UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C. 20549





FORM
10-Q





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


For
the Quarterly Period Ended February 28, 2010





OR





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


For
the transition period from ____ to ___





Commission
File Number 1-13436





TELETOUCH
COMMUNICATIONS, INC.


(Exact
name of registrant in its charter)





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





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


(Address
and telephone number of principal executive offices)








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





Yes  x 
No  ̈





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





Yes   ̈ 
No  ̈





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





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





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





Indicate
the number of shares outstanding of each of the Registrant’s classes of Common
Stock, as of the latest practicable date:  Common Stock, $0.001 par
value, 48,739,002 shares at April 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 February 28, 2010 (unaudited) and May 31, 2009
      (unaudited)
                        
                        
                        4Consolidated
      Statements of Operations – Three and Nine Months Ended February 28, 2010
      (unaudited) and February 28, 2009 (unaudited)
                        
                        
                        6Consolidated
      Statements of Cash Flows - Nine Months Ended February 28, 2010 (unaudited)
      and February 28, 2009 (unaudited)
                        
                        
                        7Notes
      to Consolidated Financial Statements (unaudited)
                        
                        
                        8Item
      2.
                        
                        Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations
                        
                        
                        32Item
      3.
                        
                        Quantitative
      and Qualitative Disclosures About Market Risk
                        
                        
                        53Item
      4T.
                        
                        Controls
      and Procedures
                        
                        
                        53Part
      II. Other InformationItem
      1.
                        
                        Legal
      Proceedings
                        
                        
                        54Item
      2.
                        
                        Unregistered
      Sales of Equity Securities and Use of Proceeds
                        
                        
                        55Item
      3.
                        
                        Defaults
      Upon Senior Securities
                        
                        
                        55Item
      4.
                        
                        Submission
      of Matters to a Vote of Security Holders
                        
                        
                        55Item
      5.
                        
                        Other
      Information
                        
                        
                        55Item
      6.
                        
                        Exhibits
                        
                        
                        55Signatures
                        
                        
                        56


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





February 28,
                  
                  
                  May 31,2010
                  
                  
                  2009CURRENT
      ASSETS:Cash
                  
                  $
                  3,855
                  
                  
                  $
                  4,642Certificates
      of deposit-restricted
                  
                  
                  100
                  
                  
                  
                  300Accounts
      receivable, net of allowance of $520 at February 28, 2010 and $486 at May
      31, 2009
                  
                  
                  5,108
                  
                  
                  
                  5,853Unbilled
      accounts receivable
                  
                  
                  2,443
                  
                  
                  
                  3,002Inventories,
      net of reserve of $253 at February 28, 2010 and $242 at May 31,
      2009
                  
                  
                  1,375
                  
                  
                  
                  1,547Notes
      receivable
                  
                  
                  23
                  
                  
                  
                  903Prepaid
      expenses and other current assets
                  
                  
                  1,048
                  
                  
                  
                  652Patent
      held for sale
                  
                  
                  257
                  
                  
                  
                  -Total
      Current Assets
                  
                  
                  14,209
                  
                  
                  
                  16,899PROPERTY
      AND EQUIPMENT, net of accumulated depreciation of $7,268 at February 28,
      2010 and $7,118 at May 31, 2009
                  
                  
                  2,762
                  
                  
                  
                  2,949GOODWILL
                  
                  
                  343
                  
                  
                  
                  343INTANGIBLE
      ASSETS, net of accumulated amortization of $8,723 at February 28, 2010 and
      $7,996 at May 31, 2009
                  
                  
                  3,682
                  
                  
                  
                  4,165TOTAL
      ASSETS
                  
                  $
                  20,996
                  
                  
                  $
                  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





February 28,
                    
                    
                    May 31,2010
                    
                    
                    2009CURRENT
      LIABILITIES:Accounts
      payable
                    
                    $
                    8,241
                    
                    
                    $
                    11,167Accounts
      payable-related party
                    
                    
                    83
                    
                    
                    
                    95Accrued
      expenses and other current liabilities
                    
                    
                    5,251
                    
                    
                    
                    6,790Current
      portion of long-term debt
                    
                    
                    1,366
                    
                    
                    
                    1,313Deferred
      revenue
                    
                    
                    421
                    
                    
                    
                    339Total
      Current Liabilities
                    
                    
                    15,362
                    
                    
                    
                    19,704LONG-TERM
      DEBT, net of current portion
                    
                    
                    14,783
                    
                    
                    
                    15,103TOTAL
      LIABILITIES
                    
                    
                    30,145
                    
                    
                    
                    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 February 28,
      2010 and May 31, 2009
                    
                    
                    50
                    
                    
                    
                    50Additional
      paid-in capital
                    
                    
                    51,151
                    
                    
                    
                    50,947Treasury
      stock, 1,177,187 shares held at February 28, 2010 and 864,209 shares held
      at May 31, 2009
                    
                    
                    (216
                    )
                    
                    
                    (185
                    )Accumulated
      deficit
                    
                    
                    (60,134
                    )
                    
                    
                    (61,263
                    )Total
      Shareholders' Deficit
                    
                    
                    (9,149
                    )
                    
                    
                    (10,451
                    )TOTAL
      LIABILITIES AND SHAREHOLDERS' DEFICIT
                    
                    $
                    20,996
                    
                    
                    $
                    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
                      
                      
                      Nine Months EndedFebruary 28,
                      
                      
                      February 28,2010
                      
                      
                      2009
                      
                      
                      2010
                      
                      
                      2009Operating
      revenues:Service,
      rent, and maintenance revenue
                      
                      $
                      6,308
                      
                      
                      $
                      6,778
                      
                      
                      $
                      19,522
                      
                      
                      $
                      20,524Product
      sales revenue
                      
                      
                      10,251
                      
                      
                      
                      4,270
                      
                      
                      
                      22,375
                      
                      
                      
                      14,603Total
      operating revenues
                      
                      
                      16,559
                      
                      
                      
                      11,048
                      
                      
                      
                      41,897
                      
                      
                      
                      35,127Operating
      expenses:Cost
      of service, rent and maintenance (exclusive of depreciation and
      amortization included below)
                      
                      
                      1,693
                      
                      
                      
                      2,226
                      
                      
                      
                      5,569
                      
                      
                      
                      6,934Cost
      of products sold
                      
                      
                      8,719
                      
                      
                      
                      4,186
                      
                      
                      
                      19,791
                      
                      
                      
                      13,577Selling
      and general and administrative
                      
                      
                      4,421
                      
                      
                      
                      4,241
                      
                      
                      
                      12,594
                      
                      
                      
                      12,917Depreciation
      and amortization
                      
                      
                      311
                      
                      
                      
                      346
                      
                      
                      
                      956
                      
                      
                      
                      1,075Loss
      (gain) on disposal of assets
                      
                      
                      -
                      
                      
                      
                      (7
                      )
                      
                      
                      1
                      
                      
                      
                      (8
                      )Total
      operating expenses
                      
                      
                      15,144
                      
                      
                      
                      10,992
                      
                      
                      
                      38,911
                      
                      
                      
                      34,495Operating
      income
                      
                      
                      1,415
                      
                      
                      
                      56
                      
                      
                      
                      2,986
                      
                      
                      
                      632Interest
      expense, net
                      
                      
                      (602
                      )
                      
                      
                      (558
                      )
                      
                      
                      (1,674
                      )
                      
                      
                      (1,811
                      )Income
      (loss) before income tax expense
                      
                      
                      813
                      
                      
                      
                      (502
                      )
                      
                      
                      1,312
                      
                      
                      
                      (1,179
                      )Income
      tax expense
                      
                      
                      60
                      
                      
                      
                      81
                      
                      
                      
                      183
                      
                      
                      
                      244Net
      income (loss)
                      
                      $
                      753
                      
                      
                      $
                      (583
                      )
                      
                      $
                      1,129
                      
                      
                      $
                      (1,423
                      )Basic
      income (loss) per share applicable to common shareholders
                      
                      $
                      0.02
                      
                      
                      $
                      (0.01
                      )
                      
                      $
                      0.02
                      
                      
                      $
                      (0.03
                      )Diluted
      income (loss) per share applicable to common shareholders
                      
                      $
                      0.02
                      
                      
                      $
                      (0.01
                      )
                      
                      $
                      0.02
                      
                      
                      $
                      (0.03
                      )Weighted
      average shares outstanding:Basic
                      
                      
                      48,739,002
                      
                      
                      
                      49,051,980
                      
                      
                      
                      48,791,738
                      
                      
                      
                      49,051,980Diluted
                      
                      
                      48,830,618
                      
                      
                      
                      49,051,980
                      
                      
                      
                      48,791,738
                      
                      
                      
                      49,051,980





See
Accompanying Notes to Consolidated Financial Statements


6





TELETOUCH
COMMUNICATIONS, INC.


CONSOLIDATED
STATEMENTS OF CASH FLOWS


(in
thousands)


(unaudited)





Nine
      Months EndedFebruary
      28,2010
                    
                    
                    2009Operating
      Activities:Net
      income (loss)
                    
                    $
                    1,129
                    
                    
                    $
                    (1,423
                    )Adjustments
      to reconcile net income (loss) to net cash provided by (used in) operating
      activities:Depreciation
      and amortization
                    
                    
                    956
                    
                    
                    
                    1,075Non-cash
      compensation expense
                    
                    
                    204
                    
                    
                    
                    171Non-cash
      interest expense
                    
                    
                    57
                    
                    
                    
                    87Provision
      for losses on accounts receivable
                    
                    
                    765
                    
                    
                    
                    677Provision
      for inventory obsolescence
                    
                    
                    89
                    
                    
                    
                    249Loss
      (gain) on disposal of assets
                    
                    
                    1
                    
                    
                    
                    (8
                    )Changes
      in operating assets and liabilities:Accounts
      receivable
                    
                    
                    539
                    
                    
                    
                    835Inventories
                    
                    
                    83
                    
                    
                    
                    228Notes
      receivable
                    
                    
                    -
                    
                    
                    
                    8Prepaid
      expenses and other assets
                    
                    
                    (396
                    )
                    
                    
                    522Accounts
      payable
                    
                    
                    (2,938
                    )
                    
                    
                    (1,455
                    )Accrued
      expenses and other current liabilities
                    
                    
                    (1,539
                    )
                    
                    
                    (472
                    )Deferred
      revenue
                    
                    
                    82
                    
                    
                    
                    (10
                    )Net
      cash provided by (used in) operating activities
                    
                    
                    (968
                    )
                    
                    
                    484Investing
      Activities:Purchases
      of property and equipment
                    
                    
                    (77
                    )
                    
                    
                    (233
                    )Redemption
      of certificates of deposit
                    
                    
                    200
                    
                    
                    
                    -Net
      proceeds from sale of assets
                    
                    
                    2
                    
                    
                    
                    25Receipts
      from (issuance of) notes receivable
                    
                    
                    598
                    
                    
                    
                    (428
                    )Net
      cash provided by (used in) investing activities
                    
                    
                    723
                    
                    
                    
                    (636
                    )Financing
      Activities:Proceeds
      from long-term debt
                    
                    
                    1,373
                    
                    
                    
                    250Payments
      on long-term debt
                    
                    
                    (1,884
                    )
                    
                    
                    (1,456
                    )Payments
      on redeemable common stock purchase warrants
                    
                    
                    -
                    
                    
                    
                    (1,500
                    )Purchase
      of treasury stock
                    
                    
                    (31
                    )
                    
                    
                    -Net
      cash used in financing activities
                    
                    
                    (542
                    )
                    
                    
                    (2,706
                    )Net
      decrease in cash
                    
                    
                    (787
                    )
                    
                    
                    (2,858
                    )Cash
      at beginning of period
                    
                    
                    4,642
                    
                    
                    
                    4,729Cash
      at end of period
                    
                    $
                    3,855
                    
                    
                    $
                    1,871Supplemental
      Cash Flow Data:Cash
      payments for interest
                    
                    $
                    1,617
                    
                    
                    $
                    1,738Cash
      payments for income taxes
                    
                    $
                    273
                    
                    
                    $
                    246Non-Cash
      Transactions:Transfer
      of long-term receivable-related party to notes receivable
                    
                    $
                    -
                    
                    
                    $
                    428Transfer
      of redeemable common stock purchase warrants to long-term
    debt
                    
                    $
                    -
                    
                    
                    $
                    1,500Capitalization
      of loan origination fees to long-term debt
                    
                    $
                    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
45 years, Teletouch together with its predecessors 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 16 retail and agent stores and 4 two-way radio 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 25
years, PCI has offered various communication services on a direct bill basis and
today services approximately 64,000 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 capable call centers and the
Internet.





In
addition, PCI operates a national wholesale distribution business, “PCI
Wholesale,” which serves major carrier agents, rural cellular carriers, smaller
consumer electronics and automotive retailers and auto dealers throughout the
country, 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. The Company adopted ASC 105 and conformed all
references to authoritative accounting literature beginning with its Quarterly
Report on Form 10-Q for the period ended November 30, 2009.


8





The
accompanying unaudited interim consolidated financial statements included herein
as of February 28, 2010 and for each of the three and nine months ended February
28, 2010 and 2009, 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 to operate its two-way radio
network. Visao is a company formed to develop and distribute the Company’s
telemetry products, which as of the date of this Report are no longer being
sold.  Currently Visao is maintained as a shell company with no
operations. TLLG was formed for the express purpose of entering into an asset
purchase agreement with Preferred Networks, Inc. in May 2004 and ceased
operations following the sale of the Company’s paging business in August
2006.  TLLG is currently a shell company.In the opinion of
management, all adjustments (consisting of normal recurring adjustments)
necessary for a fair statement of financial position, results of operations and
cash flows for the interim periods presented have been made. The results of
operations for the three and nine months ended February 28, 2010, 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 fiscal year 2009 Annual
Report on Form 10-K.





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 requires management to
make estimates and assumptions.  Those assumptions affect the reported
amounts of assets and liabilities, disclosure of contingent assets and
liabilities at the date of the financial statements and the reported amounts of
revenues and expenses during the reporting period. Actual results could
materially differ from those estimates.





Cash:We deposit
our cash with high credit quality institutions.  Periodically, such
balances may exceed applicable FDIC insurance limits.  Management has
assessed the financial condition of these institutions and believes the
possibility of credit loss is minimal.





Certificates of
Deposit-Restricted:  From time to time, the Company is required
to issue standby letters of credit to it suppliers to secure purchases made
under the credit terms provided by these suppliers. The Company deposits funds
into a certificate of deposit and instructs that bank to issue the standby
letter of credit to the benefit of the supplier. All such funds are reported as
restricted funds until such time as the supplier releases the letter of credit
requirement. As of February 28, 2010 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.


9





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 $520,000
and $486,000 at February 28, 2010 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 and Internet distribution
channels, it is successful in liquidating the majority of any inventory that
becomes obsolete.  The Company has many different electronics
suppliers, all of which provide reasonable notification of model changes, which
allows the Company to minimize its level of discontinued or obsolete inventory.
Inventories are stated on the Company’s consolidated balance sheet net of a
reserve for obsolescence of $253,000 and $242,000 at February 28, 2010 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
      years


10





Leasehold
      improvements
                Shorter of estimated usefullife
      or term of lease





Intangible
Assets:Intangible assets are comprised of certain definite
lived assets as well as a single indefinite lived asset which is
goodwill.  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 fees
                2-5
      years





As of
February 28, 2010, the most significant intangible assets remaining that
continue to be amortized are the AT&T distribution agreements and subscriber
bases.  The Dallas/Fort Worth and San Antonio AT&T cellular
distribution agreements will continue to be amortized through August 31, 2014
and December 31, 2013, respectively, or for approximately 4.5 and 3.8 years,
respectively.


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 exceeds the carrying value of the asset at
all periods presented herein.  The Company regularly forecasts the
expected cash flows to be derived from this cellular subscriber base and as of
the date of this Report those expected cash flows exceed the carrying value of
the asset.





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
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 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 February 28, 2010, the patent is recorded as a current asset
held for sale on the Company’s consolidated balance sheet for approximately
$257,000 as the Company is actively pursuing the sale of this patent and it
expects to complete a sale by July 2010.


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 February 28, 2010 and
May 31, 2009, the Company has recorded a valuation allowance against the full
amount of its net deferred tax assets although the Company forecasts taxable
income for fiscal year 2010, but it is currently unable 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 provided through a master distributor agreement
with AT&T.  Product sales include sales of cellular telephones,
accessories, car and home audio products and other services and two-way radio
equipment through the Company’s retail, wholesale and two-way
operations.


13


Cellular
and other service revenues and related costs are recognized during the period in
which the service is rendered.  Associated subscriber acquisition
costs are expensed as incurred.  For the Company’s product sales,
revenue is recognized at the time of shipment, the customer takes title and
assumes risk of loss, terms are fixed and determinable and collectibility is
reasonably assured.  The Company does not generally grant rights of
return.  However, PCI offers customers a 30 day return/ exchange
program for new cellular subscribers in order to match programs put in place by
most of the other cellular carriers.  During the 30 days, a customer
may return all cellular equipment and cancel service with no
penalty.  Reserves for returns, price discounts and rebates are
estimated using historical averages, open return requests, recent product
sell-through activity and market conditions.  No reserves have been
recorded for the 30 day cellular return program since only a very small number
of customers utilize this return program and many fail to meet all of the
requirements of the program, which include returning the phone equipment in new
condition with no visible damage.





Since
1984, Teletouch’s subsidiary, PCI, has held agreements with AT&T or one of
its predecessor companies, which allowed PCI to offer cellular service and
provide the billing and customer services to its subscribers. PCI is compensated
for the services it provides based upon sharing a portion of the monthly
billings revenues with AT&T.  PCI is responsible for the billing
and collection of cellular charges from these customers and remits a percentage
of the cellular billings generated to AT&T.  Based on its
relationship with AT&T, the Company has evaluated its reporting of revenues
under ASC 605-45, Revenue
Recognition, Principal Agent Considerations (“ASC 605-45”) associated
with its services attached to the AT&T agreements.  Included in
ASC 605-45 are eight indicators that must be evaluated to support reporting
gross revenue.  These indicators are (i) the entity is the primary
obligor in the arrangement, (ii) the entity has general inventory risk before
customer order is placed or upon customer return, (iii) the entity has latitude
in establishing price, (iv) the entity changes the product or performs part of
the service, (v) the entity has discretion in supplier selection, (vi) the
entity is involved in the determination of product or service specifications,
(vii) the entity has physical loss inventory risk after customer order or during
shipment and (viii) the entity has credit risk.  In addition, ASC
605-45 includes three additional indicators that support reporting net
revenue.  These indicators are (i) the entity’s supplier is the
primary obligor in the arrangement, (ii) the amount the entity earns is fixed
and (iii) the supplier has credit risk. Based on its assessment of the
indicators listed in ASC 605-45, the Company has concluded that the AT&T
services provided by PCI should be reported on a net basis.





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





Concentration of Credit
Risk:  Teletouch offers cellular and other wireless
telecommunications services to a diversified customer base of small to mid-size
businesses and individual consumers, primarily in the Dallas/Fort Worth and San
Antonio markets in Texas.  In addition, the Company sells cellular
equipment and consumer electronics products to a large base of small to mid-size
cellular carriers, agents and resellers as well as a large group of smaller
electronics and car audio dealers throughout the United States.  As a
result, no significant concentration of credit risk exists.  The
Company performs periodic credit evaluations of its customers to determine
individual customer credit risks and promptly terminates services 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 February 28, 2010 the
Company had two stock-based compensation plans for employees and nonemployee
directors, which authorize the granting of various equity-based incentives
including stock options and stock appreciation rights.


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 nine months ended February 28,
2010 and 2009 because the Company provided for a full valuation allowance
against all accrued future tax benefits for all periods presented
until its operations improve and the Company is able to forecast taxable income
in the future sufficient to utilize its deferred tax assets.





For the
nine months ended February 28, 2010 and 2009, 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 nine months ended
February 28, 2010 was 240.4 % and ranged from 172.6% to 173.7% for the
options issued in the nine months ended February 28, 2009.  The
Company has elected to estimate the expected life of an award based upon the SEC
approved “simplified method” noted under the provisions of Staff Accounting
Bulletin No. 107 with the continued use of this method extended under the
provisions of Staff Accounting Bulletin No. 110. Under this formula, the
expected term is equal to: ((weighted-average vesting term + original
contractual term)/2). The expected term used by the Company as computed by this
method for options issued in the nine months ended February 28, 2010 was 5.0
years and ranged from 5.0 years to 6.0 years for the options issued in the nine
months ended February 28, 2009. The interest rate used is the risk free interest
rate and is based upon U.S. Treasury rates appropriate for the expected term.
Interest rates used in the Company’s Black-Scholes calculations for options
issued in the nine months ended February 28, 2010 was 2.55% and  ranged
from 3.39% to 3.54% for the options issued in the nine months ended February 28,
2009. Dividend yield is zero for these options as the Company does not expect to
declare any dividends on its common shares in the foreseeable
future.





In
addition to the key assumptions used in the Black-Scholes model, the estimated
forfeiture rate at the time of valuation is a critical assumption.  The
Company has estimated an annualized forfeiture rate of 0.0% for the stock
options granted to senior management and the Company’s directors in the nine
months ended February 28, 2010 and 2009.  The Company reviews the
expected forfeiture rate annually to determine if that percent is still
reasonable based on historical experience.





Options
exercisable at February 28, 2010 and May 31, 2009 totaled 3,054,545
and 1,424,326, respectively.  The weighted-average exercise price
per share of options exercisable at February 28, 2010 and May 31, 2009 was $0.27
and $0.38, respectively, with remaining weighted-average contractual terms of
approximately 7.2 years and 6.2 years, respectively.





The
weighted-average grant date fair value of options granted during the nine months
ended February 28, 2010 and 2009 was $0.12 and $0.19,
respectively.


15





At
February 28, 2010, the total remaining unrecognized compensation cost
related to unvested stock options amounted to approximately $197,000, which will
be amortized over the weighted-average remaining requisite service period of
1.42 years.





Income (loss) Per
Share:In accordance with ASC 260, Earnings Per Share,basic income (loss) per
share (“EPS”) is calculated by dividing net income (loss) by the weighted
average number of common shares outstanding.  Diluted EPS is
calculated by dividing net income available to common shareholders by the
weighted average number of common shares outstanding including any dilutive
securities outstanding.  At February 28, 2010, the Company’s
outstanding common stock options totaled 4,563,316. For the
three   months ended February 28, 2010, 91,616 common stock
options were dilutive securities and were included in the diluted earnings per
share calculation due to the Company’s market price of its common stock at
February 28, 2010 exceeding the options’ exercise price.  For the nine
months ended February 28, 2010, the Company’s common stock options were excluded
from the diluted earnings per share calculation because the options’ exercise
price exceeded the Company’s market price of its common stock at February 28,
2010. The Company’s outstanding common stock options totaled 3,910,815 at
February 28, 2009 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 nine months ended February 28, 2009.





Recently
Adopted Accounting Standards:





In
February 2010, the Financial Accounting Standards Board (“FASB”) issued
Accounting Standard Update (“ASU”) No. 2010-09, Subsequent Events: Amendments to
Certain Recognition and Disclosure Requirements, (“ASU 2010-09”) which
amends Accounting Standards Codification (“ASC”) Topic 855 to address certain
implementation issues related to an entity's requirement to perform and disclose
subsequent events procedures. The amendments in ASU 2010-09 remove the
requirement for an SEC filer to disclose a date through which subsequent events
have been evaluated in both issued and revised financial statements.The new guidance became
effective for the Company on February 24, 2010 and did not have an impact on the
Company’s consolidated financial statements or results of
operations.




In
August 2009, FASB issued ASU No. 2009-05,Measuring Liabilities at Fair
Value, (“ASU 2009-05”). ASU 2009-05 amends FASB 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 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.


16





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.





Recently
Issued Accounting Standards:





In
January 2010, the FASB issued ASU No. 2010-06, Fair Value Measurements and
Disclosures (Topic 820):Improving Disclosures about Fair
Value Measurements (“ASU 2010-06”). This update requires additional
disclosures about (1) the different classes of assets and liabilities measured
at fair value, (2) the valuation techniques and inputs used, (3) the activity in
Level 3 fair value measurements, and (4) the transfersbetween Levels 1, 2, and
3. This guidance is effective for the Company’s interim and annual reporting
periods beginning after December 15, 2009. The Company does not expect the
adoption of this guidance to have a material impact on its consolidated
financial positions or results of operations.




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 of this
guidance to have a material impact on its consolidated financial positions or
results of operations.





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 of this guidance to
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 of
this guidance to have a material impact on its consolidated financial positions
or results of operations.


17





NOTE
3 – RELATIONSHIP WITH CELLULAR CARRIER





The
Company has historically had six distribution agreements with AT&T which
provide for the Company to distribute AT&T wireless services, on an
exclusive basis, in major markets in Texas and Arkansas, including the
Dallas-Fort Worth, Texas Metropolitan Statistical Area (“MSA”), San Antonio,
Texas MSA, Austin, Texas MSA, Houston, Texas MSA, East Texas Regional MSA and
Arkansas, including primarily the Little Rock, Arkansas MSA. During 2010 and
following the Company’s commencement of an arbitration proceeding against
AT&T (discussed further below), AT&T has noticed the Company it is
cancelling or not renewing three of the six distribution agreements including
those agreements that cover the Austin, Texas MSA, Houston, Texas MSA and
Arkansas.  The Company is disputing these cancellations and is
attempting to have these matters included in the arbitration hearing related to
the DFW Agreement. The distribution agreements permit the Company to offer
AT&T cellular phone service with identical pricing characteristics to
AT&T and provide billing customer services to its customers on behalf of
AT&T in exchange for certain predetermined compensation and fees, which are
primarily in the form of a revenue sharing of the core wireless services the
Company bills on behalf of AT&T. In addition, the Company bills the same
subscribers several additional features and products that it offers and retains
all revenues and gross margins related to those certain services and
products.





The
Company is responsible for all of the billing and collection of cellular charges
from its customers and remains liable to AT&T for pre-set percentages of all
AT&T related cellular service customer billings. Because of the volume of
business transacted with AT&T, as well as the revenue generated from
AT&T services, there is a significant concentration of credit and business
risk involved with having AT&T as a primary vendor. The Company’s largest
distribution agreement with AT&T for the Dallas/Fort Worth, Texas MSA was
amended effective September 1, 1999 with an initial term of 10 years (the
“DFW Agreement”). The DFW Agreement provided for two 5-year extensions unless
either party provides written notice to the other party at least six months
prior to the expiration of the initial term or the additional renewal term.
Specifically, under the terms of its distribution agreement with AT&T, the
Company is allowed to continue to service its existing Subscribers (each
telephone number assigned to a customer is deemed to be a separate Subscriber)
at the time of expiration until the Subscribers, of their own free will,
independently and without any form of encouragement or inducement from AT&T,
have their services terminated with the Company. The initial term of the DFW
Agreement expired on August 31, 2009, and the Company received the required six
month notice from AT&T in February 2009 stating 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.


18


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
                      
                      
                      Nine Months EndedFebruary 28,
                      
                      
                      February 28,2010
                      
                      
                      2009
                      
                      
                      2010
                      
                      
                      2009Gross
      service, rent and maintenance billings
                      
                      $
                      12,907
                      
                      
                      $
                      15,298
                      
                      
                      $
                      41,083
                      
                      
                      $
                      46,560Less:
      Direct costs paid to AT&T
                      
                      
                      (6,599
                      )
                      
                      
                      (8,520
                      )
                      
                      
                      (21,561
                      )
                      
                      
                      (26,036
                      )Net
      service, rent and maintenance revenue
                      
                      $
                      6,308
                      
                      
                      $
                      6,778
                      
                      
                      $
                      19,522
                      
                      
                      $
                      20,524





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.





NOTE
4 – NOTES RECEIVABLE





February 28, 2010
                  
                  
                  May 31, 2009Mobui
      Note
                  
                  $
                  -
                  
                  
                  $
                  441Air-bank
      Note
                  
                  
                  -
                  
                  
                  
                  439Other
                  
                  
                  23
                  
                  
                  
                  23$
                  23
                  
                  
                  $
                  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 was 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.


19





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.  On October
29, 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 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.





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):





February 28, 2010
                    
                    
                    May 31, 2009Cost
                    
                    
                    Reserve
                    
                    
                    Net Value
                    
                    
                    Cost
                    
                    
                    Reserve
                    
                    
                    Net ValuePhones
      and related accessories
                    
                    $
                    798
                    
                    
                    $
                    (81
                    )
                    
                    $
                    717
                    
                    
                    $
                    726
                    
                    
                    $
                    (65
                    )
                    
                    $
                    661Automotive
      products
                    
                    
                    294
                    
                    
                    
                    (41
                    )
                    
                    
                    253
                    
                    
                    
                    501
                    
                    
                    
                    (56
                    )
                    
                    
                    445Satellite
      products
                    
                    
                    18
                    
                    
                    
                    (3
                    )
                    
                    
                    15
                    
                    
                    
                    20
                    
                    
                    
                    (4
                    )
                    
                    
                    16Two-way
      products
                    
                    
                    512
                    
                    
                    
                    (126
                    )
                    
                    
                    386
                    
                    
                    
                    527
                    
                    
                    
                    (111
                    )
                    
                    
                    416Other
                    
                    
                    6
                    
                    
                    
                    (2
                    )
                    
                    
                    4
                    
                    
                    
                    15
                    
                    
                    
                    (6
                    )
                    
                    
                    9Total
      inventory and reserves
                    
                    $
                    1,628
                    
                    
                    $
                    (253
                    )
                    
                    $
                    1,375
                    
                    
                    $
                    1,789
                    
                    
                    $
                    (242
                    )
                    
                    $
                    1,547


20





NOTE
6 – PROPERTY AND EQUIPMENT





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





February 28, 2010
                  
                  
                  May 31, 2009Land
                  
                  $
                  774
                  
                  
                  $
                  774Buildings
      and leasehold improvements
                  
                  
                  3,058
                  
                  
                  
                  3,151Two-way
      network infrastructure
                  
                  
                  1,205
                  
                  
                  
                  1,177Office
      and computer equipment
                  
                  
                  3,230
                  
                  
                  
                  3,207Signs
      and displays
                  
                  
                  1,395
                  
                  
                  
                  1,385Other
      equipment
                  
                  
                  368
                  
                  
                  
                  373$
                  10,030
                  
                  
                  $
                  10,067Accumulated
      depreciation
                  
                  
                  (7,268
                  )
                  
                  
                  (7,118
                  )$
                  2,762
                  
                  
                  $
                  2,949





Depreciation
expense was approximately $87,000 and $116,000 for the three months ended
February 28, 2010 and 2009, respectively and $285,000 and $377,000 for the nine
months ended February 28, 2010 and 2009, respectively.





Property
and equipment are recorded at cost.  Depreciation is computed using the
straight-line method.  The following table contains the property, plant and
equipment by estimated useful life, net of accumulated depreciation as of
February 28, 2010 (in thousands):





Less than
                  
                  
                  3 to 4
                  
                  
                  5 to 9
                  
                  
                  10 to 14
                  
                  
                  15 to 19
                  
                  
                  20 years
                  
                  
                  Total Net3 years
                  
                  
                  years
                  
                  
                  years
                  
                  
                  years
                  
                  
                  years
                  
                  
                  and greater
                  
                  
                  ValueLand
                  
                  $
                  -
                  
                  
                  $
                  -
                  
                  
                  $
                  -
                  
                  
                  $
                  -
                  
                  
                  $
                  -
                  
                  
                  $
                  774
                  
                  
                  $
                  774Buildings
      and leasehold improvements
                  
                  
                  15
                  
                  
                  
                  74
                  
                  
                  
                  76
                  
                  
                  
                  -
                  
                  
                  
                  10
                  
                  
                  
                  1,214
                  
                  
                  
                  1,389Two-way
      network infrastructure
                  
                  
                  17
                  
                  
                  
                  113
                  
                  
                  
                  133
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  263Office
      and computer equipment
                  
                  
                  124
                  
                  
                  
                  87
                  
                  
                  
                  33
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  244Signs
      & displays
                  
                  
                  57
                  
                  
                  
                  5
                  
                  
                  
                  6
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  68Other
      equipment
                  
                  
                  14
                  
                  
                  
                  10
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  24$
                  227
                  
                  
                  $
                  289
                  
                  
                  $
                  248
                  
                  
                  $
                  -
                  
                  
                  $
                  10
                  
                  
                  $
                  1,988
                  
                  
                  $
                  2,762





NOTE
7 – GOODWILL AND OTHER INTANGIBLE ASSETS





Intangible Assets with Indefinite
Lives:  In accordance with ASC 350, the Company performs an annual
impairment test of goodwill as well as evaluates this goodwill for
recoverability upon any significant change in the business. There was no change
in the $343,000 carrying amount of goodwill for the nine months ended February
28, 2010.





The
reported goodwill of the Company at February, 2010 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.


21





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





February 28, 2010
                
                
                May 31, 2009Gross
                
                
                
                
                
                Net
                
                
                Gross
                
                
                
                
                
                NetCarrying
                
                
                Accumulated
                
                
                Carrying
                
                
                Carrying
                
                
                Accumulated
                
                
                CarryingAmount
                
                
                Amortization
                
                
                Value
                
                
                Amount
                
                
                Amortization
                
                
                ValueAT&T
      distribution agreements and subscriber bases
                
                $
                10,258
                
                
                $
                (6,901
                )
                
                $
                3,357
                
                
                $
                10,258
                
                
                $
                (6,326
                )
                
                $
                3,932FCC
      licenses
                
                
                104
                
                
                
                (69
                )
                
                
                35
                
                
                
                104
                
                
                
                (62
                )
                
                
                42PCI
      marketing list
                
                
                1,235
                
                
                
                (1,235
                )
                
                
                -
                
                
                
                1,235
                
                
                
                (1,235
                )
                
                
                -Loan
      origination fees
                
                
                638
                
                
                
                (348
                )
                
                
                290
                
                
                
                394
                
                
                
                (203
                )
                
                
                191Internally
      developed software
                
                
                170
                
                
                
                (170
                )
                
                
                -
                
                
                
                170
                
                
                
                (170
                )
                
                
                -Balance
      at February 28, 2010 and May 31, 2009
                
                $
                12,405
                
                
                $
                (8,723
                )
                
                $
                3,682
                
                
                $
                12,161
                
                
                $
                (7,996
                )
                
                $
                4,165





Total
amortization expense for the three months ended February 28, 2010 and 2009 was
approximately $224,000 and $230,000, respectively and $671,000 and $698,000 for
the nine months ended February, 2010 and 2009, respectively.





NOTE
8 – ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES





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





February 28,
                  
                  
                  May 31,2010
                  
                  
                  2009Accrued
      payroll and other personnel expense
                  
                  $
                  1,454
                  
                  
                  $
                  1,882Accrued
      state and local taxes
                  
                  
                  642
                  
                  
                  
                  885Unvouchered
      accounts payable
                  
                  
                  2,306
                  
                  
                  
                  2,826Customer
      deposits payable
                  
                  
                  465
                  
                  
                  
                  585Other
                  
                  
                  384
                  
                  
                  
                  612Total
                  
                  $
                  5,251
                  
                  
                  $
                  6,790





NOTE
9 – LONG-TERM DEBT





Long-term
debt at February 28, 2010 and May 31, 2009 consists of the following (in
thousands):





February 28,
                  
                  
                  May 31,2010
                  
                  
                  2009East
      West Bank debt (formerly United Commercial Bank)
                  
                  $
                  2,388
                  
                  
                  $
                  2,463Jardine
      Capital Corporation bank debt
                  
                  
                  628
                  
                  
                  
                  635Thermo
      revolving credit facility
                  
                  
                  12,294
                  
                  
                  
                  12,117Warrant
      redemption notes payable
                  
                  
                  839
                  
                  
                  
                  1,200Other
      notes
                  
                  
                  -
                  
                  
                  
                  1Total
      long-term debt
                  
                  
                  16,149
                  
                  
                  
                  16,416Less:
      Current portion
                  
                  
                  (1,366
                  )
                  
                  
                  (1,313
                  )Long-term
      debt, net
                  
                  $
                  14,783
                  
                  
                  $
                  15,103


22





Current
portion of long-term debt at February 28, 2010 and May 31, 2009 consists of the
following (in thousands):





February 28,
                  
                  
                  May 31,2010
                  
                  
                  2009East
      West Bank debt (formerly United Commercial Bank)
                  
                  $
                  105
                  
                  
                  $
                  102Jardine
      Capital Corporation bank debt
                  
                  
                  10
                  
                  
                  
                  10Thermo
      revolving credit facility
                  
                  
                  951
                  
                  
                  
                  -Warrant
      redemption notes payable
                  
                  
                  300
                  
                  
                  
                  1,200Other
                  
                  
                  -
                  
                  
                  
                  1Total
      current portion of  long-term debt
                  
                  $
                  1,366
                  
                  
                  $
                  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.




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 was recorded 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.


23





In prior
years, the Company’s factoring debt obligation with Thermo was presented as a
current liability on the Company’s consolidated balance sheet, in accordance
with ASC 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 was
February 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 Company reclassified  the $7,493,000 current liability
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”).





The
Second Amended Thermo Revolver provides for the Company to obtain revolving
credit loans from Thermo from time to time up to approximately
$18,000,000.  Borrowings against the Second Amended Thermo Revolver are
limited to specific advance rates against the aggregate fair value of the
Company’s assets, as defined in the amendment, including real estate, equipment,
infrastructure assets, inventory, accounts receivable, intangible assets and
notes receivable (collectively, the “Borrowing Base”). The Company is allowed to
borrow the lesser of the borrowing base amount or the initial commitment amount
of $18,000,000, less a monthly step down amount. If the Company were to maximize
its credit line, beginning in December 31, 2009, the availability under the
Second Amended Thermo Revolver would be reduced monthly by an amount equal to
the average principal balance of loans outstanding against the non-accounts
receivable assets in the Borrowing Base for that month divided by sixty
(60) (the “Monthly Step Down”). The loans outstanding on the accounts
receivable component of the Borrowing Base will be increased or decreased
through periodic reporting of the Borrowing Base to Thermo. The balance of all
principal and interest outstanding under the Second Amended Thermo Revolver is
due January 31, 2012.  The annual interest rate on the Second Amended
Thermo Revolver is the lesser of: (a) the maximum non-usurious rate of
interest per annum permitted by applicable Louisiana law or (b) the greater
of (i) the prime rate plus 8% or (ii) fourteen percent (14%). Under the terms of
the Second Amended Thermo Revolver, the Company must maintain certain financial
covenants including a net worth of at least $5,000,000, computed on a fair value
basis, at each fiscal quarter, a debt service coverage ratio that ranges between
1.10 and 1.20 over the remaining life of the revolver and an operating income no
less than zero at any fiscal quarter. The purpose of the Second Amended Thermo
Revolver was to retire the former factoring debt facility with Thermo and to
provide additional availability to the Company for its ongoing working capital
needs.  As of February 28, 2010, the Company has a current repayment
liability under the Second Amended Thermo Revolver related to a loan commitment
fee obligation of approximately $135,000.





In
February 2010, the Company began making principal payments on the Second Amended
Thermo Revolver.  The principal payment of approximately $76,000 represents
1/60th of the borrowings outstanding against non-accounts receivable assets.
These monthly principal payments (Monthly Step Down) reduce the commitment
amount under the revolver. As of February 28, 2010 the maximum potential
borrowings available under the revolver are $17,924,000. The Company does expect
to make monthly principal payments through the remainder of the term of the
loan.


24




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 terms of the Second Amended Thermo Revolver. As of
February 28, 2010, the Company had a maximum availability of $5,969,000 against
non-accounts receivable assets and $11,955,000 against accounts receivable for a
total maximum availability of $17,924,000. Additionally, the Company had
approximately $12,294,000 in loans outstanding under the Second Amended Thermo
Revolver as of February 28, 2010 which included 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 February 28, 2010, $7,229,000 was advanced against accounts
receivable and $5,065,000 was advanced against non-accounts receivable assets.
The availability to the Company as of February 28, 2010 under the Second Amended
Thermo Revolver is approximately $4,726,000 to be borrowed against future
accounts receivable and $904,000 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.  As of February 28, 2010, $750,000 of these
additional borrowings has been repaid to Thermo.





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.





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.


25





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.





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





February 28, 2010
                  
                  
                  May 31, 2009Deferred
      Tax Assets:Current
      deferred tax assets:Accrued
      liabilities
                  
                  $
                  760
                  
                  
                  $
                  748Deferred
      revenue
                  
                  
                  70
                  
                  
                  
                  32Inventories
                  
                  
                  92
                  
                  
                  
                  88Bad
      debt reserve
                  
                  
                  177
                  
                  
                  
                  1651,099
                  
                  
                  
                  1,033Valuation
      allowance
                  
                  
                  (1,094
                  )
                  
                  
                  (1,033
                  )Current
      deferred tax assets, net of valuation allowance
                  
                  
                  5
                  
                  
                  
                  -Non-current
      deferred tax assets:Net
      operating loss
                  
                  
                  10,973
                  
                  
                  
                  11,447Intangible
      assets
                  
                  
                  132
                  
                  
                  
                  193Fixed
      assets
                  
                  
                  257
                  
                  
                  
                  256Licenses
                  
                  
                  16
                  
                  
                  
                  18Other
                  
                  
                  2
                  
                  
                  
                  211,380
                  
                  
                  
                  11,916Valuation
      allowance
                  
                  
                  (11,309
                  )
                  
                  
                  (11,847
                  )Non-current
      deferred tax assets, net of valuation allowance
                  
                  
                  71
                  
                  
                  
                  69Deferred
      Tax Liabilities:Current
      deferred tax liabilities:Other
                  
                  
                  5
                  
                  
                  
                  -Non-current
      deferred tax liabilities:Fixed
      assets
                  
                  
                  71
                  
                  
                  
                  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):


26





Total
                    
                    
                    2011
                    
                    
                    2012
                    
                    
                    2013
                    
                    
                    2014
                    
                    
                    ThereafterOperating
      leases
                    
                    $
                    5,273
                    
                    
                    $
                    701
                    
                    
                    $
                    450
                    
                    
                    $
                    348
                    
                    
                    $
                    338
                    
                    
                    $
                    3,436





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:





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 was
scheduled for trial in April 2010.  Since February 2010, the Company has
been negotiating a settlement with the other party that made the infringement
allegation. On February 22nd and
23rd2010, the Company attended a court ordered mediation on this matter and
believes it is in the final stages of negotiating a settlement with the other
party. Additional mediation is set for April 15, 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.





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.


27





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





As of February 28, 2010, approximately
27,995 Non-Qualified Options and 12,000 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 nine months ended February 28, 2010 is as
follows:





WeightedWeighted
                    
                    
                    AverageAverage
                    
                    
                    Remaining
                    
                    
                    AggregateExercise
                    
                    
                    Contractual
                    
                    
                    IntrinsicShares
                    
                    
                    Price
                    
                    
                    Term
                    
                    
                    ValueOutstanding
      at June 1, 2009
                    
                    
                    3,910,815
                    
                    
                    $
                    0.27
                    
                    
                    
                    7.99
                    
                    
                    $
                    -Nine
      months ended February 28, 2010Granted
                    
                    
                    693,167
                    
                    
                    
                    0.12
                    
                    
                    
                    -Exercised
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -Forfeited
                    
                    
                    (40,666
                    )
                    
                    
                    0.24
                    
                    
                    
                    -Outstanding
      at February 28, 2010
                    
                    
                    4,563,316
                    
                    
                    
                    0.25
                    
                    
                    
                    7.62
                    
                    
                    $
                    -Options
      exercisable at February 28, 2010
                    
                    
                    3,054,545
                    
                    
                    $
                    0.27
                    
                    
                    
                    7.22
                    
                    
                    $
                    -





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 February 28,
    2010
                            
                            
                            1,508,771
                            
                            
                            $
                            0.18


28





The
Company estimates the fair value of employee stock options on the date of grant
using the Black-Scholes model. The determination of fair value of stock-based
payment awards on the date of grant using an option-pricing model is affected by
the stock price as well as assumptions regarding a number of highly complex and
subjective variables. These variables include, but are not limited to the
expected stock price volatility over the term of the awards and the actual and
projected employee stock option exercise behaviors. The Company has elected to
estimate the expected life of an award based on the SEC approved “simplified
method.” The Company calculated its expected volatility assumption required
in the Black-Scholes model based on the historical volatility of its
stock.  The Company recorded approximately $35,000 and $85,000 in stock
based compensation expense in the consolidated financial statements for the
three months ended February 28, 2010 and 2009, respectively.  The Company
recorded approximately $204,000 and $171,000 in stock based compensation expense
in the consolidated financial statements for the nine months ended February 28,
2010 and 2009, respectively.





NOTE
14 – RELATED PARTY TRANSACTIONS





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





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





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





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 February 28, 2010, the
Company paid certain expenses on behalf of TLLP which reduced the Company’s
related party payable. As of February 28, 2010 approximately $83,000 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.


29





The
Company’s cellular business segment represents its core business, which has been
acquiring, billing, and supporting cellular subscribers under a revenue sharing
relationship with AT&T and its predecessor companies for over 25 years. The
consumer services and retail business within the cellular segment is operated
primarily under the Hawk Electronics brand name, with additional business and
government sales provided by a direct sales group operating throughout all of
the Company’s markets. As a master distributor for AT&T wireless services,
the Company controls the entire customer experience, including initiating and
maintaining the cellular service agreements, rating the cellular plans,
providing complete customer care, underwriting new account acquisitions and
providing multi-service billing, collections, and account maintenance. 
Furthermore, in January 2009, Teletouch entered into a new distribution
agreement with T-Mobile USA, Inc (“T-Mobile”). The Company closed its last two
Oklahoma retail locations selling T-Mobile branded cellular services and
products in October 2009. Subsequent to these closings, in January 2010, the
T-Mobile agreement was terminated due to the Company closing all of its retail
locations in the Oklahoma market.





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





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





The
two-way business segment includes radio services provided on the Company’s Logic
Trunked Radio (“LTR”) system and the related radio equipment sales as well as
radio equipment sales to customers operating their own two-way radio
system.  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 for the Company’s accounting,
information technology, human resources, marketing and executive management
functions.


30





The
following tables summarize the Company’s operating financial information by each
segment for the three and nine months ended February 28, 2010 and 2009 (in
thousands):





Three Months Ended
                          
                          
                          Nine Months EndedFebruary 28,
                          
                          
                          February 28,2010
                          
                          
                          2009
                          
                          
                          2010
                          
                          
                          2009Operating
      revenues:Service,
      rent and maintenance revenueCellular
                          
                          $
                          5,835
                          
                          
                          $
                          6,290
                          
                          
                          $
                          18,000
                          
                          
                          $
                          19,137Two-way
                          
                          
                          434
                          
                          
                          
                          458
                          
                          
                          
                          1,384
                          
                          
                          
                          1,246Other
                          
                          
                          39
                          
                          
                          
                          30
                          
                          
                          
                          138
                          
                          
                          
                          141Total
                          
                          
                          6,308
                          
                          
                          
                          6,778
                          
                          
                          
                          19,522
                          
                          
                          
                          20,524Product
      sales revenueCellular
                          
                          
                          950
                          
                          
                          
                          1,774
                          
                          
                          
                          3,454
                          
                          
                          
                          5,366Wholesale
                          
                          
                          8,450
                          
                          
                          
                          1,870
                          
                          
                          
                          16,464
                          
                          
                          
                          7,071Two-way
                          
                          
                          714
                          
                          
                          
                          542
                          
                          
                          
                          2,054
                          
                          
                          
                          1,878Other
                          
                          
                          137
                          
                          
                          
                          84
                          
                          
                          
                          403
                          
                          
                          
                          288Total
                          
                          
                          10,251
                          
                          
                          
                          4,270
                          
                          
                          
                          22,375
                          
                          
                          
                          14,603Operating
      revenueCellular
                          
                          
                          6,785
                          
                          
                          
                          8,064
                          
                          
                          
                          21,454
                          
                          
                          
                          24,503Wholesale
                          
                          
                          8,450
                          
                          
                          
                          1,870
                          
                          
                          
                          16,464
                          
                          
                          
                          7,071Two-way
                          
                          
                          1,148
                          
                          
                          
                          1,000
                          
                          
                          
                          3,438
                          
                          
                          
                          3,124Other
                          
                          
                          176
                          
                          
                          
                          114
                          
                          
                          
                          541
                          
                          
                          
                          429Total
                          
                          
                          16,559
                          
                          
                          
                          11,048
                          
                          
                          
                          41,897
                          
                          
                          
                          35,127Operating
      expenses:Cost
      of service, rent and maintenance(exclusive of depreciation and amortization included below)Cellular
                          
                          
                          1,285
                          
                          
                          
                          1,763
                          
                          
                          
                          4,338
                          
                          
                          
                          5,516Two-way
                          
                          
                          391
                          
                          
                          
                          435
                          
                          
                          
                          1,182
                          
                          
                          
                          1,313Other
                          
                          
                          17
                          
                          
                          
                          28
                          
                          
                          
                          49
                          
                          
                          
                          105Total
                          
                          
                          1,693
                          
                          
                          
                          2,226
                          
                          
                          
                          5,569
                          
                          
                          
                          6,934Cost
      of products soldCellular
                          
                          
                          1,130
                          
                          
                          
                          2,077
                          
                          
                          
                          3,691
                          
                          
                          
                          5,739Wholesale
                          
                          
                          6,904
                          
                          
                          
                          1,635
                          
                          
                          
                          14,217
                          
                          
                          
                          6,254Two-way
                          
                          
                          590
                          
                          
                          
                          407
                          
                          
                          
                          1,605
                          
                          
                          
                          1,373Other
                          
                          
                          95
                          
                          
                          
                          67
                          
                          
                          
                          278
                          
                          
                          
                          211Total
                          
                          
                          8,719
                          
                          
                          
                          4,186
                          
                          
                          
                          19,791
                          
                          
                          
                          13,577Selling
      and general and administrativeCellular
                          
                          
                          969
                          
                          
                          
                          1,335
                          
                          
                          
                          3,411
                          
                          
                          
                          4,096Wholesale
                          
                          
                          652
                          
                          
                          
                          317
                          
                          
                          
                          1,282
                          
                          
                          
                          958Two-way
                          
                          
                          156
                          
                          
                          
                          130
                          
                          
                          
                          410
                          
                          
                          
                          404Corporate
                          
                          
                          2,594
                          
                          
                          
                          2,375
                          
                          
                          
                          7,332
                          
                          
                          
                          7,081Other
                          
                          
                          50
                          
                          
                          
                          84
                          
                          
                          
                          159
                          
                          
                          
                          378Total
                          
                          
                          4,421
                          
                          
                          
                          4,241
                          
                          
                          
                          12,594
                          
                          
                          
                          12,917Depreciation
      and amortizationTwo-way
                          
                          
                          29
                          
                          
                          
                          46
                          
                          
                          
                          92
                          
                          
                          
                          158Corporate
                          
                          
                          282
                          
                          
                          
                          300
                          
                          
                          
                          864
                          
                          
                          
                          917Total
                          
                          
                          311
                          
                          
                          
                          346
                          
                          
                          
                          956
                          
                          
                          
                          1,075Loss(gain)
      on disposal of assetsCorporate
                          
                          
                          -
                          
                          
                          
                          (7
                          )
                          
                          
                          1
                          
                          
                          
                          (8
                          )Total
      operating expenses
                          
                          
                          15,144
                          
                          
                          
                          10,992
                          
                          
                          
                          38,911
                          
                          
                          
                          34,495Operating
      income (loss)Cellular
                          
                          
                          3,401
                          
                          
                          
                          2,889
                          
                          
                          
                          10,014
                          
                          
                          
                          9,152Wholesale
                          
                          
                          894
                          
                          
                          
                          (82
                          )
                          
                          
                          965
                          
                          
                          
                          (141
                          )Two-way
                          
                          
                          (18
                          )
                          
                          
                          (18
                          )
                          
                          
                          149
                          
                          
                          
                          (124
                          )Corporate
                          
                          
                          (2,876
                          )
                          
                          
                          (2,668
                          )
                          
                          
                          (8,197
                          )
                          
                          
                          (7,990
                          )Other
                          
                          
                          14
                          
                          
                          
                          (65
                          )
                          
                          
                          55
                          
                          
                          
                          (265
                          )Total
                          
                          
                          1,415
                          
                          
                          
                          56
                          
                          
                          
                          2,986
                          
                          
                          
                          632Interest
      expense, netTwo-way
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          -Corporate
                          
                          
                          (602
                          )
                          
                          
                          (558
                          )
                          
                          
                          (1,674
                          )
                          
                          
                          (1,811
                          )Total
                          
                          
                          (602
                          )
                          
                          
                          (558
                          )
                          
                          
                          (1,674
                          )
                          
                          
                          (1,811
                          )Net
      income (loss) before income tax expense
                          
                          
                          813
                          
                          
                          
                          (502
                          )
                          
                          
                          1,312
                          
                          
                          
                          (1,179
                          )Income
      tax expenseCorporate
                          
                          
                          60
                          
                          
                          
                          81
                          
                          
                          
                          183
                          
                          
                          
                          244Net
      income (loss)
                          
                          $
                          753
                          
                          
                          $
                          (583
                          )
                          
                          $
                          1,129
                          
                          
                          $
                          (1,423
                          )





During
the three and nine months ended February 28, 2010 and 2009, the Company did not
have a single customer that represented more than 10% of total
revenues.





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 February 28,
2010 and May 31, 2009 are as follows:


31





February 28, 2010
                                  
                                  
                                  May 31, 2009Total Assets
                                  
                                  
                                  Property and
                                    Equipment, net
                                  
                                  
                                  IntangibleAssets,net
                                  
                                  
                                  Total Assets
                                  
                                  
                                  Property and
                                    Equipment, net
                                  
                                  
                                  IntangibleAssets,netSegmentCellular
                                  
                                  $
                                  10,869
                                  
                                  
                                  $
                                  137
                                  
                                  
                                  $
                                  3,614
                                  
                                  
                                  $
                                  12,751
                                  
                                  
                                  $
                                  195
                                  
                                  
                                  $
                                  3,932Two-way
                                  
                                  
                                  1,864
                                  
                                  
                                  
                                  421
                                  
                                  
                                  
                                  377
                                  
                                  
                                  
                                  1,806
                                  
                                  
                                  
                                  467
                                  
                                  
                                  
                                  385Wholesale
                                  
                                  
                                  890
                                  
                                  
                                  
                                  2
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  1,123
                                  
                                  
                                  
                                  3
                                  
                                  
                                  
                                  -Corporate
                                  
                                  
                                  7,083
                                  
                                  
                                  
                                  2,200
                                  
                                  
                                  
                                  34
                                  
                                  
                                  
                                  8,639
                                  
                                  
                                  
                                  2,284
                                  
                                  
                                  
                                  191Other
                                  
                                  
                                  290
                                  
                                  
                                  
                                  2
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  37
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -Totals
                                  
                                  $
                                  20,996
                                  
                                  
                                  $
                                  2,762
                                  
                                  
                                  $
                                  4,025
                                  
                                  
                                  $
                                  24,356
                                  
                                  
                                  $
                                  2,949
                                  
                                  
                                  $
                                  4,508





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





Overview





For over
45 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 16 retail and agent stores and 4 two-way radio 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 and its
predecessor companies have been in place for over 25 years. 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 the 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
also operates a national wholesale distribution business, known as PCI Wholesale
that serves major carrier agents, rural cellular carriers, smaller consumer and
electronic retailers and automotive dealers throughout the United States.
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.





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


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 approximately 64,000 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 25 years has been distributing cellular
services under several exclusive master distributor agreements with AT&T and
its predecessor companies.  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
experienced a predicted decline in cellular subscribers and cellular revenues
due to AT&T subscribers no longer being allowed to transfer their service to
PCI. Subscriber attrition rates have remained flat following the August 2009
expiration of the DFW agreement but the inability to replace these subscribers
has resulted in a declining subscriber base and declining cellular service
revenues. The Company is currently negotiating new cellular carrier distribution
relationships and 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 cellular 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. In fiscal year 2009, macro-economic issues
attributed to the lower cellular and electronics sales in the Company’s
wholesale business and budgetary constraints imposed on many governmental
entities and commercial enterprises resulted 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 third quarter of fiscal 2010 through aggressive cost
management and improved product sales from its wholesale and two-way
businesses.  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 has historically
had five distribution agreements with AT&T in addition to the distribution
agreement covering the DFW market discussed above.  Under these other
distribution agreements, the Company is allowed to distribute AT&T wireless
services, on an exclusive basis, in certain major markets in Texas and Arkansas,
including the San Antonio, Texas Metropolitan Statistical Area (“MSA”), Austin,
Texas MSA, Houston, Texas MSA, East Texas Regional MSA and Arkansas, including
primarily the Little Rock, Arkansas MSA. These distribution agreements have
varying terms with the longest extending through October 2013.





In August
2009, the Company received notice from AT&T of its intent not to renew the
Houston distribution agreement but let it naturally expire in February 2010
which would allow the Company to continue servicing its small subscriber base in
the Houston area through February 2011.  In September 2009, the Company
received notice from AT&T of its intent to terminate the Arkansas
distribution agreement substantially on the grounds the Company did not maintain
a sufficient number of retail outlets in that market.  The Arkansas
agreement would otherwise expire in July 2012.  Additionally, AT&T has
claimed the San Antonio distribution agreement should have been previously
conformed to an agreement similar 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 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.





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





During
the remainder of fiscal 2010, the Company will focus on expanding distribution
of existing products and services to its approximately 64,000 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 nine months ended February, 2010.  The Company expects the handset
brokerage business to 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 $600,000 in installation
revenues during the next year.  Teletouch’s long-term relationships and
reputation with the various governmental entities over its almost 47 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 and
expected to continue into 2011.





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. The Company is currently in the process of applying to have
its emergency vehicle products listed and sold through the United States
Government Services Administration (“GSA”).  If successful in its efforts
to get approved and listed by GSA, the Company would be able to sell its
products to all Federal agencies without those agencies having to go through a
bidding process.





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.


36





Service,
rent and maintenance revenues and related costs are recognized during the period
in which the service is rendered.  Associated acquisition costs are
expensed as incurred.  Product sales revenue is recognized when delivery
occurs, the customer takes title and assumes risk of loss, terms are fixed and
determinable and collectibility is reasonably assured.  The Company does
not generally grant rights of return.  However, PCI offers customers a 30
day return/exchange program for new cellular subscribers in order to match
programs in place by most of the other cellular carriers.  During the 30
days, a customer may return all cellular equipment and cancel service with no
penalty.  Reserves for returns, price discounts and rebates are estimated
using historical averages, open return requests, recent product sell-through
activity and market conditions.  No reserves have been recorded for the 30
day cellular return program since only a very small number of customers utilize
this return program and many fail to meet all of the requirements of the
program, which include returning the phone equipment in new condition with no
visible damage.





Since
1984, the Company’s subsidiary, PCI, has held agreements with AT&T and its
predecessor companies, which allowed PCI to offer cellular service and customer
service to AT&T customers in exchange for certain compensation and
fees.  PCI is responsible for the billing and collection of cellular
charges from these customers and remits a percentage of the cellular billings
generated to AT&T.  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.


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


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


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





Cost of
products sold consists of the net book value of items sold from the Company’s
operating segments, which are cellular telephones, accessories, two-way radio,
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 Nine Months Ended February 28, 2010 and
2009





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)
                        
                        February 28,
                        
                        
                        2010 vs 20092010
                        
                        
                        2009
                        
                        
                        $ Change
                        
                        
                        % ChangeThree Months EndedService,
      rent, and maintenance revenueCellular
      operationsGross
      cellular subscription billings
                        
                        $
                        12,434
                        
                        
                        $
                        14,810
                        
                        
                        $
                        (2,376
                        )
                        
                        
                        -16
                        %Net
      revenue adjustment (revenue share due AT&T)
                        
                        
                        (6,599
                        )
                        
                        
                        (8,520
                        )
                        
                        
                        1,921
                        
                        
                        
                        -23
                        %Cellular
      operations total service revenues:
                        
                        
                        5,835
                        
                        
                        
                        6,290
                        
                        
                        
                        (455
                        )
                        
                        
                        -7
                        %Two-way
      radio operations
                        
                        
                        434
                        
                        
                        
                        458
                        
                        
                        
                        (24
                        )
                        
                        
                        -5
                        %Other
      operations
                        
                        
                        39
                        
                        
                        
                        30
                        
                        
                        
                        9
                        
                        
                        
                        30
                        %Service,
      rent, and maintenance revenue
                        
                        $
                        6,308
                        
                        
                        $
                        6,778
                        
                        
                        $
                        (470
                        )
                        
                        
                        -7
                        %Nine Months EndedService,
      rent, and maintenance revenueCellular
      operationsGross
      cellular subscription billings
                        
                        $
                        39,561
                        
                        
                        $
                        45,173
                        
                        
                        $
                        (5,612
                        )
                        
                        
                        -12
                        %Net
      revenue adjustment (revenue share due AT&T)
                        
                        
                        (21,561
                        )
                        
                        
                        (26,036
                        )
                        
                        
                        4,475
                        
                        
                        
                        -17
                        %Cellular
      operations total service revenues:
                        
                        
                        18,000
                        
                        
                        
                        19,137
                        
                        
                        
                        (1,137
                        )
                        
                        
                        -6
                        %Two-way
      radio operations
                        
                        
                        1,384
                        
                        
                        
                        1,246
                        
                        
                        
                        138
                        
                        
                        
                        11
                        %Other
      operations
                        
                        
                        138
                        
                        
                        
                        141
                        
                        
                        
                        (3
                        )
                        
                        
                        -2
                        %Service,
      rent, and maintenance revenue
                        
                        $
                        19,522
                        
                        
                        $
                        20,524
                        
                        
                        $
                        (1,002
                        )
                        
                        
                        -5
                        %




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


38





Service, Rent and
Maintenance Revenue Discussion for the Three and Nine Months Ended February 28,
2010 and 2009





The
decrease in gross cellular subscription billings for the three and nine
months ended February 28, 2010 compared to the same periods in the prior
fiscal year resulted primarily from a decrease in monthly access charges of
$1,834,000 and $4,752,000, respectively.  The reduction is due to a decline
in the Company’s cellular subscriber base 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 64,198 cellular subscribers as of
February 28, 2010 compared to 74,128 cellular subscribers as of February
28, 2009.   In addition, the cellular operations segment experienced a
decrease in gross billings for roamer and toll charges of approximately $294,000
and $1,000,000 for the three and nine months ended February 28, 2010,
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 $180,000 and $429,000 in the three and nine months ended February
28, 2010, respectively compared to the same periods in the prior fiscal
year.  The decrease in revenues were partially offset by an increase in
billings for data charges and customer billing fees of $346,000 and $253,000,
respectively, for the nine months ended February 28, 2010 compared to the same
periods in the prior fiscal year.





The
decrease in service, rent and maintenance revenue from the Company’s two-way
business for the three months ended February 28, 2010 compared to the three
months ended February 28, 2009 is attributable to a  decrease in radio
maintenance revenue, radio repair revenue and logic trunked radio subscription
service revenue of approximately $33,000, $34,000 and $16,000,
respectively.  The decrease in revenue was partially offset by an increase
in radio installation revenue of approximately $61,000 primarily due to the City
of Tyler radio frequency re-banding project.  The increase in service, rent
and maintenance revenue from the Company’s two-way business for the nine months
ended February 28, 2010 compared to the nine months ended February 28, 2009 is
primarily due to an increase in installation revenue related to the City of
Tyler radio frequency re-banding project.  Installation revenue increased
by approximately $270,000 for the nine months ended February 28, 2010 compared
to the same period in the prior fiscal year.  The increase in service
revenue was partially offset by a decrease in maintenance revenue, radio repair
revenue and logic trunked radio subscription service revenue of approximately
$64,000, $41,000 and $41,000, respectively in the nine months ended February 28,
2010 compared to the nine months ended February 28, 2009.





Cost of Service, Rent and
Maintenance for the Three and Nine Months Ended February 28, 2010 and
2009





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


39





(dollars
      in thousands)
                                
                                February 28,
                                
                                
                                2010 vs 20092010
                                
                                
                                2009
                                
                                
                                $ Change
                                
                                
                                % ChangeThree Months EndedCost
      of service, rent and maintenanceCellular
      operations
                                
                                $
                                1,285
                                
                                
                                $
                                1,763
                                
                                
                                $
                                (478
                                )
                                
                                
                                -27
                                %Two-way
      operations
                                
                                
                                391
                                
                                
                                
                                435
                                
                                
                                
                                (44
                                )
                                
                                
                                -10
                                %Other
      operations
                                
                                
                                17
                                
                                
                                
                                28
                                
                                
                                
                                (11
                                )
                                
                                
                                -39
                                %Total
      cost of service, rent and maintenance
                                
                                $
                                1,693
                                
                                
                                $
                                2,226
                                
                                
                                $
                                (533
                                )
                                
                                
                                -24
                                %Nine Months EndedCost
      of service, rent and maintenanceCellular
      operations
                                
                                $
                                4,338
                                
                                
                                $
                                5,516
                                
                                
                                $
                                (1,178
                                )
                                
                                
                                -21
                                %Two-way
      operations
                                
                                
                                1,182
                                
                                
                                
                                1,313
                                
                                
                                
                                (131
                                )
                                
                                
                                -10
                                %Other
      operations
                                
                                
                                49
                                
                                
                                
                                105
                                
                                
                                
                                (56
                                )
                                
                                
                                -53
                                %Total
      cost of service, rent and maintenance
                                
                                $
                                5,569
                                
                                
                                $
                                6,934
                                
                                
                                $
                                (1,365
                                )
                                
                                
                                -20
                                %





Cost of Service, Rent and
Maintenance Discussion for the Three and Nine Months Ended February 28, 2010 and
2009





The
decrease in cost of service, rent and maintenance related to the Company’s
cellular operations for the three and nine months ended February 28, 2010
compared to the three and nine months ended February 28, 2009 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
$62,000 and $314,000 for the three and nine months ended February 28, 2010,
respectively compared to the three and nine months ended February 28,
2009.  In addition, employee compensation costs from the Company’s cellular
operations decreased by approximately $128,000 and $426,000 for the three and
nine months ended February 28, 2010, respectively compared to the same periods
in the prior fiscal year due to a reduction in personnel.  The cellular
customer service department had 54 employees as of February 28, 2010 compared to
65 employees as of February 28, 2009.  Furthermore, the recovery of bad
debt expense increased by approximately $55,000 for the three months ended
February 28, 2010 compared to the same period in the prior fiscal
year.





The
decrease in cost of service, rent and maintenance related to the Company’s
two-way operations for the three months ended February 28, 2010 compared to the
three months ended February 28, 2009 is primarily due to a decrease in salaries
and wages and other personnel costs of approximately $32,000.  In addition,
office and travel expenses decreased by approximately $8,000 and office lease
expense decreased by approximately $2,500 quarter over quarter due to closing
the Nacogdoches two-way service center in the first quarter of fiscal year
2010.  The decrease in cost of service rent and maintenance for the
nine months ended February 28, 2010 compared to the nine months ended February
28, 2009 is related to a decrease in two-way network infrastructure repairs of
approximately $31,000 as well as a decrease in salaries and wages and other
personnel costs of approximately $69,000.


40


Sales Revenue and Cost of
Products Sold for the Three and Nine Months ended February 28, 2010 and
2009
 
 (dollars
      in thousands)
                                                                                  
                                                                                  February
      28,
                                                                                  
                                                                                  
                                                                                  2010
      vs 20092010
                                                                                  
                                                                                  
                                                                                  2009
                                                                                  
                                                                                  
                                                                                  $
      Change
                                                                                  
                                                                                  
                                                                                  %
      ChangeThree Months EndedProduct
      Sales RevenueCellular
                                                                                  
                                                                                  $
                                                                                  950
                                                                                  
                                                                                  
                                                                                  $
                                                                                  1,774
                                                                                  
                                                                                  
                                                                                  $
                                                                                  (824
                                                                                  )
                                                                                  
                                                                                  
                                                                                  -46
                                                                                  %Wholesale
                                                                                  
                                                                                  
                                                                                  8,450
                                                                                  
                                                                                  
                                                                                  
                                                                                  1,870
                                                                                  
                                                                                  
                                                                                  
                                                                                  6,580
                                                                                  
                                                                                  
                                                                                  
                                                                                  352
                                                                                  %Two-Way
                                                                                  
                                                                                  
                                                                                  714
                                                                                  
                                                                                  
                                                                                  
                                                                                  542
                                                                                  
                                                                                  
                                                                                  
                                                                                  172
                                                                                  
                                                                                  
                                                                                  
                                                                                  32
                                                                                  %Other
                                                                                  
                                                                                  
                                                                                  137
                                                                                  
                                                                                  
                                                                                  
                                                                                  84
                                                                                  
                                                                                  
                                                                                  
                                                                                  53
                                                                                  
                                                                                  
                                                                                  
                                                                                  63
                                                                                  %Total
      product sales revenue
                                                                                  
                                                                                  $
                                                                                  10,251
                                                                                  
                                                                                  
                                                                                  $
                                                                                  4,270
                                                                                  
                                                                                  
                                                                                  $
                                                                                  5,981
                                                                                  
                                                                                  
                                                                                  
                                                                                  140
                                                                                  %Cost
      of products soldCellular
                                                                                  
                                                                                  
                                                                                  1,130
                                                                                  
                                                                                  
                                                                                  
                                                                                  2,077
                                                                                  
                                                                                  
                                                                                  
                                                                                  (947
                                                                                  )
                                                                                  
                                                                                  
                                                                                  -46
                                                                                  %Wholesale
                                                                                  
                                                                                  
                                                                                  6,904
                                                                                  
                                                                                  
                                                                                  
                                                                                  1,635
                                                                                  
                                                                                  
                                                                                  
                                                                                  5,269
                                                                                  
                                                                                  
                                                                                  
                                                                                  322
                                                                                  %Two-Way
                                                                                  
                                                                                  
                                                                                  590
                                                                                  
                                                                                  
                                                                                  
                                                                                  407
                                                                                  
                                                                                  
                                                                                  
                                                                                  183
                                                                                  
                                                                                  
                                                                                  
                                                                                  45
                                                                                  %Other
                                                                                  
                                                                                  
                                                                                  95
                                                                                  
                                                                                  
                                                                                  
                                                                                  67
                                                                                  
                                                                                  
                                                                                  
                                                                                  28
                                                                                  
                                                                                  
                                                                                  
                                                                                  42
                                                                                  %Cost
      of products sold
                                                                                  
                                                                                  $
                                                                                  8,719
                                                                                  
                                                                                  
                                                                                  $
                                                                                  4,186
                                                                                  
                                                                                  
                                                                                  $
                                                                                  4,533
                                                                                  
                                                                                  
                                                                                  
                                                                                  108
                                                                                  %Nine Months EndedProduct
      Sales RevenueCellular
                                                                                  
                                                                                  $
                                                                                  3,454
                                                                                  
                                                                                  
                                                                                  $
                                                                                  5,366
                                                                                  
                                                                                  
                                                                                  $
                                                                                  (1,912
                                                                                  )
                                                                                  
                                                                                  
                                                                                  -36
                                                                                  %Wholesale
                                                                                  
                                                                                  
                                                                                  16,464
                                                                                  
                                                                                  
                                                                                  
                                                                                  7,071
                                                                                  
                                                                                  
                                                                                  
                                                                                  9,393
                                                                                  
                                                                                  
                                                                                  
                                                                                  133
                                                                                  %Two-Way
                                                                                  
                                                                                  
                                                                                  2,054
                                                                                  
                                                                                  
                                                                                  
                                                                                  1,878
                                                                                  
                                                                                  
                                                                                  
                                                                                  176
                                                                                  
                                                                                  
                                                                                  
                                                                                  9
                                                                                  %Other
                                                                                  
                                                                                  
                                                                                  403
                                                                                  
                                                                                  
                                                                                  
                                                                                  288
                                                                                  
                                                                                  
                                                                                  
                                                                                  115
                                                                                  
                                                                                  
                                                                                  
                                                                                  40
                                                                                  %Total
      product sales revenue
                                                                                  
                                                                                  $
                                                                                  22,375
                                                                                  
                                                                                  
                                                                                  $
                                                                                  14,603
                                                                                  
                                                                                  
                                                                                  $
                                                                                  7,772
                                                                                  
                                                                                  
                                                                                  
                                                                                  53
                                                                                  %Cost
      of products soldCellular
                                                                                  
                                                                                  
                                                                                  3,691
                                                                                  
                                                                                  
                                                                                  
                                                                                  5,739
                                                                                  
                                                                                  
                                                                                  
                                                                                  (2,048
                                                                                  )
                                                                                  
                                                                                  
                                                                                  -36
                                                                                  %Wholesale
                                                                                  
                                                                                  
                                                                                  14,217
                                                                                  
                                                                                  
                                                                                  
                                                                                  6,254
                                                                                  
                                                                                  
                                                                                  
                                                                                  7,963
                                                                                  
                                                                                  
                                                                                  
                                                                                  127
                                                                                  %Two-Way
                                                                                  
                                                                                  
                                                                                  1,605
                                                                                  
                                                                                  
                                                                                  
                                                                                  1,373
                                                                                  
                                                                                  
                                                                                  
                                                                                  232
                                                                                  
                                                                                  
                                                                                  
                                                                                  17
                                                                                  %Other
                                                                                  
                                                                                  
                                                                                  278
                                                                                  
                                                                                  
                                                                                  
                                                                                  211
                                                                                  
                                                                                  
                                                                                  
                                                                                  67
                                                                                  
                                                                                  
                                                                                  
                                                                                  32
                                                                                  %Cost
      of products sold
                                                                                  
                                                                                  $
                                                                                  19,791
                                                                                  
                                                                                  
                                                                                  $
                                                                                  13,577
                                                                                  
                                                                                  
                                                                                  $
                                                                                  6,214
                                                                                  
                                                                                  
                                                                                  
                                                                                  46
                                                                                  %
 
 Sales Revenue and Cost of
Products Sold Discussion for the Three and Nine Months Ended February 28, 2010
and 2009
 
 Product sales revenue: The
decrease in product sales revenue from the Company’s cellular operations for the
three and nine months ended February 28, 2010 compared to the three and nine
months ended February 28, 2009 is primarily due to a decrease in cellular phone
activations and upgrades. The Company’s cellular phone activations decreased by
a quantity of 1,977 and 3,949 for the three and nine months ended February 28,
2010, respectively compared to the same periods from the prior fiscal
year.  The Company’s cellular phone upgrades decreased by a quantity
of 1,626 and 4,279 for the three and nine months ended February 28, 2010,
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 nine months ended February 28, 2010 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 February 28,
2010, 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 nine months ended February 28, 2010 compared to the three and nine
months ended February 28, 2009 is related to brokering large quantities of
cellular handsets to certain domestic and international cellular
distributors.  These high volume and relatively low margin brokerage
sales generated approximately $7,100,000 and $11,850,000 in additional product
sales for the three and nine months ended February 28, 2010, respectively. There
were no similar cellular brokering sales for the three and nine months ended
February 28, 2009.
 
 The
increase in product sales from the Company’s two-way operations for the three
months ended February 28, 2010 compared to the three months ended February 28,
2009 is primarily related to an increase in emergency vehicle product (“EVP”)
sales, two-way radio sales and two-way radio parts sales
of  approximately $40,000, $76,000 and $48,000, respectively. The
increase in products sales for the nine months ended February 28, 2010 compared
to the nine months ended February 28, 2009 is primarily related to an increase
in EVP sales of approximately $314,000.  The increase in revenue was
partially offset by a decrease in two-way radio and parts sales of approximately
$95,000 and $28,000, respectively, compared to the same period in the prior
fiscal year.
 
 The
increase in product sales related to the Company’s other operations for the
three and nine months ended February 28, 2010 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 nine months ended February 28, 2010 compared to the three and nine
months ended February 28, 2009 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
nine 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.  In
addition, the cost of products related to the Company’s two-way business
increased greater than the increase in two-way sales, year over year, due to an
increase in emergency vehicle products sales which are sold at lower profit
margins.
 
 Selling and General and
Administrative Expenses for the Three and Nine Months ended February 28, 2010
and 2009
 
 Selling
and general and administrative expenses consist of the following significant
components:
  42
 
 (dollars
      in thousands)
                          
                          February
      28,
                          
                          
                          2010
      vs 20092010
                          
                          
                          2009
                          
                          
                          $
      Change
                          
                          
                          %
      ChangeThree Months EndedSelling
      and general and administrativeSalaries
      and other personnel expenses
                          
                          $
                          2,804
                          
                          
                          $
                          2,677
                          
                          
                          $
                          127
                          
                          
                          
                          5
                          %Office
      expense
                          
                          
                          446
                          
                          
                          
                          464
                          
                          
                          
                          (18
                          )
                          
                          
                          -4
                          %Advertising
      expense
                          
                          
                          111
                          
                          
                          
                          190
                          
                          
                          
                          (79
                          )
                          
                          
                          -42
                          %Professional
      fees
                          
                          
                          461
                          
                          
                          
                          465
                          
                          
                          
                          (4
                          )
                          
                          
                          -1
                          %Taxes
      and licenses fees
                          
                          
                          24
                          
                          
                          
                          35
                          
                          
                          
                          (11
                          )
                          
                          
                          -31
                          %Stock-based
      compensation expense
                          
                          
                          35
                          
                          
                          
                          85
                          
                          
                          
                          (50
                          )
                          
                          
                          -59
                          %Other
      expenses
                          
                          
                          540
                          
                          
                          
                          325
                          
                          
                          
                          215
                          
                          
                          
                          66
                          %Total
      selling and general and administrative
                          
                          $
                          4,421
                          
                          
                          $
                          4,241
                          
                          
                          $
                          180
                          
                          
                          
                          4
                          %Nine Months EndedSelling
      and general and administrativeSalaries
      and other personnel expenses
                          
                          $
                          7,826
                          
                          
                          $
                          8,184
                          
                          
                          $
                          (358
                          )
                          
                          
                          -4
                          %Office
      expense
                          
                          
                          1,432
                          
                          
                          
                          1,496
                          
                          
                          
                          (64
                          )
                          
                          
                          -4
                          %Advertising
      expense
                          
                          
                          456
                          
                          
                          
                          579
                          
                          
                          
                          (123
                          )
                          
                          
                          -21
                          %Professional
      fees
                          
                          
                          1,368
                          
                          
                          
                          1,215
                          
                          
                          
                          153
                          
                          
                          
                          13
                          %Taxes
      and licenses fees
                          
                          
                          117
                          
                          
                          
                          151
                          
                          
                          
                          (34
                          )
                          
                          
                          -23
                          %Stock-based
      compensation expense
                          
                          
                          204
                          
                          
                          
                          171
                          
                          
                          
                          33
                          
                          
                          
                          19
                          %Other
      expenses
                          
                          
                          1,191
                          
                          
                          
                          1,121
                          
                          
                          
                          70
                          
                          
                          
                          6
                          %Total
      selling and general and administrative
                          
                          $
                          12,594
                          
                          
                          $
                          12,917
                          
                          
                          $
                          (323
                          )
                          
                          
                          -3
                          %
 
 Selling and General and
Administrative Expenses Discussion for the Three and Nine Months Ended February
28, 2010 and 2009
 
 The
increase in salaries and other personnel expenses for the three months ended
February 28, 2010 compared to the three months ended February 28, 2009 is due to
an increase of bonus accrual expenses of approximately $255,000 which is related
to the Company’s expectation of achieving its fiscal 2010 bonus targets
established by its Board. The increase was partially offset by a decrease in
contract labor expense of approximately $123,000 due to the Company terminating
its computer services contract with a group of IT contractors in the later part
of fiscal year 2009.  The decrease in salaries and other personnel
expenses for the nine months ended February 28, 2010 compared to the same period
in the prior fiscal year is due to a decrease in expenses related to contract
labor, third party commissions and employee welfare of approximately $458,000,
$207,000, and $190,000 respectively.  As mentioned previously, the
decrease in contract labor is related to the Company terminating its computer
services with a group of IT contractors. Third party commissions decreased due
to lower agent sales and activations which are directly related to the
termination of the Company’s Dallas/Fort Worth distribution agreement with
AT&T in August 2009. The decrease in employee welfare expense is
attributable to forfeitures from the Company’s 401(k) program used to offset
Company matching funds paid into the 401(k) plan.  The decrease in
salaries and other personnel expenses for the nine months ended February 28,
2010 compared to the nine months ended February 28, 2009, were partially offset
by an increase in salary expenses and bonus accrual expenses of approximately
$121,000 and $344,000, respectively.
 
 The
decrease in advertising expense for the three and nine months ended February 28,
2010 compared to the three and nine months ended February 28, 2009 is primarily
related to advertising reimbursements the Company received from certain vendors
for achieving sales based objectives.  Advertising reimbursements
increased by approximately $91,000 and $149,000 for the three and nine months
ended February 28, 2010, respectively, compared to the three and nine months
ended February 28, 2009.  In addition, the Company reduced expenses
related to billboard advertising and other promotions by approximately $40,000
and $82,000 for the three and nine months ended February 28, 2010, respectively,
compared to the same period in the prior year.  The decrease in
expenses were partially offset by an increase in sponsorships of approximately
$33,000 and $81,000 for the three and nine months ended February 28, 2010,
respectively, compared to the same period in the prior fiscal
year.  In addition, expenses related to print media advertising
increased by approximately $20,000 and $28,000 for the three and nine months
ended February 28, 2010, respectively, compared to the three and nine months
ended February 28, 2009.
  43
 
 The
increase in professional fees for the nine months ended February 28, 2010
compared to the nine months ended February 28, 2009 is due to an increase in
legal fees of approximately $540,000, primarily related to costs associated with
defending the Company against an alleged infringement on the Hawk Electronics
trade name as well as legal fees attributable to the arbitration with AT&T.
The increase in legal fees was partially offset by a reduction in other
professional fees including accounting fees, board of directors fees, consulting
fees and investor relations fees by approximately $160,000,  $54,000,
$91,000 and $78,000, respectively, for the nine months ended February 28, 2010
compared to the nine months ended February 28, 2009.  The decrease in
accounting fees is primarily related to the reversal of fees accrued for the
Company’s fiscal year 2007 quarterly reviews since the SEC granted the Company
relief on these filings. Board of director’s fees decreased primarily from the
reduction of meeting fees and consulting fees declined due to fewer expenses
related to its internal controls assessments required under Section 404 of the
Sarbanes-Oxley Act of 2002.  The Company experienced a decrease in
investor relations expense as a result of expenses incurred during fiscal year
2009 to help promote investor awareness.  The nine months ended
February 28, 2010 had no similar occurring expenses.
 
 The
decrease in stock-based compensation expense for the three months ended February
28, 2010 compared to the three months ended February 28, 2009 is attributable to
stock options that were fully amortized in the second quarter of fiscal year
2010. The increase in stock-based compensation expense for the nine months ended
February 29, 2010 compared to the nine months ended February 28, 2009 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 nine months ended February 28, 2010 compared to the
nine months ended February 28, 2009.
 
 The
increase in other expenses for the three months ended February 28, 2010 compared
to the three months ended February 28, 2009 is attributable to an increase in
bad debt expense of approximately $47,000 related to the Company’s wholesale and
two-way businesses. In addition, the Company experienced increased costs for
travel, business insurance and computer expense of approximately $52,000,
$27,000 and $15,000, respectively, for the three months ended February 28, 2010
compared to the same period in the prior fiscal year.  The increase in
other expenses for the nine months ended February 28, 2010 compared to the same
period in the prior fiscal year is attributable to an increase in travel and
postage expense of approximately $50,000 and $40,000,
respectively.  The increase in other expenses for the nine months
ended February 28, 2010 compared to the nine months ended February 28, 2009 was
offset by a decrease in business insurance of approximately
$20,000.
  44
  Other Operating Expenses for
the Three and Nine Months Ended February 28, 2010 and 2009
 
 (dollars
      in thousands)February
      28,
                          
                          
                          2010
      vs 20092010
                          
                          
                          2009
                          
                          
                          $
      Change
                          
                          
                          %
      ChangeThree Months EndedOther
      Operating ExpensesDepreciation
      and amortization:Depreciation
                          
                          $
                          87
                          
                          
                          $
                          116
                          
                          
                          $
                          (29
                          )
                          
                          
                          -25
                          %Amortization
                          
                          
                          224
                          
                          
                          
                          230
                          
                          
                          
                          (6
                          )
                          
                          
                          -3
                          %Total
      depreciation and amortization
                          
                          
                          311
                          
                          
                          
                          346
                          
                          
                          
                          (35
                          )
                          
                          
                          -10
                          %Gain
      on disposal of assets
                          
                          
                          -
                          
                          
                          
                          (7
                          )
                          
                          
                          7
                          
                          
                          
                          -100
                          %Total
      other operating expenses
                          
                          $
                          311
                          
                          
                          $
                          339
                          
                          
                          $
                          (28
                          )
                          
                          
                          -8
                          %Nine Months EndedOther
      Operating ExpensesDepreciation
      and amortization:Depreciation
                          
                          $
                          285
                          
                          
                          $
                          377
                          
                          
                          $
                          (92
                          )
                          
                          
                          -24
                          %Amortization
                          
                          
                          671
                          
                          
                          
                          698
                          
                          
                          
                          (27
                          )
                          
                          
                          -4
                          %Total
      depreciation and amortization
                          
                          
                          956
                          
                          
                          
                          1,075
                          
                          
                          
                          (119
                          )
                          
                          
                          -11
                          %Loss(gain)
      on disposal of assets
                          
                          
                          1
                          
                          
                          
                          (8
                          )
                          
                          
                          9
                          
                          
                          
                          -113
                          %Total
      other operating expenses
                          
                          $
                          957
                          
                          
                          $
                          1,067
                          
                          
                          $
                          (110
                          )
                          
                          
                          -10
                          %
 
 The
decrease in depreciation and amortization expense for the three and nine months
ended February 28, 2010 compared to the three and nine months ended February 28,
2009 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.  The decrease in
the gain on the sale of assets for the three and nine months ended February 28,
2010 compared to the same periods in the prior fiscal year is due to sale of
certain assets used in the Company’s cellular operations.
 
 Interest Expense, Net of
Interest Income for the Three and Nine Months Ended February 28, 2010 and
2009
 
 (dollars
      in thousands)
                            
                            February
      28,
                            
                            
                            2010
      vs 20092010
                            
                            
                            2009
                            
                            
                            $
      Change
                            
                            
                            %
      ChangeThree
    Months  EndedInterest
      expense (income)Mortgage
      debt
                            
                            $
                            41
                            
                            
                            $
                            41
                            
                            
                            $
                            -
                            
                            
                            
                            0
                            %Thermo
      factoring debt
                            
                            
                            -
                            
                            
                            
                            361
                            
                            
                            
                            (361
                            )
                            
                            
                            -100
                            %Thermo
      revolving credit facility
                            
                            
                            528
                            
                            
                            
                            139
                            
                            
                            
                            389
                            
                            
                            
                            280
                            %Warrant
      redemption notes payable
                            
                            
                            31
                            
                            
                            
                            40
                            
                            
                            
                            (9
                            )
                            
                            
                            -23
                            %Other
                            
                            
                            2
                            
                            
                            
                            (23
                            )
                            
                            
                            25
                            
                            
                            
                            -109
                            %Total
      interest expense, net
                            
                            $
                            602
                            
                            
                            $
                            558
                            
                            
                            $
                            44
                            
                            
                            
                            8
                            %Nine
Months  EndedInterest
      expense (income)Mortgage
      debt
                            
                            $
                            123
                            
                            
                            $
                            145
                            
                            
                            $
                            (22
                            )
                            
                            
                            -15
                            %Thermo
      factoring debt
                            
                            
                            306
                            
                            
                            
                            1,108
                            
                            
                            
                            (802
                            )
                            
                            
                            -72
                            %Thermo
      revolving credit facility
                            
                            
                            1,163
                            
                            
                            
                            458
                            
                            
                            
                            705
                            
                            
                            
                            154
                            %Warrant
      redemption notes payable
                            
                            
                            101
                            
                            
                            
                            126
                            
                            
                            
                            (25
                            )
                            
                            
                            -20
                            %Other
                            
                            
                            (19
                            )
                            
                            
                            (26
                            )
                            
                            
                            7
                            
                            
                            
                            -27
                            %Total
      interest expense, net
                            
                            $
                            1,674
                            
                            
                            $
                            1,811
                            
                            
                            $
                            (137
                            )
                            
                            
                            -8
                            %
  45
  The
increase in interest expense for the three months ended February 28, 2010
compared to the three months ended February 28, 2009 is primarily attributable
to interest income the Company recorded in three months ended February 28, 2009,
related to the Mobui Note and the Air-bank Note (see Note 4 – Notes Receivable
for additional information) with no comparable interest income recorded in the
three months ended February 28, 2010. The decrease in interest expense for the
nine months ended February 28, 2010 compared to the nine months ended February
28, 2009 is due to a decrease in cellular billings which resulted in lower
levels of accounts receivable year over year.   During the nine
months ended February 28, 2009 the Company incurred greater discount fees
related to the factoring debt facility compared to the same periods in the
current 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 Nine Months Ended February 28, 2010 and 2009
 
 In all
periods presented, the combined operations of the Company did not generate a
federal tax liability even though the company recorded net income in both the
three and nine months ended February 28, 2010.  Since the Company’s
deferred tax assets are fully reserved, the current period income tax expense
was offset by a decrease in the Company’s deferred tax asset valuation allowance
balance. In the three months ended February 28, 2010 and 2009, the Company
recorded $60,000 and $81,000 in state tax expenses, respectively. In the nine
months ended February 28, 2010 and 2009, the Company recorded $183,000 and $244,000
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 nine months ended February 28, 2010 compared to the
three and nine months ended February 28, 2009.
 
 FINANCIAL
CONDITION
 
 (dollars
      in thousands)
                          
                          Nine
      Months Ended February 28,
                          
                          
                          2010
      vs 20092010
                          
                          
                          2009
                          
                          
                          $
      ChangeCash
      provided by (used in) operating activities
                          
                          $
                          (968
                          )
                          
                          $
                          484
                          
                          
                          $
                          (1,452
                          )Cash
      provided by (used in) investing activities
                          
                          
                          723
                          
                          
                          
                          (636
                          )
                          
                          
                          1,359Cash
      used in financing activities
                          
                          
                          (542
                          )
                          
                          
                          (2,706
                          )
                          
                          
                          2,164Net
      decrease in cash
                          
                          $
                          (787
                          )
                          
                          $
                          (2,858
                          )
                          
                          $
                          2,071
 
 Operating
Activities
 
 The
decrease in cash provided by operations during the nine months ended February
28, 2010 compared to the nine months ended February 28, 2009 is primarily
attributable to additional payments made against the Company’s accounts payable
and accrued liabilities of approximately $2,900,000 and $1,500,000, respectively
during the first nine months of fiscal year 2010 compared to the same period in
fiscal year 2009.  The Company had additional cash in the first nine
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.  These cash decreases were partially offset by net income of
$1,129,000 for the nine months ended February 28, 2010 compared to a net loss of
$1,423,000 for the nine months ended February 28, 2009.
  46
 
 Investing
Activities
 
 The
increase in cash provided by investing activities for the nine months ended
February 28, 2010 compared to nine months ended February 28, 2009 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 $156,000 in the nine months ended February 28, 2010 compared to
the nine months ended February 28, 2009, 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 nine months of fiscal year 2009.
 
 Financing
Activities
 
 The
decrease in cash used by financing activities for the nine months ended February
28, 2010 compared to the nine months ended February 28, 2009 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 nine months of fiscal year
2010.  In addition, the Company received $1,123,000 in additional cash
proceeds in the nine months ended February 28, 2010 compared to the nine months
ended February 28, 2009 due to a draw on the Company’s  revolving
credit line with Thermo in November 2009 for approximately $1,400,000 due to the
needs of the Company’s wholesale brokerage business.  The increase in
cash was partially offset by additional payments on long-term debt of $428,000
in the first nine months of fiscal year 2010 compared to the first nine 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.  In addition, the Company made principal
payments of approximately $826,000 against the Thermo revolving credit
facility’s principal balance in February 2010. Due to the decline in the
Company’s wholesale brokerage business, the majority of the principal payments
made were to pay back a portion of the approximate $1,400,000 draw the Company
received in the second quarter of fiscal year 2010.
 
 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 approximately 64,000 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.
  47
  The
Company’s primary business for over 25 years has been distributing cellular
services under several exclusive master distributor agreements with AT&T and
its predecessor companies.  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
experienced a predicted decline in cellular subscribers and cellular revenues
due to AT&T subscribers no longer being allowed to transfer their service to
PCI. Subscriber attrition rates have remained flat following the August 2009
expiration of the DFW agreement but the inability to replace these subscribers
has resulted in a declining subscriber base and declining cellular service
revenues. The Company is currently negotiating new cellular carrier distribution
relationships and 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 cellular 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. In fiscal year 2009, macro-economic issues
attributed to the lower cellular and electronics sales in the Company’s
wholesale business and budgetary constraints imposed on many governmental
entities and commercial enterprises resulted 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 third quarter of fiscal 2010 through aggressive cost management and
improved product sales from its wholesale and two-way businesses. 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.
 
 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.
  48
  As of
February 28, 2010, the Company has $3,855,000 cash on hand and available
borrowings under its current credit facilities of up to $4,726,000 against
future accounts receivable and $904,000 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
throughout the remainder 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 February 28, 2010, 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 $1,366,000
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.
 
 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 $520,000
and $486,000 at February 28, 2010 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.
  49
  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 and Internet
distribution channels, it is successful in liquidating the majority of any
inventory that becomes obsolete.  The Company has many different
electronics suppliers, all of which provide reasonable notification of model
changes, which allows the Company to minimize its level of discontinued or
obsolete inventory. Actual results could differ from those
estimates.  Inventories are stated on the Company’s consolidated
balance sheet net of a reserve for obsolescence of $253,000 and $242,000 at
February 28, 2010 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 third 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.
 
 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.
  50
  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, (“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.
 
 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.
  51
 
 Revenue
Recognition:Teletouch recognizes
revenue over the period the service is performed in accordance with SEC Staff
Accounting Bulletin No. 104, "Revenue Recognition in Financial Statements" and
ASC 605, Revenue
Recognition, (“ASC 605”). In general, ASC 605 requires that four basic
criteria must be met before revenue can be recognized: (1) persuasive evidence
of an arrangement exists, (2) delivery has occurred or services rendered, (3)
the fee is fixed and determinable, and (4) collectability is reasonably assured.
Teletouch believes, relative to sales of products, that all of these conditions
are met; therefore, product revenue is recognized at the time of
shipment.
 
 The
Company primarily generates revenues by providing and billing recurring cellular
services and product sales.  Cellular services include cellular
airtime and other recurring services provided through a master distributor
agreement with AT&T.  Product sales include sales of cellular
telephones, accessories, car and home audio products and services and two-way
radio equipment through the Company’s retail, wholesale and two-way radio
operations.
 
 Cellular
and other service revenues and related costs are recognized during the period in
which the service is rendered.  Associated subscriber acquisition
costs are expensed as incurred.  Product sales revenue is recognized
when delivery occurs, the customer takes title and assumes risk of loss, terms
are fixed and determinable and collectability is reasonably
assured.  The Company does not generally grant rights of
return.  However, PCI offers customers a 30 day return/exchange
program for new cellular subscribers in order to match programs in place by most
of the other cellular carriers.  During the 30 days, a customer may
return all cellular equipment and cancel service with no
penalty.  Reserves for returns, price discounts and rebates are
estimated using historical averages, open return requests, recent product
sell-through activity and market conditions.  No reserves have been
recorded for the 30 day cellular return program since only a very small number
of customers utilize this return program and many fail to meet all of the
requirements of the program, which include returning the phone equipment in new
condition with no visible damage.  In addition, it is typical to incur
losses on the sale of the cellular phone equipment related to signing up
customers under a cellular airtime contract; therefore, any reserves recorded
for customer returns would be an accrual of gains via reversing the losses
incurred on the original cellular phone sale transaction.  The Company
does not believe accruing for the potential gains would be in accordance with
GAAP but rather records this gain in the period that it is actually
realized.
 
 Since
1984, Teletouch’s subsidiary, PCI, has held agreements with AT&T or one of
its predecessor companies, which allowed PCI to offer cellular service and
customer service to its subscribers.  PCI is responsible for the
billing and collection of cellular charges from these customers and remits a
percentage of the cellular billings generated to AT&T.  Based on
PCI’s relationship with AT&T, the Company has evaluated its reporting of
revenues, under ASC 605-45, Revenue Recognition, Principal Agent Considerations
(“ASC 605-45”) associated with its services attached to the AT&T
agreements.
 
 Based on
its assessment of the indicators listed in ASC 605-45, the Company has concluded
that the AT&T services provided by PCI should be reported on a net
basis.
 
 Deferred
revenue represents prepaid monthly service fees billed to customers, primarily
monthly access charges for cellular services that are billed in advance by the
Company.
  52
  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 February 28, 2010.  We do not enter into financial
instruments for trading or speculative purposes and do not currently utilize
derivative financial instruments.  Our operations are conducted
primarily in the United States and as such are not subject to material foreign
currency exchange rate risk.
 
 Item
4T. Controls and Procedures
 
 Controls
and procedures
  As of the
end of the period covered by this report, the Company conducted an evaluation,
under the supervision and with the participation of our management, including
the Chief Executive Officer, President and Chief Operating Officer and Chief
Financial Officer (the “Certifying Officers”) of our disclosure controls and
procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act).
Based on this evaluation, the Certifying Officers concluded that, as of February
28, 2010, our disclosure controls and procedures were effective to ensure that
information required to be disclosed by us in reports that we file or submit
under the Exchange Act is recorded, processed, summarized and reported, within
the time periods specified in the Commission’s rules and forms and to ensure
that information required to be disclosed by us in the reports that we file or
submit under the Exchange Act is accumulated and communicated to us, including
our principal executive and principal financial officers, as appropriate to
allow timely decisions regarding required disclosure.
  Change
in internal control over financial reporting
  There
were no changes in our internal control over financial reporting during our most
recently completed fiscal quarter that have materially affected or are
reasonably likely to materially affect our internal control over financial
reporting.
  53
 
 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
was scheduled for trial in April 2010.  Since February 2010, the
Company has been negotiating a settlement with the other party that made the
infringement allegation. On February 22nd and
23rd2010, the Company attended a court ordered mediation on this matter and
believes it is in the final stages of negotiating a settlement with the other
party. Additional mediation is set for April 15, 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.
 
 AT&T Arbitration: In late
June, 2007, Apple, Inc. introduced the iPhone to the United States in an
exclusive distribution and wireless services partnership with
AT&T.  AT&T was at the time, and remains today, the only
authorized carrier provider for the iPhone. Since that time, AT&T has
refused to allow the Company to sell the iPhone as well as other products and
services, despite AT&T’s contractual obligation to do so under previously
executed distribution agreements between AT&T and the Company. Furthermore,
the Company asserts that AT&T has continued to make direct contact with
Company customers and aggressively markets, advertises and promotes the iPhone
and other AT&T exclusive products and services to Company customers in an
attempt to induce them to switch to AT&T.
 
 In June
2007, the Company serviced approximately 84,000 subscribers in the DFW market.
As of September 30, 2009, more than 12,500 subscribers had transferred their
accounts to AT&T, approximately half solely due to the exclusive
availability of the iPhone at AT&T and Apple stores only.
 
 Since
July 2007, the Company had attempted to negotiate with AT&T for the purpose
of obviating the need for legal action. However, such attempt failed. Therefore,
on September 30, 2009, the Company, through the legal entity Progressive
Concepts, Inc. or PCI, commenced an arbitration proceeding against New Cingular
Wireless PCS, LLC and AT&T Mobility Texas LLC (collectively, “AT&T”)
seeking at least $100 million in damages. The binding arbitration was commenced
to seek relief for damages incurred as AT&T has prevented PCI from selling
the popular iPhone and other AT&T exclusive products and services that PCI
is and has been contractually entitled to provide to its customers under
distribution agreements between PCI and AT&T. The action further asserts
that AT&T violated the longstanding non-solicitation provisions of the DFW
market distribution agreement by and between the companies by actively inducing
customers to leave PCI for AT&T and employing predatory business practices.
PCI is being represented in the matter by the Company’s legal counsel, Bracewell
& Giuliani, LLP.
  54
  On
February 28, 2010, Teletouch and its wholly-owned subsidiary, PCI, as Claimant
and AT&T as Respondent announced that they received the Agreed Scheduling
Order from the JAMS Arbitrator assigned to the binding arbitration. Among other
matters, including the provision of the Rules and Law governing the arbitration,
the Agreed Scheduling Order sets out the proposed completion dates for
Discovery, Depositions, Dispositive Motions and Briefing Deadlines, culminating
in an Arbitration hearing period scheduled for November 8, 2010 through November
12, 2010.
 
 For a
more detailed description of the Company’s legal proceedings and legal action
Notice and Initial Statement of Claim, please refer to the related Form 8-K,
filed October 1, 2009 (available at the Company’s website: www.teletouch.com and
on EDGAR at www.sec.gov).
 
 Item
2.     Unregistered Sales of Equity Securities and Use
of Proceeds
 
 None
 
 Item
3.     Defaults Upon Senior Securities
 
 None
 
 Item
4.    Submission of Matters to a Vote of Security
Holders
 
 None
 
 Item
5.    Other Information
 
 None
 
 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
  55
 
 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:
      April 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)
  56