAAP.
The other category includes the service revenues generated by the remaining
operations of the Company that individually do not meet the quantitative
requirements for reporting separately under GAAP, including car dealer
installation, satellite television and dial up internet
services.


37





(dollars
      in thousands)
                        
                        February
      29,
                        
                        
                        February
      28,
                        
                        
                        2008
      vs 20072008
                        
                        
                        2007
                        
                        
                        $ Change
                        
                        
                        % ChangeThree Months EndedService,
      rent, and maintenance revenueCellular
      operationsGross
      cellular subscription billings
                        
                        $
                        15,713
                        
                        
                        $
                        15,092
                        
                        
                        $
                        621
                        
                        
                        
                        4
                        %Net
      revenue adjustment (revenue share due AT&T)
                        
                        
                        (9,079
                        )
                        
                        
                        (9,307
                        )
                        
                        
                        228
                        
                        
                        
                        -2
                        %Net
      revenue reported from cellular subscription billings
                        
                        
                        6,634
                        
                        
                        
                        5,785
                        
                        
                        
                        849
                        
                        
                        
                        15
                        %Other
      service revenue
                        
                        
                        -
                        
                        
                        
                        159
                        
                        
                        
                        (159
                        )
                        
                        
                        -100
                        %Cellular
      operations total service revenues:
                        
                        
                        6,634
                        
                        
                        
                        5,944
                        
                        
                        
                        690
                        
                        
                        
                        12
                        %Two-way
      radio operations
                        
                        
                        526
                        
                        
                        
                        510
                        
                        
                        
                        16
                        
                        
                        
                        3
                        %Other
      operations
                        
                        
                        93
                        
                        
                        
                        178
                        
                        
                        
                        (85
                        )
                        
                        
                        -48
                        %Service,
      rent, and maintenance revenue
                        
                        $
                        7,253
                        
                        
                        $
                        6,632
                        
                        
                        $
                        621
                        
                        
                        
                        9
                        %Nine Months EndedService,
      rent, and maintenance revenueCellular
      operationsGross
      cellular subscription billings
                        
                        $
                        47,318
                        
                        
                        $
                        44,732
                        
                        
                        $
                        2,586
                        
                        
                        
                        6
                        %Net
      revenue adjustment (revenue share due AT&T)
                        
                        
                        (27,269
                        )
                        
                        
                        (26,975
                        )
                        
                        
                        (294
                        )
                        
                        
                        1
                        %Net
      revenue reported from cellular subscription billings
                        
                        
                        20,049
                        
                        
                        
                        17,757
                        
                        
                        
                        2,292
                        
                        
                        
                        13
                        %Other
      service revenue
                        
                        
                        159
                        
                        
                        
                        614
                        
                        
                        
                        (455
                        )
                        
                        
                        -74
                        %Cellular
      operations total service revenues:
                        
                        
                        20,208
                        
                        
                        
                        18,371
                        
                        
                        
                        1,837
                        
                        
                        
                        10
                        %Two-way
      radio operations
                        
                        
                        1,410
                        
                        
                        
                        1,451
                        
                        
                        
                        (41
                        )
                        
                        
                        -3
                        %Other
      operations
                        
                        
                        376
                        
                        
                        
                        617
                        
                        
                        
                        (241
                        )
                        
                        
                        -39
                        %Service,
      rent, and maintenance revenue
                        
                        $
                        21,994
                        
                        
                        $
                        20,439
                        
                        
                        $
                        1,555
                        
                        
                        
                        8
                        %





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.





Service, Rent and
Maintenance Revenue Discussion for the Three and Nine Months Ended February 29,
2008 and February 28, 2007





The
increase in the cellular operation’s gross cellular subscription billings for
the three and nine months ended February 29, 2008 compared to the three and nine
months ended February 28, 2007 resulted primarily from an increase in wireless
data charges.  The Company’s customers continued the trend of
purchasing phones with internet capabilities, resulting in an increase of data
charges of approximately $924,000 and $2,499,000 for the three and nine months
ended February 29, 2008 compared to the three and nine months ended February 28,
2007.  In addition, the Company recorded an increase in customer
feature revenue due to a rate increase on the Company’s phone insurance
program.  The increases were partially offset by a decrease in access
charges due to a declining subscriber base.  The Company had
approximately 80,000 subscribers as of February 29, 2008 compared to
approximately 83,000 subscribers as of February 28, 2007.





The
decrease in other service revenues from the Company’s cellular operations for
the three and nine months ended February 29, 2008 compared to the same
periods in the prior fiscal year is attributable to a decrease in commission and
residual revenue earned from a decrease in DISH and DIRECTV satellite television
installations.


38





The
decrease in service, rent and maintenance revenue from the Company’s other
operations for the three and nine months ended February 29, 2008 compared to the
three and nine months ended February 28, 2007 is primarily due to the disposal
of PCI’s paging operations in 2008 and a declining subscriber base for local and
long distance phone services.  After the acquisition of PCI in August
2006, the Company determined certain ancillary businesses were no longer viable
and were subsequently phased out or eliminated.  As a result, service
revenue related to PCI’s paging business declined by approximately $37,000 and
$108,000 for the three and nine months ended February 29, 2008, respectively
compared to the same period in fiscal year 2007. Local and long distance phone
services declined by approximately $40,000 and $87,000 for the three and nine
months ended February 29, 2008, respectively compared to the same period in the
prior year.





Cost of Service, Rent and
Maintenance for the Three and Nine Months Ended February 29, 2008 and February
28, 2007





Cost of
service, rent and maintenance expense consist of the following significant
components:





(dollars
      in thousands)
                      
                      February
      29,
                      
                      
                      February
      28,
                      
                      
                      2008
      vs 20072008
                      
                      
                      2007
                      
                      
                      $ Change
                      
                      
                      % ChangeThree Months EndedCost
      of service, rent and maintenanceCellular
      operations
                      
                      $
                      1,981
                      
                      
                      $
                      2,326
                      
                      
                      $
                      (345
                      )
                      
                      
                      -15
                      %Two-way
      operations
                      
                      
                      463
                      
                      
                      
                      567
                      
                      
                      
                      (104
                      )
                      
                      
                      -18
                      %Other
      operations
                      
                      
                      51
                      
                      
                      
                      182
                      
                      
                      
                      (131
                      )
                      
                      
                      -72
                      %Total
      cost of service, rent and maintenance
                      
                      $
                      2,495
                      
                      
                      $
                      3,075
                      
                      
                      $
                      (580
                      )
                      
                      
                      -19
                      %Nine Months EndedCost
      of service, rent and maintenanceCellular
      operations
                      
                      $
                      6,529
                      
                      
                      $
                      7,509
                      
                      
                      $
                      (980
                      )
                      
                      
                      -13
                      %Two-way
      operations
                      
                      
                      1,443
                      
                      
                      
                      1,683
                      
                      
                      
                      (240
                      )
                      
                      
                      -14
                      %Other
      operations
                      
                      
                      241
                      
                      
                      
                      709
                      
                      
                      
                      (468
                      )
                      
                      
                      -66
                      %Total
      cost of service, rent and maintenance
                      
                      $
                      8,213
                      
                      
                      $
                      9,901
                      
                      
                      $
                      (1,688
                      )
                      
                      
                      -17
                      %





Cost of Service, Rent and
Maintenance Discussion for the Three and Nine Months Ended February 29, 2008 and
February 28, 2007





The
decrease in cost of service, rent and maintenance from the Company’s cellular
operations for the three and nine months ended February 29, 2008 compared to the
same periods from the prior fiscal year is attributable to a reduction in
salaries, wages and other personnel costs due to a reduction in personnel from
the restructure of the Company’s business units in August
2007.  Salary, wages and personnel costs decreased by approximately
$139,000 and $282,000 for the three and nine months ended February 29, 2008,
respectively compared to the three and nine months ended February 28, 2007. In
addition the reduction in roamer costs due to the Settlement and Release
Agreement the Company negotiated with AT&T in June 2007 (see Note 5 –
“Relationship with Cellular Carrier” for further information) contributed to the
reduction in cost of services for the three and nine months ended February 29,
2008 compared to the same periods from the prior fiscal year.  Roamer
costs decreased by approximately $498,000 and $1,399,000 for the three and nine
months ended February 29, 2008, respectively compared to the three and nine
months ended February 28, 2007.  The reduction in cost of services was
partially offset by an increase in bad debt expense of approximately $320,000
and $460,000 for the three and nine months ended February 29, 2008, respectively
compared to the three and nine months ended February 28, 2007.


39


The
decrease in cost of service, rent and maintenance related to the Company’s
two-way operations for the three and nine months ended February 29, 2008
compared to the three and nine months ended February 28, 2007 is primarily due
to the decrease in expenses related to Teletouch’s telemetry
business.  In fiscal year 2007, the Company decided not to actively
support expanding the telemetry operations due to market competition and product
development costs. Subsequently, the service costs from these operations
decreased from a continued decline in the number of telemetry
subscribers.





The
decrease in cost of service, rent and maintenance from  the Company’s
other operations for the three and nine months ended February 29, 2008 is
primarily due to a decrease in costs related to PCI’s answering service and
paging businesses. Answering service costs decreased by approximately $67,000
and $263,000 for the three and nine months ended February 29, 2008, respectively
compared to the same periods in the prior fiscal year.  The costs
related to paging business decreased by approximately $19,000 and $82,000 for
the three and nine months ended February 29, 2008, respectively compared to the
same periods in the prior fiscal year.  After the acquisition of PCI
in August 2006, the Company determined these ancillary businesses were no longer
viable and were subsequently phased out or eliminated.





Sales Revenue and Cost of
Products Sold for the Three and Nine Months ended February 29, 2008 and February
28, 2007





(dollars
      in thousands)
                                  
                                  February
      29,
                                  
                                  
                                  February
      28,
                                  
                                  
                                  2008
      vs 20072008
                                  
                                  
                                  2007
                                  
                                  
                                  $ Change
                                  
                                  
                                  % ChangeThree Months EndedProduct
      Sales RevenueCellular
                                  
                                  $
                                  1,915
                                  
                                  
                                  $
                                  2,343
                                  
                                  
                                  $
                                  (428
                                  )
                                  
                                  
                                  -18
                                  %Wholesale
                                  
                                  
                                  3,200
                                  
                                  
                                  
                                  3,178
                                  
                                  
                                  
                                  22
                                  
                                  
                                  
                                  1
                                  %Two-Way
                                  
                                  
                                  562
                                  
                                  
                                  
                                  742
                                  
                                  
                                  
                                  (180
                                  )
                                  
                                  
                                  -24
                                  %Other
                                  
                                  
                                  439
                                  
                                  
                                  
                                  668
                                  
                                  
                                  
                                  (229
                                  )
                                  
                                  
                                  -34
                                  %Total
      product sales revenue
                                  
                                  $
                                  6,116
                                  
                                  
                                  $
                                  6,931
                                  
                                  
                                  $
                                  (815
                                  )
                                  
                                  
                                  -12
                                  %Cost
      of products soldCellular
                                  
                                  
                                  1,970
                                  
                                  
                                  
                                  2,454
                                  
                                  
                                  
                                  (484
                                  )
                                  
                                  
                                  -20
                                  %Wholesale
                                  
                                  
                                  2,789
                                  
                                  
                                  
                                  2,843
                                  
                                  
                                  
                                  (54
                                  )
                                  
                                  
                                  -2
                                  %Two-Way
                                  
                                  
                                  446
                                  
                                  
                                  
                                  461
                                  
                                  
                                  
                                  (15
                                  )
                                  
                                  
                                  -3
                                  %Other
                                  
                                  
                                  315
                                  
                                  
                                  
                                  415
                                  
                                  
                                  
                                  (100
                                  )
                                  
                                  
                                  -24
                                  %Cost
      of products sold
                                  
                                  $
                                  5,520
                                  
                                  
                                  $
                                  6,173
                                  
                                  
                                  $
                                  (653
                                  )
                                  
                                  
                                  -11
                                  %Nine Months EndedProduct
      Sales RevenueCellular
                                  
                                  $
                                  5,806
                                  
                                  
                                  $
                                  6,983
                                  
                                  
                                  $
                                  (1,177
                                  )
                                  
                                  
                                  -17
                                  %Wholesale
                                  
                                  
                                  10,260
                                  
                                  
                                  
                                  9,779
                                  
                                  
                                  
                                  481
                                  
                                  
                                  
                                  5
                                  %Two-Way
                                  
                                  
                                  1,843
                                  
                                  
                                  
                                  2,469
                                  
                                  
                                  
                                  (626
                                  )
                                  
                                  
                                  -25
                                  %Other
                                  
                                  
                                  1,566
                                  
                                  
                                  
                                  2,034
                                  
                                  
                                  
                                  (468
                                  )
                                  
                                  
                                  -23
                                  %Total
      product sales revenue
                                  
                                  $
                                  19,475
                                  
                                  
                                  $
                                  21,265
                                  
                                  
                                  $
                                  (1,790
                                  )
                                  
                                  
                                  -8
                                  %Cost
      of products soldCellular
                                  
                                  
                                  5,732
                                  
                                  
                                  
                                  6,994
                                  
                                  
                                  
                                  (1,262
                                  )
                                  
                                  
                                  -18
                                  %Wholesale
                                  
                                  
                                  9,028
                                  
                                  
                                  
                                  8,637
                                  
                                  
                                  
                                  391
                                  
                                  
                                  
                                  5
                                  %Two-Way
                                  
                                  
                                  1,337
                                  
                                  
                                  
                                  1,677
                                  
                                  
                                  
                                  (340
                                  )
                                  
                                  
                                  -20
                                  %Other
                                  
                                  
                                  1,138
                                  
                                  
                                  
                                  1,121
                                  
                                  
                                  
                                  17
                                  
                                  
                                  
                                  2
                                  %Cost
      of products sold
                                  
                                  $
                                  17,235
                                  
                                  
                                  $
                                  18,429
                                  
                                  
                                  $
                                  (1,194
                                  )
                                  
                                  
                                  -6
                                  %


40





Sales Revenue and Cost of
Products Sold Discussion for the Three and Nine Months Ended February 29, 2008
and February 28, 2007





Product sales revenue: The
decline in product sales from the Company’s cellular operations for the three
and nine months ended February 29, 2008 compared to the three and nine months
ended February 28, 2007 is primarily due to a decline in the average selling
price of cellular handsets and corresponding cellular accessory
sales.   Cellular activations decreased by approximately 6% for
both the three and nine months ended February 29, 2008 compared to the same
periods in the prior fiscal year.   In addition, car audio
equipment sales from the cellular operations decreased by approximately 42% in
the nine months ending February 29, 2008 compared to the nine months ending
February 28, 2007 which contributed to the overall decrease in cellular product
sales period over period.





The
decrease in product sales from the Company’s the two-way radio operations is
partially attributable to fewer radio communication system upgrades for
municipalities because of decreased federal grant funding. Two-way radio and
part sales decreased by approximately $288,000 and $825,000 for the three and
nine months ended February 29, 2008, respectively compared to the same periods
in the prior fiscal year. In addition, sales related to telemetry equipment
decreased by approximately $23,000 and $101,000 for the three and nine months
ended February 29, 2008, respectively compared to the three and nine months
ended February 28, 2007. The decrease in sales was partially offset by an
increase in sales from the Company’s emergency vehicle product (“EVP”)
business.  Sales related to the EVP business increased by
approximately $116,000 and $307,000 for the three and nine months ended February
29, 2008, respectively compared to the three and nine months ended February 28,
2007.





The
decrease in product sales from the Company’s other operations for the three and
nine months ended February 29, 2008 compared to the same period from the prior
fiscal year is primarily related to a decrease in sales from the car dealer
expediter business due to decreased demand for aftermarket automotive and car
audio products. Sales from the Company’s car dealer expediter business decreased
by approximately $153,000 and $357,000 for the three and nine months ended
February 29, 2008, respectively compared to the same periods from the prior
fiscal year.





Cost of products
sold:  The decrease in cost of products sold is due primarily
to the overall decrease in the Company’s product sales revenues for the three
and nine months ended February 29, 2008 compared to the three and nine months
ended February 28, 2007.   The reduction in costs was less than
the reduction in sales due to lower profit margins earned on the sale of
cellular handsets and accessories from the Company’s cellular operations along
with lower margins from the Company’s wholesale and car dealer expediter
business.





Selling and General and
Administrative Expenses for the Three and Nine Months ended February 29, 2008
and February 28, 2007





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


41





(dollars
      in thousands)
                          
                          February
      29,
                          
                          
                          February
      28,
                          
                          
                          2008
      vs 20072008
                          
                          
                          2007
                          
                          
                          $ Change
                          
                          
                          % ChangeThree Months EndedSelling
      and general and administrativeSalaries
      and other personnel expenses
                          
                          $
                          3,018
                          
                          
                          $
                          3,426
                          
                          
                          $
                          (408
                          )
                          
                          
                          -12
                          %Office
      expense
                          
                          
                          544
                          
                          
                          
                          505
                          
                          
                          
                          39
                          
                          
                          
                          8
                          %Advertising
      expense
                          
                          
                          309
                          
                          
                          
                          285
                          
                          
                          
                          24
                          
                          
                          
                          8
                          %Professional
      fees
                          
                          
                          246
                          
                          
                          
                          386
                          
                          
                          
                          (140
                          )
                          
                          
                          -36
                          %Taxes
      and licenses fees
                          
                          
                          61
                          
                          
                          
                          78
                          
                          
                          
                          (17
                          )
                          
                          
                          -22
                          %Stock-based
      compensation expense
                          
                          
                          28
                          
                          
                          
                          23
                          
                          
                          
                          5
                          
                          
                          
                          22
                          %Other
      expenses
                          
                          
                          490
                          
                          
                          
                          414
                          
                          
                          
                          76
                          
                          
                          
                          18
                          %Total
      selling and general and administrative
                          
                          $
                          4,696
                          
                          
                          $
                          5,117
                          
                          
                          $
                          (421
                          )
                          
                          
                          -8
                          %Nine Months EndedSelling
      and general and administrativeSalaries
      and other personnel expenses
                          
                          $
                          9,948
                          
                          
                          $
                          9,325
                          
                          
                          $
                          623
                          
                          
                          
                          7
                          %Office
      expense
                          
                          
                          1,578
                          
                          
                          
                          1,511
                          
                          
                          
                          67
                          
                          
                          
                          4
                          %Advertising
      expense
                          
                          
                          983
                          
                          
                          
                          828
                          
                          
                          
                          155
                          
                          
                          
                          19
                          %Professional
      fees
                          
                          
                          877
                          
                          
                          
                          2,155
                          
                          
                          
                          (1,278
                          )
                          
                          
                          -59
                          %Taxes
      and licenses fees
                          
                          
                          155
                          
                          
                          
                          196
                          
                          
                          
                          (41
                          )
                          
                          
                          -21
                          %Stock-based
      compensation expense
                          
                          
                          88
                          
                          
                          
                          40
                          
                          
                          
                          48
                          
                          
                          
                          120
                          %Other
      expenses
                          
                          
                          1,651
                          
                          
                          
                          1,254
                          
                          
                          
                          397
                          
                          
                          
                          32
                          %Total
      selling and general and administrative
                          
                          $
                          15,280
                          
                          
                          $
                          15,309
                          
                          
                          $
                          (29
                          )
                          
                          
                          0
                          %





Selling and General and
Administrative Expenses Discussion for the Three and Nine Months Ended February
29, 2008 and February 28, 2007





The
decrease in salaries and other personnel expenses for the three months ended
February 29, 2008 compared to the three months ended February 28, 2007 is
attributable to a decrease in bonus and commission expenses as a result of a
decrease in personnel due to the restructure of the Company’s business units in
August 2007.  Total expenses for bonuses and commissions decreased by
approximately $454,000 in the three months ended February 29, 2008 compared to
the same period from the prior fiscal year. The increase in salaries and other
personnel expenses for the nine months ended February 29, 2008 compared to the
nine months ended February 28, 2007 is due to an increase in severance expenses
of approximately $346,000 related to the restructure of the Company’s business
units in August 2007.  In addition contract labor and employee health
insurance expenses increased by approximately $174,000 and $66,000 in the nine
months ended February 29, 2008, respectively compared the same period from the
prior fiscal year.





The
increase in advertising expense for the three and nine months ended February 29,
2008 compared to the three and nine months ended February 28, 2007 is a result
of the Company aggressively advertising through print media including newspaper
advertising and the use of promotional flyers with customer
billing.





The
decrease in professional fees for the three and nine months ended February 29,
2008 compared to the three and nine months ended February 28, 2007 is due to
legal costs related to PCI’s debt restructure and the acquisition of PCI in the
first quarter of fiscal year 2007.  There were no similar occurring
expenses recorded in fiscal year 2008.





The
increase in stock-based compensation expense for the three and nine months ended
February 29, 2008 compared to the same periods from the prior fiscal year is due
to the Company issuing stock options to the Company’s executive management and
directors in the second, third and fourth quarter of fiscal year 2007 and the
third quarter of fiscal year 2008.  The compensation expense is
recognized ratably over the vesting period of the options.


42


The
increase in other expenses for the three and nine months ended February 29, 2008
compared to the three and nine months ended February 28, 2007 is primarily
attributable to approximately $206,000 in fees paid to extend the maturity date
of PCI’s Senior Debt with Fortress. In addition the Company experienced an
increase in computer related costs of approximately $54,000 in the nine months
ended February 29, 2008 compared to the nine months ended February 28,
2007.





Other Operating Expenses for
the Three and Nine Months Ended February 29, 2008 and February 28,
2007





(dollars
      in thousands)February
      29,
                                
                                
                                February
      28,
                                
                                
                                2008
      vs 20072008
                                
                                
                                2007
                                
                                
                                $ Change
                                
                                
                                % ChangeThree Months EndedOther
      Operating ExpensesDepreciation
      and amortization:Depreciation
                                
                                $
                                146
                                
                                
                                $
                                238
                                
                                
                                $
                                (92
                                )
                                
                                
                                -39
                                %Amortization
                                
                                
                                221
                                
                                
                                
                                213
                                
                                
                                
                                8
                                
                                
                                
                                4
                                %Total
      depreciation and amortization
                                
                                
                                367
                                
                                
                                
                                451
                                
                                
                                
                                (84
                                )
                                
                                
                                -19
                                %Loss(gain)
      on disposal of assets
                                
                                
                                (17
                                )
                                
                                
                                1
                                
                                
                                
                                (18
                                )
                                
                                
                                1800
                                %Total
      other operating expenses
                                
                                $
                                350
                                
                                
                                $
                                452
                                
                                
                                $
                                (102
                                )
                                
                                
                                -23
                                %Nine Months EndedOther
      Operating ExpensesDepreciation
      and amortization:Depreciation
                                
                                $
                                507
                                
                                
                                $
                                773
                                
                                
                                $
                                (266
                                )
                                
                                
                                -34
                                %Amortization
                                
                                
                                663
                                
                                
                                
                                647
                                
                                
                                
                                16
                                
                                
                                
                                2
                                %Total
      depreciation and amortization
                                
                                
                                1,170
                                
                                
                                
                                1,420
                                
                                
                                
                                (250
                                )
                                
                                
                                -18
                                %Gain
      on forgiveness of trade payable obligation to AT&T
                                
                                
                                (3,824
                                )
                                
                                
                                -
                                
                                
                                
                                (3,824
                                )
                                
                                
                                100
                                %Loss(gain)
      on disposal of assets
                                
                                
                                (34
                                )
                                
                                
                                15
                                
                                
                                
                                (49
                                )
                                
                                
                                327
                                %Total
      other operating expenses (income)
                                
                                $
                                (2,688
                                )
                                
                                $
                                1,435
                                
                                
                                $
                                (4,123
                                )
                                
                                
                                -287
                                %





The
decrease in depreciation for the three and nine months ended February 29, 2008
compared to the three and nine months ended February 28, 2007 is attributable to
the Company’s minimal purchases of fixed assets for its corporate offices and
retail locations as well as a reduction in capital expenditures related to the
two-way network infrastructure.  In addition, the age of certain
existing capital assets also contributed to the decrease in depreciation as
these assets became fully depreciated year over year. The slight increase in
amortization expense for the three and nine months ended February 29, 2008 is
due to loan origination fees related to loans the Company executed in May 2007
to refinance the office building in Fort Worth, TX





Gain on forgiveness of trade payable
obligation to AT&T:  On June 1, 2007, the Company
entered into a Compromise Settlement and Release Agreement (the “Settlement”)
with New Cingular Wireless PCS, LLC (successor in interest to Southwestern Bell
Wireless Inc.) as General Partner of the Houston Cellular Telephone Company
L.P., successor to Dallas SMSA Limited Partnership (referred to as
“AT&T”).  In the Settlement the Company asserted it had incurred
damages in connection with alleged actions of AT&T in connection with the
Distribution Agreement between both parties effective September 1, 1999, as
amended by the Amendment to Distribution Agreement effective November 12,
1999 (the” Distribution Agreement”). The Company’s claims related to the
recovery of amounts previously remitted and/or owed to AT&T with respect to
intracompany roaming costs and /or charges. These intracompany roaming charges
were being assessed as the Company’s customer’s were traveling outside their
home calling area but still remained in an area covered by cellular systems
owned by AT&T. In connection with the allegation, the Company asserted
claims with regard to reimbursement of amounts previously remitted and disputes
the amounts owed with respect to such intracompany roaming costs and/or charges.
In addition to the claims related to intracompany roaming costs and/or charges,
the Company asserted claims related to various other actions, including but not
limited to equipment and availability, rate plan disclosures, additional
distribution, the provisions of billing and usage information, claims related to
the customers billed by the Company, along with other dealings and transactions
between both parties and those arising out of and in connections with the
Distribution Agreement (the “Dispute”). Also in the Settlement, AT&T denied
liability with respect to the Dispute.


43





As part
of the Settlement, both parties agreed to compromise and settle all disputes,
claims or causes of action of any kind asserted or which could have been
asserted regarding the Dispute, each without admitting any liability to the
other.





The
parties agreed to the following:




(1)
            Upon
      execution of the Settlement, both parties entered into a Second Amendment
      to the Distribution Agreement dated June 1,
  2007.




(2)
            As
      part of the terms of the Second Amendment, AT&T agreed to apply
      certain sections as identified in the Second Amendment that relate to
      amounts to be remitted to AT&T for intracompany roamer airtime
      retroactively back to November 1,
2005.




(3)
            The
      parties agreed that upon payment of $4,660,751 by the Company to AT&T
      on or before June 8, 2007 to settle outstanding payables owed by the
      Company, net of what the Company had previously made deductions from
      remittances with respect to certain amounts previously remitted to
      AT&T, no further amount will be due by either party to the other with
      respect to such intracompany roaming costs or other charges for the period
      up to the effective date of the Settlement, except for payments due by the
      Company for April and May 2007 billing cycles, which were calculated and
      remitted in accordance with the Second
  Amendment.





As a
result, the Company recognized a gain of $3,824,000 in June 2007. The material
gain is recorded separately as an offset to Operating Expenses and reported on
the Company’s Consolidated Statement of Operations as “Gain on forgiveness of
trade obligation” in the Company’s consolidated statements of
operations.





Loss (gain) on disposal of
assets:  The increase in the gain on the disposal of assets for
the three months ended February 29, 2008 compared to the three months ended
February 28, 2007 is due to the gain recorded on the disposal of PCI’s paging
business.  No similar transactions occurred in the third quarter of
fiscal year 2007. The increase in the gain on the disposal of assets for the
nine months ended February 29, 2008 compared to the nine months ended February
28, 2007 is also related to the disposal of PCI’s paging business as well
as  the sale of discontinued video and sound displays which were once
located in the Hawk Electronics retail stores.  No similar
transactions occurred in the nine months ended February 28, 2007.





Interest Expense, Net of
Interest Income for the Three and Nine Months Ended February 29, 2008 and
February 28, 2007


44





(dollars
      in thousands)
                        
                        February
      29,
                        
                        
                        February
      28,
                        
                        
                        2008
      vs 20072008
                        
                        
                        2007
                        
                        
                        $ Change
                        
                        
                        % ChangeThree Months EndedInterest
      expense (income)Senior
      debt
                        
                        $
                        439
                        
                        
                        $
                        370
                        
                        
                        $
                        69
                        
                        
                        
                        19
                        %Warrant
      redemption notes payable
                        
                        
                        -
                        
                        
                        
                        125
                        
                        
                        
                        (125
                        )
                        
                        
                        -100
                        %Thermo
      factoring debt
                        
                        
                        501
                        
                        
                        
                        216
                        
                        
                        
                        285
                        
                        
                        
                        132
                        %Mortgage
      debt
                        
                        
                        75
                        
                        
                        
                        10
                        
                        
                        
                        65
                        
                        
                        
                        650
                        %Other
                        
                        
                        (1
                        )
                        
                        
                        (1
                        )
                        
                        
                        -
                        
                        
                        
                        0
                        %Total
      interest expense, net
                        
                        $
                        1,014
                        
                        
                        $
                        720
                        
                        
                        $
                        294
                        
                        
                        
                        41
                        %





February
      29,
                            
                            
                            February
      28,
                            
                            
                            2008
      vs 20072008
                            
                            
                            2007
                            
                            
                            $ Change
                            
                            
                            % ChangeNine Months EndedInterest
      expense (income)Senior
      debt
                            
                            $
                            1,276
                            
                            
                            $
                            1,432
                            
                            
                            $
                            (156
                            )
                            
                            
                            -11
                            %Subordinated
      debt
                            
                            
                            -
                            
                            
                            
                            306
                            
                            
                            
                            (306
                            )
                            
                            
                            -100
                            %Warrant
      redemption notes payable
                            
                            
                            -
                            
                            
                            
                            359
                            
                            
                            
                            (359
                            )
                            
                            
                            -100
                            %Thermo
      factoring debt
                            
                            
                            1,526
                            
                            
                            
                            596
                            
                            
                            
                            930
                            
                            
                            
                            156
                            %Mortgage
      debt
                            
                            
                            231
                            
                            
                            
                            25
                            
                            
                            
                            206
                            
                            
                            
                            824
                            %Other
                            
                            
                            (6
                            )
                            
                            
                            8
                            
                            
                            
                            (14
                            )
                            
                            
                            -175
                            %Total
      interest expense, net
                            
                            $
                            3,027
                            
                            
                            $
                            2,726
                            
                            
                            $
                            301
                            
                            
                            
                            11
                            %





Interest
expense recorded for all periods presented is a combination of cash interest and
non-cash interest, primarily related to the Company’s debt facilities with
Thermo Credit LLC and the Senior Debt of PCI with Fortress Credit Corp.
(“Fortress”).  In August 2006, PCI paid $10,000,000 of its $18,700,000
Senior Debt payable to Fortress Credit Corp., and was conditionally released
from the balance of this debt, and its assets were conditionally released from
all related liens.  The remaining $8,700,000 payable to Fortress was
assumed by TLLP, the parent company of Teletouch, with the common stock of
Teletouch owned by TLLP pledged as collateral against the Senior
Debt.   Concurrent with the assumption of the Senior Debt by
TLLP, PCI, Teletouch and Fortress entered into a Transaction Party Agreement
(“TPA”), which provided Fortress with certain control over the ongoing
operations of Teletouch and PCI as well as provided for the contingent
re-instatement of the liens on PCI assets if certain conditions were not
maintained by either Teletouch or PCI.  Because of the conditional
nature of the release, the Senior Debt payable to Fortress continues to be
presented as an obligation of the Company subsequent to August 2006 and the
related interest expense is recorded even though TLLP assumed responsibility for
all future cash payments on the Senior Debt in August 2006.





In order
raise sufficient cash to make the $10,000,000 payment to Fortress, PCI entered
into a new factoring facility with Thermo secured by PCI’s accounts receivable,
which provided approximately up to $10,000,000 of available advances against
PCI’s accounts receivable (the “Thermo Factoring Debt”).  On August
11, 2006 approximately $6,200,000 was advanced to PCI under the factoring
facility, which was primarily used to make the required payment to Fortress. The
Thermo factoring facility was further amended in May 2007 and February
2008.  As of February 2008, the factoring facility provides cash
funding up to $15,000,000, depending on the amount of accounts receivable
available to pledge to Thermo. The discount fees on each of the advanced
fundings by Thermo are recorded as interest expense on the Company’s
Consolidated Statement of Operations.





The
increase in interest expense for the three months ended February 29, 2008
compared to the three months ended February 28, 2007 is due to an increase in
discount fees incurred on the factoring debt facility with Thermo due to an
increased borrowing capability, which resulted from an increase in cellular
billings.  In addition the Company recorded interest expense
associated with the borrowings received from Thermo Credit, LLC on the advances
against future customer obligations beginning in May 2007. The increase of
interest expense recorded in the third quarter of fiscal year 2008 is offset
with a decrease in interest expense recorded related to the common stock
purchase warrants (the “GM Warrants”), which were fully accreted as of May 31,
2007.


45





The
increase in interest expense for the nine months ended February 29, 2008
compared to the nine months ended February 28, 2007 is also due to the increase
in discount fees incurred on the factoring debt facility with Thermo as
mentioned above.  This increase is offset with a decrease in non-cash
interest expense related to PCI’s Senior Debt with Fortress due to the principal
payment made in the first quarter of fiscal year 2007 as well as a decrease in
non-cash interest expense related to PCI’s former subordinated debt, which was
assumed by TLLP through a capital contribution transaction in August
2006.  In addition the decrease in interest expense related to the
common stock purchase warrants also helped offset the increase in interest
expense recorded in the nine months ended February 29, 2008 compared to the nine
months ended February 28, 2007.





Income Tax Expense for the
Three and Nine Months Ended February 29, 2008 and February 28,
2007





In all
the periods presented, the combined operations of the Company did not generate a
federal tax liability. Income tax expense remained flat in the three months
ended February 29, 2008 compared to the three months February 28, 2007 but
increased by approximately $91,000 in the nine months ended February 29, 2008
compared to the same period from the prior fiscal year. The increase is due to
an increase in state tax expense primarily related to the Texas margin
tax.  The Texas 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.  The provisions of the Texas margin tax became
effective for the Company in fiscal year 2008.




FINANCIAL
CONDITION





(dollars
      in thousands)
                      
                      Nine Months EndedFebruary
      29,
                      
                      
                      February
      28,
                      
                      
                      2008
      vs 20072008
                      
                      
                      2007
                      
                      
                      $ ChangeCash
      provided by (used in) operating activities
                      
                      $
                      (5,583
                      )
                      
                      $
                      4,951
                      
                      
                      $
                      (10,534
                      )Cash
      provided by (used in) investing activities
                      
                      
                      (172
                      )
                      
                      
                      3,145
                      
                      
                      
                      (3,317
                      )Cash
      provided by (used in) financing activities
                      
                      
                      671
                      
                      
                      
                      (6,758
                      )
                      
                      
                      7,429Net
      increase (decrease) in cash
                      
                      $
                      (5,084
                      )
                      
                      $
                      1,338
                      
                      
                      $
                      (6,422
                      )





Operating
Activities





The
decrease in cash provided by operations during the nine months ended February
29, 2008 compared to the nine months ended February 28, 2007 is primarily
attributable to a decrease in the Company’s accounts payable
balances.  During the first quarter of fiscal year 2008, the Company
recognized a $3,824,000 non-cash gain on forgiveness of a trade payable
obligation to AT&T related to disputed intracompany roaming costs and/or
charges by AT&T due to a settlement agreement, which was executed between
the Company and AT&T in June 2007.  The agreement settled all
claims against the Company related to the recovery of amounts previously
remitted and/or owed to AT&T with respect to intracompany roaming costs
and/or charges.  The Company continued to accrue for the monthly
intracompany roaming costs and/or charges billed by AT&T in its Consolidated
Statement of Operations but delayed the payment of other accounts payable due to
AT&T until final resolution of the dispute. As a result of the agreement,
the Company was required to pay $4,661,000 of its past due accounts payable in
June 2007 to settle outstanding payables owed to AT&T.  The
decrease is also related to a change in the Company’s accounts receivable
balances primarily the result of increased data charges from the Company’s
cellular subscriber base.


46





Investing
Activities





The
decrease in cash provided by investing activities for the nine months ended
February 29, 2008 compared to the nine months ended February 28, 2007 is due to
the sale of the assets of Teletouch’s paging business which resulted in proceeds
of approximately $3,000,000 in the first quarter of fiscal year
2007.





Financing
Activities





The
increase in cash provided by financing activities for the nine months ended
February 29, 2008 compared to the nine months ended February 28, 2007 is
primarily due to a $10,000,000 principal payment made to the PCI senior debt
holder, Fortress Credit Corporation, offset by borrowings received from Thermo
Credit, LLC due to the factoring of the PCI accounts receivable beginning in
August 2006 with no similar transactions occurring in the nine months ended
February 29, 2008.





Current
Position/Future Requirements





Most of
the Company’s efforts during the remainder of fiscal year 2008 will continue to
focus on the integration issues related to the acquisition of PCI as well as
securing financing to complete one or more acquisitions to provide revenue
growth for the Company. PCI had historically been a privately held company which
presented challenges of migrating the systems and processes of PCI to those
required of a public company. During fiscal year 2008, the management team will
work on implementing a series of basic internal controls and processes along
with authorization levels, which were lacking while PCI was a privately held
company. Beginning with the year ending May 31, 2008, the Company’s
management will be required to internally assess and report on its internal
controls over financial reporting under the rules of Section 404 of the
Sarbanes-Oxley Act of 2002.





Another
equally as important focus at PCI is improving profitability. PCI has generated
net losses in several of its recent years, and our focus is on implementing cost
control initiatives at PCI while seeking additional opportunities to grow
revenues. The Company continues to evaluate new electronic products to introduce
in its retail and website outlets that could be marketed to its existing
customer base. PCI’s 80,000 cellular subscribers are comprised of individuals
and businesses of higher than average credit worthiness due to PCI’s stringent
credit standards.





For
fiscal year 2008, a large part of Teletouch’s efforts will be on timeliness in
its financial reporting. The Company’s financial reporting delays were caused
primarily by the acquisition of PCI in August 2006. Since that time its
inability to complete its audits and file the required financials has hindered
the Company’s ability to secure additional financing to grow the business. Until
these financial reporting and audit matters are concluded, the Company will
continue to manage closely its operating expenses to improve profitability.
Since the August 2006 acquisition of PCI, many personnel and process changes
have been completed to allow for and promote organic growth in its current
business units. In order to realize this organic growth, the Company has added
additional sales personnel and locations, increased its internet marketing
activities and enhanced its systems and processes to allow for the timely
integration of new product lines.





The core
business of Teletouch is providing cellular services to customers through PCI’s
distribution agreements with AT&T. The primary distribution agreement with
AT&T expires in August 2009. The Company cannot guarantee this agreement
with AT&T will be extended beyond its expiration date. Under the terms of
the current distribution agreement, if the agreement is not renewed by AT&T,
the Company would be allowed to continue to provide services to its existing
subscribers until these subscribers terminate service. Under this scenario the
Company could experience accelerated reductions in its cellular service revenues
beginning in September 2009 due to its inability to replace customers that
disconnect service in the normal course of business. Because of the potential
change in the Company’s cellular services business, the Company is aggressively
working to develop its other business units as well as evaluating its
alternatives to maintain the recurring revenues generated by its current
cellular subscriber base.


47





Going
Concern Matters




The
Company had a working capital deficit of approximately $22,760,000 and
$24,029,000 at February 29, 2008 and May 31, 2007, respectively, and a
shareholders’ deficit of approximately $17,015,000 and $17,387,000 at February
29, 2008 and May 31, 2007, respectively.  The Company’s senior debt
(the “Senior Debt”) payable to Fortress totaled approximately $11,154,000 and
$9,878,000 at February 29, 2008 and May 31, 2007, respectively. The Senior
Debt was due and payable in full on April 14, 2006. In September 2005, the
Company executed amendments with its senior and subordinated debt holders under,
which they agreed to waive the existing events of default and defer interest
payments on the subordinated debt until after the maturity of the Senior Debt on
April 14, 2006. In August 2006, prior to the acquisition by Teletouch, PCI
was successful in negotiating a restructuring of its debt obligations with both
its senior and subordinated lenders under which it was fully released from the
balance of $9,782,000 in subordinated debt which was converted to redeemable
equity at Teletouch’s parent company, TLL Partners, LLC (“TLLP”). TLLP also
assumed the full balance remaining on PCI’s senior debt obligations (after a
$10,000,000 cash payment to the lender by the PCI) and PCI was conditionally
released from having any future payment obligations under the Senior Debt and
all liens on the assets of PCI were conditionally released as long as certain
terms of a Transaction Party Agreement (“TPA”) by and among PCI, Teletouch, TLLP
and the senior lender, Fortress Credit Corp. (“Fortress”) were not violated (see
Note 3 “Acquisition of Progressive Concepts, Inc.” for further information on
the Company’s debt restructuring). The TPA provided Fortress with certain
control over the ongoing operations of Teletouch and PCI as well as provided for
the contingent re-instatement of the liens on PCI assets if certain conditions
were not maintained by either Teletouch or PCI. A TPA was required by Fortress
in order to assure that PCI or Teletouch would not take actions which in
Fortress’ view could reduce the value of Fortress’ security. Under the terms of
the TPA both PCI and Teletouch are bound to comply with certain negative
covenants. If either PCI or Teletouch breaches the TPA or violates any of the
negative covenants then Fortress can reinstate the Senior Debt at PCI to the
fullest extent available under the law as if the debt restructuring had never
occurred. PCI is conditionally released from having any future payment
obligations under the Senior Debt as long as the terms of the TPA are not
violated. However, in accordance with Statement of Financial Accounting Standard
No. 140, “Accounting for the Transfers and Servicing of Financial Assets
and Extinguishments of Liabilities” (“SFAS 140”), PCI must be legally released
from being the primary obligor under the Senior Debt in order to de-recognize
this liability. Because of the existence of the TPA which allows Fortress
limited control of PCI and Teletouch and a contingent ability to reinstate the
debt at PCI, we believe that PCI has not been fully released from being the
primary obligor under the Senior Debt as contemplated by SFAS 140 as of
February 29, 2008. In addition, 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 nor does it have any current plans to declare
dividends in order to allow TLLP to meet the debt obligations. Therefore, PCI
and Teletouch will continue to report the Senior Debt as a liability on its
balance sheet until such time as the debt is fully satisfied by TLLP or when PCI
and Teletouch are released from the TPA.




Beginning
in June 2007, the Company has experienced higher than normal cellular subscriber
attrition due primarily to the launch of the iPhone. Although the iPhone is
offered to customers by AT&T, PCI has been denied the approval to sell or
activate the iPhone for customers by AT&T. The Company reviews its staffing
levels on a quarterly basis and continues to seek ways to consolidate and
automate necessary functions in order to control personnel or other operating
costs. In addition the Company is focused on seeking additional distribution for
existing products lines including an emphasis on internet marketing. There can
be no assurance the Company’s current efforts to increase revenues or continue
to reduce costs will be successful nor is there any assurance that the trade
credit that is currently extended to the Company will be maintained or expanded
for fiscal 2008 to facilitate this growth. The Company is continuing to seek
additional debt and equity financing to ensure it is able to meet its remaining
trade and debt obligations as well as provide sufficient working capital to
continue and grow its operations. If it is unsuccessful in its efforts to secure
additional financing, the Company may be unable to meet its obligations and
might be forced to seek protection from its creditors.


48





In
addition the Company’s factoring debt obligation with Thermo has been presented
as a current liability on the Company’s consolidated balance sheet at
February 29, 2008 and May 31, 2007, in accordance with EITF 95-22, because
the factoring agreement requires a lockbox agreement under which customer
payments on accounts are directed to a lockbox controlled by Thermo and because
certain subjective acceleration rights are retained by Thermo under the
agreement. However, the stated maturity date of the obligation is February 2010.
The factoring debt obligations at February 29, 2008 and May 31, 2007, were
approximately $9,079,000 and $8,352,000, respectively.





As a
result of the above conditions, there exists substantial doubt about the
Company’s ability to continue as a going concern.  No adjustments have
been made to the Company’s financial statements as a result of this
uncertainty.





Obligations
and Commitments




As of
February 29, 2008, our contractual payment obligations under our long-term debt
agreements and operating leases for office and transmitter locations are
indicated in the table below.  For purposes of the table below, other
current liabilities is comprised of certain redeemable common stock warrants
issued in conjunction with the Company’s debt restructuring in May
2002.  Also included below under debt obligations is a senior debt
obligation that was assumed by Teletouch’s parent company, TLLP, in August
2006.  This senior debt obligation continues to be reported by Company
as discussed below.


Payments
Due By Period
 (in
thousands)
 
 Twelve
      Months Ending February 28 or February 29,Significant Contractual Obligations
                            
                            Total
                            
                            
                            2009
                            
                            
                            2010
                            
                            
                            2011
                            
                            
                            2012
                            
                            
                            TherafterDebt
      obligations, including interest
                            
                            $
                            24,485
                            
                            
                            $
                            20,841
                            
                            
                            $
                            277
                            
                            
                            $
                            274
                            
                            
                            $
                            274
                            
                            
                            $
                            2,819Operating
      lease obligations
                            
                            
                            6,890
                            
                            
                            
                            1,103
                            
                            
                            
                            755
                            
                            
                            
                            576
                            
                            
                            
                            408
                            
                            
                            
                            4,048Other
      current liabilities
                            
                            
                            3,000
                            
                            
                            
                            3,000
                            
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            -Total
      significant contractual cash obligaitons
                            
                            $
                            34,375
                            
                            
                            $
                            24,944
                            
                            
                            $
                            1,032
                            
                            
                            $
                            850
                            
                            
                            $
                            682
                            
                            
                            $
                            6,867





Redeemable
Common Stock Purchase Warrants: In November 2002, the Company issued
6,000,000 redeemable common stock purchase warrants as part of a debt
restructuring it completed in fiscal year 2003 (the “GM
Warrants”).  The GM Warrants were redeemable in December 2007 at $0.50
each but they have not been redeemed as of February 29, 2008 pending a new
payment arrangement with the warrant holders.  As
of  February 29, 2008 and May 31, 2007, the Company has recorded these
warrants as a current liability at their fair value of $3,000,000 (shown above
under “Other current liabilities”).  The GM Warrants were being
accreted in value over time to their redemption value of $3,000,000 in May 2007
according to their original terms.  See Note 14 of Notes to the
Consolidated Financial Statements for additional information on the GM
Warrants.





Teletouch’s Parent Company Senior
Debt: On August 11, 2006, Teletouch became the owner of all of the issued
and outstanding equity securities of PCI, by virtue of the contribution of 100%
of the issued and outstanding equity securities of PCI to Teletouch by TLLP,
without the issuance of any monetary or stock consideration by Teletouch (the
“PCI Acquisition”). Immediately preceding the PCI Acquisition, PCI and certain
of its affiliates entered into a debt restructuring, pursuant to which (i) PCI
paid $10,000,000 of its outstanding senior debt balance to Fortress Credit
Corp.(the “Senior Debt”), PCI’s senior lender (“Fortress”); (ii) PCI was
conditionally released from all of its remaining prior institutional debt, and
its assets were conditionally released from all related liens and (iii) certain
prior debt obligations of PCI were assumed by TLLP.


49





Concurrently
with the PCI Acquisition, PCI, Teletouch and Fortress entered into a Transaction
Party Agreement (“TPA”), which provided Fortress with certain control over the
ongoing operations of Teletouch and PCI as well as provided for the contingent
re-instatement of the liens on PCI assets if certain conditions were not
maintained by either Teletouch or PCI.  A TPA was required by Fortress
in order to assure that PCI or Teletouch would not take actions which in
Fortress’ view could reduce the value of Fortress’ security.  Under
the terms of the TPA both PCI and Teletouch are bound to comply with certain
negative covenants.  If either PCI or Teletouch breaches the TPA or
violates any of the negative covenants then Fortress can reinstate the Senior
Debt at PCI to the fullest extent available under the law as if the debt
restructuring had never occurred.  PCI is conditionally released from
having any future payment obligations under the Senior Debt as long as the terms
of the TPA are not violated.  However, in accordance with Statement of
Financial Accounting Standard No. 140, “Accounting for the Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities” (“SFAS 140”),
PCI must be legally released from being the primary obligor under the Senior
Debt in order to de-recognize this liability.  Because of the
existence of the TPA which allows Fortress limited control of PCI and Teletouch
and a contingent ability to reinstate the debt at PCI, we believe that PCI has
not been fully released from being the primary obligor under the Senior Debt as
contemplated by SFAS 140 as of February 29, 2008.  In addition, 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 nor does it
have any current plans to declare dividends in order to allow TLLP to meet the
debt obligations. Therefore, PCI and Teletouch will continue to report the
Senior Debt as a liability on its balance sheet until such time as the debt is
fully satisfied by TLLP or when PCI and Teletouch are released from the
TPA.





Off-Balance
Sheet Transactions




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




Application
of Critical Accounting Policies





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.





Basis of
Presentation and Accounting Treatment For The Acquisition of PCI by
Teletouch:The consolidated
financial statements include the accounts of Teletouch Communications, Inc., a
Delaware corporation and Progressive Concepts, Inc., its wholly owned
subsidiary.


50


The
acquisition of PCI was completed on August 11, 2006 through the contribution of
the stock of PCI to Teletouch by TLL Partners, LLC, a Delaware LLC
(“TLLP”).  This transaction was considered a reorganization of
entities under common control since both PCI and Teletouch were under the common
control of TLLP prior to the reorganization. Prior to the reorganization, TLLP
controlled 100% of the outstanding common stock of PCI and approximately 80% of
the outstanding common stock of Teletouch. In accordance with the accounting
guidance under Emerging Issues Task Force Issue No. 90-5, “Exchanges of
Ownership Interests Between Entities Under Common Control” and Appendix D of
Statement of Financial Accounting Standards (“SFAS”) No. 141, “Business
Combinations,” the PCI contribution is accounted for in a manner similar to a
pooling of interests, which means that the historical basis of the net assets of
PCI are combined with those of Teletouch. As a result of this reorganization and
because PCI is consolidated with Teletouch, PCI’s year end was changed from a
calendar year ending December 31 to a fiscal year ending May 31 for financial
reporting purposes.





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.





Accounts
receivable are presented net of an allowance for doubtful accounts of $626,000
and $527,000 at February 29, 2008 and May 31, 2007,
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.





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 or other incentives, such as volume incentive rebates the Company has
received from the vendor. In addition, management established specific valuation
allowances for discontinued inventory based on its prior experience liquidating
this type of inventory.  Through the Company’s wholesale distribution
channel, 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 $223,000 and $518,000 at February 29, 2008 and May 31, 2007,
respectively.





Impairment
of Long-Lived Assets:In accordance with SFAS
No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (“SFAS
144”), 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.


51





The
Company’s review of the carrying value of its tangible long-lived assets at May
31, 2007 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, 2007.  There were no
significant events in the third quarter of fiscal year 2008 which required the
Company to review the carrying value of its tangible long-lived assets. 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 exceeds the carrying value of the
property.





In
accordance with SFAS 144, 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, 2007, 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. There
were no significant events in the third quarter of fiscal year 2008 which
required the Company to review the carrying value of its long-lived intangible
assets. 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.





Provision
for Income Taxes:The Company accounts for income taxes in accordance
with SFAS No. 109, “Accounting for Income Taxes” (“SFAS 109”), 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, 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. Therefore,
the parent company of Teletouch for federal tax purposes was deemed to be
PCCI.   The Company continued to account for its taxes under SFAS
109 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.


52





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 SFAS No. 142, “Goodwill and Other Intangible Assets” (“SFAS 142”).
Teletouch’s only intangible asset with an indefinite life is goodwill, which 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, 2007, the Company evaluated the carrying value of its goodwill associated
with its two-way business and concluded that no impairment of its goodwill is
required this year.  The Company estimates the fair value of its
two-way business using a discounted cash flow method.  No changes have
occurred in the two-way business during fiscal year 2008 that indicated any
impairment of the goodwill.  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.





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" (“SAB
104”). SAB 104 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) collectibility 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 through billing services and product
sales.  Billing services include customer billings for cellular
airtime, landline service, long distance service, internet service and pager
service.  Product sales include sales of cellular telephones,
accessories and car and home audio products through the Company’s retail and
wholesale operations.





Revenues
and related costs generated through the Company’s billing services are
recognized during the period in which the service is
rendered.  Associated 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 collectibility 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 actually realized.


53





Since
1987, the Company’s subsidiary, PCI, has held agreements with AT&T, 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.  Based on
PCI’s relationship with AT&T, the Company has evaluated its reporting of
revenues, under “Emerging Issues Task Force Issue 99-19, Reporting Revenue Gross
as a Principal versus Net as an Agent,” (“EITF 99-19”) associated with its
services attached to the AT&T agreements.





Based on
its assessment of the indicators listed in EITF 99-19, the Company has concluded
that the AT&T services provided by PCI should be reported on a net
basis.





Deferred
revenue represents prepaid monthly service fees paid by customers.





Stock-Based
Compensation:Upon
adoption of SFAS No. 123(R), “Share-Based Payments,” (“SFAS 123R”), on June 1,
2006, we began estimating the 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. As
of June 1, 2006, we adopted the modified prospective transition method, and its
effect is included in our consolidated financial statements for the three and
nine months ended February 29, 2008 and 2007.  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





We did
not have any foreign currency hedges or other derivative financial instruments
as of February 29, 2008.  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.





Item
4. Controls and Procedures





(a)  Controls
and Procedures





As of the
end of the period covered by this Report, under the supervision and with the
participation of management, including the Chief Executive Officer, President
and Chief Financial Officer (the “Certifying Officers”), the Company conducted
an evaluation of its disclosure controls and procedures. As defined in Rules
13a-15(e) and 15d-15(e) of the Exchange Act, the term “disclosure controls and
procedures” means controls and other procedures of an issuer that are designed
to ensure that information required to be disclosed by the issuer in the reports
that it files or submits under the Exchange Act is recorded, processed,
summarized and reported within the time periods specified in the Commission’s
rules and forms. Disclosure controls and procedures include, without limitation,
controls and procedures designed to ensure that information required to be
disclosed by an issuer in the reports that it files or submits under the
Exchange Act is accumulated and communicated to the issuer’s management,
including the Certifying Officers, to allow timely decisions regarding required
disclosure. The Certifying Officers have evaluated our disclosure controls as of
February 29, 2008 and have determined that certain control deficiencies
(discussed below) constitute a material weakness in our system of internal
control over financial reporting as of such date.


54





A
material weakness is a control deficiency, or combination of control
deficiencies, in internal control over financial reporting such that there is a
reasonable possibility that a material misstatement of the registrant’s annual
or interim financial statements will not be prevented or detected on a timely
basis.





Deficiencies
in Internal Control Over Financial Reporting





As
previously reported on August 11, 2006, Teletouch acquired all of the issued and
outstanding equity securities of Progressive Concepts, Inc. (“PCI”), through the
contribution of 100% of the issued and outstanding equity securities of PCI to
Teletouch by TLL Partners, LLC, the holder of approximately 80% of Teletouch’s
outstanding common stock, without the issuance of any monetary or stock
consideration by Teletouch.  The Company intended to file the
historical audited financial statements of PCI within the statutorily prescribed
timeframe in October 2006. Prior to the acquisition, PCI was a privately-held
company with financial statements based on a calendar year, which were
historically included in the audited consolidated financial statements of its
prior parent company, Progressive Concepts Communications, Inc. (“PCCI”). As of
the date of acquisition, the most recent PCCI audit that had been completed was
as of December 31, 2004. Teletouch engaged its auditors, BDO Seidman, LLP, to
complete a PCI audit for calendar year 2005 and engaged PCI’s previous parent
company’s auditors, Fort Worth-based Whitley Penn LLP, to audit PCI for the 2003
and 2004 calendar years on a stand-alone basis. Subsequent to BDO’s commencement
of its work on PCI’s 2005 calendar year audit, it became clear that a greater
than originally estimated amount of time and effort would be required to
complete the PCI audit due to a lack of completed and accurate general ledger
account reconciliations, difficulty in locating support for material entries
made to PCI’s historical books due to breakdown in the records retention policy
at PCI and certain integrity issues identified with PCI’s internally developed
general ledger system.





In
addition, Teletouch had significant difficulty in segregating various business
and related accounting events from the current and prior period PCCI
consolidated financials, including related subsidiary transactions, discontinued
(sold) operations and other accounting matters. Given the significant number of
these business transactions conducted by PCI in 2005, the ability to create
separate current and prior period financial reports for PCI’s operations on a
stand-alone basis caused substantial unanticipated delays.





Remediation
Steps to Address Material Weakness





The
Company has remediated the deficiencies in the PCI accounting systems and
records that caused the breakdown in its disclosure
controls.  Teletouch completed a conversion of PCI’s accounting system
to a new platform, which included a rebuilding of PCI’s internal accounting
records from 2003 and all periods thereafter. Beginning with 2005, the first
period for which audited financials were to be prepared following the
acquisition of PCI, all accounting transactions, specifically non-standard
transactions, were reviewed or re-created and all account reconciliations not
previously completed were prepared.  Most accounting personnel
previously employed by PCI have been replaced since the acquisition and all
current accounting personnel have been adequately trained on the current systems
and the processes related to reconciliations of the financial records. In
addition, Teletouch’s policy for records retention was implemented at PCI and
all staff members have been trained on this policy.





As of
February 29, 2008 the Company is delinquent in filings its Quarterly Reports on
Form 10-Q for the periods ended August 31, 2006, November 30, 2006 and February
28, 2007.  The Company is considering requesting relief from the SEC
on filing its delinquent fiscal year 2007 Quarterly Reports on Form
10-Q.


55





(b)  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.


56


Part
II.  Other Information





Item
1.     Legal Proceedings





Teletouch
is subject 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 could result in a material adverse effect on its
results of operations or financial condition.





Claim
Against  Company by Former Employee





In March
2008, the Company received a demand letter from Keith Cole, former CFO of PCI
and General Counsel for the Company.  Mr. Cole was terminated in
January 2008.  Mr. Cole has made a demand for certain compensation
that he believed was due prior to his termination.  The basis for this
claim is certain alleged verbal conversations with management of the
Company.  The total alleged unpaid compensation amount claimed by Mr.
Cole is approximately $455,000. The Company has submitted this claim to its
Employee Practices Liability carrier and intends to vigorously defend itself in
this matter.  The Company cannot predict the outcome of this matter at
this time.





Item
1A.  Risk Factors





Our
future performance is subject to a variety of risks.  If any of the
events or circumstances described in the following risk factors actually occurs,
our business, financial condition or results of operations could
suffer.  In addition to the following disclosures, please refer to the
other information contained in this report, including consolidated financial
statements and related notes, and information contained in the Company’s other
SEC filings.





We
could fail to remain a going concern.  We may need to raise additional
capital to fund our operations and service our existing trade and debt
obligations, and we do not have any commitments for that capital.





The
Company had a working capital deficit of approximately $22,760,000 and
$24,029,000 at February 29, 2008 and May 31, 2007, respectively, and a
shareholders’ deficit of approximately $17,015,000 and $17,387,000 at February
29, 2008 and May 31, 2007, respectively.  The Company’s senior debt
(the “Senior Debt”) payable to Fortress totaled approximately $11,154,000 and
$9,878,000 at February 29, 2008 and May 31, 2007, respectively. The Senior
Debt was due and payable in full on April 14, 2006. In September 2005, the
Company executed amendments with its senior and subordinated debt holders under,
which they agreed to waive the existing events of default and defer interest
payments on the subordinated debt until after the maturity of the Senior Debt on
April 14, 2006. In August 2006, prior to the acquisition by Teletouch, PCI
was successful in negotiating a restructuring of its debt obligations with both
its senior and subordinated lenders under which it was fully released from the
balance of $9,782,000 in subordinated debt which was converted to redeemable
equity at Teletouch’s parent company, TLL Partners, LLC (“TLLP”). TLLP also
assumed the full balance remaining on PCI’s senior debt obligations (after a
$10,000,000 cash payment to the lender by the PCI) and PCI was conditionally
released from having any future payment obligations under the Senior Debt and
all liens on the assets of PCI were conditionally released as long as certain
terms of a Transaction Party Agreement (“TPA”) by and among PCI, Teletouch, TLLP
and the senior lender, Fortress Credit Corp. (“Fortress”) were not violated (see
Note 3 “Acquisition of Progressive Concepts, Inc.” for further information on
the Company’s debt restructuring). Subsequent to the acquisition of PCI,
Teletouch continued to report this senior debt obligation on it financial
statements because in accordance with Generally Accepted Accounting Principles
(“GAAP”), it was concluded that PCI was not fully released as the primary
obligor, as defined under GAAP, due to certain provisions of the contingent
release in August 2006 which could allow the lender to reinstate the debt and
the liens as if they had never been released.  Therefore, PCI and
Teletouch will continue to report the Senior Debt as a liability on its balance
sheet until such time as the debt is fully satisfied by TLLP or when PCI and
Teletouch are released from the TPA. The Company is continuing to seek
additional debt and equity financing to ensure it is able to meet its remaining
trade and debt obligations as well as provide sufficient working capital to
continue and grow its operations. If it is unsuccessful in its efforts to secure
additional financing, the Company may be unable to meet its obligations and
might be forced to seek protection from its creditors.


57





As a
result of the above conditions and in accordance with generally accepted
accounting principles in the United States, there exists substantial doubt about
the Company’s ability to continue as a going concern. The financial statements
do not include any adjustments that might result from this
uncertainty.





Teletouch
may be unable to complete its future regulatory filings in a timely
manner.





Since the
acquisition of PCI on August 11, 2006, Teletouch has been unable to meet its
deadlines for filing its periodic reports with the SEC.  Because of
the common ownership of both PCI and Teletouch prior to the acquisition, the
acquisition of PCI was accounted for in a manner similar to a “pooling of
interests.”  Because of the pooling, PCI’s fiscal year was changed,
and the historical financials of PCI were required to be audited and combined
with Teletouch’s historical financials.  PCI was a privately held
company and although its parent company had been previously audited, PCI had
never been audited on a stand-alone basis.   This auditing
process had been ongoing but certain financial reporting challenges were
encountered, which delayed the progress on these audits.  Due to the
size of PCI relative to that of Teletouch at the date of acquisition, Teletouch
was required to file three consecutive years of audited financial statements for
PCI on a stand-alone basis with the SEC within 75 days of the completion of the
acquisition.  The latest date that these financials could have been
filed to be considered a timely filer was October 27, 2006. Once the Company
became a late filer with the SEC, then the Company became subject to more
comprehensive requirements related to future registration
statements.  These additional requirements to register its securities
for sale could directly impact its ability to raise the necessary capital to
grow the business.  Furthermore, once the Company became a late filer
with the SEC, Teletouch was in violation of the American Stock Exchange’s (the
“AMEX”) continued listing standards. On January 12, 2007, the Board of Directors
of the Company approved delisting of the Company’s securities from the AMEX and
the move of the listing of the Company’s securities to the Pink Sheets
electronic exchange.  The foregoing action by the Board was taken
following the delisting determination by the AMEX Panel issued on January 9,
2007.





As of
February 29, 2008, the Company is delinquent in filing its Quarterly Reports on
Form 10-Q for the quarters ended August 31, 2006, November 30, 2006 and February
28, 2007. The Company is considering requesting relief from the SEC on filing
its delinquent fiscal year 2007 Quarterly Reports on Form 10-Q.





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





Prior to
the acquisition of PCI, 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
December 11, 2007.  TLLP is a holding company with no operations and
only a minimal amount 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 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 its plan to settle this debt obligation is to
sell a sufficient number of its shares of Teletouch’s common stock in order to
raise the necessary funds when this obligation becomes payable. If TLLP is
unsuccessful in repaying these obligations, then the ownership of Teletouch
could substantially change in the future.  If the lenders foreclose on
Teletouch’s common stock owned by TLLP and become the majority shareholders of
Teletouch, then there is a risk these lenders could vote through matters that
may not be in the best interest of the shareholders as a whole.


58





Teletouch
may be unable to secure the financing needed for future
acquisitions.





Teletouch
may be unable to secure financing or only be presented with financing options
that contain unfavorable terms to finance future acquisitions.  If
financing is unavailable to the Company, Teletouch will be unable to complete
future acquisitions and would then be forced to grow its revenues from its
existing businesses, which to-date has proved difficult without additional
capital funding.





We
depend upon a limited number of suppliers, who may not provide us with
competitive products at reasonable prices when we need them in the future, or
have adequate financing to secure such products.




Our
business depends upon several factors, one of which is our relationship with
AT&T, the Company’s largest supplier of cellular services and
products.  The loss of AT&T or any other significant vendor, a
substantial price increase or decrease imposed by any vendor, a shortage or
oversupply of product available from our vendors or tightening of credit terms
by our vendors could have a material adverse impact on the Company. We are
dependent on maintaining open vendor trade credit lines on reasonable terms.
Interruption of these lines could have a material adverse impact and could
determine whether or not the Company can continue as a going concern. We cannot
assure you that product shortages, product surpluses or renewed tightening of
trade credit terms will not occur in the future.




The
loss of any of our key customers, a material reduction in our customer base for
cellular service or a reduction in prices charged to customers could have a
material adverse effect on our business.




Many of
our customers have experienced severe price competition and for this and other
reasons may seek to obtain products or services from us at lower prices than
previously provided. The Company’s wholesale business contains several key
customers.  As a result, we remain vulnerable to a significant loss of
revenues in the event we should lose any key customer.  The loss of any key
customer, a reduction in the amount of product or services from key customers or
the inability to maintain current terms, including price, with these or other
customers could have an adverse effect on our financial condition, results of
operations and liquidity. We do not maintain agreements with the majority of our
customers in the wholesale business, which increases the risk that such
relationships could be terminated at any time. The Company does maintain
contracts varying from one to two years with a portion of its customer base for
cellular service; however, the customer may elect to transfer to another carrier
at any time and incur a penalty fee.  We cannot assure you that any of
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.




The
demand for our products depends in large part on the continued growth of the
cellular industry. A marked decline in growth of the cellular industry and/or
demand for cellular products in the areas in which we operate could have an
adverse effect on our business.




Our
success depends largely upon continued consumer demand for cellular products.
While the industry has been experiencing growth, we cannot assure you that such
growth will continue or that we will be able to adjust our business model to
capitalize on that growth. The demand for our products and services has
fluctuated and may continue to vary substantially.


59




Economic
slowdowns or changes in promotional programs offered by AT&T may lower
consumer demand and create higher levels of inventories in our distribution
channels, resulting in lower than anticipated demand for the products and
services that we offer.





Any
type of systems failure could reduce sales, increase costs or result in
liability claims.





Despite
the Company’s implementation of preventive safety measures, Teletouch’s
technology is vulnerable to systems failure due to such things as computer
viruses, unauthorized access, energy blackouts, natural disasters and
telecommunications failures.  Any systems failure, accident or
security breach could cause significant interruptions in our
operations.  In addition, we could be subject to liability for any
loss or damage to our customers’ data or applications or inappropriate
disclosure of customers’ confidential information.  The cost to remedy
a systems failure, accident or security breach could have a significant effect
on our financial condition.





We cannot
be sure that our systems will operate appropriately if we experience a hardware
or software failure or if there is an earthquake, fire or other natural
disaster, a power or telecommunications failure, intentional disruptions of
service by third parties, an act of God or an act of war.  A failure
in our systems could cause us to be unable to service our customers or provide
timely and accurate billing, and as a result, we may lose customers or face
litigation that could involve material costs and distract management from
operating our business.





Any
defects in Teletouch’s products or in those provided to us by suppliers could
expose the Company to liability, damage its reputation and customer relations,
and adversely affect the development and release of future
products.





Teletouch’s
products are inherently complex; therefore, it is possible that any defects
contained therein may only be detectable once the product is in
use.  Given the critical services our products provide, these defects
could have a serious adverse impact on our customers, which could damage our
reputation, harm customer relations and expose us to liability.





Demand
for our products may be adversely affected by the increasing presence of our
competitors in these markets.





Although
Teletouch’s subsidiary, PCI has operated in the Dallas/Fort Worth metropolitan
market for over 20 years, demand for its products may be adversely affected by
the increasing presence of competitors.  These competitors are
comprised of competing cellular service providers, including the Company’s
primary supplier, AT&T.  Several of the Company’s competitors,
including AT&T, have more extensive marketing capabilities and greater
financial, technical and personnel resources.  Furthermore,
Teletouch’s competitors may have greater brand recognition, broader product
lines and more established customer relations.





Our
success depends on the introduction and acceptance of new products and
services.





The
telecommunications market is constantly changing, due in part to technological
advances, evolving industry standards and the development of new
products.  Teletouch’s future success will depend partly on our
ability to keep up with these changes by purchasing new products for resale and
developing unique service offerings with a high market demand.  If we
fail to identify such products and services in response to market demands, we
could fail to obtain an adequate return on our investments and could lose market
share to our competitors.




60




We
face risks inherent in new product and service offerings as well as new
markets.




From time
to time, we introduce new products and services or expand our previous product
and service offerings to existing and target markets.  Our products
must therefore be considered in light of the risks, expenses, problems and
delays inherent in establishing new lines of business in a rapidly changing
industry.  Although we believe we can successfully differentiate our
product and service offerings from others in the marketplace, we must be able to
compete against other companies, who may already be established in the
marketplace and have greater resources. There can be no assurance we will be
successful in adding products or services or expanding into new markets or that
our administrative, operational, infrastructure and financial resources and
systems will be adequate to accommodate such offerings or
expansion.





We
may incur losses if we are unable to collect our accounts
receivable.




Although
the Company entered into a factoring facility with Thermo in August 2006, the
Company, as part of the agreement, continues to service the accounts
receivables.  The Company is subject to recourse on the accounts
receivables if they age over 90 days from the due date.  As a result,
accounts receivable management continues to be important to the Company’s
liquidity. The Company uses credit management tools, which include credit
scoring services in the Company’s operations, to manage its accounts receivable
exposure. Several factors can affect the collection of our accounts receivable,
including, but not limited to, the financial health of the customer, industry
and economic conditions, our policies related to extending credit, contractual
provisions and the ability of the customer to provide security, collateral or
guarantees relative to credit granted by us. Adverse changes in any of these
factors, some of which may not be wholly within our control, could create delays
in collecting or an inability to collect our accounts receivable, which could
have a material adverse effect on our financial position, cash flows and results
of operations.




Our
future operating results will depend on our ability to maintain or improve
operating margins.




The
Company’s primary source of revenue is generated from its subsidiary, PCI,
through the sale of AT&T’s cellular service and the related sale of wireless
products.  Any disruption in the relationship between PCI and AT&T
could have a material adverse effect on the Company’s financial position, cash
flows and results of operations.  Our ability to be successful will
depend upon our ability to maintain or improve our operating margins. Given the
fixed revenue share relationship with AT&T on the service billings, PCI can
only improve gross margins through the introduction of add-on services to these
cellular subscribers.  Under the agreement with AT&T, PCI absorbs
100% of the cost of third party roaming charges incurred by its customer base
under its primary Dallas/Fort Worth, Texas distribution
agreement.  Gross margins could be negatively affected by increased
roaming usage by its customer base, which is difficult to predict and
control.  We may not be able to improve our current operating margins
for products or services offered or increase our sales. Even if our sales
volumes increase, the gross margins that we receive from our sales may not be
sufficient to make our operations profitable.




Teletouch
may be unsuccessful in obtaining and enforcing intellectual property
protection.





The
Company’s ability to compete with its competitors in the markets that it
operates depends in part on its ability to enforce its intellectual property
rights, such as the Hawk Electronics name.  The Company’s subsidiary,
PCI has operated under the Hawk Electronics name since the late 1970’s in the
Dallas/Fort Worth market, and the brand recognition provides some advantage to
PCI over its competitors.





If we
determine that our intellectual property rights have been infringed upon or if
we are notified that we are infringing upon certain intellectual property
rights, the Company may become involved in litigation.  Such
litigation or claims could result in substantial costs and diversion of
resources.  Furthermore, an adverse result in an action against the
Company may require that we pay substantial damages, cease operating under the
Hawk Electronics name and expend significant resources to either license the
infringing brand name or develop a non-infringing brand name.  We
cannot give any assurance that we would be able to develop a similar
non-infringing brand name quickly enough in the market to continue to remain
competitive with more well-known brand competitors.


61





Compliance
with changing regulation of corporate governance and public disclosure may
result in additional expenses.





Changing
laws, regulations and standards relating to corporate governance and public
disclosure, including the Sarbanes-Oxley Act of 2002, new SEC regulations and
stock exchange rules, have required most public companies, including our
Company, to devote additional internal and external resources to various
governance and compliance matters.  Because we have a relatively small
corporate staff, we rely heavily on outside professional advisers to assist us
with these efforts.  As a result, we incurred additional operating
expenses in 2007 and 2008 and will incur further expenses in the
future.  These future costs will include increased accounting related
fees associated with preparing the attestation report on our internal controls
over financial reporting as required under Section 404 of the Sarbanes-Oxley Act
of 2002 by May 2010.  In addition, these new or changed laws,
regulations and standards are subject to varying interpretations, as well as
modifications by the government and stock exchanges.  The way in which
they are applied and implemented may change over time, which could result in
even higher costs to address and implement revisions to compliance (including
disclosure) and governance practices.





Our
products are subject to government regulation.





Two-way
radio communications are subject to regulation by the
government.  Teletouch’s two-way radio products and technology must
conform to domestic rules and regulations established to avoid interference
among users and facilitate interconnection of telecommunications
systems.  It is our opinion that our products and technology are in
compliance with all currently existing government rules and
regulations.  However, new rules or regulations could adversely affect
our business by requiring that current products or technology be modified to
comply with such rules or regulations or by rendering current products or
technology obsolete.  Furthermore, Teletouch cannot predict if and
when new rules or regulations will come into effect.  Regulatory
changes could adversely affect our business by restricting our development of
our services and increasing the opportunity for additional
competition.





The
Federal Communications Commission (the “FCC”) must approve renewal applications
for Teletouch’s radio licenses.





The FCC
grants radio licenses for varying terms of up to 10 years, and the FCC must
approve renewal applications.  There can be no assurance that the FCC
will approve or act upon Teletouch’s future applications in a timely
manner.  Delays in or denial of our renewal applications could
adversely affect our business operations, which could reduce our revenues and
decrease our level of profitability.





Future
applications by Teletouch for additional transmitter sites to expand our
coverage on existing frequencies must be approved by the FCC.





Teletouch
regularly applies to the FCC to use additional frequencies and to add additional
transmitter sites to expand coverage on existing frequencies.  Under
current FCC guidelines, we can expand our coverage and add additional sites only
under frequencies below 929 MHz.  All other frequencies below 929 MHz
on which Teletouch holds licenses are frozen in a status quo condition pending
the final announcement and implementation of geographic area licensing
auctions.  In addition, FCC approval is required for the Company’s
acquisitions of radio licenses held by other companies, as well as transfers of
controlling interests of any entities that hold radio
licenses.  Teletouch cannot be sure that the FCC will approve or act
upon the Company’s future applications in a timely manner.  Denial or
delayed approval by the FCC could affect our business operations, which could
reduce our revenues and adversely affect our level of
profitability.


62





Also, all
major modification and expansion applications are subject to competitive bidding
procedures.  Teletouch cannot predict the impact that these procedures
will have on its licensing practices.





The
global wireless industry is intensely competitive, and we may not be able to
continue to compete successfully in this industry.




We
operate in a highly competitive environment and believe that such competition
will intensify in the future. We compete primarily on the basis of inventory
availability and selection, price, delivery time and service. Many of our
competitors are larger and have greater capital and management resources than we
do. We are constantly exposed to the risk that our competitors may obtain access
to new technologies before we do or may offer lower prices, additional products
or services or other incentives that we cannot or will not offer. In addition,
potential users of wireless systems may find their communications needs
satisfied by other current and developing technologies. During the last several
years, the telecommunications industry has been very volatile as a result of
overcapacity, which has led to price erosion and bankruptcies.  If the
Company cannot control subscriber and customer attrition through maintaining
competitive services and pricing, revenue could decrease
significantly.  Our ability to remain competitive will therefore
depend upon our ability to anticipate and adapt our business to such
technological changes and our ability to achieve significant penetration in
existing and new geographic markets. There can be no assurance that we will be
successful in anticipating and adapting to such technological
changes.





Terrorist
attacks or acts of war may seriously harm our business.





Terrorist
attacks or acts of war may cause damage or disruption to our operations, our
employees, our facilities and our customers, which could significantly impact
our revenues, costs and expenses, and financial condition.  The
terrorist attacks that took place in the United States on September 11, 2001
were unprecedented events that have created many economic and political
uncertainties, some of which may materially adversely affect our business,
results of operations and financial condition.  The potential for
future terrorist attacks, the national and international responses to terrorist
attacks, and other acts of war or hostility have created many economic and
political uncertainties, which could materially adversely affect our business,
results of operations, and financial condition in ways that management currently
cannot predict.





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





None





Item
3.     Defaults Upon Senior Securities





None





Item
4.     Submission of Matters to a Vote of Security
Holders





None





Item
5.     Other Information





None


63





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


64


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:
      December 23, 2009
                    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)


65