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 November 30, 2009





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  x  No o





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





Yes  o  No o





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





Large
accelerated filer  o    
Accelerated filer  o    Non-accelerated
filer  o    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 o  No
x





Indicate
the number of shares outstanding of each of the Registrant’s classes of Common
Stock, as of the latest practicable date:  Common Stock, $0.001 par
value, 48,739,002 shares at January 14, 2010.








TELETOUCH
COMMUNICATIONS, INC.





TABLE OF
CONTENTS





Page
      No.Part
      I.  Financial InformationItem
      1.
                                Financial
      Statements - Teletouch Communications, Inc .
                                4Consolidated
      Balance Sheets as of November 30, 2009 (unaudited)and
      May 31, 2009 (unaudited)
                                4Consolidated
      Statements of Operations – Three and Six Months EndedNovember
      30, 2009 (unaudited) and November 30, 2008 (unaudited)
                                6Consolidated
      Statements of Cash Flows - Six Months EndedNovember
      30, 2009 (unaudited) and November 30, 2008 (unaudited)
                                7Notes
      to Consolidated Financial Statements (unaudited)
                                8Item
      2.
                                Management’s
      Discussion and Analysis of FinancialCondition
      and Results of Operations
                                32Item
      3.
                                Quantitative
      and Qualitative Disclosures About Market Risk
                                52Item 4T.
                                Controls
      and Procedures
                                52Part
      II.  Other InformationItem
      1.
                                Legal
      Proceedings
                                53Item
      2.
                                Unregistered
      Sales of Equity Securities and Use of Proceeds
                                53Item
      3.
                                Defaults
      Upon Senior Securities
                                54Item
      4.
                                Submission
      of Matters to a Vote of Security Holders
                                54Item
      5.
                                Other
      Information
                                54Item
      6.
                                Exhibits
                                54Signatures
                                55


2


Forward-Looking
Statements





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


3





PART
1 – FINANCIAL INFORMATION





Item
1.   Financial Statements





TELETOUCH
COMMUNICATIONS, INC.


CONSOLIDATED
BALANCE SHEETS


(unaudited)


(in
thousands, except share data)





ASSETS





November 30,
                
                
                May 31,2009
                
                
                2009CURRENT
      ASSETS:Cash
                
                $
                5,408
                
                
                $
                4,642Certificates
      of deposit-restricted
                
                
                100
                
                
                
                300Accounts
      receivable, net of allowance of $501 at November 30, 2009 and $486 at May
      31, 2009
                
                
                5,419
                
                
                
                5,853Unbilled
      accounts receivable
                
                
                2,720
                
                
                
                3,002Inventories,
      net of reserve of $246 at November 30, 2009 and $242 at May 31,
      2009
                
                
                1,930
                
                
                
                1,547Notes
      receivable
                
                
                20
                
                
                
                903Prepaid
      expenses and other current assets
                
                
                597
                
                
                
                652Patent
      held for sale
                
                
                257
                
                
                
                -Total
      Current Assets
                
                
                16,451
                
                
                
                16,899PROPERTY
      AND EQUIPMENT, net of accumulated depreciation of $7,185 at November 30,
      2009 and $7,118 at May 31, 2009
                
                
                2,814
                
                
                
                2,949GOODWILL
                
                
                343
                
                
                
                343INTANGIBLE
      ASSETS, net of accumulated amortization of $8,476 at November 30, 2009 and
      $7,996 at May 31, 2009
                
                
                3,929
                
                
                
                4,165TOTAL
      ASSETS
                
                $
                23,537
                
                
                $
                24,356





See
Accompanying Notes to Consolidated Financial Statements


4





TELETOUCH
COMMUNICATIONS, INC.


CONSOLIDATED
BALANCE SHEETS


(unaudited)


(in
thousands, except share data)





LIABILITIES
AND SHAREHOLDERS’ DEFICIT





November
      30,
                  
                  
                  May
      31,2009
                  
                  
                  2009CURRENT
      LIABILITIES:Accounts
      payable
                  
                  $
                  9,807
                  
                  
                  $
                  11,167Accounts
      payable-related party
                  
                  
                  93
                  
                  
                  
                  95Accrued
      expenses and other current liabilities
                  
                  
                  6,198
                  
                  
                  
                  6,790Current
      portion of long-term debt
                  
                  
                  549
                  
                  
                  
                  1,313Deferred
      revenue
                  
                  
                  299
                  
                  
                  
                  339Total
      Current Liabilities
                  
                  
                  16,946
                  
                  
                  
                  19,704LONG-TERM
      DEBT, net of current portion
                  
                  
                  16,528
                  
                  
                  
                  15,103TOTAL
      LIABILITIES
                  
                  
                  33,474
                  
                  
                  
                  34,807COMMITMENTS
      AND CONTINGENCIES
                  
                  
                  -
                  
                  
                  
                  -SHAREHOLDERS'
      DEFICIT:Common
      stock, $.001 par value, 70,000,000 shares authorized, 49,916,189 shares
      issued and 48,739,002 and 49,051,980 shares outstanding at November 30,
      2009 and May 31, 2009
                  
                  
                  50
                  
                  
                  
                  50Additional
      paid-in capital
                  
                  
                  51,116
                  
                  
                  
                  50,947Treasury
      stock, 1,177,187 shares held at November 30, 2009 and 864,209 shares held
      at May 31, 2009
                  
                  
                  (216
                  )
                  
                  
                  (185
                  )Accumulated
      deficit
                  
                  
                  (60,887
                  )
                  
                  
                  (61,263
                  )Total
      Shareholders' Deficit
                  
                  
                  (9,937
                  )
                  
                  
                  (10,451
                  )TOTAL
      LIABILITIES AND SHAREHOLDERS' DEFICIT
                  
                  $
                  23,537
                  
                  
                  $
                  24,356





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
                
                
                Six
      Months EndedNovember 30,
                
                
                November 30,2009
                
                
                2008
                
                
                2009
                
                
                2008Operating
      revenues:Service,
      rent, and maintenance revenue
                
                $
                6,556
                
                
                $
                6,744
                
                
                $
                13,214
                
                
                $
                13,746Product
      sales revenue
                
                
                7,323
                
                
                
                4,448
                
                
                
                12,123
                
                
                
                10,332Total
      operating revenues
                
                
                13,879
                
                
                
                11,192
                
                
                
                25,337
                
                
                
                24,078Operating
      expenses:Cost
      of service, rent and maintenance (exclusive of depreciation and
      amortization included below)
                
                
                1,910
                
                
                
                2,274
                
                
                
                3,875
                
                
                
                4,708Cost
      of products sold
                
                
                6,668
                
                
                
                4,089
                
                
                
                11,072
                
                
                
                9,392Selling
      and general and administrative
                
                
                3,975
                
                
                
                4,170
                
                
                
                8,173
                
                
                
                8,675Depreciation
      and amortization
                
                
                319
                
                
                
                355
                
                
                
                645
                
                
                
                729Loss
      (gain) on disposal of assets
                
                
                -
                
                
                
                (1
                )
                
                
                1
                
                
                
                (1
                )Total
      operating expenses
                
                
                12,872
                
                
                
                10,887
                
                
                
                23,766
                
                
                
                23,503Operating
      income
                
                
                1,007
                
                
                
                305
                
                
                
                1,571
                
                
                
                575Interest
      expense, net
                
                
                (569
                )
                
                
                (619
                )
                
                
                (1,072
                )
                
                
                (1,254
                )Income
      (loss) before income tax expense
                
                
                438
                
                
                
                (314
                )
                
                
                499
                
                
                
                (679
                )Income
      tax expense
                
                
                62
                
                
                
                81
                
                
                
                123
                
                
                
                162Net
      income (loss)
                
                $
                376
                
                
                $
                (395
                )
                
                $
                376
                
                
                $
                (841
                )Income
      (loss) per share applicable to common shareholders - basic and
      diluted
                
                $
                0.01
                
                
                $
                (0.01
                )
                
                $
                0.01
                
                
                $
                (0.02
                )Weighted
      average basic and diluted shares outstanding
                
                
                48,739,002
                
                
                
                49,051,980
                
                
                
                48,817,674
                
                
                
                49,051,980





See
Accompanying Notes to Consolidated Financial Statements


6





TELETOUCH
COMMUNICATIONS, INC.


CONSOLIDATED
STATEMENTS OF CASH FLOWS


(in
thousands)


(unaudited)





Six
      Months EndedNovember 30,2009
                    
                    
                    2008Operating
      Activities:Net
      income (loss)
                    
                    $
                    376
                    
                    
                    $
                    (841
                    )Adjustments
      to reconcile net income (loss) to net cash provided by (used in) operating
      activities:Depreciation
      and amortization
                    
                    
                    645
                    
                    
                    
                    729Non-cash
      compensation expense
                    
                    
                    169
                    
                    
                    
                    86Non-cash
      interest expense
                    
                    
                    32
                    
                    
                    
                    76Provision
      for losses on accounts receivable
                    
                    
                    489
                    
                    
                    
                    382Provision
      for inventory obsolescence
                    
                    
                    3
                    
                    
                    
                    146Loss
      (gain) on disposal of assets
                    
                    
                    1
                    
                    
                    
                    (1
                    )Changes
      in operating assets and liabilities:Accounts
      receivable
                    
                    
                    227
                    
                    
                    
                    660Inventories
                    
                    
                    (386
                    )
                    
                    
                    95Notes
      receivable
                    
                    
                    -
                    
                    
                    
                    4Prepaid
      expenses and other assets
                    
                    
                    55
                    
                    
                    
                    104Accounts
      payable
                    
                    
                    (1,362
                    )
                    
                    
                    (451
                    )Accrued
      expenses and other current liabilities
                    
                    
                    (592
                    )
                    
                    
                    150Deferred
      revenue
                    
                    
                    (40
                    )
                    
                    
                    17Net
      cash provided by (used in) operating activities
                    
                    
                    (383
                    )
                    
                    
                    1,156Investing
      Activities:Purchases
      of property and equipment
                    
                    
                    (40
                    )
                    
                    
                    (211
                    )Redemption
      of certificates of deposit
                    
                    
                    200
                    
                    
                    
                    -Net
      proceeds from sale of assets
                    
                    
                    2
                    
                    
                    
                    1Receipts
      from (issuance of) notes receivable
                    
                    
                    601
                    
                    
                    
                    (263
                    )Net
      cash provided by (used in) investing activities
                    
                    
                    763
                    
                    
                    
                    (473
                    )Financing
      Activities:Proceeds
      from long-term debt
                    
                    
                    1,373
                    
                    
                    
                    250Payments
      on long-term debt
                    
                    
                    (956
                    )
                    
                    
                    (645
                    )Payments
      on redeemable common stock purchase warrants
                    
                    
                    -
                    
                    
                    
                    (1,500
                    )Purchase
      of treasury stock
                    
                    
                    (31
                    )
                    
                    
                    -Net
      cash provided by (used in) financing activities
                    
                    
                    386
                    
                    
                    
                    (1,895
                    )Net
      increase (decrease) in cash
                    
                    
                    766
                    
                    
                    
                    (1,212
                    )Cash
      at beginning of period
                    
                    
                    4,642
                    
                    
                    
                    4,729Cash
      at end of period
                    
                    $
                    5,408
                    
                    
                    $
                    3,517Supplemental
      Cash Flow Data:Cash
      payments for interest
                    
                    $
                    1,040
                    
                    
                    $
                    1,187Cash
      payments for income taxes
                    
                    $
                    272
                    
                    
                    $
                    235Non-Cash
      Transactions:Transfer
      of redeemable common stock purchase warrants to long-term
    debt
                    
                    $
                    -
                    
                    
                    $
                    1,500Capitalization
      of loan origination fees
                    
                    $
                    244
                    
                    
                    $
                    -Intangible
      asset received for payment of note receivable
                    
                    $
                    257
                    
                    
                    $
                    -Fixed
      assets received for payment of note receivable
                    
                    $
                    25
                    
                    
                    $
                    -





See
Accompanying Notes to Consolidated Financial Statements


7


TELETOUCH COMMUNICATIONS,
INC.





NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(unaudited)





NOTE
1 – BASIS OF PRESENTATION AND NATURE OF BUSINESS





Nature of Business: Teletouch
Communications, Inc. was incorporated under the laws of the State of Delaware in
July 1994 and its corporate headquarters are in Fort Worth, Texas. References to
Teletouch or the Company as used throughout this document mean Teletouch
Communications, Inc. or Teletouch Communications, Inc. and its subsidiaries, as
the context requires.





For over
40 years, Teletouch has offered a comprehensive suite of telecommunications
products and services under the Teletouch and AT&T® brands, including
cellular, two-way radio, GPS-telemetry, wireless messaging and public
safety/emergency response products and services. Teletouch operates
approximately 20 retail stores and service locations in Texas. Locations include
both “Teletouch” and “Hawk Electronics” branded in-line and free-standing stores
and service centers. The Teletouch branded locations offer the Company’s own
two-way radio network. Teletouch’s wholly-owned subsidiary, Progressive
Concepts, Inc. (“PCI”) is a Master Distributor and Authorized Provider of
cellular voice, data and entertainment services though AT&T Mobility
(“AT&T”) to consumers, businesses and government agencies and markets these
services under the Hawk Electronics brand name. For over 20 years, PCI has
offered various communication services on a direct bill basis and today services
approximately 66,000 cellular subscribers. PCI sells consumer electronics
products and cellular services through its stores, its own network of
Hawk-branded sub-agents stores, its own direct sales force and on the Internet
at various sites, including its primary consumer-facing sites: www.hawkelectronics.com and www.hawkexpress.com. The Company
handles all aspects of the wireless customer relationship,
including:




•
            Initiating
      and maintaining all subscribers’ cellular, two-way radio and other service
      agreements;


•
            Determining
      credit scoring standards and underwriting new account
      acquisitions;


•
            Handling
      all billing, collections, and related credit risk through its own
      proprietary billing systems;


•
            Providing
      all facets of real-time customer support, using a proprietary, fully
      integrated Customer Relationship Management (CRM) system through its own
      24x7x365 call centers and the
Internet.





In
addition, PCI operates a national wholesale distribution business, “PCI
Wholesale,” which serves major carrier agents, rural cellular carriers, smaller
consumer electronics and automotive retailers and auto dealers throughout the
country, with ongoing product and sales support through www.pciwholesale.com and www.pcidropship.com, among other
sites. Teletouch also sells safety and emergency response vehicle products and
services under the brand “Teletouch EVP” (Emergency Vehicle Products) directly
and through www.teletouchevp.com. Teletouch
periodically acquires minority equity positions in cellular-related technology
companies, including most recently, Apple, Inc., iPhone mobile applications
developer and provider, Redmond, WA-based Mobui Corporation
(www.mobui.com).




Basis of Presentation: In
June 2009, the Financial Accounting Standards Board (“FASB”) issued
Accounting Standards Codification 105 (“ASC”), Generally Accepted
Accounting Principles, which became the single source of authoritative
nongovernmental U.S. generally accepted accounting principles (“GAAP”),
superseding existing FASB, American Institute of Certified Public Accountants
(“AICPA”), Emerging Issues Task Force (“EITF”), and related accounting
literature. This pronouncement reorganizes the thousands of GAAP pronouncements
into roughly 90 accounting topics and displays them using a consistent
structure. Also included is relevant Securities and Exchange Commission guidance
organized using the same topical structure in separate sections and will be
effective for financial statements issued for reporting periods that end after
September 15, 2009. This will have an impact on our financial disclosures
since all future references to authoritative accounting literature will be
references in accordance with ASC 105.


8


The
accompanying unaudited interim consolidated financial statements included herein
as of November 30, 2009 and for each of the three and six months ended November
30, 2009 and 2008, have been prepared by the Company without an audit, pursuant
to accounting principles generally accepted in the United States of America and
in accordance with the rules and regulations of the Securities and Exchange
Commission (“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., a Texas corporation (“PCI”), Teletouch Licenses, Inc., a Delaware
corporation (“TLI”), Visao Systems, Inc., a Delaware corporation (“Visao”) and
TLL Georgia, Inc., a Delaware corporation (“TLLG”). PCI is the primary operating
business of Teletouch. TLI is a company formed for the express purpose of owning
all of the FCC licenses utilized by Teletouch on its two-way radio network.
Visao is a company formed to develop and distribute the Company’s telemetry
products, which as of the date of this Report are no longer being sold.
Currently Visao is maintained as a shell company with no operations. TLLG was
formed for the express purpose of entering into an asset purchase agreement with
Preferred Networks, Inc. in May 2004 and ceased operations following the sale of
the Company’s paging business in August 2006. TLLG is currently a shell
company.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 six months ended November 30, 2009, are
not necessarily indicative of the results which will be realized for the year
ending May 31, 2010.





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 2009 Annual Report on Form
10-K.





In
accordance with ASC 855, Subsequent Events, we evaluated subsequent events
through the date and time our consolidated financial statements were issued on
January 14, 2010.





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.




9




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 November 30, 2009 and May 31, 2009, the Company had a $100,000 and
$300,000, respectively, cash certificate of deposit securing a standby letter of
credit with one of 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.




In
determining the adequacy of the allowance for doubtful accounts, management
considers a number of factors, including historical collections experience,
aging of the receivable portfolio, financial condition of the customer and
industry conditions. The Company considers an account receivable past due when
customers exceed the terms of payment granted to them by the Company. The
Company writes-off its fully reserved accounts receivable when it has exhausted
all collection efforts, which is generally within 90 days following the last
payment received on the account.




Accounts
receivable are presented net of an allowance for doubtful accounts of $501,000
and $486,000 at November 30, 2009 and May 31, 2009, respectively. Based on the
information available to the Company, management believes the allowance for
doubtful accounts as of those periods are adequate. However, actual write-offs
may exceed the recorded allowance.





The
Company evaluates its write-offs on a monthly basis. The Company determines
which accounts are uncollectible, and those balances are written-off against the
Company’s allowance for doubtful accounts balance.




Reserve for Inventory Obsolescence:Inventories are stated at the lower of cost (primarily on a moving
average basis), which approximates actual cost determined on a first-in,
first-out (“FIFO”) basis, or fair market value and are comprised of finished
goods. In determining the adequacy of the reserve for inventory obsolescence,
management considers a number of factors including recent sales trends, industry
market conditions and economic conditions. In assessing the reserve, management
also considers price protection credits the Company expects to recover from its
vendors when the vendor cost on certain inventory items is reduced shortly after
purchase of the inventory by the Company. In addition, management establishes
specific valuation allowances for discontinued inventory based on its prior
experience 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 $246,000 and $242,000 at November 30, 2009 and May
31, 2009, respectively. Actual results could differ from these
estimates.




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





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


10


Intangible Assets:Intangible
assets are comprised of certain definite lived assets as well as a single
indefinite lived asset which is goodwill. Goodwill is not amortized but
evaluated annually (or more frequently) for impairment under ASC 350, Intangibles-Goodwill and
Other, (“ASC 350”). Definite lived intangible assets, including
capitalized loan origination costs, the purchase and development of key
distribution agreements, purchased subscriber bases and FCC license acquisition
costs, are amortized over the estimated useful life of the asset and reviewed
for impairment upon any triggering event that gives rise to any question as to
the assets ultimate recoverability as prescribed under ASC 360, Property, Plant and
Equipment, (“ASC 360”).





Indefinite
Lived Intangible Assets: The Company 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 guidance provided by ASC 350. Under ASC 350,
goodwill testing for impairment 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 ASC 350, companies are required to test for
impairment of goodwill at least annually. Teletouch’s goodwill asset 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 cost associated with acquiring the cellular distribution agreements
with AT&T, purchased subscriber bases, FCC licenses, internally developed
software and loan origination costs. The Company does not capitalize customer
acquisition costs in the normal course of business but would capitalize the
purchase costs of acquiring customers from a third party. Intangible assets are
carried at cost less accumulated amortization. Amortization on the wireless
contracts is computed using the straight-line method over the contract’s
expected life. The estimated useful lives for the intangible assets are as
follows:





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





The
Company defers certain direct costs in obtaining loans and amortizes such
amounts using the straight-line method over the expected life of the loan, which
approximates the effective interest method as follows:





Loan
      origination costs
              
              2-5
      years


11


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





Amortization
of the distribution agreements, subscriber bases, FCC licenses and internally
developed software is considered an operating expense and included in
“Depreciation and Amortization” in the accompanying consolidated statements of
operations. The Company periodically reviews the estimated useful lives of its
identifiable intangible assets, taking into consideration any events or
circumstances that might result in a lack of recoverability or revised useful
life.





Impairment of Long-lived
Assets: In accordance with ASC 360, the Company evaluates the
recoverability of the carrying value of its long-lived assets based on estimated
undiscounted cash flows to be generated from such assets. If the undiscounted
cash flows indicate 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 exceeded the carrying value of the
property.




Asset Held for Sale: In
accordance with ASC 360, the Company will reclassify certain long-lived assets
as a current asset held for sale on the Company’s consolidated balance sheet if
certain requirements are met. In order for an asset to be held for sale
under the provisions of ASC 360, management must determine the asset is to be
held for sale in its current condition, an active plan to complete the sale of
the asset has been initiated and the sale of the asset is probable within one
year. The Company evaluated the hotspot network patent it acquired during the
public auction of all of Air-bank, Inc.’s assets in July 2009 and has determined
this asset met all the criteria for an asset held for sale under ASC 360. At
November 30, 2009, the patent is recorded as a current asset held for sale on
the Company’s consolidated balance sheet for approximately
$257,000.




12




Provision for Income Taxes:The Company accounts for income taxes in accordance with ASC 740, Income Taxes, (“ASC 740”)
using the asset and liability approach, which requires recognition of deferred
tax liabilities and assets for the expected future tax consequences of temporary
differences between the carrying amounts and the tax basis of such assets and
liabilities. This method utilizes enacted statutory tax rates in effect for the
year in which the temporary differences are expected to reverse and gives
immediate effect to changes in income tax rates upon enactment. Deferred tax
assets are recognized, net of any valuation allowance, for temporary
differences, net operating loss and tax credit carry forwards. Deferred income
tax expense represents the change in net deferred assets and liability balances.
Deferred income taxes result from temporary differences between the basis of
assets and liabilities recognized for differences between the financial
statement and tax basis thereon and for the expected future tax benefits to be
derived from net operating losses and tax credit carry forwards. A valuation
allowance is recorded when it is more likely than not that deferred tax assets
will be unrealizable in future periods. As of November 30, 2009 and May 31,
2009, the Company has recorded a valuation allowance against the full amount of
its net deferred tax assets even though it does forecast taxable income for
fiscal year 2010, but the Company is not able to reasonably forecast taxable
income beyond this 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.




On
November 1, 2005, the Company became a member of the consolidated tax group of
Progressive Concepts Communications, Inc. (“PCCI”) as a result of PCCI’s gaining
control of over 80% of the outstanding common stock of Teletouch on that date.
PCCI gained control of Teletouch’s common stock through the conversion by TLL
Partners, LLC (“TLLP”), PCCI’s wholly-owned subsidiary, of all of its shares of
the Company’s outstanding Series C Preferred Stock into 43,500,000 shares of
common stock on November 1, 2005. As of November 1, 2005, TLLP was a disregarded
entity for federal tax purposes since it was at that time a single member
limited liability company. Therefore, the parent of Teletouch for federal tax
purposes was deemed to be PCCI. The Company continued to account for its taxes
under ASC 740 and record its deferred taxes on a stand-alone basis while part of
PCCI’s consolidated tax group. In August 2006, as a result 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.




Revenue Recognition:Teletouch
recognizes revenue over the period the service is performed in accordance with
SEC Staff Accounting Bulletin No. 104, “Revenue Recognition in Financial
Statements” and ASC 605, Revenue Recognition, (“ASC
605”). In general, ASC 605 requires that four basic criteria must be met before
revenue can be recognized: (1) persuasive evidence of an arrangement exists, (2)
delivery has occurred or services rendered, (3) the fee is fixed and
determinable and (4) 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 recurring cellular services
and through product sales. Cellular services include 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 cellular services are
recognized during the period in which the service is rendered. Associated
subscriber 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.





13




Since
1987, Teletouch’s subsidiary, PCI, has held agreements with AT&T, which
allowed PCI to offer cellular service and provide the billing and customer
services to its subscribers. PCI is compensated for the services it provides
based upon sharing a portion of the monthly billings revenues with AT&T. PCI
is responsible for the billing and collection of cellular charges from these
customers and remits a percentage of the cellular billings generated to
AT&T. Based on its relationship with AT&T, the Company has evaluated its
reporting of revenues under ASC 605-45, Revenue Recognition, Principal Agent
Considerations (“ASC 605-45”) associated with its services attached to
the AT&T agreements. Included in ASC 605-45 are eight indicators that must
be evaluated to support reporting gross revenue. These indicators are (i) the
entity is the primary obligor in the arrangement, (ii) the entity has general
inventory risk before customer order is placed or upon customer return, (iii)
the entity has latitude in establishing price, (iv) the entity changes the
product or performs part of the service, (v) the entity has discretion in
supplier selection, (vi) the entity is involved in the determination of product
or service specifications, (vii) the entity has physical loss inventory risk
after customer order or during shipment and (viii) the entity has credit risk.
In addition, ASC 605-45 includes three additional indicators that support
reporting net revenue. These indicators are (i) the entity’s supplier is the
primary obligor in the arrangement, (ii) the amount the entity earns is fixed
and (iii) the supplier has credit risk. Based on its assessment of the
indicators listed in ASC 605-45, the Company has concluded that the AT&T
services provided by PCI should be reported on a net basis.




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 mid-size to small 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 large base of small to mid-size cellular carriers, agents and
resellers as well as a large group of smaller electronics and car audio dealers
throughout the United States. As a result, no significant concentration of
credit risk exists. The Company performs periodic credit evaluations of its
customers to determine individual customer credit risks and promptly terminates
services for nonpayment.




Financial Instruments: The
Company’s financial instruments consists of certificates of deposit-restricted,
accounts receivable, accounts payable and debt. Management believes the carrying
value of its financial instruments approximates fair value due to the short
maturity of the current assets and liability and the reasonableness of the
interest rates on the Company’s debt.




Advertising and Pre-opening Costs:Labor costs, costs of hiring and training personnel and certain other
costs relating to the opening of new retail locations are expensed as incurred.
Additionally, advertising costs are expensed as incurred although the Company is
partially reimbursed based on various vendor agreements.




Stock-based Compensation:At November 30, 2009 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.


14


We
account for stock-based awards to employees in accordance with ASC 718, Compensation-Stock
Compensation, (“ASC 718”) and for stock based awards to non-employees in
accordance with ASC 505-50, Equity, Equity-Based Payments to
Non-Employees (“ASC 505-50”). Under both ASC 718 and ASC 505-50, we use a
fair value based method to determine compensation for all arrangements where
shares of stock or equity instruments are issued for compensation. For share
option instruments issued, compensation cost is recognized ratably using the
straight-line method over the expected vesting period.




Cash
flows resulting from excess tax benefits are classified as a financing activity.
Excess tax benefits are realized from tax deductions for exercised options in
excess of the deferred tax asset attributable to stock compensation costs for
such options. The Company did not record any excess tax benefits as a result of
any exercises in stock options in the three and six months ended November 30,
2009 and 2008 because the Company provided for a full valuation allowance
against all accrued future tax benefits for all periods presented
until its operations improve and the Company is able to forecast taxable income
in the future sufficient to utilize its deferred tax assets.





For the
six months ended November 30, 2009 and 2008, the Company elected to use the
Black-Scholes option-pricing model to calculate the fair value of stock-based
awards. The Black-Scholes option-pricing model 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 six months ended November
30, 2009 was 240.4 % and ranged from 172.6% to 173.7% for the options issued in
the six months ended November 30, 2008. 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 six months ended
November 30, 2009 was 5.0 years and ranged from 5.0 years to 6.0 years for the
options issued in the six months ended November 30, 2008. 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 six months ended November 30, 2009 was
2.55% and ranged from 3.39% to 3.54% for the options issued in the six months
ended November 30, 2008. Dividend yield is zero for these options as the Company
does not expect to declare any dividends on its common shares in the foreseeable
future.





In
addition to the key assumptions used in the Black-Scholes model, the estimated
forfeiture rate at the time of valuation is a critical assumption.  The
Company has estimated an annualized forfeiture rate of 0.0% for the stock
options granted to senior management and the Company’s directors in the six
months ended November 30, 2009 and 2008. The Company reviews the expected
forfeiture rate annually to determine if that percent is still reasonable based
on historical experience.





Options
exercisable at November 30, 2009 and May 31, 2009 totaled 3,095,211
and 1,424,326, respectively. The weighted-average exercise price per
share of options exercisable at November 30, 2009 and May 31, 2009 was $0.27 and
$0.38, respectively, with remaining weighted-average contractual terms of
approximately 7.4 years and 6.2 years, respectively.





The
weighted-average grant date fair value of options granted during the six months
ended November 30, 2009 and 2008 was $0.12 and $0.19,
respectively.





At
November 30, 2009, the total remaining unrecognized compensation cost related to
unvested stock options amounted to approximately $231,000, which will be
amortized over the weighted-average remaining requisite service period of 1.67
years.


15


Income (loss) Per Share:In
accordance with ASC 260, Earnings Per Share,basic income (loss) per
share (“EPS”) is calculated by dividing net income (loss) by the weighted
average number of common shares outstanding. Diluted EPS is calculated by
dividing net income available to common shareholders by the weighted average
number of shares outstanding and potential shares outstanding. At November 30,
2009, the Company’s outstanding common stock options totaled 4,603,982 and were
excluded from the diluted earnings per share calculation for the three and six
months ended November 30, 2009 because the options were not dilutive due to the
their exercise price exceeding the Company’s market price of its common stock at
November 30, 2009. The Company’s outstanding common stock options totaled
3,911,481 at November 30, 2008 and were not included in the computation of
diluted earnings per share due to their antidilutive effect as a result of the
net loss incurred during the three and six months ended November 30,
2008.




Recently Adopted
Accounting Standards:In August 2009, the Financial Accounting
Standards Board (“FASB”) issued Accounting Standard Update (“ASU”)
No. 2009-05,Measuring
Liabilities at Fair Value, (“ASU 2009-05). ASU 2009-05 amends FASB
Accounting Standards Codification (“ASC”) Topic 820,Fair Value Measurements
(“ASC 820”). Specifically, ASU 2009-05 provides clarification that in
circumstances in which a quoted price in an active market for the identical
liability is not available, a reporting entity is required to measure fair value
using one or more of the following methods: 1) a valuation technique that uses
a) the quoted market price of the identical liability when trades as an asset or
b) quoted prices for similar liabilities or similar liabilities when trades as
assets and/or 2) a valuation technique that is consistent with the principles of
ASC 820. ASU 2009-05 also clarifies that when estimating the fair value of a
liability, a reporting entity is not required to adjust inputs relating to the
existence of transfer restrictions on that liability. The adoption of this
standard did not have an impact on our financial position or results of
operations; however, this standard may impact us in future periods.





In June
2009, the FASB issued Statement of Financial Accounting Standards (“SFAS”) No.
168, “FASB Accounting Standards Codification”, (“SFAS 168”) (“ASC” or “the
Codification”) as the single source of authoritative U.S. generally accepted
accounting principles (“GAAP”) for all non-governmental entities. FASB then
issued Accounting Standards Update (“ASU”) 2009-01, Topic 105-Generally Accepted
Accounting Principles amendments based on Statement of Financial Accounting
Standards No. 168-The FASB Accounting Standards Codification and the Hierarchy
of Generally Accepted Accounting Principles, which amended the
Codification for the issuance of FAS 168. The Codification, which launched
July 1, 2009, changes the referencing and organization of accounting
guidance. The Codification became effective for the Company beginning
September 1, 2009. The issuance of FASB Codification did not change GAAP
and therefore the adoption has only affected how specific references to GAAP
literature are disclosed in the notes to our consolidated financial
statements.




In May
2009, the FASB issued SFAS No 165, “Subsequent Events”, which has been
incorporated into ASC 855, which establishes general standards of accounting and
disclosure for events that occur after the balance sheet date but before
financial statements are issued. This guidance became effective for the Company
beginning June 1, 2009. The adoption of this guidance did not have an
impact on the Company’s consolidated financial position or results of
operations. See Note 1- Basis of Presentation and Nature of Business, “Basis of
Presentation” for the required disclosure under the newly adopted
guidance.




Recently Issued Accounting
Standards:




In
January 2010, the FASB issued ASU No. 2010-01, Equity (Topic 505): Accounting for
Distributions to Shareholders with Components of Stock and Cash (“ASU
2010-01”). ASU 2010-01 clarifies that the stock portion of a distribution to
shareholders that allows them to elect to receive cash or stock with a potential
limitation on the total amount of cash that all shareholders can elect to
receive in the aggregate is considered a share issuance that is reflected in
earnings per share prospectively and is not a stock dividend. This ASU codifies
the consensus reached by the Emerging Issues Task Force in Issue No. 09-E,
"Accounting for Stock Dividends, Including Distributions to Shareholders with
Components of Stock and Cash." This guidance is effective for the Company
beginning June 1, 2010. The Company does not expect the adoption will have
a material impact on its consolidated financial positions or results of
operations.




16




In
December 2009, the FASB issued ASU 2009-17, Consolidations (Topic
810)-Improvements to Financial Reporting by Enterprises Involved with Variable
Interest Entities, (“ASU 2009-17”). ASU 2009-17 amends the ASC for the issuance
of FASB Statement No. 167, Amendments to FASB Interpretation
No. 46(R). The amendments in ASU 2009-17 replace the quantitative-based
risks and rewards calculation for determining which reporting entity, if any,
has a controlling financial interest in a variable interest entity with an
approach focused on identifying which reporting entity has the power to direct
the activities of a variable interest entity that most significantly impact the
entity’s economic performance and (1) the obligation to absorb losses of the
entity or (2) the right to receive benefits from the entity. An approach that is
expected to be primarily qualitative will be more effective for identifying
which reporting entity has a controlling financial interest in a variable
interest entity. The amendments in this update also require additional
disclosures about an reporting entity’s involvement in variable interest
entities, which will enhance the information provided to users of financial
statements. This guidance is effective for the Company beginning June 1,
2010. The Company does not expect the adoption will have a material impact on
its consolidated financial positions or results of operations.




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




NOTE
3 – RELATIONSHIP WITH CELLULAR CARRIER





The
Company is party to six distribution agreements with AT&T which provide for
the Company to distribute AT&T wireless services, on an exclusive basis, in
major markets in Texas and Arkansas, including the Dallas-Fort Worth, Texas
Metropolitan Statistical Area (“MSA”), San Antonio, Texas MSA, Austin, Texas
MSA, Houston, Texas MSA, East Texas Regional MSA and Arkansas, including
primarily the Little Rock, Arkansas MSA. The distribution agreements permit the
Company to offer AT&T cellular phone service with identical pricing
characteristics to AT&T and provide billing customer services to its
customers on behalf of AT&T in exchange for certain predetermined
compensation and fees, which are primarily in the form of a revenue sharing of
the core wireless services the Company bills on behalf of AT&T. In addition,
the Company bills the same subscribers several additional features and products
that it offers and retains all revenues and gross margins related to those
certain services and products.





The
Company is responsible for all of the billing and collection of cellular charges
from its customers and remains liable to AT&T for pre-set percentages of all
AT&T related cellular service customer billings. Because of the volume of
business transacted with AT&T, as well as the revenue generated from
AT&T services, there is a significant concentration of credit and business
risk involved with having AT&T as a primary vendor. The Company’s largest
distribution agreement with AT&T for the Dallas/Fort Worth, Texas MSA was
amended effective September 1, 1999 with an initial term of 10 years (the
“DFW Agreement”). The DFW Agreement provided for two 5-year extensions unless
either party provides written notice to the other party at least six months
prior to the expiration of the initial term or the additional renewal term.
Specifically, under the terms of its distribution agreement with AT&T, the
Company is allowed to continue to service its existing Subscribers (defined as
the Company’s activated cellular numbers) at the time of expiration until the
subscribers, of their own free will, independently and without any form of
encouragement or inducement from AT&T, have their services terminated with
the Company.




17




The
initial term of the DFW Agreement expired on August 31, 2009, and the Company
received the required six month notice from AT&T in February 2009 stating
they will not extend the DFW Agreement in its current form with the Company
beyond the expiration date of the initial term. As a result of the expiration of
the initial term of the DFW Agreement, the exclusivity requirements under this
agreement terminated in August 2009, which allows the Company to expand its
cellular offerings in the previously AT&T exclusive areas, under new
agreements with one or more carriers.





Further,
the challenges posed by ongoing cellular customer migration to the iPhone, have
caused a decline in AT&T-related gross cellular subscription billing
revenues. Since the launch of the iPhone in June of 2007, the Company has
experienced higher than historical AT&T-induced subscriber attrition rates
due to customers wanting to acquire the iPhone. The Company has been prohibited
by AT&T from selling the iPhone or servicing its own subscribers desiring an
iPhone, which has required any of the Company’s customers desiring an iPhone to
move their Company-provided billing services to AT&T’s own billing
platform.




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





The
Company reports its revenues related to the AT&T services on a net basis in
accordance with ASC 605-45 as follows (in thousands):





Three
      Months Ended
                    
                    
                    Six
      Months EndedNovember 30,
                    
                    
                    November 30,2009
                    
                    
                    2008
                    
                    
                    2009
                    
                    
                    2008Gross
      service, rent and maintenance billings
                    
                    $
                    13,782
                    
                    
                    $
                    15,394
                    
                    
                    $
                    28,177
                    
                    
                    $
                    31,262Less:
      Direct costs paid to AT&T
                    
                    
                    (7,226
                    )
                    
                    
                    (8,650
                    )
                    
                    
                    (14,963
                    )
                    
                    
                    (17,516
                    )Net
      service, rent and maintenance revenue
                    
                    $
                    6,556
                    
                    
                    $
                    6,744
                    
                    
                    $
                    13,214
                    
                    
                    $
                    13,746





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.




18




NOTE
4 – NOTES RECEIVABLE





November
      30, 2009
                      
                      
                      May
      31, 2009Mobui
      Note
                      
                      $
                      -
                      
                      
                      $
                      441Air-bank
      Note
                      
                      
                      -
                      
                      
                      
                      439Other
                      
                      
                      20
                      
                      
                      
                      23$
                      20
                      
                      
                      $
                      903





Mobui Note: In October 2008,
Teletouch agreed to provide certain financing to Mobui Corporation, a privately
held Washington corporation (“Mobui”), in exchange for a minority equity
position in the company. Mobui was founded in July 2008 and is an advanced
mobile applications development and content delivery company with a growing
catalogue of proprietary mobile applications, content and delivery platforms,
including those for the Apple, Inc.’s iPhone, Research In Motion Ltd.’s
Blackberry devices, the new Google, Inc. Android G1, among hundreds of other
handset types from virtually all leading manufacturers.





On
October 3, 2008, Teletouch loaned to Mobui an initial $60,000 in return for a
promissory note payable bearing an annual interest rate of 14% with all
principal and accrued interest payable due upon demand of Teletouch anytime
after November 2, 2008 (the “Mobui Note”). The Note is secured by substantially
all of the assets of Mobui, excluding certain intellectual property, and by
personal guarantee from the founder of Mobui.




The
Company agreed to amend the Mobui Note on 6 different occasions due to
additional financing requests by Mobui in the second and third quarter of fiscal
year 2009. On January 15, 2009, Teletouch amended the Mobui Note for a final
time to reflect an additional funding of $60,000 to Mobui. The sixth amended
Mobui note revised the total Mobui Note amount to $415,000 and provided for the
repayment of $165,000 in principal and any unpaid accrued interest by July 15,
2009. The remaining principal and interest is due on December 22, 2009. Since
Teletouch agreed to enter into a sixth amended Mobui Note, Mobui issued
additional shares of its common stock to the Company, which increased
Teletouch’s minority equity position in Mobui.





On August
6, 2009, the Company notified Mobui of its payment default and various other
defaults under the Note and demanded payment in full. On August 17, 2009, the
Company received a $415,000 payment from Mobui which was applied against the
Note’s principal balance leaving a balance on the Note of approximately $37,000
related to unpaid accrued interest. As of the quarter ended November 30, 2009,
the total unpaid accrued interest due under the Mobui Note was paid in full and
the Company released all liens related to the Note.





Air-bank Note: In 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. Beginning in June 2006 and through
fiscal year 2009, the Company also provided certain leased office space to
Air-bank. In January 2009, PCCI contributed the receivable due from Air-bank to
Teletouch, which assigned all claims to the receivable to the Company to retire
all of its intercompany obligations due to the Company. In addition Air-bank
owed the Company other balances due to certain operating expenses paid by the
Company on its behalf. In January 2009, the Company converted all amounts due
from Air-bank into a single promissory note with an annual interest rate of 15%
and secured by all of the assets of Air-bank (the “Air-bank Note”). The initial
maturity date of the Air-bank Note was March 31, 2009 with a $250,000 principal
payment due at that date with any remaining principal balance and all unpaid
accrued interest due on June 30, 2009.





19




In April
2009, the Company initiated foreclosure proceedings on the assets of Air-bank
since they could not make the principal and accrued interest payments within the
terms set forth in the promissory note. On July 24, 2009, the assets of Air-bank
were sold in a public auction to the Company in exchange for $460,000 of the
balance due under the Air-bank Note. The assets the Company obtained in the
foreclosure proceedings included a hotspot network communication patent valued
at approximately $257,000, a certificate of deposit for approximately $178,000
and various telecommunication and computer equipment for approximately
$25,000.




NOTE
5 – INVENTORY





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





November
      30, 2009
                    
                    
                    May
      31, 2009Cost
                    
                    
                    Reserve
                    
                    
                    Net
      Value
                    
                    
                    Cost
                    
                    
                    Reserve
                    
                    
                    Net
      ValuePhones
      and related accessories
                    
                    $
                    1,365
                    
                    
                    $
                    -
                    
                    
                    $
                    1,365
                    
                    
                    $
                    726
                    
                    
                    $
                    -
                    
                    
                    $
                    726Automotive
      products
                    
                    
                    299
                    
                    
                    
                    -
                    
                    
                    
                    299
                    
                    
                    
                    501
                    
                    
                    
                    -
                    
                    
                    
                    501Satellite
      products
                    
                    
                    15
                    
                    
                    
                    -
                    
                    
                    
                    15
                    
                    
                    
                    20
                    
                    
                    
                    -
                    
                    
                    
                    20Two-way
      products
                    
                    
                    489
                    
                    
                    
                    (137
                    )
                    
                    
                    352
                    
                    
                    
                    527
                    
                    
                    
                    (113
                    )
                    
                    
                    414Other
                    
                    
                    8
                    
                    
                    
                    -
                    
                    
                    
                    8
                    
                    
                    
                    15
                    
                    
                    
                    -
                    
                    
                    
                    15Total
      inventory and reserves
                    
                    $
                    2,176
                    
                    
                    $
                    (137
                    )
                    
                    $
                    2,039
                    
                    
                    $
                    1,789
                    
                    
                    $
                    (113
                    )
                    
                    $
                    1,676General
      obsolescence reserve
                    
                    
                    -
                    
                    
                    
                    (109
                    )
                    
                    
                    (109
                    )
                    
                    
                    -
                    
                    
                    
                    (129
                    )
                    
                    
                    (129
                    )Total
      inventory and reserves
                    
                    $
                    2,176
                    
                    
                    $
                    (246
                    )
                    
                    $
                    1,930
                    
                    
                    $
                    1,789
                    
                    
                    $
                    (242
                    )
                    
                    $
                    1,547





NOTE
6 – PROPERTY AND EQUIPMENT




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





November
      30, 2009
                    
                    
                    May
      31, 2009Land
                    
                    $
                    774
                    
                    
                    $
                    774Buildings
      and leasehold improvements
                    
                    
                    3,056
                    
                    
                    
                    3,151Two-way
      network infrastructure
                    
                    
                    1,075
                    
                    
                    
                    1,177Office
      and computer equipment
                    
                    
                    3,330
                    
                    
                    
                    3,207Signs
      and displays
                    
                    
                    1,389
                    
                    
                    
                    1,385Other
      equipment
                    
                    
                    375
                    
                    
                    
                    373$
                    9,999
                    
                    
                    $
                    10,067Accumulated
      depreciation
                    
                    
                    (7,185
                    )
                    
                    
                    (7,118
                    )$
                    2,814
                    
                    
                    $
                    2,949





Depreciation
expense was approximately $95,000 and $126,000 for the three months ended
November 30, 2009 and 2008, respectively and $198,000 and $261,000 for the six
months ended November 20, 2009 and 2008, respectively.





Property and equipment are recorded at
cost. Depreciation is computed using the straight-line method. Thefollowing table contains the property,
plant and equipment by estimated useful life, net of accumulated depreciation as
of November 30, 2009 (in thousands):


20





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
                    
                    
                    21
                    
                    
                    
                    79
                    
                    
                    
                    79
                    
                    
                    
                    -
                    
                    
                    
                    10
                    
                    
                    
                    1,229
                    
                    
                    
                    1,418Two-way
      network infrastructure
                    
                    
                    22
                    
                    
                    
                    9
                    
                    
                    
                    216
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    247Office
      and computer equipment
                    
                    
                    137
                    
                    
                    
                    126
                    
                    
                    
                    12
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    275Signs
      & displays
                    
                    
                    62
                    
                    
                    
                    5
                    
                    
                    
                    4
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    71Other
      equipment
                    
                    
                    18
                    
                    
                    
                    11
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    29$
                    260
                    
                    
                    $
                    230
                    
                    
                    $
                    311
                    
                    
                    $
                    -
                    
                    
                    $
                    10
                    
                    
                    $
                    2,003
                    
                    
                    $
                    2,814





NOTE
7 – GOODWILL AND OTHER INTANGIBLE ASSETS





Intangible Assets
with Indefinite Lives:In
accordance withASC
350,the Company performs
an annual impairment test of goodwill as well as evaluatesthis goodwill for recoverability upon
any significant change in the business. There was nochange in the$343,000carrying amount ofgoodwillfor thesix monthsendedNovember 30, 2009.





The
reported goodwill of the Company at November 30, 2009 and May 31, 2009 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):





November
      30, 2009
                  
                  
                  May
      31, 2009Gross
                  
                  
                  
                  
                  
                  Net
                  
                  
                  Gross
                  
                  
                  
                  
                  
                  NetCarrying
                  
                  
                  Accumulated
                  
                  
                  Carrying
                  
                  
                  Carrying
                  
                  
                  Accumulated
                  
                  
                  CarryingAmount
                  
                  
                  Amortization
                  
                  
                  Value
                  
                  
                  Amount
                  
                  
                  Amortization
                  
                  
                  ValueWireless
      contracts and subscriber bases
                  
                  $
                  10,259
                  
                  
                  $
                  (6,710
                  )
                  
                  $
                  3,549
                  
                  
                  $
                  10,258
                  
                  
                  $
                  (6,326
                  )
                  
                  $
                  3,932FCC
      licenses
                  
                  
                  103
                  
                  
                  
                  (67
                  )
                  
                  
                  36
                  
                  
                  
                  104
                  
                  
                  
                  (62
                  )
                  
                  
                  42PCI
      marketing list
                  
                  
                  1,235
                  
                  
                  
                  (1,235
                  )
                  
                  
                  -
                  
                  
                  
                  1,235
                  
                  
                  
                  (1,235
                  )
                  
                  
                  -Loan
      origination fees
                  
                  
                  638
                  
                  
                  
                  (294
                  )
                  
                  
                  344
                  
                  
                  
                  394
                  
                  
                  
                  (203
                  )
                  
                  
                  191Internally
      developed software
                  
                  
                  170
                  
                  
                  
                  (170
                  )
                  
                  
                  -
                  
                  
                  
                  170
                  
                  
                  
                  (170
                  )
                  
                  
                  -Balance
      at August 31,2009 and May 31, 2008
                  
                  $
                  12,405
                  
                  
                  $
                  (8,476
                  )
                  
                  $
                  3,929
                  
                  
                  $
                  12,161
                  
                  
                  $
                  (7,996
                  )
                  
                  $
                  4,165





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





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





Total amortization expense for thethree months
endedNovember 30,2009 and2008was approximately $224,000and $229,000, respectivelyand $447,000 and $468,000 for the six
months ended November 30, 2009 and 2008, respectively.


21


NOTE
8 – ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES





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





November 30,
                  
                  
                  May 31,2009
                  
                  
                  2009Accrued payroll and other
      personnel expense
                  
                  $
                  1,326
                  
                  
                  $
                  1,882Accrued state and local
      taxes
                  
                  
                  758
                  
                  
                  
                  885Unvouchered accounts
      payable
                  
                  
                  2,397
                  
                  
                  
                  2,826Customer deposits
      payable
                  
                  
                  1,319
                  
                  
                  
                  585Other
                  
                  
                  398
                  
                  
                  
                  612Total
                  
                  $
                  6,198
                  
                  
                  $
                  6,790





NOTE
9 – LONG-TERM DEBT





Long-term
debt at November 30, 2009 and May 31, 2009 consists of the following (in
thousands):





November 30,
                  
                  
                  May 31,2009
                  
                  
                  2009United Commercial Bank
      debt
                  
                  $
                  2,413
                  
                  
                  $
                  2,463Jardine Capital Corporation bank
      debt
                  
                  
                  631
                  
                  
                  
                  635Thermo revolving credit
      facility
                  
                  
                  13,119
                  
                  
                  
                  12,117Warrant redemption notes
      payable
                  
                  
                  914
                  
                  
                  
                  1,200Other notes
                  
                  
                  -
                  
                  
                  
                  1Total long-term
      debt
                  
                  
                  17,077
                  
                  
                  
                  16,416Less: Current
      portion
                  
                  
                  (549
                  )
                  
                  
                  (1,313
                  )Long-term debt,
      net
                  
                  $
                  16,528
                  
                  
                  $
                  15,103





Current
portion of long-term debt at November 30, 2009 and May 31, 2009 consists of the
following (in thousands):





November 30,
                  
                  
                  May 31,2009
                  
                  
                  2009United Commercial Bank
      debt
                  
                  $
                  104
                  
                  
                  $
                  102Jardine Capital Corporation bank
      debt
                  
                  
                  10
                  
                  
                  
                  10Thermo revolving credit
      facility
                  
                  
                  135
                  
                  
                  
                  -Warrant redemption notes
      payable
                  
                  
                  300
                  
                  
                  
                  1,200Other
                  
                  
                  -
                  
                  
                  
                  1Total current portion of 
      long-term debt
                  
                  $
                  549
                  
                  
                  $
                  1,313





As of May
31, 2009, the Company had two debt facilities with Thermo Credit, LLC (“Thermo”)
which included a factoring debt facility (the “Thermo Factoring Debt”) and a
revolving credit facility (the “Thermo Revolver”). Effective August 1, 2009,
Teletouch amended its revolving credit facility with Thermo to include increased
borrowing capabilities under the Thermo Revolver as well as extending the
Revolver’s maturity date (see discussion below under “Thermo Revolving Credit
Facility” for additional information). The purpose of amending the Thermo
Revolver was to combine the Thermo Factoring Debt facility and the Thermo
Revolver into a single credit facility by expanding the revolving credit
facility to allow the Company to retire the Thermo Factoring Debt. Simultaneous
with closing the amended Thermo Revolver, the Thermo Factoring Debt was retired
and the pledge of all of PCI’s accounts receivable and future contractual
billings was transferred to the amended Thermo Revolver.


22




Thermo Factoring Debt:As part of the August 2006 debt
restructuring, PCI entered into a financing facility with Thermo Credit, LLC
secured by PCI’s accounts receivable, which provided up to approximately
$10,000,000 of available borrowing against PCI’s accounts receivable. The
advance rate was initially set at 70% of the accounts receivable pledged against
the facility but at Thermo’s discretion, was increased to 85% of the pledged
accounts receivable. The Thermo Factoring Debt provided for an initial discount
fee of 1.0% (with additional discount fees computed as the accounts receivable
aged) and a 5% contingency reserve. Additionally, PCI was required to repurchase
receivables that were not collected within 120 days or that were otherwise
rejected under the agreement. On May 18, 2007, the Company and Thermo amended
the Thermo Factoring Debt to increase the overall borrowing limit to
$13,000,000, set a fixed discount fee on receivables pledged at 1.45%, extended
the termination date of the agreement to August 2009 and allowed for certain
advances on “in-process billings.” Under the terms of the first amended
factoring agreement, the Company created a “pseudo billing” file for the
following month’s recurring billing, and Thermo advanced against the in-process
billings at an initial advance rate of 80% with the advance rate scheduled to
step down quarterly through June 2008 to an advance rate at that date of 60%
against these in-process billings. The discount fee charged against in-process
billings was fixed at 1% under this amendment. On February 26, 2008, Teletouch
entered into a second amendment to the factoring facility 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”).





The
Thermo Factoring Debt was constructed by Thermo to be a factoring facility under
which PCI would sell its accounts receivable to Thermo at a specified discount
rate, subject to certain reserves to be held by Thermo. Upon review of ASC
860,Transfers and
Servicing,the Company concluded that all of the
required criteria to treat this transaction as a sale of assets were not met by
the agreement entered into with Thermo, primarily the criteria that requires
that assets must be placed out of the reach of the creditors of the Company to
be deemed a sale. Therefore,this financing facility wasrecorded as debt obligation of the
Company with the discount fees paid against batches of receivables pledged
against the facility recorded in the period pledged as interest
expense.





In prior years, the Company’s factoring debtobligation with Thermo waspresented as a current liability on the
Company’s consolidated
balance sheet,in
accordance withASC 470,Debt,(“ASC 470”)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. The stated
maturity date of the
factoring debt wasFebruary
2010.As a result of the August 1, 2009
restructuring of its credit facilities with Thermo under which the factoring
debt was retired through additional borrowings under an amended revolving credit
facility with Thermo, the
Companyreclassified the
$7,493,000currentliability under the Thermo
Factoring Debt to a long-term liability under the Thermo Revolving Credit
Facility as of May 31, 2009 in accordance with ASC 470.





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


23


The
Second Amended Thermo Revolver provides for the Company to obtain revolving
credit loans from Thermo from time to time up to $18,000,000. Borrowings against
the Second Amended Thermo Revolver are limited to specific advance rates against
the aggregate fair value of the Company’s assets, as defined in the amendment,
including real estate, equipment, infrastructure assets, inventory, accounts
receivable, intangible assets and notes receivable (collectively, the “Borrowing
Base”). The Company is allowed to borrow the lesser of the borrowing base amount
or the initial commitment amount of $18,000,000, less a monthly step down
amount. If the Company were to maximize its credit line, beginning in December
31, 2009, the availability under the Second Amended Thermo Revolver would be
reduced monthly by an amount equal to the average principal balance of loans
outstanding against the non-accounts receivable assets in the Borrowing Base for
that month divided by sixty (60) (the “Monthly Step Down”). The Company does not
expect to make these payments in fiscal year 2010 since the Company’s Borrowing
Base is and is expected to remain below the reducing commitment level amount for
the next year. The loans outstanding on the accounts receivable component of the
Borrowing Base will be increased or decreased through periodic reporting of the
Borrowing Base to Thermo. The balance of all principal and interest outstanding
under the Second Amended Thermo Revolver is due January 31, 2012. The annual
interest rate on the Second Amended Thermo Revolver is the lesser of: (a) the
maximum non-usurious rate of interest per annum permitted by applicable
Louisiana law or (b) the greater of (i) the prime rate plus 8% or (ii) fourteen
percent (14%). Under the terms of the Second Amended Thermo Revolver, the
Company must maintain certain financial covenants including a net worth of at
least $5,000,000, computed on a fair value basis, at each fiscal quarter, a debt
service coverage ratio that ranges between 1.10 and 1.20 over the remaining life
of the revolver and an operating income no less than zero at any fiscal quarter.
The purpose of the Second Amended Thermo Revolver was to retire the former
factoring debt facility with Thermo and to provide additional availability to
the Company for its ongoing working capital needs. As of November 30, 2009, the Company hasa current repayment liability under the
Second Amended Thermo Revolver related to a loan commitment fee obligation of
approximately $135,000.




Under the
previous Thermo Factoring Debt, the Company had adequate credit availability
under the facility but was limited in its ability to borrow additional funds due
to declining levels of accounts receivable. With the Second Amended Thermo
Revolver, the Company can finance other non-accounts receivable asset purchases
by including them in the Borrowing Base. Borrowings by the Company against
non-accounts receivable assets are limited to 33.3% of the total amount of loans
outstanding under the revolver under the terms of the Second Amended Thermo
Revolver, which results in a maximum availability of $5,994,000 against
non-accounts receivable assets and $12,006,000 against accounts receivable for a
total of $18,000,000. As of November 30, 2009, the Company had approximately
$13,119,000 in loans outstanding under the Second Amended Thermo Revolver which
includes an obligation of approximately $203,000 related to loan commitment fees
under the Second Amended Thermo Revolver. A portion of the loan commitment fee
obligation is due and payable on August 1, 2010 with the remaining balance due
on August 1, 2011. As of November 30, 2009, $8,551,000 was advanced against
accounts receivable and $4,568,000 was advanced against non-accounts receivable
assets. The availability to the Company as of November 30, 2009 under the Second
Amended Thermo Revolver is approximately $3,455,000 to be borrowed against
future accounts receivable and $1,426,000 to be borrowed against non-accounts
receivable asset future purchases.





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





In
November 2009, the Company made a draw of approximately $1,400,000 against the
Second Amended Thermo Revolver primarily for the use of purchasing inventory for
its wholesale business.





Warrant Redemption Notes
Payable: 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”). 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.


24


As of
December 12, 2007, the 12 holders of the collective 6,000,000 outstanding GM
Warrants (collectively, the “GM Warrant Holders”) had the right to redeem these
warrants for an aggregate amount of $3,000,000 in cash or to convert these
warrants into an aggregate amount of 6,000,000 shares of Teletouch’s common
stock under the terms of their respective warrant agreements. In December 2007,
the Company received redemption notices from all of the holders of the GM
Warrants. On May 23, 2008, definitive agreements were executed with each of the
12 holders of the GM Warrants (the “Warrant Redemption Payment Agreements”). The
Warrant Redemption Payment provided for (i) an initial payment in the total
amount of $1,500,000 payable on or before June 2, 2008, (ii) additional 17 equal
monthly payments in the amount of $25,000 each, together with interest on the
outstanding principal balance at an annual interest rate of 12% beginning July
1, 2008 and (iii) a final single payment in the amount of $1,075,000 due on or
before December 10, 2009 (such payments collectively referred to as the
“Payments”). The Payments will be divided among each of the GM Warrant Holders
based on their proportionate ownership of the previously outstanding GM
Warrants. Teletouch’s obligations to make such payments are evidenced by
individual promissory notes (the “GM Promissory Notes”) to each of the GM
Warrant Holders. In addition, Teletouch will be required to make accelerated
payments to the GM Warrant Holders in the event of (i) a sale of Teletouch’s
assets not in the ordinary course of its business or (ii) a change of control.
The negotiated agreement also contains certain events of default, mutual
releases, covenants and other provisions, which are customary for agreements of
this nature.





Effective
November 1, 2009, the GM Promissory Notes were amended to extend maturity dates
to June 10, 2011. The terms of the amendments provided for (i) a one time
principal payment of $161,250 payable on or before December 10, 2009, (ii) a
continuance of 17 equal monthly payments in the amount of $25,000 each, together
with interest on the outstanding principal balance beginning January 10, 2010,
(iii) a final single payment in the amount of $488,750 due on or before June 10,
2011 and (iv) the annual interest rate on the outstanding principal balance is
increased to 14%, effective November 1, 2009 (such payments collectively
referred to as the “Amended Payments”). The Amended Payments will be divided
among each of the GM Warrant Holders based on the proportionate outstanding
principal balance under the GM Promissory Notes. All other terms of the GM
Promissory Notes remain unchanged.





NOTE
10 - INCOME TAXES





Teletouch
uses the liability method to account for income taxes under the guidance of ASC
740. 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.


25


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





November 30, 2009
                  
                  
                  May 31, 2009Deferred Tax
      Assets:Current deferred tax
      assets:Accrued
      liabilities
                  
                  $
                  645
                  
                  
                  $
                  748Deferred
      revenue
                  
                  
                  27
                  
                  
                  
                  32Inventories
                  
                  
                  91
                  
                  
                  
                  88Bad debt
      reserve
                  
                  
                  170
                  
                  
                  
                  165933
                  
                  
                  
                  1,033Valuation
      allowance
                  
                  
                  (915
                  )
                  
                  
                  (1,033
                  )Current deferred tax assets, net
      of valuation allowance
                  
                  
                  18
                  
                  
                  
                  -Non-current deferred tax
      assets:Net operating
      loss
                  
                  
                  11,394
                  
                  
                  
                  11,447Intangible
      assets
                  
                  
                  124
                  
                  
                  
                  193Fixed
assets
                  
                  
                  253
                  
                  
                  
                  256Licenses
                  
                  
                  16
                  
                  
                  
                  18Other
                  
                  
                  2
                  
                  
                  
                  211,789
                  
                  
                  
                  11,916Valuation
      allowance
                  
                  
                  (11,722
                  )
                  
                  
                  (11,847
                  )Non-current deferred tax assets,
      net of valuation allowance
                  
                  
                  67
                  
                  
                  
                  69Deferred Tax
      Liabilities:Current deferred tax
      liabilities:Other
                  
                  
                  18
                  
                  
                  
                  -Non-current deferred tax
      liabilities:Fixed
assets
                  
                  
                  67
                  
                  
                  
                  69Net Current Deferred Tax
      Asset
                  
                  $
                  -
                  
                  
                  $
                  -Net Non-Current Deferred Tax
      Asset
                  
                  $
                  -
                  
                  
                  $
                  -





NOTE
11 – COMMITMENTS AND CONTINGENCIES





Teletouch
leases buildings, office space, a sports entertainment suite, 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):





Total
                  
                  
                  2010
                  
                  
                  2011
                  
                  
                  2012
                  
                  
                  2013
                  
                  
                  ThereafterOperating
      leases
                  
                  $
                  5,395
                  
                  
                  $
                  691
                  
                  
                  $
                  488
                  
                  
                  $
                  357
                  
                  
                  $
                  339
                  
                  
                  $
                  3,520





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:


26


Claim Asserted Against Use of Hawk
Electronics’ Name:In June 2008, the Company was notified of its alleged
infringement on the trade name Hawk Electronics and impending litigation against
it. While the Company has had limited settlement discussions with the other
party, the Company is aggressively defending its position that its use of the
Hawk Electronics name in the markets that it operates is legal and proper. In
July 2008, the Company filed suit in Tarrant County, Texas against the other
party seeking to protect its use of the Hawk Electronics’ trade name. The other
party has defended this lawsuit and the matter is scheduled for trial in April
2010. We cannot give any assurance that we will be successful in resolving this
matter, and while the Company believes it is unlikely, there is a risk that the
court may force Teletouch to cease using the Hawk Electronics’ name. Further
litigation to resolve the infringement claim could result in substantial costs
and diversion of resources, and 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.





The
Company attended a court ordered mediation on this matter and was unsuccessful
reaching a settlement with the other party. Currently, the trial date set by the
court is scheduled to begin the week of April 5, 2010. Based on discussions with
our counsel, the Company believes it will prevail in this matter.





NOTE
12 – SHAREHOLDERS’ EQUITY





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





In June
2009, Glaubman, Rosenburg & Robotti Fund, L.P., a non-affiliated New York
limited partnership and holder of 312,978 shares of Teletouch’s common stock,
(the “Shareholder”) notified the Company of its intent to sell all of its shares
of Teletouch’s common stock and offered these shares to Teletouch at a discount
from market. On June 15, 2009, the Company entered into a Securities Purchase
Agreement with the Shareholder to purchase the 312,978 shares of Teletouch
common stock it held at $0.10 per share. Teletouch’s purchase price of $0.10 per
share represented a 13% discount from the $0.115 average of the 10 day closing
price on Teletouch’s common stock prior to the effective date of this agreement.
The purchase of the shares was completed on July 16, 2009 following the payment
of $31,298 to the Shareholder and the surrender of the 312,978 shares of stock.
These shares are held by the Company in treasury.





NOTE
13 - STOCK OPTIONS





Teletouch’s
1994 Stock Option and Stock Appreciation Rights Plan (the “1994 Plan”) was
adopted in July 1994 and provides for the granting of incentive and
non-incentive stock options and stock appreciation rights to officers,
directors, employees and consultants to purchase not more than an aggregate of
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.


27


As of November 30, 2009, approximately
28,661 Non-Qualified Options and 52,000 Incentive Options are outstanding under
the 1994 Plan, and approximately 376,998 Non-Qualified Options and 4,146,323
Incentive Options are outstanding under the 2002 Plan.





A summary
of option activity for the six months ended November 30, 2009 is as
follows:





WeightedWeighted
                  
                  
                  AverageAverage
                  
                  
                  Remaining
                  
                  
                  AggregateExercise
                  
                  
                  Contractual
                  
                  
                  IntrinsicShares
                  
                  
                  Price
                  
                  
                  Term
                  
                  
                  ValueOutstanding at June 1,
      2009
                  
                  
                  3,910,815
                  
                  
                  $
                  0.27
                  
                  
                  
                  7.99
                  
                  
                  $
                  -Six months ended November 30,
      2009Granted
                  
                  
                  693,167
                  
                  
                  
                  0.12
                  
                  
                  
                  -Exercised
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -Forfeited
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -Outstanding at November 30,
      2009
                  
                  
                  4,603,982
                  
                  
                  
                  0.25
                  
                  
                  
                  7.79
                  
                  
                  $
                  2,773Options exercisable at November
      30, 2009
                  
                  
                  3,095,211
                  
                  
                  $
                  0.27
                  
                  
                  
                  7.36
                  
                  
                  $
                  2,773





The
following table summarizes the status of the Company’s non-vested stock options
since June 1, 2009:





Non-vested OptionsWeighted-Number of
                    
                    
                    Average FairShares
                    
                    
                    ValueNon-vested at June 1,
      2009
                    
                    
                    2,486,489
                    
                    
                    $
                    0.20Granted
                    
                    
                    693,167
                    
                    
                    
                    0.11Vested
                    
                    
                    (1,670,885
                    )
                    
                    
                    0.18Forfeited
                    
                    
                    -
                    
                    
                    
                    -Non-vested at November 30,
      2009
                    
                    
                    1,508,771
                    
                    
                    $
                    0.18





The Companyestimatesthefairvalue 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 bythestock 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 Companycalculateditsexpected volatility assumption required
in the Black-Scholes model based on the historical volatility ofits stock.  The Company recorded
approximately $38,000 and $44,000 in stock based compensation expense in
theconsolidated financial
statements for thethreemonths ended November 30, 2009 and 2008,
respectively.The Company recorded
approximately $169,000 and $86,000 in stock based compensation expense in
theconsolidated financial
statements for thesixmonths ended November 30, 2009 and 2008,
respectively.


28


NOTE
14 – RELATED PARTY TRANSACTIONS





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





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





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





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 recorded these expenses of approximately $63,000 in fiscal year 2007 as
well as the related party payable to TLLP for the same amount. In addition the
Company received certain dividend payments from investments belonging to TLLP in
fiscal year 2009. In the quarter ended November 30, 2009, the Company paid
certain expenses on behalf of TLLP which reduced the Company’s related party
payable. As of November 30, 2009 approximately $93,000 remains payable to TLLP
by the Company.





NOTE
15 – SEGMENT INFORMATION





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





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





The
Company’s cellular business segment represents its core business, which has been
acquiring, billing, and supporting cellular subscribers under a revenue sharing
relationship with AT&T 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. Furthermore, in January 2009, Teletouch
entered into a new distribution agreement with T-Mobile USA, Inc. (“T-Mobile”).
The Company closed its last two Oklahoma retail locations selling T-Mobile
branded cellular services and products in October 2009. Subsequent to these
closings, in January 2010, the T-Mobile agreement was terminated due to the
Company closing all of its retail locations in the Oklahoma market.





The
Company’s wholesale business segment represents its distribution of cellular
telephones, accessories, car audio and car security products to major carrier
agents, rural cellular carriers, smaller consumer electronics and automotive
retailers and auto dealers throughout the country.


29





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





Corporate
overhead is reported separate from the Company’s identified segments. The
Corporate overhead costs include expenses 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 six months ended November 30, 2009 and 2008 (in
thousands):


30





Three Months
      Ended
                      
                      
                      Six Months
      EndedNovember
30,
                      
                      
                      November
30,2009
                      
                      
                      2008
                      
                      
                      2009
                      
                      
                      2008Operating
      revenues:Service, rent and maintenance
      revenueCellular
                      
                      $
                      5,971
                      
                      
                      $
                      6,339
                      
                      
                      $
                      12,164
                      
                      
                      $
                      12,848Two-way
                      
                      
                      544
                      
                      
                      
                      376
                      
                      
                      
                      950
                      
                      
                      
                      788Other
                      
                      
                      41
                      
                      
                      
                      29
                      
                      
                      
                      100
                      
                      
                      
                      110Total
                      
                      
                      6,556
                      
                      
                      
                      6,744
                      
                      
                      
                      13,214
                      
                      
                      
                      13,746Product sales
      revenueCellular
                      
                      
                      935
                      
                      
                      
                      1,728
                      
                      
                      
                      2,504
                      
                      
                      
                      3,592Wholesale
                      
                      
                      5,499
                      
                      
                      
                      1,982
                      
                      
                      
                      8,014
                      
                      
                      
                      5,200Two-way
                      
                      
                      777
                      
                      
                      
                      680
                      
                      
                      
                      1,339
                      
                      
                      
                      1,337Other
                      
                      
                      112
                      
                      
                      
                      58
                      
                      
                      
                      266
                      
                      
                      
                      203Total
                      
                      
                      7,323
                      
                      
                      
                      4,448
                      
                      
                      
                      12,123
                      
                      
                      
                      10,332Operating
      revenueCellular
                      
                      
                      6,906
                      
                      
                      
                      8,067
                      
                      
                      
                      14,668
                      
                      
                      
                      16,440Wholesale
                      
                      
                      5,499
                      
                      
                      
                      1,982
                      
                      
                      
                      8,014
                      
                      
                      
                      5,200Two-way
                      
                      
                      1,321
                      
                      
                      
                      1,056
                      
                      
                      
                      2,289
                      
                      
                      
                      2,125Other
                      
                      
                      153
                      
                      
                      
                      87
                      
                      
                      
                      366
                      
                      
                      
                      313Total
                      
                      
                      13,879
                      
                      
                      
                      11,192
                      
                      
                      
                      25,337
                      
                      
                      
                      24,078Operating
      expenses:Cost of service, rent and
      maintenance(exclusive of depreciation
      and amortization included below)Cellular
                      
                      
                      1,499
                      
                      
                      
                      1,813
                      
                      
                      
                      3,053
                      
                      
                      
                      3,753Two-way
                      
                      
                      390
                      
                      
                      
                      424
                      
                      
                      
                      791
                      
                      
                      
                      879Other
                      
                      
                      21
                      
                      
                      
                      37
                      
                      
                      
                      31
                      
                      
                      
                      76Total
                      
                      
                      1,910
                      
                      
                      
                      2,274
                      
                      
                      
                      3,875
                      
                      
                      
                      4,708Cost of products
      soldCellular
                      
                      
                      972
                      
                      
                      
                      1,752
                      
                      
                      
                      2,560
                      
                      
                      
                      3,662Wholesale
                      
                      
                      5,048
                      
                      
                      
                      1,775
                      
                      
                      
                      7,313
                      
                      
                      
                      4,620Two-way
                      
                      
                      573
                      
                      
                      
                      526
                      
                      
                      
                      1,015
                      
                      
                      
                      966Other
                      
                      
                      75
                      
                      
                      
                      36
                      
                      
                      
                      184
                      
                      
                      
                      144Total
                      
                      
                      6,668
                      
                      
                      
                      4,089
                      
                      
                      
                      11,072
                      
                      
                      
                      9,392Selling and general and
      administrativeCellular
                      
                      
                      1,116
                      
                      
                      
                      1,338
                      
                      
                      
                      2,442
                      
                      
                      
                      2,761Wholesale
                      
                      
                      351
                      
                      
                      
                      308
                      
                      
                      
                      630
                      
                      
                      
                      641Two-way
                      
                      
                      126
                      
                      
                      
                      137
                      
                      
                      
                      254
                      
                      
                      
                      274Corporate
                      
                      
                      2,334
                      
                      
                      
                      2,291
                      
                      
                      
                      4,738
                      
                      
                      
                      4,705Other
                      
                      
                      48
                      
                      
                      
                      96
                      
                      
                      
                      109
                      
                      
                      
                      294Total
                      
                      
                      3,975
                      
                      
                      
                      4,170
                      
                      
                      
                      8,173
                      
                      
                      
                      8,675Depreciation and
      amortizationTwo-way
                      
                      
                      30
                      
                      
                      
                      55
                      
                      
                      
                      62
                      
                      
                      
                      112Corporate
                      
                      
                      289
                      
                      
                      
                      300
                      
                      
                      
                      583
                      
                      
                      
                      617Total
                      
                      
                      319
                      
                      
                      
                      355
                      
                      
                      
                      645
                      
                      
                      
                      729Loss(gain) on disposal of
      assetsCorporate
                      
                      
                      -
                      
                      
                      
                      (1
                      )
                      
                      
                      1
                      
                      
                      
                      (1
                      )Total Operating
      expenses
                      
                      
                      12,872
                      
                      
                      
                      10,887
                      
                      
                      
                      23,766
                      
                      
                      
                      23,503Operating income
      (loss)Cellular
                      
                      
                      3,319
                      
                      
                      
                      3,164
                      
                      
                      
                      6,613
                      
                      
                      
                      6,264Wholesale
                      
                      
                      100
                      
                      
                      
                      (101
                      )
                      
                      
                      71
                      
                      
                      
                      (61
                      )Two-way
                      
                      
                      202
                      
                      
                      
                      (86
                      )
                      
                      
                      167
                      
                      
                      
                      (106
                      )Corporate
                      
                      
                      (2,623
                      )
                      
                      
                      (2,590
                      )
                      
                      
                      (5,322
                      )
                      
                      
                      (5,321
                      )Other
                      
                      
                      9
                      
                      
                      
                      (82
                      )
                      
                      
                      42
                      
                      
                      
                      (201
                      )Total
                      
                      
                      1,007
                      
                      
                      
                      305
                      
                      
                      
                      1,571
                      
                      
                      
                      575Interest expense,
      NetTwo-way
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -Corporate
                      
                      
                      (569
                      )
                      
                      
                      (619
                      )
                      
                      
                      (1,072
                      )
                      
                      
                      (1,254
                      )Total
                      
                      
                      (569
                      )
                      
                      
                      (619
                      )
                      
                      
                      (1,072
                      )
                      
                      
                      (1,254
                      )Net income (loss) before income
      taxes
                      
                      
                      438
                      
                      
                      
                      (314
                      )
                      
                      
                      499
                      
                      
                      
                      (679
                      )Income tax
      expenseCorporate
                      
                      
                      62
                      
                      
                      
                      81
                      
                      
                      
                      123
                      
                      
                      
                      162Net income
      (loss)
                      
                      $
                      376
                      
                      
                      $
                      (395
                      )
                      
                      $
                      376
                      
                      
                      $
                      (841
                      )





The
Company identifies its assets by segment. Significant assets of the Company’s
corporate offices include cash, property and equipment, notes receivable and
loan origination costs.  The Company’s assets by segment as of November 30,
2009 and May 31, 2009 are as follows:


31





November30,2009
                  
                  
                  May31,2009Total Assets
                  
                  
                  Property and
                    Equipment, net
                  
                  
                  Intangible Assets,
                    net
                  
                  
                  Total Assets
                  
                  
                  Property and
                    Equipment, net
                  
                  
                  Intangible Assets,
                    netSegmentCellular
                  
                  $
                  9,744
                  
                  
                  $
                  164
                  
                  
                  $
                  3,549
                  
                  
                  $
                  12,751
                  
                  
                  $
                  195
                  
                  
                  $
                  3,932Two-way
                  
                  
                  1,735
                  
                  
                  
                  425
                  
                  
                  
                  379
                  
                  
                  
                  1,806
                  
                  
                  
                  467
                  
                  
                  
                  385Wholesale
                  
                  
                  3,657
                  
                  
                  
                  2
                  
                  
                  
                  -
                  
                  
                  
                  1,123
                  
                  
                  
                  3
                  
                  
                  
                  -Corporate
                  
                  
                  8,355
                  
                  
                  
                  2,223
                  
                  
                  
                  344
                  
                  
                  
                  8,639
                  
                  
                  
                  2,284
                  
                  
                  
                  191Other
                  
                  
                  46
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  37
                  
                  
                  
                  -
                  
                  
                  
                  -Totals
                  
                  $
                  23,537
                  
                  
                  $
                  2,814
                  
                  
                  $
                  4,272
                  
                  
                  $
                  24,356
                  
                  
                  $
                  2,949
                  
                  
                  $
                  4,508





During the three and six months ended
November 30, 2009 and 2008,
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





For over
40 years, Teletouch has offered a comprehensive suite of telecommunications
products and services under the Teletouch and AT&T® brands, including
cellular, two-way radio, GPS-telemetry, wireless messaging and public
safety/emergency response products and services. Teletouch operates
approximately 20 retail stores and service locations in Texas. Locations include
both “Teletouch” and “Hawk Electronics” branded in-line and free-standing
stores. Teletouch’s core-business
is acquiring, billing and supporting cellular subscribers under a long-term
recurring revenue relationship with AT&T. The distribution agreements with
AT&T have been in place forover 20years.Through its subsidiary,
Progressive Concepts Inc., (“PCI”), the Company is a leading 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. PCI operates a chain of retail stores and
sells under the “Hawk Electronics” brand, through Hawk-branded sub-agents, its
own direct sales force and Internet. 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. PCI alsooperates a national wholesale distribution business, known as PCI
Wholesale that serves major carrier agents, rural cellular carriers, smaller
consumer and electronic retailers and automotive dealers throughout the country.
Teletouch’s original business continues to provide two-way radio products and
services on its own network in North and East Texas. In January 2009, Teletouch
entered into an Exclusive Retailer Agreement with T-Mobile USA,
Inc.(“T-Mobile”). The agreement provided for Teletouch to open, operate and
manage mall locations, with the Company's first locations opening in major
markets in Oklahoma in February 2009. The Company closed its last two Oklahoma
retail locations selling T-Mobile branded cellular services and products in
October 2009. Subsequent to these closings, in January 2010, the T-Mobile
agreement was terminated due to the Company closing all of its retail locations
in the Oklahoma market. In late 2007, Teletouch began selling safety and
emergency response vehicle products and services under the brand Teletouch EVP
(“Emergency Vehicle Products”). The EVP business is a complementary offering to
the Company’s existing two-way radio business and the Company has expanded its
product lines to include light bars, sirens and other accessories used in or on
emergency response vehicles through a number of distribution agreements with
manufacturers of these products. Teletouch also holds an equity stake in Mobui
Corporation, a Redmond, Washington based mobile applications developer and
provider.


32





2010
Business Strategy





Summary





Most of
the Company’s efforts from August 2006 through fiscal 2009 were focused on the
complex integration issues related to the acquisition of PCI, its subsequent
reorganization activities, as well as on securing financing to grow its retail
business and work to complete one or more acquisitions to provide new avenues of
revenue growth for the Company. After rationalizing a number of business units
and resizing the workforce over the past two years, Teletouch is better
positioned to achieve its financing, retail expansion and acquisition goals. Key
to this strategy is and has been leveraging the Company’s various customer
relationships, including PCI’s 66,000 cellular subscribers, which are comprised
of individuals and businesses of higher than average credit worthiness (due to
PCI’s stringent credit standards). The Company believes that there are
opportunities to grow revenues in excess of its current cellular revenues with
these monthly-billed customers.





The
Company’s primary business for over 35 years has been distributing AT&T
cellular services under several exclusive master distributor agreements. As of
the date of this Report, certain changes to the Company’s relationship with
AT&T have occurred, including the expiration of the exclusivity with
AT&T under the primary Dallas/Fort Worth (“DFW”) distribution agreement and
the commencement of legal action against AT&T by the Company. Following the August 2009 expiration of
the DFW distribution agreement, the Company maintained the right to continue
servicing its cellular subscriber base until the last subscriber terminates
service. Since the launch of the iPhone in June 2007, and following AT&T’s
refusal to allow the Company to offer the iPhone to its subscriber base, the
Company has experienced higher rates of attrition in its cellular subscriber
base due to subscribers having to transfer their service to AT&T to purchase
an iPhone. The iPhone and certain other products and services that have been
withheld from the Company by AT&T were the primary reasons the Company
commenced the legal action against AT&T in September 2009. Following
expiration of the DFW agreement and the commencement of the legal action, the
Company has not experienced a significant increase in subscriber attrition from
the levels experienced since June 2007, nor are subscriber attrition levels
expected to increase further during the remainder of 2010. The Company is
currently negotiating new cellular carrier distribution relationships and
expects to be offering multiple carrier cellular services by the end of the year
with the intent of offsetting some of the losses of its AT&T cellular
service revenues.





The
Company experienced significant declines in revenues during the last year due to
the migration of a large number of cellular subscribers to AT&T in order to
purchase services and products directly from AT&T that the Company was not
allowed to sell, macro-economic issues driving lower cellular and electronics
sales in its wholesale business and budgetary constraints imposed on many
governmental entities and commercial enterprises resulting in lower sales in the
Company’s two-way radio business. In spite of the loss of revenues, the Company
was successful in improving its operating results during 2009 and continuing
through the first quarter of fiscal 2010 through aggressive cost management and
improved margins on the revenues it maintained. During the remainder of fiscal
2010, the Company will continue to manage its costs closely but will focus on
developing sources of revenue for all of its business units. These new revenue
sources will be several anticipated distribution agreements and, potentially,
the acquisition of one or more complementary businesses. Following the
acquisition of PCI in August 2006, the Company struggled to complete the
required audits because of the condition of PCI’s records. Because of the delays
in completing these audits, the Company was unable to maintain a current
standing with its regulatory reporting requirements. The Company’s inability to
file the required financials hindered the Company’s ability to secure additional
financing to grow the business or to complete any of the major acquisitions it
has identified. Significant progress was made in 2009 by catching up on its
delinquent financial statement audits and filings, and in December 2010, the
Company completed and filed all of its required previously delinquent quarterly
financial reports which brought the Company into compliance with its reporting
requirements as determined by the SEC. The SEC granted the Company relief as to
the quarterly filings in the year ended May 31, 2007. The Company is hopeful
that it can now secure the necessary financing to complete one or more of these
acquisitions in 2010. There is no assurance that any of the acquisitions will be
concluded.


33





Certain
non-recurring expenses are expected to be incurred through the remainder of
fiscal 2010 related to the arbitration proceeding against AT&T and the
startup and expansion costs related to the new products and services. The
Company believes that these non-recurring expenses will be manageable and will
not materially impair its operating results during 2010. In addition, on October
2, 2009, the Securities and Exchange Commission, delayed the implementation of
section 404(b) of the Sarbanes Oxley Act of 2002 for smaller reporting companies
until fiscal years ending after June 15, 2010. The impact of this delay is that
Teletouch will not be required to have its independent auditors attest to the
effectiveness of its internal controls during fiscal 2010 which results in a
further reduction of costs anticipated during 2010. Under the current guidance,
Teletouch would be required to have an independent audit of its internal
controls as of its fiscal year ended May 31, 2011.





Cellular
Services





In August
2009, the initial term of the primary distribution agreement between Teletouch’s
subsidiary, PCI and AT&T expired. Under this agreement, PCI distributes
AT&T cellular services in the DFW market. With the expiration of this
agreement, the Company is no longer exclusive to AT&T in DFW, which allows
the Company to expand it cellular service offerings in this market for the first
time in over 35 years. The August 2009 expiration of the initial term of the DFW
distribution agreement also restricts PCI from growing its subscriber base in
DFW by limiting new activations and prohibiting AT&T subscribers from moving
their service to PCI, but the majority of the provisions of the agreement remain
in tact at the option of PCI, including the right for PCI to continue servicing
its existing DFW subscribers until there are no more subscribers remaining as
customers of PCI. Based on its current subscriber attrition rates, the Company
estimates that it will maintain subscribers in DFW for the next eight years. The
Company is party to five distribution agreements with AT&T in addition to
the distribution agreement covering the DFW market discussed above. Under these
other distribution agreements, the Company is allowed to distribute AT&T
wireless services, on an exclusive basis, in certain major markets in Texas and
Arkansas, including the San Antonio, Texas Metropolitan Statistical Area
(“MSA”), Austin, Texas MSA, Houston, Texas MSA, East Texas Regional MSA and
Arkansas, including primarily the Little Rock, Arkansas MSA. These distribution
agreements have varying terms with the longest extending through October
2012.





In August
2009, the Company received notice from AT&T of its intent not to renew the
Houston distribution agreement but let it naturally expire in February 2010
which would allow the Company to continue servicing its small subscriber base in
the Houston area through February 2011. In September 2009, the Company received
notice from AT&T of its intent to terminate the Arkansas distribution
agreement substantially on the grounds the Company did not maintain a sufficient
number of retail outlets in that market. The Arkansas agreement would otherwise
expire in July 2012. Additionally, AT&T has claimed the San Antonio
distribution agreement should have been previously conformed to an agreement
similar in form to the Houston agreement in accordance with an agreement reached
between the parties in connection with a settlement agreement in June 2007. If
the San Antonio agreement were conformed to the Houston agreement, the Company
would be allowed to service its San Antonio subscriber base through August 2010.
The Company is aggressively disputing the contract matters with AT&T and is
hopeful these matters can all be resolved through the arbitration in process
over matters related to its DFW distribution agreement (see discussion below).
With the exception of the San Antonio and DFW distribution agreements, none of
the other distribution agreements are deemed material to the current operations
of the Company. The Company cannot provide any assurance that it will be
successful in maintaining its Houston, Arkansas or San Antonio distribution
agreements beyond their contractual expiration dates.


34





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





With
PCI’s exclusivity to AT&T in the Dallas/Fort Worth market lifted in August
2009 and after being unable to reach an alternate form of agreement with
AT&T, the Company has begun actively negotiating final terms under a variety
of new cellular carriers, WiFi, WiMax and related wireless communications
relationships. The Company expects to begin launching some of these products and
services in the later part of the 3rd fiscal
quarter and throughout the remainder of 2010. Teletouch’s first new cellular
carrier relationship outside of AT&T was formed during fiscal year 2009 that
initially contemplates distribution in markets not protected under the
exclusivity provisions granted to AT&T under the existing distribution
agreements. To provide new and innovative cellular solutions, Teletouch entered
into an Exclusive Retailer Agreement with T-Mobile USA, Inc. (“T-Mobile”). The
agreement provided for Teletouch to open, operate and manage mall locations,
with the Company's first new locations having opened in major markets in
Oklahoma. The Company closed its last two Oklahoma retail locations selling
T-Mobile branded cellular services and products in October 2009. Subsequent to
these closings, in January 2010, the T-Mobile agreement was terminated due to
the Company closing all of its retail locations in the Oklahoma
market.





During
the remainder of fiscal 2010, the Company will focus on expanding distribution
of existing products and services to its 66,000 cellular subscribers which
primarily reside in the DFW and San Antonio markets in Texas. In addition, the
Company will focus on developing the other markets covered by its existing
AT&T distribution agreements, starting with the East Texas market where
Teletouch currently has personnel and existing infrastructure in place. A
primary focus of the Company will be on expanding its product and service
offerings through a variety of new distribution agreements that are currently
being negotiated. Through these new relationships, the Company will be able to
offer its customers a choice in services and additional products and expects to
be allowed to expedite expansion of its distribution to other
markets.





Wholesale
Business





During
2009, a large focus in the wholesale business was on the ongoing credit
worthiness of our customers, pricing, margins and inventory turnover. The
extensive re-evaluation of the wholesale business in 2009 resulted in certain
sustainable operating changes to the business, including office staff
reductions, new sales hiring, re-pricing of new and non-current inventory, as
well as identified the necessity to grow market share and focus on more
exclusive product offerings. The Company will continue to focus on expanding its
distributor relationships and expand its product line with a focus on products
that it can offer exclusively for wholesale distribution for the remainder of
2010 and expects revenues to improve with the slowly improving economic outlook
for the country. In October 2009 the Company started a cellular handset
brokerage business selling to volume buyers both domestically and
internationally. Initially the Company has primarily brokered phones
manufactured by Research In Motion, better known as the manufacturer of
Blackberry® cellular handsets. This brokerage business contributed to the
increase in product sales for the Company’s wholesale business during the three
and six months ended November 30, 2009. The handset brokerage business will
decline throughout the remainder of the fiscal year unless the Company is
successful in locating a new supplier of cellular handsets as the Company has
experienced a lack of certain wholesale cellular handset inventory due to
purchasing restrictions from AT&T. The Company is currently pursuing new
vendors to purchase the inventory required for the wholesale brokerage
business.


35





Two-Way
Radio Operations





For 2010,
the Company’s two way division has secured a contract in support of the
re-banding efforts being undertaken nationally to migrate public safety
communications to frequencies that will not experience interference from certain
radio channels operated by Nextel Communications. This project covers the East
Texas market and is expected to generate up to $500,000 in installation revenues
during the next year. Teletouch’s long-term relationships and reputation with
the various governmental entities over its almost 44 year presence in East Texas
has allowed the Company to procure this business to date. The Company believes
it will be successful in procuring more of this business as a variety of sources
of government funds are made available throughout 2010.





As a
complement to and embedded in its two-way radio segment, the Company began
selling emergency vehicle products in late 2007 under several master distributor
agreements with its suppliers. The product lines include various aftermarket
accessories that are added to vehicles in the public safety industry, but
primarily includes light bars, sirens and computer equipment supports mounted
in-vehicle. During 2010, the Company will be focusing on expanding the
distribution of these product lines to other markets by cross-training of
existing sales personnel in those other markets as well as by opening new
distribution points in those markets. In addition, the Company is working with
its manufacturers to secure approval to sell these products into other protected
markets and to potentially acquire other existing distribution in these
markets.





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 the car dealer expediter operations.





The
majority of the Company’s product sales are generated by PCI’s wholesale
operations and are comprised of cellular telephones, cellular accessories and
12-volt 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. The two-way radio operations’ products
are comprised of radios and service parts for radio communication systems and
safety and emergency response vehicle products.





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.


36





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 ASC 605-45, Revenue
Recognition, Principal Agent Considerations, (“ASC 605-45”) associated
with its services attached to the AT&T agreements.





Based on
its assessment of the indicators listed in ASC 605-45, the Company has concluded
that the AT&T services provided by PCI should be reported on a net basis.
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 PCI’s cellular subscriber base under the master distributor agreement
with AT&T including:





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


§
            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.





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,
safety and emergency response products 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.


37





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 Six Months Ended November 30, 2009 and
2008





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 expeditor
and installation services.





(dollars in
      thousands)
                                                  
                                                  November
30,
                                                  
                                                  2009 vs
20082009
                                                  
                                                  
                                                  2008
                                                  
                                                  
                                                  $ Change
                                                  
                                                  
                                                  % ChangeThree Months
      EndedService, rent, and maintenance
      revenueCellular
      operationsGross cellular subscription
      billings
                                                  
                                                  $
                                                  13,197
                                                  
                                                  
                                                  $
                                                  14,989
                                                  
                                                  
                                                  $
                                                  (1,792
                                                  )
                                                  
                                                  
                                                  -12
                                                  %Net revenue adjustment (revenue
      share due AT&T)
                                                  
                                                  
                                                  (7,226
                                                  )
                                                  
                                                  
                                                  (8,650
                                                  )
                                                  
                                                  
                                                  1,424
                                                  
                                                  
                                                  
                                                  -16
                                                  %Cellular operations total service
      revenues:
                                                  
                                                  
                                                  5,971
                                                  
                                                  
                                                  
                                                  6,339
                                                  
                                                  
                                                  
                                                  (368
                                                  )
                                                  
                                                  
                                                  -6
                                                  %Two-way radio
      operations
                                                  
                                                  
                                                  544
                                                  
                                                  
                                                  
                                                  376
                                                  
                                                  
                                                  
                                                  168
                                                  
                                                  
                                                  
                                                  45
                                                  %Other
      operations
                                                  
                                                  
                                                  41
                                                  
                                                  
                                                  
                                                  29
                                                  
                                                  
                                                  
                                                  12
                                                  
                                                  
                                                  
                                                  41
                                                  %Service, rent, and maintenance
      revenue
                                                  
                                                  $
                                                  6,556
                                                  
                                                  
                                                  $
                                                  6,744
                                                  
                                                  
                                                  $
                                                  (188
                                                  )
                                                  
                                                  
                                                  -3
                                                  %Six Months
      EndedService, rent, and maintenance
      revenueCellular
      operationsGross cellular subscription
      billings
                                                  
                                                  $
                                                  27,127
                                                  
                                                  
                                                  $
                                                  30,364
                                                  
                                                  
                                                  $
                                                  (3,237
                                                  )
                                                  
                                                  
                                                  -11
                                                  %Net revenue adjustment (revenue
      share due AT&T)
                                                  
                                                  
                                                  (14,963
                                                  )
                                                  
                                                  
                                                  (17,516
                                                  )
                                                  
                                                  
                                                  2,553
                                                  
                                                  
                                                  
                                                  -15
                                                  %Cellular operations total service
      revenues:
                                                  
                                                  
                                                  12,164
                                                  
                                                  
                                                  
                                                  12,848
                                                  
                                                  
                                                  
                                                  (684
                                                  )
                                                  
                                                  
                                                  -5
                                                  %Two-way radio
      operations
                                                  
                                                  
                                                  950
                                                  
                                                  
                                                  
                                                  788
                                                  
                                                  
                                                  
                                                  162
                                                  
                                                  
                                                  
                                                  21
                                                  %Other
      operations
                                                  
                                                  
                                                  100
                                                  
                                                  
                                                  
                                                  110
                                                  
                                                  
                                                  
                                                  (10
                                                  )
                                                  
                                                  
                                                  -9
                                                  %Service, rent, and maintenance
      revenue
                                                  
                                                  $
                                                  13,214
                                                  
                                                  
                                                  $
                                                  13,746
                                                  
                                                  
                                                  $
                                                  (532
                                                  )
                                                  
                                                  
                                                  -4
                                                  %





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


38


Service, Rent and
Maintenance Revenue Discussion for the Three and Six Months Ended November 30,
2009 and 2008





The decrease in theGross cellular subscription billings for
the three and six months ended November30, 2009compared to the same periods in the
prior fiscal year resulted primarily from a decrease in monthly access charges
of $1,438,000 and $2,918,000, respectively. The reduction is dueto a decline inthe Company’scellular subscriberbase which is primarily a result of the
Company’s inability to offer the iPhone to its cellular customers resulting in
PCI’s cellular subscribers being forced to transfer their service to AT&T in
order to purchase the iPhone. The Company had 66,293 cellular subscribers as of
November 30, 2009 compared to 76,352cellular subscribers as of November 30,
2008. In addition, the cellular operations segment experienceda decreasein billings forroamerand toll chargesof approximately $300,000 and $698,000
for the three and six months ended November 30, 2009, respectively compared to
the same periods in the prior fiscal year. The decrease in roamer and toll
charges is a direct result of a declining subscriber base. During the later part
of fiscal year 2009 the Company focused on improving its cellular collections
efforts on past due cellular account balances and as a result late penalty fee
revenues decreased by approximately $116,000 and $249,000 in the three and six
months ended November 30, 2009, respectively compared to the same periods in the
prior fiscal year. These decreases in revenues were partially offset by an
increase in billings for data charges of $147,000 and $457,000 in the three and
six months ended November 30, 2009, respectively compared to the same periods in
the prior fiscal year as the Company’s customers continued the trend of
purchasing phones with internet connection capabilities. In addition, revenues
generated from other PCI services such as product warranty revenues and billing
related fees generated an additional $152,000 and $319,000 in the three and six
months ended November 30, 2009, respectively compared to the three and six
months ended November 30, 2008.





The
increase in service, rent and maintenance revenue from the Company’s two-way
business for the three and six months ended November 30, 2009 compared to the
three months and six months ended November 30, 2008 is primarily due to billings
related to the City of Tyler radio frequency re-banding project. Total billings
recorded for this project was approximately $200,000 in the quarter ended
November 30, 2009. The increase in service revenues for the three months ended
November 30, 2009 compared to the same period in the prior fiscal year was
partially offset by a decrease in maintenance and logic trunked radio (“LTR”)
service revenues of approximately $27,000 and $12,000, respectively. The
increase in service revenues for the six months ended November 30, 2009 compared
to the same period in the prior fiscal year was partially offset by a decrease
in maintenance and LTR revenues of approximately $31,000 and $25,000,
respectively.





The
increase in service, rent and maintenance revenue from the Company’s other
operations for the three months ended November 30, 2009 compared to the three
months ended November 30, 2008 is due to an increase in sales from the Company’s
car dealer expediter business. The decrease in service, rent and maintenance
from the Company’s other operations for the six months ended November 30, 2009
compared to the six months ended November 30, 2008 is due to a decrease in
service revenue related to the Company’s legacy dial-up internet service. The
Company eliminated its dial-up internet services in the later part of fiscal
year 2009 and discontinued offering these services to its
customers.


39


Cost of Service, Rent and
Maintenance for the Three and Six Months Ended November 30, 2009 and
2008





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





(dollars in
      thousands)
                              
                              November
30,
                              
                              
                              2009 vs
20082009
                              
                              
                              2008
                              
                              
                              $ Change
                              
                              
                              % ChangeThree Months
      EndedCost of service, rent and
      maintenanceCellular
      operations
                              
                              $
                              1,499
                              
                              
                              $
                              1,813
                              
                              
                              $
                              (314
                              )
                              
                              
                              -17
                              %Two-way
      operations
                              
                              
                              390
                              
                              
                              
                              424
                              
                              
                              
                              (34
                              )
                              
                              
                              -8
                              %Other
      operations
                              
                              
                              21
                              
                              
                              
                              37
                              
                              
                              
                              (16
                              )
                              
                              
                              -43
                              %Total cost of service, rent
      and maintenance
                              
                              $
                              1,910
                              
                              
                              $
                              2,274
                              
                              
                              $
                              (364
                              )
                              
                              
                              -16
                              %Six Months
      EndedCost of service, rent and
      maintenanceCellular
      operations
                              
                              $
                              3,053
                              
                              
                              $
                              3,753
                              
                              
                              $
                              (700
                              )
                              
                              
                              -19
                              %Two-way
      operations
                              
                              
                              791
                              
                              
                              
                              879
                              
                              
                              
                              (88
                              )
                              
                              
                              -10
                              %Other
      operations
                              
                              
                              31
                              
                              
                              
                              76
                              
                              
                              
                              (45
                              )
                              
                              
                              -59
                              %Total cost of service, rent
      and maintenance
                              
                              $
                              3,875
                              
                              
                              $
                              4,708
                              
                              
                              $
                              (833
                              )
                              
                              
                              -18
                              %





Cost of Service, Rent and
Maintenance Discussion for the Three and Six Months Ended November 30, 2009 and
2008





The
decrease in cost of service, rent and maintenance related to the Company’s
cellular operations for the three and six months ended November 30, 2009
compared to the three and six months ended November 30, 2008 is directly related
to the decrease in the Company’s cellular service revenues as a result of a
declining cellular subscriber base. Roamer costs decreased by approximately
$117,000 and $250,000 for the three and six months ended November 30, 2009,
respectively compared to the three and six months ended November 30, 2008. 
In addition, employee compensation costs from the Company’s cellular operations
decreased by approximately $147,000 and $300,000 for the three and six months
ended November 30, 2009, respectively compared to the same periods in the prior
fiscal year due to a reduction in personnel.  The cellular customer service
department had 57 employees as of November 30, 2009 compared to 68 employees as
of November 30, 2008.





The
decrease in cost of service, rent and maintenance related to the Company’s
two-way operations for the three months ended November 30, 2009 compared to the
three months ended November 30, 2008 is due to a decrease in network
infrastructure repairs of approximately $9,000 and a decrease in tower lease
expense of approximately $4,000.  In addition, personnel costs and travel
expenses decreased by approximately $12,000 and $10,000, respectively quarter
over quarter.  The decrease in cost of service rent and maintenance for the
six months ended November 30, 2009 compared to the six months ended November 30,
2008 is related to decrease in network infrastructure repairs of approximately
$29,000 and decrease in tower lease expense of approximately $6,000.  In
addition, personnel costs decreased approximately $37,000 period over period
primarily due to lower overtime costs and insurance premiums.





The
decrease in cost of service, rent and maintenance related to the Company’s other
operations for the three and six months ended November 30, 2009 compared to the
three and six months ended November 30, 2008 is related to a decrease in
internet service costs. The Company eliminated its legacy dial-up internet
services in the later part of fiscal year 2009.


40




Sales Revenue and Cost of
Products Sold for the Three and Six Months ended November 30, 2009 and
2008





(dollars in thousands)
                                                  
                                                  November 30,
                                                  
                                                  
                                                  2009 vs 20082009
                                                  
                                                  
                                                  2008
                                                  
                                                  
                                                  $ Change
                                                  
                                                  
                                                  %ChangeThree Months EndedProduct
      Sales RevenueCellular
                                                  
                                                  $
                                                  935
                                                  
                                                  
                                                  $
                                                  1,728
                                                  
                                                  
                                                  $
                                                  (793
                                                  )
                                                  
                                                  
                                                  -46
                                                  %Wholesale
                                                  
                                                  
                                                  5,499
                                                  
                                                  
                                                  
                                                  1,982
                                                  
                                                  
                                                  
                                                  3,517
                                                  
                                                  
                                                  
                                                  177
                                                  %Two-Way
                                                  
                                                  
                                                  777
                                                  
                                                  
                                                  
                                                  680
                                                  
                                                  
                                                  
                                                  97
                                                  
                                                  
                                                  
                                                  14
                                                  %Other
                                                  
                                                  
                                                  112
                                                  
                                                  
                                                  
                                                  58
                                                  
                                                  
                                                  
                                                  54
                                                  
                                                  
                                                  
                                                  93
                                                  %Total
      product sales revenue
                                                  
                                                  $
                                                  7,323
                                                  
                                                  
                                                  $
                                                  4,448
                                                  
                                                  
                                                  $
                                                  2,875
                                                  
                                                  
                                                  
                                                  65
                                                  %Cost
      of products soldCellular
                                                  
                                                  
                                                  972
                                                  
                                                  
                                                  
                                                  1,752
                                                  
                                                  
                                                  
                                                  (780
                                                  )
                                                  
                                                  
                                                  -45
                                                  %Wholesale
                                                  
                                                  
                                                  5,048
                                                  
                                                  
                                                  
                                                  1,775
                                                  
                                                  
                                                  
                                                  3,273
                                                  
                                                  
                                                  
                                                  184
                                                  %Two-Way
                                                  
                                                  
                                                  573
                                                  
                                                  
                                                  
                                                  526
                                                  
                                                  
                                                  
                                                  47
                                                  
                                                  
                                                  
                                                  9
                                                  %Other
                                                  
                                                  
                                                  75
                                                  
                                                  
                                                  
                                                  36
                                                  
                                                  
                                                  
                                                  39
                                                  
                                                  
                                                  
                                                  108
                                                  %Cost
      of products sold
                                                  
                                                  $
                                                  6,668
                                                  
                                                  
                                                  $
                                                  4,089
                                                  
                                                  
                                                  $
                                                  2,579
                                                  
                                                  
                                                  
                                                  63
                                                  %Six Months EndedProduct
      Sales RevenueCellular
                                                  
                                                  $
                                                  2,504
                                                  
                                                  
                                                  $
                                                  3,592
                                                  
                                                  
                                                  $
                                                  (1,088
                                                  )
                                                  
                                                  
                                                  -30
                                                  %Wholesale
                                                  
                                                  
                                                  8,014
                                                  
                                                  
                                                  
                                                  5,200
                                                  
                                                  
                                                  
                                                  2,814
                                                  
                                                  
                                                  
                                                  54
                                                  %Two-Way
                                                  
                                                  
                                                  1,339
                                                  
                                                  
                                                  
                                                  1,337
                                                  
                                                  
                                                  
                                                  2
                                                  
                                                  
                                                  
                                                  0
                                                  %Other
                                                  
                                                  
                                                  266
                                                  
                                                  
                                                  
                                                  203
                                                  
                                                  
                                                  
                                                  63
                                                  
                                                  
                                                  
                                                  31
                                                  %Total
      product sales revenue
                                                  
                                                  $
                                                  12,123
                                                  
                                                  
                                                  $
                                                  10,332
                                                  
                                                  
                                                  $
                                                  1,791
                                                  
                                                  
                                                  
                                                  17
                                                  %Cost
      of products soldCellular
                                                  
                                                  
                                                  2,560
                                                  
                                                  
                                                  
                                                  3,662
                                                  
                                                  
                                                  
                                                  (1,102
                                                  )
                                                  
                                                  
                                                  -30
                                                  %Wholesale
                                                  
                                                  
                                                  7,313
                                                  
                                                  
                                                  
                                                  4,620
                                                  
                                                  
                                                  
                                                  2,693
                                                  
                                                  
                                                  
                                                  58
                                                  %Two-Way
                                                  
                                                  
                                                  1,015
                                                  
                                                  
                                                  
                                                  966
                                                  
                                                  
                                                  
                                                  49
                                                  
                                                  
                                                  
                                                  5
                                                  %Other
                                                  
                                                  
                                                  184
                                                  
                                                  
                                                  
                                                  144
                                                  
                                                  
                                                  
                                                  40
                                                  
                                                  
                                                  
                                                  28
                                                  %Cost
      of products sold
                                                  
                                                  $
                                                  11,072
                                                  
                                                  
                                                  $
                                                  9,392
                                                  
                                                  
                                                  $
                                                  1,680
                                                  
                                                  
                                                  
                                                  18
                                                  %





Sales Revenue and Cost of
Products Sold Discussion for the Three and Six Months Ended November 30, 2009
and 2008





Product sales revenue: The
decrease in product sales revenue from the Company’s cellular operations for the
three and six months ended November 30, 2009 compared to the three and six
months ended November 30, 2008 is primarily due to a decrease in cellular phone
activations and upgrades. The Company’s cellular phone activations decreased by
a quantity of 690 and 1,270 for the three and six months ended November 30,
2009, respectively compared to the same periods from the prior fiscal
year.  The Company’s cellular phone upgrades decreased by a quantity
of 1,624 and 2,425 for the three and six months ended November 30, 2009,
respectively compared to the same period from the prior fiscal
year.  In addition, the average revenue per phone sold continues to
decline as the Company continues to subsidize the sale of cellular handsets to
compete with the pricing of other cellular carriers. The decrease in cellular
product sales for the six months ended November 30, 2009 was partially offset by
cellular product sales of approximately $278,000 related to the Company’s
T-Mobile operations in Oklahoma. The Company opened 5 retail locations in
February 2009 selling T-Mobile branded products and services. As of November 30,
2009, the Company had closed all of its Oklahoma retail locations selling
T-Mobile branded products and services. In January 2010, the Company’s retail
agreement with T-Mobile was terminated due to the Company closing all of its
retail locations in the Oklahoma market.


41


The
increase in product sales from the Company’s wholesale operations for the three
months and six months ended November 30, 2009 compared to the three and six
months ended November 30, 2008 is related to brokering large quantities of
cellular handsets to certain domestic and international cellular
distributors.  The high volume, low margin sales generated
approximately $3,850,000 and $4,750,000 in additional product sales for the
three and six months ended November 30, 2009, respectively. There were no
similar cellular brokering sales for the three and six months ended November 30,
2008.





The
increase in product sales from the Company’s two-way operations for the three
months ended November 30, 2009 compared to the three months ended November 30,
2009 is primarily related to an increase in emergency vehicle product (“EVP”)
sales.  Two-way product sales for the six months ended November 30,
2009 compared to the six months ended November 30, 2008 remained flat due to the
limited  budget increases of city and county municipalities, two-way’s
primary customers.





The
increase in product sales related to the Company’s other operations for the
three and six months ended November 30, 2009 compared to the same periods in the
prior fiscal year is due to an increase in demand for aftermarket automotive
audio, video and vehicle accessory products related to the Company’s car dealer
expediter business.





Cost of products
sold:  The increase in total cost of products sold for the
three and six months ended November 30, 2009 compared to the three and six
months ended November 30, 2008 is primarily due to an increase in product sales
revenues from the Company’s wholesale operations partially offset by a decrease
in cellular product sales. The Company’s wholesale operations experienced large
volume, low margin sales related to brokering cellular handsets in the first six
months of fiscal year 2010 which created corresponding increases in cost of
products sold.  The Company’s cellular operations segment continued to
experience low or negative profit margins related to the sales of cellular
handsets due to increased market competition in the cellular industry and the
shift in equipment sales to higher-end PDA devices.  The Company is
required to offer higher equipment subsidies on the higher-end handsets to match
pricing offered by AT&T and other competing cellular
carriers.  Cost of products increased slightly from the Company’s
two-way operations despite flat product sales year over year as a result of the
type of products sold.  The two-way business experienced higher sales
in emergency vehicle products, year over year, which has lower profit margins
compared to two-way radio products and accessories.





Selling and General and
Administrative Expenses for the Three and Six Months ended November 30, 2009 and
2008





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


42





(dollars in thousands)
                      
                      November 30,
                      
                      
                      2009 vs 20082009
                      
                      
                      2008
                      
                      
                      $
      Change
                      
                      
                      %
      ChangeThree Months EndedSelling
      and general and administrativeSalaries
      and other personnel expenses
                      
                      $
                      2,502
                      
                      
                      $
                      2,624
                      
                      
                      $
                      (122
                      )
                      
                      
                      -5
                      %Office
      expense
                      
                      
                      469
                      
                      
                      
                      504
                      
                      
                      
                      (35
                      )
                      
                      
                      -7
                      %Advertising
      expense
                      
                      
                      232
                      
                      
                      
                      239
                      
                      
                      
                      (7
                      )
                      
                      
                      -3
                      %Professional
      fees
                      
                      
                      332
                      
                      
                      
                      345
                      
                      
                      
                      (13
                      )
                      
                      
                      -4
                      %Taxes
      and licenses fees
                      
                      
                      40
                      
                      
                      
                      56
                      
                      
                      
                      (16
                      )
                      
                      
                      -29
                      %Stock-based
      compensation expense
                      
                      
                      38
                      
                      
                      
                      45
                      
                      
                      
                      (7
                      )
                      
                      
                      -16
                      %Other
      expenses
                      
                      
                      362
                      
                      
                      
                      357
                      
                      
                      
                      5
                      
                      
                      
                      1
                      %Total
      selling and general and administrative
                      
                      $
                      3,975
                      
                      
                      $
                      4,170
                      
                      
                      $
                      (195
                      )
                      
                      
                      -5
                      %Six Months EndedSelling
      and general and administrativeSalaries
      and other personnel expenses
                      
                      $
                      5,022
                      
                      
                      $
                      5,507
                      
                      
                      $
                      (485
                      )
                      
                      
                      -9
                      %Office
      expense
                      
                      
                      987
                      
                      
                      
                      1,032
                      
                      
                      
                      (45
                      )
                      
                      
                      -4
                      %Advertising
      expense
                      
                      
                      345
                      
                      
                      
                      389
                      
                      
                      
                      (44
                      )
                      
                      
                      -11
                      %Professional
      fees
                      
                      
                      905
                      
                      
                      
                      750
                      
                      
                      
                      155
                      
                      
                      
                      21
                      %Taxes
      and licenses fees
                      
                      
                      93
                      
                      
                      
                      116
                      
                      
                      
                      (23
                      )
                      
                      
                      -20
                      %Stock-based
      compensation expense
                      
                      
                      170
                      
                      
                      
                      86
                      
                      
                      
                      84
                      
                      
                      
                      98
                      %Other
      expenses
                      
                      
                      651
                      
                      
                      
                      795
                      
                      
                      
                      (144
                      )
                      
                      
                      -18
                      %Total
      selling and general and administrative
                      
                      $
                      8,173
                      
                      
                      $
                      8,675
                      
                      
                      $
                      (502
                      )
                      
                      
                      -6
                      %





Selling and General and
Administrative Expenses Discussion for the Three and Six Months Ended November
30, 2009 and 2008





The
decrease in salaries and other personnel expenses for the three and six months
ended November 30, 2009 compared to the three and six months ended November 30,
2008 is due to a decrease in contract labor and commission expense. Contract
labor expenses decreased by approximately $183,000 and $334,000 for the three
and six months ended November 30, 2009, respectively compared to the same
periods in the prior fiscal year.  The reduction in contract labor was
primarily the result of the Company terminating its computer services contract
with a group of IT contractors in the later part of fiscal year
2009.  The decrease in commission expense for the three and six months
ended November 30, 2009 compared to the same periods from the prior fiscal year
was approximately $63,000 and $178,000, respectively.  The decrease in
commission expense is attributable to the overall reduction in commissionable
sales.





The
decrease in advertising expense for the three and six months ended November 30,
2009 compared to the three and six months ended November 30, 2008 is primarily
related to advertising reimbursements the Company received from certain vendors
for achieving sales based objectives.  Advertising reimbursements
increased by approximately $57,000 in the six months ended November 30, 2009
compared to the six months ended November 30, 2008.  In addition, the
Company reduced expenses related to billboard advertising and promotions by
approximately $26,000 and $17,000, respectively in the six months ended November
30, 2009 compared to the same period in the prior year.  The decrease
in expenses was partially offset by an increase in sponsorships and print media
expenses of approximately $48,000 and $8,000, respectively for the six months
ended November 30, 2009 compared to the same period in the prior fiscal
year.





The
increase in professional fees for the six months ended November 30, 2009
compared to the six months ended November 30, 2008 is due to an increase in
legal fees of approximately $400,000, primarily related to costs associated with
defending the Company against an alleged infringement on the Hawk Electronics
trade name as well as legal fees related to the foreclosure on the assets of
Air-bank, Inc. The increase in legal fees was partially offset by a reduction in
accounting and other professional fees of approximately $64,000 for the six
months ending November 30, 2009 compared to the six months ending November 30,
2008.  In addition, board of director fees and consulting fees
decreased by approximately $57,000 and $60,000, respectively for the six months
ended November 30, 2009 compared to the six months ended November 30,
2008.  The decrease in consulting fees is primarily related to charges
the Company incurred in the prior fiscal year attributable to its internal
controls assessment required under Section 404 of the Sarbanes-Oxley Act of
2002.


43


The
increase in stock-based compensation expense for the six months ended November
30, 2009 compared to the six months ended November 30, 2008 is due to stock
options granted to the Company’s executive management on June 1, 2009, under the
terms of their employment agreement effective June 1, 2008 as well as granting
additional options to the Company’s board of directors in June 2009. During the
first quarter of fiscal year 2010, the Company granted an additional 693,167 in
stock options which contributed to the increase in stock compensation
expense for the six months ended November 30, 2009 compared to the six months
ended November 30, 2008.





The 18%
decrease in other expenses for the six months ended November 30, 2009 compared
to the six months November 30, 2009 is attributable to bad debt recoveries of
approximately $100,000 in the first six months of fiscal year 2010 with no
similar occurring transactions in the first six months of fiscal year
2009.  This is a direct result of the Company focusing on the
collection efforts of past due cellular account balances beginning in the later
part of fiscal year 2009. The Company also incurred lower premium costs on its
business insurance coverage of approximately $47,000 when comparing the six
months ended November 30, 2009 to the six months ended November 30,
2008.





Other Operating Expenses for
the Three and Six Months Ended November 30, 2009 and 2008





(dollars in thousands)November 30,
                        
                        
                        2009 vs 20082009
                        
                        
                        2008
                        
                        
                        $
      Change
                        
                        
                        %
      ChangeThree Months EndedOther
      Operating ExpensesDepreciation
      and amortization:Depreciation
                        
                        $
                        95
                        
                        
                        $
                        126
                        
                        
                        $
                        (31
                        )
                        
                        
                        -25
                        %Amortization
                        
                        
                        224
                        
                        
                        
                        229
                        
                        
                        
                        (5
                        )
                        
                        
                        -2
                        %Total
      depreciation and amortization
                        
                        
                        319
                        
                        
                        
                        355
                        
                        
                        
                        (36
                        )
                        
                        
                        -10
                        %Loss
      on disposal of assets
                        
                        
                        -
                        
                        
                        
                        (1
                        )
                        
                        
                        1
                        
                        
                        
                        -100
                        %Total
      other operating expenses
                        
                        $
                        319
                        
                        
                        $
                        354
                        
                        
                        $
                        (35
                        )
                        
                        
                        -10
                        %Six Months EndedOther
      Operating ExpensesDepreciation
      and amortization:Depreciation
                        
                        $
                        198
                        
                        
                        $
                        261
                        
                        
                        $
                        (63
                        )
                        
                        
                        -24
                        %Amortization
                        
                        
                        447
                        
                        
                        
                        468
                        
                        
                        
                        (21
                        )
                        
                        
                        -4
                        %Total
      depreciation and amortization
                        
                        
                        645
                        
                        
                        
                        729
                        
                        
                        
                        (84
                        )
                        
                        
                        -12
                        %Loss(gain)
      on disposal of assets
                        
                        
                        1
                        
                        
                        
                        (1
                        )
                        
                        
                        2
                        
                        
                        
                        -200
                        %Total
      other operating expenses
                        
                        $
                        646
                        
                        
                        $
                        728
                        
                        
                        $
                        (82
                        )
                        
                        
                        -11
                        %





The
decrease in depreciation and amortization expenses for the three and six months
ended November 30, 2009 compared to the three and six months ended November 30,
2008 is attributable to the Company’s minimal purchases of fixed assets for its
corporate offices and retail locations.  In addition certain existing
capital assets which became fully depreciated also contributed to the decrease
in depreciation expense.  The decrease in amortization expense year
over year is due to certain intangibles that were fully amortized in the third
quarter of fiscal year 2009.  These intangibles were associated with
the Company’s two-way segment due to the purchase of the assets of Delta
Communications and Electronics, Inc. in January 2004.


44


Interest Expense, Net of
Interest Income for the Three and Six Months Ended November 30, 2009 and
2008





(dollars in thousands)
                              
                              November 30,
                              
                              
                              2009 vs 20082009
                              
                              
                              2008
                              
                              
                              $
      Change
                              
                              
                              %
      ChangeThree
    Months  EndedInterest
      expense (income)Mortgage
      debt
                              
                              $
                              40
                              
                              
                              $
                              50
                              
                              
                              $
                              (10
                              )
                              
                              
                              -20
                              %Thermo
      factoring debt
                              
                              
                              -
                              
                              
                              
                              366
                              
                              
                              
                              (366
                              )
                              
                              
                              -100
                              %Thermo
      revolving credit facility
                              
                              
                              495
                              
                              
                              
                              160
                              
                              
                              
                              335
                              
                              
                              
                              209
                              %Warrant
      redemption notes payable
                              
                              
                              35
                              
                              
                              
                              42
                              
                              
                              
                              (7
                              )
                              
                              
                              -17
                              %Other
                              
                              
                              (1
                              )
                              
                              
                              1
                              
                              
                              
                              (2
                              )
                              
                              
                              -200
                              %Total
      interest expense, net
                              
                              $
                              569
                              
                              
                              $
                              619
                              
                              
                              $
                              (50
                              )
                              
                              
                              -8
                              %November 30,
                              
                              
                              2009 vs 20082009
                              
                              
                              2008
                              
                              
                              $
      Change
                              
                              
                              %
      ChangeSix Months  EndedInterest
      expense (income)Mortgage
      debt
                              
                              $
                              82
                              
                              
                              $
                              103
                              
                              
                              $
                              (21
                              )
                              
                              
                              -20
                              %Thermo
      factoring debt
                              
                              
                              306
                              
                              
                              
                              747
                              
                              
                              
                              (441
                              )
                              
                              
                              -59
                              %Thermo
      revolving credit facility
                              
                              
                              635
                              
                              
                              
                              319
                              
                              
                              
                              316
                              
                              
                              
                              99
                              %Warrant
      redemption notes payable
                              
                              
                              70
                              
                              
                              
                              86
                              
                              
                              
                              (16
                              )
                              
                              
                              -19
                              %Other
                              
                              
                              (21
                              )
                              
                              
                              (1
                              )
                              
                              
                              (20
                              )
                              
                              2000
                              %Total
      interest expense, net
                              
                              $
                              1,072
                              
                              
                              $
                              1,254
                              
                              
                              $
                              (182
                              )
                              
                              
                              -15
                              %





The
decrease in interest expense for the three and six months ended November 30,
2009 compared to the three and six months ended November 30, 2009 is due to a
decrease in cellular billings which resulted in lower levels of accounts
receivable year over year.   During the three and six months
ended November 2008 the Company incurred greater discount fees related to the
factoring debt facility compared to the same periods in the prior fiscal year
due to a higher cellular subscriber base which resulted in higher accounts
receivable levels. In addition, the Company combined the Thermo factoring debt
facility and the Thermo revolving credit facility into a single credit facility
by expanding the revolving credit facility to allow the Company to retire the
Thermo factoring debt in August 2009.  The debt restructure included a
change in the calculation of interest related to the Company’s debt balance with
Thermo (see Note 9 – Long-Term Debt for additional information).





Income Tax Expense for the
Three and Six Months Ended August 31, 2009 and 2008





In all
periods presented, the combined operations of the Company did not generate a
federal tax liability.  In the three months ended November 30, 2009
and 2008, the Company recorded $62,000 and $81,000 in state tax expenses,
respectively. In the six months ended November 30, 2009 and 2008, the Company
recorded $123,000 and $ 162,000 in state tax expenses,
respectively.  The state tax expense in all periods presented relates
primarily to the Texas margin tax, which was initially implemented by the state
effective January 1, 2008.  The margin tax is calculated by using the
Company’s gross receipts from business conducted in Texas each fiscal year less
a cost of goods sold deduction.  Due to a reduction in the Company’s
gross receipts in Texas, the Texas state tax expense decreased in the three and
six months ended November 30, 2009 compared to the three and six months ended
November 30, 2008.




45




FINANCIAL
CONDITION





(dollars in thousands)
                    
                    Six Months Ended November 30,
                    
                    
                    2009 vs 20082009
                    
                    
                    2008
                    
                    
                    $
      ChangeCash
      provided by (used in) operating activities
                    
                    $
                    (383
                    )
                    
                    $
                    1,156
                    
                    
                    $
                    (1,539
                    )Cash
      provided by (used in) investing activities
                    
                    
                    763
                    
                    
                    
                    (473
                    )
                    
                    
                    1,236Cash
      provided by (used in) financing activities
                    
                    
                    386
                    
                    
                    
                    (1,895
                    )
                    
                    
                    2,281Net
      decrease in cash
                    
                    $
                    766
                    
                    
                    $
                    (1,212
                    )
                    
                    $
                    1,978





Operating
Activities





The
decrease in cash provided by operations during the six months ended November 30,
2009 compared to the six months ended November 30, 2008 is primarily
attributable to additional payments made against the Company’s accounts payable
and accrued liabilities of approximately $1,400,000 and $600,000, respectively
during the first six months of fiscal year 2010 compared to the same period in
fiscal year 2009.  The Company had additional cash in the first six
months of fiscal year 2010 to pay down certain accounts payable and accrued
liabilities, primarily revenue share invoices payable to AT&T for cellular
services billed by the Company as well as bonus payments to employees. For
fiscal year 2009, approximately $502,000 in additional bonuses were awarded to
the Company’s management as compared to the bonuses awarded for fiscal year
2008.  The fiscal 2009 bonuses were paid between August and December
2009.





Investing
Activities





The
increase in cash provided by investing activities for the six months ended
November 30, 2009 compared to six months ended November 30, 2008 is due to cash
receipts received against the Mobui Note and Air-bank Note of $415,000 and
$177,000, respectively (see Note 4 - “Notes Receivable” for additional
information).  In addition, the Company had fewer capital expenditures
of approximately $171,000 in the six months ended November 30, 2009 compared to
the six months ended November 30, 2008, primarily due to the completion of a
two-way shop building in the first quarter of fiscal year 2009.  The
first quarter of fiscal year 2010 had no similar occurring
transactions.  The Company also redeemed $200,000 in certificates of
deposit during the quarter ended November 30, 2009 due to renegotiating a letter
of credit with one its suppliers. There was no similar occurring transaction in
the first six months of fiscal year 2009.





Financing
Activities





The
increase in cash provided by financing activities for the six months ended
November 30, 2009 compared to the six months ended November 30, 2008 is
primarily attributable to a $1,500,000 cash payment to the 12 holders of the GM
Warrants on June 2, 2008 in accordance with the Warrant Redemption Payment
Agreements. There was no corresponding payment made in the first six months of
fiscal year 2010.  In addition, the Company received $1,123,000 in
additional cash proceeds in the six months ended November 30, 2009 compared to
the six months ended November 30, 2008 due to a draw on the
Company’s  revolving credit line with Thermo in November 2009 for
approximately $1,400,000.  The increases in cash were partially offset
by additional payments on long-term debt of $311,000 in the first six months of
fiscal year 2010 compared to the first six months of fiscal year
2009.  In the first quarter of fiscal year 2010, the Company paid down
the balance of its former factoring debt facility with Thermo due to a decrease
in its accounts receivable levels which was a direct result of a declining
subscriber base.


46


Current
Position/Future Requirements





Most of
the Company’s efforts from August 2006 through fiscal 2009 were focused on the
complex integration issues related to the acquisition of PCI, its subsequent
reorganization activities, as well as on securing financing to grow its retail
businesses and work to complete one or more acquisitions to provide new avenues
of revenue growth for the Company. After rationalizing a number of business
units and resizing the workforce over the past two years, Teletouch is better
positioned to achieve its financing, retail expansion and acquisition goals. Key
to this strategy is and has been leveraging the Company’s various customer
relationships, including PCI’s nearly 66,000 cellular subscribers, which are
comprised of individuals and businesses of higher than average credit worthiness
(due to PCI’s stringent credit standards). The Company believes that there are
opportunities to grow revenues in excess of its current cellular revenues with
these monthly-billed customers.





The
Company’s primary business for over 35 years has been distributing AT&T
cellular services under several exclusive master distributor
agreements.  As of the date of this Report, certain changes to the
Company’s relationship with AT&T have occurred, including the expiration of
the exclusivity with AT&T under the primary Dallas/Fort Worth (“DFW”)
distribution agreement and the commencement of legal action against AT&T by
the Company. Following the August 2009 expiration of the DFW distribution
agreement, the Company maintained the right to continue servicing its cellular
subscriber base until the last subscriber terminates service.  Since the
launch of the iPhone in June 2007, and following AT&T’s refusal to allow the
Company to offer the iPhone to its subscriber base, the Company has experienced
higher rates of attrition in its cellular subscriber base due to subscribers
having to transfer their service to AT&T to purchase an iPhone.  The
iPhone and certain other products and services that have been withheld from the
Company by AT&T were the primary reasons the Company commenced the legal
action against AT&T in September 2009.  Following expiration of the DFW
agreement and the commencement of the legal action, the Company has not
experienced a significant increase in subscriber attrition from the levels
experienced since June 2007, nor are subscriber attrition levels expected to
increase further during the remainder of 2010.  The Company is currently
negotiating new cellular carrier distribution relationships and expects to be
offering multiple carrier cellular services by the end of the year with the
intent of offsetting some of the losses of its AT&T cellular service
revenues.





The
Company experienced significant declines in revenues during the last year due to
migration of large number of cellular subscriber to AT&T in order to
purchase services and products directly from AT&T that the Company was not
allowed to sell, macro-economic issues driving lower sales of cellular and
electronics sales in its wholesale business and budgetary constraints imposed on
many governmental entities and commercial enterprises resulting in lower sales
in the Company’s two-way radio business.   In spite of the loss
of revenues, the Company was successful in improving its operating results
during 2009 and continuing through the first quarter of fiscal 2010 through
aggressive cost management and improved margins on the revenues it
maintained.  During the remainder of fiscal 2010, the Company will
continue to manage its costs closely but will focus on developing new sources of
revenue for all of its business units.  These new revenue sources will
be several anticipated distribution agreements and, potentially, the acquisition
of one or more complementary businesses. Following the acquisition of PCI in
August 2006, the Company struggled to complete the required audits because of
the condition of the financial records of PCI. Because of the delays in
completing these audits, the Company was unable to maintain a current standing
its regulatory reporting requirements.   The Company’s inability
to file the required financials hindered the Company’s ability to secure
additional financing to grow the business or to complete any of the major
acquisitions it has identified. Significant progress was made in 2009 catching
up on its delinquent financial statement audits and filings and in December of
2010, the Company completed and filed all of its required previously delinquent
quarterly financial reports which brought the Company into compliance with its
reporting requirements as determined by the SEC. The SEC granted the Company
relief as to the quarterly filings in the year ended May 31, 2007. The Company
and is hopeful that it can now secure the necessary financing to complete one or
more of these acquisitions in 2010. There is no assurance that any of the
acquisitions will be concluded.


47


Certain
non-recurring expenses are expected to be incurred through the remainder of
fiscal 2010 related to the arbitration proceeding against AT&T and the
startup and expansion costs related to the new products and
services.  The Company believes that these non-recurring expenses will
be manageable and will not materially impair its operating results during
2010.  In addition, on October 2, 2009, the Securities and Exchange
Commission, delayed the implementation of section 404(b) of the Sarbanes Oxley
Act of 2002 for smaller reporting companies until fiscal years ending after June
15, 2010.  The impact of this delay is that Teletouch will not be
required to have its independent auditors attest to the effectiveness of its
internal controls during fiscal 2010 which results in a further reduction of
costs anticipated during 2010.  Under the current guidance, Teletouch
would be required to have an independent audit of its internal controls as of
its fiscal year ended May 31, 2011.





As of
November 30, 2009, the Company has $5,408,000 cash on hand and available
borrowings under its current credit facilities of up to $3,455,000 against
future accounts receivable and $1,426,000 that can be borrowed against purchases
of assets, other than accounts receivable.  For 2010, the Company
expects its operations to continue to improve and believes that it has
sufficient cash and cash available under its current financing facilities to
meet its obligations in the upcoming 12 months.  As discussed above,
the impact of the expiration of the distribution agreement with AT&T for the
DFW market is not expected to have a significant negative impact on operations
during the next 12 months.  The Company is in the process of
finalizing new distribution agreements with other cellular and related service
carriers and providers and expects to launch these new products and services
beginning in the third quarter of fiscal 2010.  The Company will
continue to manage expenses to align with any continued reductions in revenues,
if it is not able to offset these declines with its new revenue
initiatives.  During fiscal 2008 and 2009 and continuing through the
quarter ended November 30, 2009, the Company has demonstrated its ability to
manage expenses to drive material improvement in its operating
results.  For the remainder of 2010, the Company is prepared to
continue reducing expenses, if necessary, to maintain stability in its operating
results.  As discussed above, certain non-recurring expenses are
expected to be incurred throughout the remainder of 2010, but the Company
believes these will be manageable and will not impact its ability to service any
of its payment obligations for the next 12 months.  The debt
obligations of the Company for the next 12 months are approximately $550,000 and
the Company believes it has sufficient cash to meet its obligations for at least
the 12 months following the date of this Report.





Off-Balance
Sheet Transactions




The
Company does not engage in 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.





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.


48


In
determining the adequacy of the allowance for doubtful accounts, management
considers a number of factors including historical collections experience, aging
of the receivable portfolio, financial condition of the customer and industry
conditions.  The Company considers an account receivable past due when
customers exceed the terms of payment granted to them by the
Company.  The Company writes off its fully reserved accounts
receivable when it has exhausted all collection efforts, which is typically 90
days following the last payment received from the customer.





Accounts
receivable are presented net of an allowance for doubtful accounts of $501,000
and $486,000 at November 30, 2009 and May 31, 2009,
respectively.  Based on the information available to the Company,
management believes the allowance for doubtful accounts as of those periods are
adequate.  However, actual write-offs may exceed the recorded
allowance.





The
Company evaluates its write-offs on a monthly basis.  The Company
determines which accounts are uncollectible, and those balances are written-off
against the Company’s allowance for doubtful accounts balance.





Reserve
for Inventory Obsolescence:Inventories are stated
at the lower of cost (primarily on a moving average basis), which approximates
actual cost determined on a first-in, first-out (“FIFO”) basis, or fair market
value and are comprised of finished goods. In determining the adequacy of the
reserve for inventory obsolescence, management considers a number of factors,
including recent sales trends, industry market conditions and economic
conditions. In assessing the reserve, management also considers price protection
credits the Company expects to recover from its vendors when the vendor cost on
certain inventory items is reduced shortly after purchase of the inventory by
the Company.  In addition, management establishes specific valuation
allowances for discontinued inventory based on its prior experience 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 $246,000 and $242,000 at November 30, 2009 and May 31, 2009,
respectively.





Impairment
of Long-Lived Assets:In accordance with ASC
360, Property, Plant and
Equipment, (“ASC 360”), the Company evaluates the recoverability of the
carrying value of its long-lived assets based on estimated undiscounted cash
flows to be generated from such assets. If the undiscounted cash flows indicate
an impairment, then the carrying value of the assets being evaluated is
written-down to the estimated fair value of those assets.  In
assessing the recoverability of these assets, the Company must project estimated
cash flows, which are based on various operating assumptions, such as average
revenue per unit in service, disconnect rates, sales productivity ratios and
expenses. Management develops these cash flow projections on a periodic basis
and reviews the projections based on actual operating trends. The projections
assume that general economic conditions will continue unchanged throughout the
projection period and that their potential impact on capital spending and
revenues will not fluctuate. Projected revenues are based on the Company's
estimate of units in service and average revenue per unit as well as revenue
from various new product initiatives. Projected revenues assume a continued
decline in cellular service revenue while projected operating expenses are based
upon historic experience and expected market conditions adjusted to reflect an
expected decrease in expenses resulting from cost saving
initiatives.





The
Company’s review of the carrying value of its tangible long-lived assets at May
31, 2009 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, 2009.  There were no
significant events in the first quarter of fiscal year 2010 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.


49


The most
significant long-lived tangible asset owned by the Company is the Fort Worth,
Texas corporate office building and the associated land.  The Company
has received periodic appraisals of the fair value of this property. In each
instance the appraised value exceeded the carrying value of the
property.





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





The
evaluation of the Company’s long-lived intangible assets is discussed in Note 2
under “Intangible Assets.” Under the same premise as the long-lived tangible
assets, their market values were also evaluated at May 31, 2009, 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 current quarter 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 ASC 740, 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 and net operating loss and tax credit carry forwards.
Deferred income tax expense represents the change in net deferred assets and
liability balances. Deferred income taxes result from temporary differences
between the basis of assets and liabilities recognized for differences between
the financial statement and tax basis thereon and for the expected future tax
benefits to be derived from net operating losses and tax credit carry forwards.
A valuation allowance is recorded when it is more likely than not that deferred
tax assets will be unrealizable in future periods.  On November 1,
2005, the Company became a member of the consolidated tax group of Progressive
Concepts Communications, Inc. (“PCCI”) as a result of PCCI’s gaining control of
over 80% of the outstanding common stock of Teletouch on that
date.  PCCI gained control of Teletouch’s common stock through the
conversion by TLL Partners, LLC (“TLLP”), PCCI’s wholly-owned subsidiary, of all
of its shares of the Company’s outstanding Series C Preferred Stock into
43,500,000 shares of common stock on November 1, 2005.  As of November
1, 2005, TLLP was a disregarded entity for federal tax purposes since it was at
that time a single member limited liability company (“LLC”). Therefore, the
parent company of Teletouch for federal tax purposes was deemed to be
PCCI.   The Company continued to account for its taxes under 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.





Goodwill:
Goodwill represents the excess of costs over fair value of assets of businesses
acquired.  Goodwill and intangible assets acquired in a business
combination and determined to have an indefinite useful life are not amortized
but instead are tested for impairment at least annually in accordance with the
provisions of ASC 350, Intangibles-Goodwill and
Other, (“ASC 350”). Teletouch’s 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.


50


At March
1, 2009, the Company evaluated the carrying value of its goodwill associated
with its two-way business and concluded that no impairment of its goodwill was
required in fiscal year 2009.  The Company estimates the fair value of
its two-way business using a discounted cash flow
method.    The Company continually evaluates whether events
and circumstances have occurred that indicate the remaining balance of goodwill
may not be recoverable. In evaluating impairment the Company estimates the sum
of the expected future cash flows derived from such goodwill. Such evaluations
for impairment are significantly impacted by estimates of future revenues, costs
and expenses and other factors. A significant change in cash flows in the future
could result in an additional impairment of goodwill. No changes occurred in the
two-way business during the current quarter that warranted an impairment to
goodwill.





Revenue
Recognition:Teletouch recognizes
revenue over the period the service is performed in accordance with SEC Staff
Accounting Bulletin No. 104, "Revenue Recognition in Financial Statements" and
ASC 605, Revenue
Recognition, (“ASC 605”). In general, ASC 605 requires that four basic
criteria must be met before revenue can be recognized: (1) persuasive evidence
of an arrangement exists, (2) delivery has occurred or services rendered, (3)
the fee is fixed and determinable, and (4) collectability is reasonably assured.
Teletouch believes, relative to sales of products, that all of these conditions
are met; therefore, product revenue is recognized at the time of
shipment.





The
Company primarily generates revenues by providing and billing recurring cellular
services and product sales.  Cellular services include cellular
airtime and other recurring services 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 cellular services are
recognized during the period in which the service is
rendered.  Associated subscriber acquisition costs are expensed as
incurred.  Product sales revenue is recognized when delivery occurs,
the customer takes title and assumes risk of loss, terms are fixed and
determinable and collectability is reasonably assured.  The Company
does not generally grant rights of return.  However, PCI offers
customers a 30 day return/exchange program for new cellular subscribers in order
to match programs in place by most of the other cellular
carriers.  During the 30 days, a customer may return all cellular
equipment and cancel service with no penalty.  Reserves for returns,
price discounts and rebates are estimated using historical averages, open return
requests, recent product sell-through activity and market
conditions.  No reserves have been recorded for the 30 day cellular
return program since only a very small number of customers utilize this return
program and many fail to meet all of the requirements of the program, which
include returning the phone equipment in new condition with no visible
damage.  In addition, it is typical to incur losses on the sale of the
cellular phone equipment related to signing up customers under a cellular
airtime contract; therefore, any reserves recorded for customer returns would be
an accrual of gains via reversing the losses incurred on the original cellular
phone sale transaction.  The Company does not believe accruing for the
potential gains would be in accordance with GAAP but rather records this gain in
the period that it is actually realized.





Since
1987, Teletouch’s subsidiary, PCI, has held agreements with AT&T, which
allowed PCI to offer cellular service and customer service to its
subscribers.  PCI is responsible for the billing and collection of
cellular charges from these customers and remits a percentage of the cellular
billings generated to AT&T.  Based on PCI’s relationship with
AT&T, the Company has evaluated its reporting of revenues, under ASC 605-45,
Revenue Recognition, Principal Agent
Considerations (“ASC 605-45”) associated with its services attached to
the AT&T agreements.


51


Based on
its assessment of the indicators listed in ASC 605-45, the Company has concluded
that the AT&T services provided by PCI should be reported on a net
basis.





Deferred
revenue represents prepaid monthly service fees paid by customers.





Stock-Based
Compensation:We
account for stock-based awards to employees in accordance with ASC 718, Compensation-Stock
Compensation, (“ASC 718”) and for stock based awards to non-employees in
accordance with ASC 505-50, Equity, Equity-Based Payments to
Non-Employees (“ASC 505-50”). Under both ASC 718 and ASC 505-50, we use a
fair value based method to determine compensation for all arrangements where
shares of stock or equity instruments are issued for compensation. For share
option instruments issued, compensation cost is recognized ratably using the
straight-line method over the expected vesting period. The Company estimates the
fair value of employee stock options on the date of grant using the
Black-Scholes model. The determination of fair value of stock-based payment
awards on the date of grant using an option-pricing model is affected by our
stock price as well as assumptions regarding a number of highly complex and
subjective variables. These variables include, but are not limited to the
expected stock price volatility over the term of the awards and the actual and
projected employee stock option exercise behaviors. The Company has elected to
estimate the expected life of an award based on the SEC approved “simplified
method”. We calculated our expected volatility assumption required in the
Black-Scholes model based on the historical volatility of our stock. We will
update these assumptions on at least an annual basis and on an interim basis if
significant changes to the assumptions are warranted.





Item
3.  Quantitative and Qualitative Disclosures About Market
Risk





The
Company did not have any foreign currency hedges or other derivative financial
instruments as of November 30, 2009.  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
4T. Controls and Procedures





(a)
Controls and procedures




As of the
end of the period covered by this report, the Company conducted an evaluation,
under the supervision and with the participation of our management, including
the Chief Executive Officer, President and Chief Operating Officer and Chief
Financial Officer (the “Certifying Officers”) of our disclosure controls and
procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act).
Based on this evaluation, the Certifying Officers concluded that, as of November
30, 2009, our disclosure controls and procedures were effective to ensure that
information required to be disclosed by us in reports that we file or submit
under the Exchange Act is recorded, processed, summarized and reported, within
the time periods specified in the Commission’s rules and forms and to ensure
that information required to be disclosed by us in the reports that we file or
submit under the Exchange Act is accumulated and communicated to us, including
our principal executive and principal financial officers, as appropriate to
allow timely decisions regarding required disclosure.




(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.


52


Part II.  Other
Information





Item
      1.
            Legal
      Proceedings





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





Claim Asserted Against Use of Hawk
Electronics’ Name:In June 2008, the Company was notified of its alleged
infringement on the trade name Hawk Electronics and impending litigation against
it.  While the Company has had limited settlement discussions with the
other party, the Company is aggressively defending its position that its use of
the Hawk Electronics name in the markets that it operates is legal and
proper.  In July 2008, the Company filed suit in Tarrant County, Texas
against the other party seeking to protect its use of the Hawk Electronics’
trade name.  The other party has defended this lawsuit and the matter
is scheduled for trial in April 2010.  We cannot give any assurance
that we will be successful in resolving this matter, and while the Company
believes it is unlikely, there is a risk that the court may force Teletouch to
cease using the Hawk Electronics’ name.  Further litigation to resolve
the infringement claim could result in substantial costs and diversion of
resources, and 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.





The
Company attended a court ordered mediation on this matter and was unsuccessful
reaching a settlement with the other party.  Currently, the trial date
set by the court is scheduled to begin the week of April 5,
2010.  Based on discussions with our counsel, the Company believes it
will prevail in this matter.





AT&T Arbitration:
Progressive Concepts, Inc., commenced an arbitration proceeding against New
Cingular Wireless PCS, LLC and AT&T Mobility Texas LLC (collectively,
“AT&T”) seeking at least $100 million in damages. The binding arbitration
was commenced to seek relief for damages incurred as AT&T has prevented the
Company from selling the popular iPhone and other “AT&T exclusive” products
and services that PCI is contractually entitled to provide to its
customers.  In addition the Company’s initial statement of claim
alleges, among other things, that AT&T has violated the longstanding
non-solicitation provisions of the Dallas/Fort Worth market distribution
agreement by and between the companies by actively inducing customers to leave
PCI for AT&T and employing predatory business practices. While PCI has
attempted to negotiate with AT&T for the purpose of obviating the need for
legal action, such attempts have failed. Accordingly, PCI has been forced to
initiate this arbitration.  The Company expects this arbitration
process to take between nine and fourteen months before a final outcome is
determined unless this matter is able to be settled sooner with AT&T outside
of this venue.





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





(a)
            There
      were no unregistered sales of securities for the three and six months
      ended November 30, 2009.





(b)
              On
      June 15, 2009, the Company entered into a single Securities Purchase
      Agreement with Glaubman, Rosenburg & Robotti Fund, L.P., a
      non-affiliated New York limited partnership, to purchase 312,978 shares of
      Teletouch common stock it held at $0.10 per share.  The purchase
      of the shares was completed on July 16, 2009 following the payment of
      $31,298 to Glaubman, Rosenburg & Robotti Fund,
      L.P.,  following the surrender of the 312,978 shares of
      stock.  These shares are held by the Company in
      treasury.


53


(c)  Below
is a summary of stock repurchases for the six months ended November 30,
2009.





Total Numberof Shares
                                  
                                  Maximum ApproximatePurchased as
                                  
                                  Dollar Value of Shares(b)
                                  
                                  
                                  
                                  Part of Publicity
                                  
                                  that May Yet BeTotal Number
                                  
                                  Average
                                  
                                  Announced
                                  
                                  Purchased Underof Shares
                                  
                                  Price Paid
                                  
                                  Plans or
                                  
                                  the Plans orPeriod
                                  
                                  Purchased
                                  
                                  per Share
                                  
                                  Programs
                                  
                                  ProgramsJuly 1, 2009 - July 31, 2009
                                  
                                  312,978
                                  
                                  $                   0.10
                                  
                                  -
                                  
                                  N/A





Item
      3.
            Defaults
      Upon Senior Securities





None





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





None





Item
      5.
            Other
      Information





None





Item
      6.
              Exhibits





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


54


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:
      January 14, 2010
                  TELETOUCH
      COMMUNICATIONS, INC.RegistrantBy:
                  /s/
      Robert M. McMurreyRobert
      M. McMurreyChief
      Executive Officer(Principal
      Executive Officer)By:
                  /s/
      Douglas E. SloanDouglas
      E. SloanChief
      Financial Officer(Principal Financial and Accounting Officer)


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