ITEM 1. BUSINESS
GENERAL DEVELOPMENT OF THE BUSINESS
Our primary business is providing specialized call processing and other services to the corrections industry directly or through our telecommunications service provider customers. In 1999, we began providing inter-LATA Internet bandwidth to a customer's Internet subscribers, which service continued through 2000. In addition, we provide specialized speaker verification computer products. Although our office headquarters is located in Englewood, Colorado we have significant operations in Carrollton, Texas and are in the process of moving most of our operations to Carrollton. At December 31, 2000 we had 441 employees in 36 states.
We were incorporated on August 21, 1986 under the name of Tele-Matic Corporation. In 1995 we changed our name to T-NETIX, Inc. In October 1995, we acquired SpeakEZ, Inc. ("SpeakEZ"). SpeakEZ is a wholly-owned subsidiary and is engaged in the sale, marketing, and development of speaker verification biometric technology. On June 14, 1999, we completed a merger with Gateway Technologies, Inc. ("Gateway"), a privately held provider of inmate call processing services. Gateway became a wholly-owned subsidiary of T-NETIX and its name was changed to T-NETIX Telecommunications Services, Inc. The merger with Gateway was accounted for as a pooling-of-interests and as a result, our financial statements were restated as indicated in the notes which accompany the consolidated financial statements
In December 1998, we adopted a fiscal year-end reporting period of December 31. This change from our July 31 year-end was effective on December 31, 1998
FINANCIAL INFORMATION ABOUT SEGMENTS
Information relating to our revenue, operating profit or loss, and total assets by segment, is set forth in Note 7 of "Notes to Consolidated Financial Statements."
NARRATIVE DESCRIPTION OF BUSINESS
T-NETIX has three operating segments; the corrections division, the Internet services division, and the SpeakEZ division. The corrections division remains, and is expected to remain, as the core business of the Company and is by far its largest revenue producer.
CORRECTIONS DIVISION
MARKET DESCRIPTION
We are primarily a provider of specialized call processing and other services to the corrections industry. These services are delivered through direct contracts with correctional facilities and through well-established relationships with large telecommunications companies or telecommunication service providers. Our primary customers for these services are AT&T, Bell South, Qwest, SBC Communications (including Ameritech), Verizon, Sprint, and WorldCom. Through a series of acquisitions, we have expanded our presence in the corrections industry. It is our intent to increase the level of direct provisioning of specialized call processing services. We intend to do this through increased relationship management efforts and by offering an array of calling alternatives to our customers such as T-Net Direct Connections, T-Net Family Connections and T-Net Budget Connections.
Calls from inmates of federal, state, and local correctional facilities comprise a significant segment of the public communications market. Inmates typically may only place calls for a limited duration, which generates a high volume of calls per phone, and generally may only place collect calls, which tend to generate higher revenue per call than other types of calling. Consequently, the inmate calling market is an attractive segment of the corrections industry to other telecommunications service providers and to us. Specialized call processing within the corrections industry requires the development of advanced capabilities such as fraud control of outgoing calls and flexible billing systems.
According to the U.S. Bureau of Justice Statistics as of December 1999
o 6.3 million adults were under some form of correctional supervision
o approximately 4.25 million adults were under parole or probation sanction
o there were approximately 2.5 million inmates in state and federal and local prisons
o from 1990 to 1999 the number of inmates increased by an average of 6.0 percent annually
o there are approximately 4,500 correctional facilities in the U.S.
The inmate calling market presents unique and substantial challenges to the telecommunications service provider. Correctional authorities generally favor telecommunications service providers who can manage the inmate phone systems themselves, maintain consistent service and easily process new inmates into the systems. Correctional authorities generally require control features that limit the length of calls, limit the time of day calls are made, and restrict the ability of inmates to make harassing or unapproved telephone calls. The telecommunications service provider must be able to customize the call control features by facility, cellblock, telephone and, in some cases, each inmate. One of the unique challenges is to prevent the fraudulent bypassing of these controls through three-way calling. Inmates attempt to bypass traditional control features by calling an accomplice at an approved number and having the accomplice use three-way calling to conference a non-allowed party. Through this method, inmates have been known to harass and intimidate people such as witnesses, whose numbers would otherwise be blocked, and to call merchants to conduct fraudulent activities.
Correctional authorities generally select telecommunications service providers on the basis of services and features provided and on the level of commissions paid to the facilities. Competition is intense among the telecommunications service providers and this has led to commission payments to correctional facilities at very high levels. In addition, to win new contracts and renew existing contracts, telecommunications service providers must differentiate their services from those of the competition. They do so by offering advanced call control services as well as additional complementary services such as booking and identification processes, trust fund and commissary automation and management, investigation support and jail management support systems. Correctional authorities need these additional services due to the increasing administrative requirements placed on them. Correctional authorities recognize the benefits in outsourcing to telecommunications service providers that provide leading edge technology that can assist their goal of improving efficiency in operations.
PRINCIPAL PRODUCTS AND SERVICES
The primary focus in the design of our products and services is to provide software-based solutions to "niche" problems faced in the corrections industry. We believe that this approach results in correctional authorities and our telecommunication service providers' customers finding our products and services economically advantageous.
Inmate Calling System
Our inmate calling system has provided us with telecommunications services revenue and direct call provisioning revenue in the following percentages of our total revenue:
Our primarily inmate calling system is the digital ComBridge Platform ("ComBridge"). ComBridge is a Windows based telephony control system that utilizes the latest technology in Graphical User Interfaces, open architecture, standardized telephony modules and flexible database functions. However, we still support a large installed base of pre-existing technology. We use our inmate calling systems (ComBridge and pre-existing systems) to manage the inmate calling process.
The inmate calling system provides dialing instructions, call announcement and acceptance messages and error prompts in up to six different languages. A flexible inmate account option allows for management of inmate personal identification numbers ("PINs"). System control features applicable to each inmate telephone such as call blocking, call timers, system reports, alarm parameters and real-time display of activity allow for expanded control. The system may be configured to have one inmate phone for every one
outbound telephone line or our ComBridge system can be configured to concentrate multiple inmate phones to one outbound telephone line. This line concentration allows for cost savings in the provisioning of the number of inmate telephone lines.
Our systems contain many patented technologies, one of which is our patented three-way call detection/ prevention technology, Strike-Three!(TM), that prevents inmates from bypassing control features through three-way calling. We believe that our intellectual property portfolio, with a total of six patents, and licenses to an additional six patents, gives our customers leading edge technology that is recognized as technologically unique within the corrections industry.
The ComBridge platform has a QNX operating system with a Windows 95(R)/NT(R) interface for client use. The use of high-density digital/analog network interfaces and sharing hardware resources allows for many channels of call control to be housed in a single box. We believe that these expanded capabilities are especially critical in the installation of larger systems.
We record all inmate calling system revenue in our financial statements under the caption of either "Telecommunications services" revenue or "Direct Call Provisioning" revenue, depending upon the contractual relationship at the site and the type of customer.
Digital Recording System
The DRS-500 Digital Recording System or the "DRS" is a fully digital recording system designed specifically for use in conjunction with one or more of our inmate calling systems. The DRS allows for the recording of specific dialed numbers, lines, or PINs. When the DRS detects activity based on the selected criteria, conversations will be automatically recorded. As an alternative mode of operation, the system will simultaneously record all inmate conversations. In addition, telephone numbers can be defined as "Record Restricted" to prevent recording of privileged communication. Recorded conversations may be played back on demand using the integrated playback module. The audio may be directed to the integrated loudspeaker or headphones. This output may also be used to record the conversations to a standard analog tape recorder.
A local area network connects the DRS to our inmate calling system. The DRS is fully automatic with each call being digitally recorded onto high-speed, high-capacity disk drives. When all recordings on the first drive are completed, the DRS archives the recordings automatically onto an external digital storage device. This dual, active drive process also provides for immediate redundancy should one of the active drives fail.
Once a recording has been made, a designated party can access one or more recordings by completing a search screen on the monitor to retrieve all recordings matching the specified parameters. Once the search form has been completed, the system user is presented with a list of matching recordings that can be reviewed. In addition, the DRS enables correctional authorities to listen to a conversation in progress on a near real-time basis and have the conversation recorded at the same time. When live monitoring is selected from the main menu, the selected recording screen will display all conversations currently in progress.
We record all DRS sales in our financial statements under the caption of "Equipment sales and other" revenue.
Trust Fund/Commissary
Our Corrections Division's Trust Fund/Commissary system or "TFC" manages inmate trust fund and commissary accounts through an integrated automated accounting and operations system. TFC is a software system that automates all inmate accounting and product inventory while also managing commissary operations with comprehensive retail and banking capabilities. TFC uses bar code technology and Oracle(R)-based software. TFC is a Windows(R)-based environment that allows for system navigation to access logically organized screens. Security features control system access and archive and purge routines allow for user defined system maintenance.
TFC manages all inmate account activity, including initial deposits, regular accounting activity such as fund disbursements, commissary charges and the ultimate disbursement of the funds upon release, all on a real time basis. TFC integrates the inmate account with the cash management and sales accounting data of the correctional facility commissary. This integration allows for enforcement of inmate restrictions and facility imposed mandates.
TFC also allows for the efficient operation of the correctional facility commissary with its inventory tracking and management system. Each inventory-affecting commissary transaction is recorded real-time and with adjustments upon completion of the transaction. The inventory reporting system provides information on items received, suggested pricing, adjustments and transfers, sales histories, supplies on hand and vendors.
TFC is also used as the accounting engine for our pre-paid debit inmate calling systems. We are currently integrating this application with the ComBridge system and expanding it to include features common to most debit calling platforms. We expect to offer these additional debit-based services during fiscal 2000.
We record all TFC sales in our financial statements under the caption of "Telecommunications services" revenue.
Jail Management System
Lock&Track(TM) is our jail and prison information management system. This system assists correctional authorities in performing most major data tasks necessary to run a correctional facility, such as:
o inmate booking and classification
o visitation documentation
o food services management
o inmate work and educational programs
o inmate medical records
o commissary ordering and inventory
o facilities maintenance tracking
o officer training in scheduling and system maintenance
Lock&Track(TM) is easy to set up and operate. It includes the following:
o functional desktop organization for easy customization to job functions
o screens and report customization
o keyboard shortcuts for data entry
o integrated tools, such as photo, bar-codes, and document imaging systems
o flexible record searching
Lock&Track(TM) uses an Internet-based client/server application. With this application, we can then administer a secure and virtually maintenance-free system. The server is powered using fault-tolerant Compaq DEC Alpha hardware, which runs a large percentage of the Internet traffic. The operating system is Open VMS and the database is Oracle(R)/Rdb. The user can choose a traditional "green screen" interface or a graphical user interface, which is based on a more sophisticated client technology called RAPT.
Lock&Track(TM) has been deployed in a customer environment for more than ten years. Using an applications service provider model, Lock&Track(TM) is available to numerous correctional authorities that may have common reporting requirements. We believe this centralized service delivery is a competitive advantage for products such as Lock&Track(TM). This service-bureau type deployment uses an Internet-based access system and provides our customers with a lower initial cost of ownership while providing us recurring revenues for the Company.
We record all Lock&Track(TM) revenue in our financial statements under the caption of either "Equipment sales and other" or "Telecommunications Services" revenue depending upon the terms of the contracts.
Contain(R)
Contain(R) is a service offering which uses voice verification and the Internet for cost-effective caseload management by community corrections, probation and parole agencies. A combination of advanced computer telephony, automated speech and Internet technologies, Contain(R) facilitates automated, programmable telephone contact with the subject offender during which the Company's SpeakEZ Voice Print(R) speaker verification technology is utilized to verify the subject's identity.
Contain(R) is a Windows(R)-based product that uses the Internet as the transport mechanism between the officer and the Contain(R) database, allowing for access to the system from a remote location via an Internet-ready portable desktop PC. The Contain(R) system allows the officer to verify that a subject is present at one of a number of approved locations. Subject verification is performed via a comparison of a stored voice print to the utterance obtained in response to the system request.
We record all Contain(R) sales in our financial statements under the caption of "Telecommunications services" revenue, and such revenue has not been significant to date.
PIN-LOCK(R)
PIN-LOCK(R) is a method of biometric authentication of an inmate's identity using SpeakEZ Voice Print(R) technology. PIN-LOCK(R) makes it practical for all correctional facilities to assign PINs to inmates. Currently, in high turnover institutions, like large county jails, the cost and effort required to assign numbers to all inmates is prohibitive. With PIN-LOCK(R), an inmate being booked into a facility speaks his name into a preprogrammed phone, enrolling the inmate into the system. This voice print becomes the basis for the inmate's personal voice verification file, replacing the traditional PINs requiring large amounts of data maintenance. This means of identification may also be used in different parts of the prison to allow access to different areas, secured from others.
When an inmate places a call he keys in his PIN and speaks his name. Once approved, which may take less than a second, the inmate can then place his call. We believe that PIN-LOCK(R) is a significant enhancement to the security features of our inmate calling system.
We record all PIN-LOCK(R) sales in our financial statements under the caption of "Telecommunications services" revenue and such revenue has not been significant to date.
T-NET Budget Connections
Telecommunications fraud throughout the United States is estimated at over $4 billion. This fraud has focused telecommunication service providers on the bad debt expense associated with calls processed by their systems. The Corrections Division has developed a fraud service that identifies and controls higher risk users of inmate telecommunications services. This automated billing inquiry service, under the name T-NET Budget Connections, combines our inmate calling system with a credit inquiry program. T-NET Budget Connections provides daily, weekly, and monthly call limit reporting. This service plays messages for the calling and called party advising them of their balances and assisting them with their calling budget. We utilize this system with our Direct Contracts and market the service to our telecommunication service provider customers.
Our telecommunications customers are increasingly affected by the problem of bad debt expense allocation and are interested in a solution that controls fraud and bad debt while encouraging the use of inmate calling services. We believe T-NET Budget Connections is such a solution. We use a trained staff of customer service representatives in our call center in Carrollton, Texas to verify payment history, determine appropriate credit levels and monitor outstanding debt balances. The integration with our inmate calling system allows us to take corrective action, which may include blocking calls until credit has improved. We anticipate using our nationwide frame-relay network as a part of our service delivery infrastructure that will help us provide these services on a real-time basis, cost-effectively.
We record all T-NET Budget Connection sales in our financial statements under the caption of "Telecommunications services" revenue and such revenue has not been significant to date.
SERVICE DELIVERY AND SUPPORT INFRASTRUCTURE
National Service Center
We operate a trouble-shooting help desk that is available 24 hours a day, seven days a week. Located in Carrollton, Texas, the National Service Center ("NSC") provides a single point of contact for all customers for remote diagnostic systems maintenance. Once a call is placed, the NSC Customer Service Analysts perform an initial problem diagnosis. In addition to remote repair capabilities, we also have a network of trained and experienced field support personnel who can perform on-site repairs and maintenance. Field personnel consists of over 150 employees covering 36 states. We deploy our service administrators depending on several criteria, including the contract terms, the size of the facility, the feature set the facility requires (PIN versus non-PIN), the geographic proximity of our current service administrator force and the correctional facility contract requirements.
Located in Denver is the Network Operations Center ("NOC"). Our NOC provides remote system management and real-time system diagnostics across our wide area frame relay network. This system monitors the wide area network that connects many of our installed systems and provides for centralized collection of call and reporting data and real-time diagnostic information on the status of each major system component. We also use the network to process the on-line, real-time called number validation, process its call records and transmit administrative data between each location and headquarters. Call data are then formatted and provided to customers for their billing process. As part of the system calling process, we perform real-time billed number validation by querying an external database over the network to an on-line database. The NOC provides 24-hour a day, seven days a week system support.
Web-Based Service Delivery
The Corrections Division's Lock&Track(TM) and Contain(R) systems can be accessed from the Internet by correctional authorities. In addition, we are continuing to develop Internet access for our Digital Combridge platform. Internet access provides correctional authorities comprehensive management and information systems with minimal capital investment and administration costs. For example, a corrections administrator is interested in incarceration information, a parole officer in parole information, but a judge may be interested in the entire history of the subject under scrutiny.
The Corrections Division infrastructure can support Internet access, web site hosting, educational content for officers and inmates alike, law research facilities, and trust fund/commissary operations. We are developing a complete suite of web-based corrections applications
PRICING
Transaction-based Pricing
We have historically offered our inmate calling system on a transaction fee based compensation model. During 2000, we have negotiated arrangements with some of our telecommunications service provider customers to charge for our services as a percentage of the gross revenue charged to the end users of our service. We believe that this pricing is a better representation of the value defined by our services in relation to the end product. This is in contrast to a fixed price per call. Our Corrections Division's pricing models provide us with a recurring, usage-driven revenue stream. In a typical arrangement, we operate under long-term, site-specific contracts generally for a period of three to five years, with both a long-distance carrier and a local call provider. The customer pays transaction fees or a percentage of revenue for each call processed by us. The type of service performed and the total volume of calls processed for the customer during the monthly billing period determine the service fees. We bill these customers for services associated with calls processed during the previous month on net 30-day terms. Our fees also include our cost of other network services required by the customer, such as on-line database queries performed as part of the collect call validation process, and for certain types of network access lines.
Direct Call Provisioning
Our Corrections Division also provides our inmate calling services directly as a certified telecommunications provider to correctional authorities or "Direct Customers". In a typical arrangement, we operate under long-term site-specific contracts, generally for a period of three to five years. We buy "wholesale" call services and re-sell such services as collect calls to the inmates' called parties. We use the services of third parties to bill our calls on the called party's local exchange carrier bill. We pay commissions on the gross billed revenue to the correctional facilities. The higher prices associated with billing the collect calls directly, results in direct call provisioning services providing substantially higher revenue than percentage of revenue or transaction based pricing. However,
because of commissions and other operating costs, including bad debt write-offs, the percentage gross margins from this line of business are lower than our transaction-based arrangements.
Equipment Sales and Software Licensing
We also sell our inmate calling system on a per unit price basis with software and maintenance provided and priced separately. This arrangement is primarily with only one customer. Our DRS product is also sold on a per unit basis or using a monthly lease payment.
We license our Lock&Track(TM) product through various contractual relationships including system sales of hardware and software as well as transactional based fees for monthly services. The contractual arrangements often include component pricing for hardware, software, installation and design services, and post contract customer support.
CUSTOMERS
Service Providers
Our Corrections Division provides our corrections products to specific correctional institutions and to telecommunications service providers such as AT&T, SBC, Qwest, BellSouth, Sprint, Worldcom, Verizon and other call providers. For the year ended December 31, 2000, revenue from the following customers accounted for the noted percentages of our total revenue:
No other customer accounted for more than 10% of our total revenue in the same period. Our strategic relationships with our telecommunications service provider customers have resulted in several important benefits to us:
o our Corrections Division services over 1,600 correctional facilities, containing approximately 30% of the current U.S. inmate population
o we are currently servicing all or a portion of 19 state departments of corrections as of December 31, 2000
o we service state, federal, and county facilities in 43 states
o we believe we have the largest single sales force in the correction services industry
Direct Customers
Our Corrections Division also has generated significant revenue from direct call provisioning. For the year ended December 31, 2000, 21% of our total revenue was generated from agreements with Direct Customers as the exclusive provider of telecommunications services to inmates within the facility. No single customer accounted for more than 10% of our direct call provisioning revenue.
Lock&Track(TM) Customers
Lock&Track(TM) is currently being used by the Oregon Department of Corrections in conjunction with numerous counties in Oregon, and by the City of Philadelphia, and most recently by Suffolk County, Massachusetts (Boston).
Contain(R) Customers
The Contain(R) product is used by approximately 15 community correction probation and parole agencies, including a program for the U.S. Probation and Pre-Trial Services Division of the federal government. We also market Contain(R) distributor relationships which we believe should expand the acceptance of the product with less direct marketing by us.
COMPETITION
The corrections industry, which includes the inmate calling market, is and can be expected to remain highly competitive. We compete directly with other suppliers of inmate call processing systems and other corrections related products that market their products to the same customers as those of the Company. These competitors include Evercom Inc., Global Tel*Link (a wholly owned subsidiary of Schlumberger Technologies, Inc.) and Science Dynamics Corporation. We also compete with some of these same companies that are teamed with various telecommunications service providers, including our current customers. The competition for our other products and services such as jail management and parolees systems includes companies such as BI, Inc., TRW, Inc., Science Applications International Corporation, Voicetrack Corporation, Ameritech Corporation, and FileNET Corporation.
RESEARCH AND PRODUCT DEVELOPMENT
We believe that the timely development of new products and enhancements to existing products is essential to maintain our competitive position. We conduct ongoing research and development to enhance existing products and to build new products, both complementary to the existing product line and in new functional areas. Our research and product development expenditures for the Corrections Division were approximately as follows:
See "Management's Discussion and Analysis of Financial Condition and Results of Operations".
INTERNET SERVICES DIVISION
PRODUCTS AND SERVICES
In 1999 we established a separate subsidiary, T-NETIX Internet Services, Inc. whose primary function was to be a Global Service Provider (GSP) for Internet subscribers of US WEST ENTERPRISE America, Inc., a subsidiary of US WEST, Inc (now known as "Qwest"). This division provides inter-LATA Internet transport to Qwest's Internet subscribers through the assignment of contracts with Internet service providers, or ISPs, such as UUNET Technologies, Inc., Sprint Communications Company L. P., GTE Internetworking, Cable and Wireless and others. In conjunction with this service, we provide Qwest ordering and provisioning services, network operation, design, and capacity planning services. This GSP contract is for a term of the later of 16 months or until Qwest is allowed to provide these inter-LATA services directly to its subscribers by certain state regulatory entities. We receive monthly revenue from Qwest for retail, dial-up, ISDN, and dedicated service subscribers, and a monthly management fee for other services provided to Qwest. Upon expiration of the initial period in March 2001, we are continuing to provide service on a month-to-month basis. At the conclusion of the contract, we anticipate that these services will be discontinued.
SPEAKER VERIFICATION DIVISION
MARKET DESCRIPTION
Technologies surrounding the use of speech as a data automation tool are common to a variety of industries. Speech recognition has become a common means of processing information in a significant number of service markets. The use of biometric technologies (those which use unique human characteristics such as fingerprints, hand, facial or eye images and voice) for personal identification are becoming more integrated with these information and data processing systems.
SpeakEZ Voice Print(R) technology is proprietary software that compares the speech pattern of a current speaker with a stored digital voice print of the authorized person to confirm or reject claimed identity. A digital voice print for a user is created when the user speaks a specific password several times, using any phrase in any language. This is one of the unique aspects about the SpeakEZ Voice Print(R) technology compared to most speaker verification technologies that require the user enroll with digits or a specific phrase that is not selected by the user.
Speaker verification occurs when the user speaks the same password used during enrollment. The system computes a decision regarding authenticity of the user using a patented pattern recognition algorithm called the "Neural Tree Network" or "NTN". During enrollment, the NTN processes the input speech data from the enrolling user along with speech data from other users. The NTN learns which parts of the enrolling user's password are unique for that user and which parts are easily confused with data from other people.
The NTN then uses this information during the verification phase to determine whether or not the speech came from the authentic user. The NTN is a unique component of the SpeakEZ Voice Print(R) technology.
SpeakEZ Voice Print(R) has several competitive advantages: it does not require additional and expensive special purpose hardware to support the technology (SpeakEZ Voice Print(R) uses in-place microphones and sound cards) and it is not intrusive to the user. Because biometric technologies measure something that a person "is" rather than a piece of information or a piece of equipment a person "has", they lend themselves well to solving the many information needs associated with data and other information security. Specifically, speaker verification offers the optimal combination of accuracy, user-friendliness (it is non-intrusive and natural), and value.
PRODUCTS AND SERVICES
SpeakEZ Voice Print(R) products are designed to be technically superior and cost effective forms of personal security. The marketing strategy centers around a licensing strategy that focuses on larger scale customers whom can integrate the SpeakEZ software product into its existing product line. This larger customer, such as a computer manufacturer or software application designer, would then be responsible for the product integration and ultimate delivery to the end user customer. The SpeakEZ Division's products do not currently, nor have they in the past, generated significant revenue. The products are primarily associated with computer and network security and are as follows:
o VoicEntry I(sm) Screen Saver and VoicEntry II(sm) Secure Logon are alternatives to typed password protection for individual and shared computer users and are available for Windows 95(R) and Windows 98(R) systems.
o VeriNetWEB(sm) is a user verification product designed for Internet-based applications including electronic commerce and wireless electronic commerce applications.
PRICING
Pricing for the SpeakEZ Voice Print(R) technology is primarily based on the licensing of software to a large OEM or system integrator, or providing the system through a royalty agreement.
CUSTOMERS
The SpeakEZ Division markets its SpeakEZ Voice Print(R) technology through various marketing channels. These include leveraging off current strategic relationships with OEMs using distribution and sales agreements to deploy the technology to a variety of industries. We also have a long-standing installation with Intrust Bank, N.A. The SpeakEZ Division also has a distributor relationship with Sentry Systems, Inc., a developer of a turnkey Internet security systems for E-Commerce transactions.
COMPETITION
The market for speaker verification technology is just emerging. Our SpeakEZ Division competes with speaker verification providers and with established companies using technology such as speech recognition, interactive voice response and automated call distribution. These competitors include Lucent Technologies, ITT Industries, Phillips Electronics, Lernout and Hauspie Speech Products, Nuance Communications, and Veritel Corporation. We also face competition from a variety of biometric technology providers with products such as facial recognition, iris scan, retina scan and fingerprint technology. Additionally, the more traditional forms of verification, such as PINs and token technology are also a form of competition that is a barrier to the increased use of products like our SpeakEZ Voice Print(R) technology. We believe that our ability to compete for verification processing, depends on the performance of our technology, and the acceptance of voice related security products in general.
RESEARCH AND PRODUCT DEVELOPMENT
Research and development in the SpeakEZ Division is primarily focused upon improving the efficiency of the core software engine. Currently not as much time is spent on product integration as there was in past years. The new licensing strategy is designed to have other parties incur such integration costs. We maintain a staff of research professionals that we believe is necessary to maintain the software at a highly productive and competitive position. Our research and product development expenditures for the SpeakEZ Division were approximately as follows:
See "Management's Discussion and Analysis of Financial Condition and Results of Operations".
PATENTS AND OTHER PROPRIETARY RIGHTS
We rely on a combination of patents, copyrights, and trade secrets to establish and protect our intellectual proprietary rights. We consider any patents issued to be a significant factor in enabling us to compete in the inmate calling industry. We believe our success is primarily dependent on the knowledge, ability and experience of our personnel, and our ongoing ability to develop viable products and services to meet our customers' needs. We have sought and received federal and state trademark protection for certain of our trademarks, including Strike Three!(TM) and T-NET(TM).
As it relates to our SpeakEZ Voice Print(R) technology, Rutgers University had developed technology relating to speaker and speech recognition. Such technology centered around the verification of a speaker by comparison of spoken phrases to speech patterns stored on a computer. Rutgers entered into a license agreement with SpeakEZ to develop that technology, prior to our acquisition of SpeakEZ. We became a successor-in-interest to SpeakEZ's rights under the license agreement. We then negotiated with Rutgers an Assumed and Amended License Agreement in 1996. As a part of this agreement, the Company acquired exclusive worldwide rights under existing Rutgers' patents and patent applications, copyrights and software related to speaker and speech recognition developed by Rutgers. Several additional Rutgers-owned patent applications are pending. We have also filed for and received patent applications in our own name for further developments in this field.
REGULATION
We are primarily affected by regulation in the Corrections Division. However, the Internet Services Division also is affected. Our telecommunications service provider customers and we are subject to varying degrees of federal, state, and local regulation. Regulatory actions have impacted, and are likely to continue to impact, both our customers and us. For example, the adoption of regulations that would encourage additional competition in the business of our customers could have a material adverse effect on the amount of business done by such customers and the manner in which such business is done. A reduction in the amount of business done by our customers would have a material adverse impact on our revenue since such revenues are directly related to volumes of calls processed under our transaction fee pricing structure. Changes in the manner in which our customers conduct their business could have a material adverse impact on us if, as a result of such changes, our services and features were no longer needed or desired or if the we were not able to modify, or add to, our services in a way that meets the new market demands of our customers.
The inmate calling market is regulated at the federal level by the FCC and at the state level by the public utilities commissions of various states. In addition, from time to time, Congress or the various state legislatures that affect the telecommunications industry generally and the inmate calling industry specifically may enact legislation. Court decisions interpreting applicable laws and regulations may also have a significant effect on the inmate calling industry. Changes in existing laws and regulations, as well as the adoption of new laws and regulations applicable to our activities or other telecommunications businesses, could have a material adverse effect on us.
Federal Regulation
Prior to 1996, the federal government's role in the regulation of the inmate calling industry was limited. The enactment of the Telecommunications Act of 1996 or the "Act", however, marked a significant change in scope of federal regulation of the inmate telephone service. Section 276 of the Act directed the FCC to implement rules to overhaul the regulation of the provisioning of pay phone service, which Congress defined to include the provisioning of inmate telephone service in correctional institutions. The Act (i) opens local exchange service to competition and preempts states from imposing barriers preventing such competition, (ii) imposes new unbundling and interconnection requirements on incumbent local exchange carrier networks, (iii) removes prohibitions on inter-LATA services and manufacturing if certain competitive conditions are met, (iv) transfers any remaining requirements of the consent decree (including its nondiscrimination provisions) to the FCC's jurisdiction, (v) imposes requirements to conduct certain competitive activities only through structurally separate affiliates and (vi) eliminates many of the remaining cable and telephone company cross-ownership restrictions.
Section 276 of the Act directed the FCC to require all incumbent local exchange carriers or "ILECs" to transfer their inmate telephone operations from their regulated accounts to the ILEC's unregulated accounts. Many aspects of the FCC's rules implementing
Section 276 are currently the subject of requests for clarification or reconsideration by the FCC or in collateral proceedings. This legislation and related rulings will significantly change the competitive landscape of the telecommunications industry as a whole. For example, permitting the ILECs to provide long-distance service cause our ILEC customers to become direct competitors of AT&T, which in turn could adversely affect our relationships with all such customers. For example, our current relationship with AT&T may foreclose opportunities to provide long distance services to its current ILEC customers, if and when they enter the long-distance market. As a result, a loss of long-distance market share by AT&T could result in a corresponding loss of market share by us.
On January 29, 1998 the FCC issued Order 98-7. This Order required that all called parties have the opportunity to receive a rate quote before accepting a collect call. These rate quotes are necessary for all public payphones and all inmate collect calling. Currently, our inmate calling systems provide such a feature.
State Regulation
The most significant state involvement in the regulation of inmate telephone service is the limit on the maximum rates that can be charged for intrastate collect calls set by most states, referred to as "rate ceilings". Since collect calls are generally the only kind of calls that can be made by inmates in correctional facilities, the state-imposed rate ceilings on those calls can have a significant effect on our business.
The foregoing discussion does not describe all present and proposed federal, state and local regulations, legislation, and related judicial or administrative proceedings relating to the telecommunications industry and thereby affecting our business. The impact of increased competition on our operations will be influenced by the future actions of regulators and legislators who are increasingly advocating competition. While we would attempt to modify our customer relationships and our service offerings to meet the challenges resulting from changes in the telecommunications competitive environment, there is no assurance we will be able to do so.
EMPLOYEES
As of December 31, 2000, we employed 441 full-time equivalent employees. None of our employees are represented by a labor union and we have experienced no work stoppages to date.
FORWARD LOOKING STATEMENTS AND RISK FACTORS
We have included in this Annual Report on Form 10-K forward looking statements that state our own or our management's intentions, beliefs, expectations, or predictions for the future. Forward-looking statements are subject to a number of risks, assumptions and uncertainties which could cause our actual results to differ materially from those projected in forward looking statements. The discussions set forth below constitute cautionary statements identifying important factors with respect to such forward looking statements, including risks and uncertainties, that could cause actual results to differ materially from results referred to in the forward-looking statements. There can be no assurance that our expectations regarding any of these matters will be fulfilled.
A SMALL NUMBER OF CUSTOMERS ACCOUNTED FOR A HIGH PERCENTAGE OF OUR REVENUE, THEREFORE, THE LOSS OF A MAJOR CUSTOMER COULD HARM OUR BUSINESS
In the Corrections Division, a small number of customers account for a significant portion of our revenue. If we lose existing customers and do not replace them with new customers, our revenue will decrease and may not be sufficient to cover our costs. For the year ended December 31, 2000, AT&T, Verizon and SBC Communications, Inc. accounted for approximately 13%, 13% and 6%, respectively of our total revenue.
CHANGES IN GOVERNMENT TELECOMMUNICATIONS REGULATIONS COULD REDUCE DEMAND FOR OUR PRODUCTS AND SERVICES.
In our Corrections Division, our telecommunications service provider customers and we are subject to varying degrees of federal, state, and local regulation. Regulatory actions have impacted, and are likely to continue to impact, both our customers and us. Regulatory actions may cause changes in the manner in which our customers or we conduct business. The products that we develop must comply with standards established by the Federal Communications Commission. A change in these standards may have a material adverse affect on our business, operating results, and financial condition.
WE OPERATE IN HIGHLY COMPETITIVE MARKETS AND MAY NOT BE ABLE TO COMPETE EFFECTIVELY.
The telecommunications industry, particularly the inmate calling market, is and can be expected to remain highly competitive. In our Corrections Division we compete directly against other suppliers of inmate call processing systems, such as private pay phone operators and manufacturers of call processing equipment. In addition, our customers and we jointly compete against other call providers to obtain contracts for inmate calling services. Finally, we may also compete against our customers who choose to use another call provider on a particular bid. Changes in regulations have affected the competitive dynamics within our industry. Increased competition may reduce the fees we charge, reduce margins and cause a loss of market share. As a result of these and other factors, we may not be able to compete effectively with our current or future competitors, which would have a material adverse affect on our business, operating results, and financial condition.
CHANGES IN TECHNOLOGY AND OUR ABILITY TO ENHANCE OUR EXISTING PRODUCTS MAY ADVERSELY AFFECT OUR FINANCIAL RESULTS
The markets for our products, especially the telecommunications industry, change rapidly because of technological innovation, changes in customer requirements, declining prices, and evolving industry standards, among other factors. To be competitive, we must develop and introduce product enhancements and new products, which increase our customers' and our ability to increase market share in the corrections industry. New products and new technology often render existing information services or technology infrastructure obsolete, excessively costly, or otherwise unmarketable. As a result, our success depends on our ability to timely innovate and integrate new technologies into our current products and services and to develop new products. In addition, as the telecommunications networks are modernized and evolve from analog-based to digital-based systems, certain features offered by us may diminish in value. Moreover, regulatory actions affecting the telecommunications industry may require significant upgrades to our current technology or may render our service offerings obsolete or commercially unattractive. We cannot guarantee that we will have sufficient technical, managerial or financial resources to develop or acquire new technology or to introduce new services or products that would meet our customers needs in a timely manner.
OUR SUCCESS DEPENDS ON OUR ABILITY TO PROTECT OUR PROPRIETARY TECHNOLOGY AND ENSURE THAT OUR SYSTEMS ARE NOT INFRINGING ON OTHER COMPANIES
Our success depends to a significant degree on our protection of our proprietary technology, particularly in the area of three-way call prevention. The unauthorized reproduction or other misappropriation or our proprietary technology could enable third parties to benefit from our technology without paying us for it. Although we have taken steps to protect our proprietary technology, they may be inadequate. We rely on a combination of patent and copyright law and non-disclosure agreements to establish and protect our proprietary rights in our systems. However, existing trade secret, copyright and trademark laws offer only limited protection. Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy aspects of our products or obtain and use trade secrets or other information we regard as proprietary. If we resort to legal proceedings to enforce our intellectual property rights, the proceedings would be burdensome and expensive and could involve a high degree of risk.
In addition, with respect to our intellectual property rights, we cannot be sure that a third party will not accuse us of infringement. Any claim of infringement could cause us to incur substantial costs defending against that claim, even if the claim is not valid, and could distract our management from our business. A party making a claim also could secure judgment that requires us to pay substantial damages. A judgment could also include an injunction or other court order that could prevent us from selling our products. Any of these events could have a material adverse effect on our business, operating results and financial condition.
OUR BUSINESS COULD BE ADVERSELY AFFECTED IF OUR PRODUCTS AND SERVICES FAIL TO PERFORM OR BE PERFORMED PROPERLY
Products as complex as ours may contain undetected errors or "bugs", which result in product failures or security breaches or otherwise fail to perform in accordance with customer expectations. Any failure of our systems could result in a claim for substantial damages against us, regardless of our responsibility for the failure. Although we maintain general liability insurance, including coverage for errors and omissions, there can be no assurance that our existing coverage will continue to be available on reasonable terms or will be available in amounts sufficient to cover one or more large claims, or that the insurer will not disclaim coverage as to any future claim. The occurrence of errors could result in loss of data to us or our customers which could cause a loss of revenue, failure to achieve acceptance, diversion of development resources, injury to our reputation, or damages to our efforts to build brand awareness, any of which could have a material adverse affect on our market share and, in turn, our operating results and financial condition.
OUR FAILURE TO EFFECTIVELY INTEGRATE THE BUSINESSES WE HAVE ACQUIRED MAY ADVERSELY AFFECT OUR BUSINESS
On June 14, 1999 we merged with Gateway Technologies, Inc. A failure to effectively integrate this business could have a material adverse effect on our business, operating results and financial condition. There can be no assurance that we will be able to consolidate the operations of Gateway with our operations in a manner that will achieve efficient operating results. In addition, there can be no assurance that we will be able to retain personnel from Gateway.
WE HAVE SUBSTANTIAL LEVERAGE WHICH MAY LIMIT OUR ABILITY TO COMPLY WITH THE TERMS OF OUR INDEBTEDNESS AND MAY RESTRICT OUR ABILITY TO OPERATE
Our significant indebtedness could adversely affect us by leaving us with insufficient cash to fund operations and impairing our ability to obtain additional financing. The amount of our debt could have important consequences for our future, including, among other things:
o cash from operations may be insufficient to meet the principal and interest on our indebtedness as it becomes due;
o payments of principal and interest on borrowings may leave us with insufficient cash resources for our operations; and
o restrictive debt covenants may impair our ability to obtain additional financing
We have incurred a high level of debt. As of December 31, 2000, we had a total of $31.6 million of total indebtedness, including approximately $25.5 million in senior indebtedness outstanding under our bank credit facility. Our ability to repay our indebtedness depends primarily upon many factors, including future profitability and the level of capital expenditures. Our current bank credit facility has been extended to March 31, 2002.
If we are unable to generate sufficient cash flows to meet our debt service requirements, we may have to renegotiate the terms of our long-term debt. We cannot assure you that we would be able to renegotiate successfully those terms or refinance our indebtedness when required or that satisfactory terms of any refinancing would be available. If we were not able to refinance our indebtedness or obtain new financing under these circumstances, we would have to consider other options, such as:
o sale of some assets;
o sales of equity;
o negotiations with our lenders to restructure applicable indebtedness; or
o other options available to us under applicable law
ITEM 2.
ITEM 2. PROPERTIES
Our corporate headquarters is currently located in approximately 38,000 square feet of leased office space in Englewood, Colorado. This lease terminates effective November 1, 2001 and the Company does not plan to renew or extend it. We are in the process of consolidating operations and relocating our headquarters to Carrollton, Texas, although we will maintain a small facility in the Denver area for certain Company functions. The Texas-based operations are located in over 26,000 square feet in a leased suburban Dallas office park which is leased through September 30, 2005. We expect to lease an additional 10,000 square feet (approximately) either in the same office park or in an office park not far from this location.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
From time to time we have been, and expect to continue to be subject to various legal and administrative proceedings or various claims in the normal course of our business. We believe the ultimate disposition of these matters will not have a material affect on our financial condition, liquidity, or results of operations.
Last year Gateway won a dismissal of a case brought in the First Judicial District Court of the State of New Mexico, styled Valdez v. State of New Mexico, et al. An appeal of the case was recently certified and the case is currently in the appellate briefing phase.
The case named as defendants the State of New Mexico, several political subdivisions of the State of New Mexico, and several inmate telecommunications service providers, including Gateway. The complaint included a request for certification by the court of a plaintiffs' class action consisting of all persons who had been billed for and paid for telephone calls initiated by an inmate confined in a jail, prison, detention center or other New Mexico correctional facility. The complaint alleged violations of New Mexico Unfair Practices Act, the New Mexico Antitrust Act and the New Mexico Constitution, and also alleged unjust enrichment, constructive trust, economic compulsion, constructive fraud and illegality of contracts, all in connection with the provision of "collect only" inmate telecommunications services. The case was never certified as a class action.
T-NETIX is a defendant in another state case brought in the Superior Court of Washington for King County, styled Sandy Judd, et al. v. American Telephone and Telegraph Company, et al. In this case, the complaint joined several inmate telecommunications service providers as defendants, including T-NETIX. The complaint includes a request for certification by the court of a plaintiffs' class action consisting of all persons who have been billed for and paid for telephone calls initiated by an inmate confined in a jail, prison, detention center or other Washington correctional facility. The complaint alleges violations of the Washington Consumer Protection Act (WCPA) and requests an injunction under the Washington Consumer Protection Act and common law to enjoin further violations. The trial court has dismissed all claims with prejudice against all defendants except T-NETIX and AT&T. These claims have been referred to the Washington Utilities and Transportation Commission while the trial court proceeding is in abeyance.
Gateway is presently litigating an appeal from a favorable ruling in Kentucky federal court in the case Gus "Skip" Daleure, Jr., et al vs. Commonwealth of Kentucky, et al. The complaint in this case joined as defendants several states, political subdivisions of states, and inmate service telecommunications providers and was filed contemporaneously with a request for certification by the court of a nationwide plaintiffs' class action consisting of all persons who have received and paid for telephone calls initiated by an inmate at a prison, jail or other correctional institution for the provision of "collect only" inmate telecommunications services. The complaint sought declaratory and injunctive relief and money damages in an unstated amount for alleged violations of the Sherman Antitrust Act, the Robinson-Patman Act and the U.S. Constitution. The district court held, on motions to dismiss, that Kentucky did not have personal jurisdiction over defendants not located in or doing business in the state of Kentucky; that telephone calls are not goods or commodities and thus are not subject to the antitrust provisions of the Robinson-Patman Act; that Plaintiffs did not state a claim for relief under the Equal Protection Clause of the Fourteenth Amendment; and that Plaintiffs had not shown any harm in support of its antitrust claim under Section 1 of the Sherman Act. The trial judge did not, however, dismiss the plaintiff's prayer for injunctive relief, despite these findings. The case is currently subject to appeal and cross appeal in the Second Circuit Court of Appeals. Although Gateway believes the District Court holding will not be overturned, it is possible that it may be, and there can be no assurance that a judgment against a class of the providers will not ultimately be entered.
In another case styled Robert E. Lee Jones, Jr. vs. MCI Communications, et al, plaintiffs, 43 inmates of the Bland Correctional Center in Virginia, filed a pro se action alleging constitutional violations, RICO Act violations and violations of Federal wiretapping laws. Plaintiff's motion for certification for a class action was denied and T-NETIX and MCI have filed Motions to Dismiss. Pleadings are still being submitted in this case.
In February, 2001 a case styled Mildred Fair, et al vs. Sprint Payphone Services, et al was filed by four relatives of inmates of an unnamed South Carolina correctional institution. The case was initially filed in state court but was removed to Federal court. Defendants, in addition to T-NETIX, include AT&T, BellSouth, GTE, Sprint United, Rock Hill Telephone Company, the South Carolina Department of Corrections and the State of South Carolina. Plaintiffs' claims include violations of the South Carolina Antitrust Act and the South Carolina Unfair Trade Practices Act, unjust enrichment, constructive fraud and unlawful taking under the South Carolina constitution. This case is in its very early stage and answers and responsive pleadings by the various parties are being prepared and submitted.
We believe the ultimate disposition of the forgoing matters will not have a material affect on our financial condition, liquidity, or results of operations.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of shareholders during the fourth quarter of the fiscal year on which this report is being made.
PART II
ITEM 5.
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Our Common Stock is quoted on the Nasdaq Stock Market(sm) under the symbol "TNTX." The following table sets forth the range of quarterly high and low closing sale prices of our Common Stock, all as reported on the Nasdaq Stock Market(sm) for the two most recent fiscal years.
As of April 12, 2001, we had approximately 155 record holders of our common stock, and we estimate that as of that date there were approximately 2,000 beneficial owners of our stock.
We have never declared or paid any cash dividends on our capital stock. We currently intend to retain our earnings, if any, to finance future growth and therefore we do not anticipate paying any cash dividends in the foreseeable future.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The following selected financial data under the captions "Statement of Operations Data" and "Consolidated Balance Sheet Data" has been presented for each of the years in the five-year period ended December 31, 2000. The selected financial data has been derived from our audited consolidated financial statements. The consolidated financial statements as of December 31, 2000 and 1999, and for each of the years in the three-year period ended December 31, 2000, are included elsewhere in this Form 10-K.
All periods reflect our merger with Gateway Technologies, Inc., which was accounted for as a pooling of interests, and the change in our year-end to December 31. The Selected Financial Data for the year ended December 31, 1999 reflects the combined results of
T-NETIX and Gateway for that year. The Statement of Operations Data for the years ended December 31, 1998, 1997 and 1996 reflects the results of operations of T-NETIX for the years ended July 31, 1998, 1997 and 1996, respectively, combined with that of Gateway for the years ended December 31, 1998, 1997, 1996 and 1995. The Balance Sheet Data as of December 31, 1998, 1997 and 1996 reflects the financial position of T-NETIX as of December 31, 1998, and July 31, 1997 and 1996 combined with the financial position of Gateway as of December 31, 1998, 1997 and 1996. See Note 1 of "Notes to Consolidated Financial Statements."
As a result of T-NETIX and Gateway having different fiscal year ends prior to 1999, the results of operations of T-NETIX for the five month period ended December 31, 1998, have been excluded from the reported results of operations. The net loss for the period has been accounted for as an adjustment of the accumulated deficit at January 1, 1999. T-NETIX had revenue, expenses, and net loss of $15.0 million, $17.6 million, and $2.2 million, respectively, for the five month period ended December 31, 1998.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
For a comprehensive understanding of our financial condition and performance, this discussion should be considered within the context of the consolidated financial statements and accompanying notes and other information contained herein.
The Private Securities Litigation Reform Act of 1995 provides a "safe harbor" for forward-looking statements. Certain information contained in this Management's Discussion and Analysis of Financial Condition and Results of Operations and elsewhere in this Form 10-K includes forward-looking statements. Important factors that could cause actual results to differ materially from those in the forward-looking statements include, but are not limited to, those listed under the caption "Risk Factors" which may affect the potential technological obsolescence of existing systems, the renewal of existing site specific Corrections and Internet Service Division customer contracts, the ability to retain the base of current site specific customer contracts, the ability to perform under contractual performance requirements, the continued relationship with existing customers, the ability to win new contracts for our products and services, including Lock & Track(TM), Contain(R) and our Internet Services Division, the ability of our existing customers, including AT&T, to maintain their market share of the inmate calling market, our ability to penetrate the market for jail management systems and to successfully license voice verification and fraud prevention technology, the effect of economic conditions, the effect of regulation, including the Telecommunications Act of 1996 that could affect our sales or pricing, the impact of competitive products and pricing particularly in the our Corrections Division, our continuing ability to develop hardware and software products, commercialization and technological difficulties, manufacturing capacity and product supply constraints or difficulties, actual purchases by current and prospective customers under existing and expected agreements, and the results of financing efforts, along with the other risks detailed therein.
OVERVIEW
Acquisition of Gateway Technologies, Inc.
On June 14, 1999, we completed our merger with Gateway Technologies, Inc. or "Gateway" by exchanging 3,672,234 shares of our common stock for all of the common stock of Gateway. Each share of Gateway was exchanged for 5.0375 shares of our common stock. In addition, outstanding Gateway stock options were converted at the same exchange rate into options to purchase approximately 379,000 shares of our common stock.
The merger constituted a tax-free reorganization and has been accounted for as a pooling of interests under Accounting Principles Board Opinion No. 16. Accordingly, all prior period information contained in this Management's Discussion and Analysis of Financial Condition and Results of Operations has been restated to include the combined results of operations, financial position and cash flows of T-NETIX and Gateway as though Gateway had always been a part of T-NETIX. The results of operations, financial position and cash flows for the years ended December 31, 1998 and 1997 reflect the results of operations and cash flows for T-NETIX for the year ended July 31, 1998 and 1997, respectively, combined with Gateway's results for the years ended December 31, 1998 and 1997. The consolidated balance sheet as of December 31, 1997 reflects the financial position of T-NETIX as of August 1, 1997 combined with the financial position of Gateway as of December 31, 1997.
In addition, in connection with the merger transaction, T-NETIX issued 375,341 shares of common stock to certain shareholders of Gateway in exchange for their terminating a royalty agreement with Gateway. The royalty agreement related to automated call processing technology and intellectual property rights that were assigned to Gateway by the royalty owners in exchange for royalty payments. The termination of the royalty owners' interests resulted in the acquisition of an intangible asset. The asset was recorded at fair value, or $2,487,000. The fair value is based on the value of T-NETIX common stock at February 10, 1999 (date of the Merger
Agreement), or $6.625, multiplied by the number of shares issued in exchange for termination of the royalty owners' interests. The intangible asset has an estimated useful life of 10 years, the remaining term of the underlying patent.
Corrections Division
In the Corrections Division we derive revenue from three main sources: telecommunications services, direct call provisioning and equipment sales. Each form of revenue has specific and varying operating costs associated with such revenue. Selling, general and administrative expenses, along with research and development and depreciation and amortization are common expenses regardless of the revenue generated.
Telecommunications services revenue is generated under long-term contracts, which provide for transaction fees paid on a per-call basis. The per-call charge is primarily for the provisioning of specialized call processing services to telecommunications service providers for their customers, the correctional facilities. Such telecommunications service providers include AT&T, Verizon, Qwest, SBC Communications (including Ameritech), Sprint, GTE Worldcom, and other telecommunications service providers. We are paid a prescribed fee for each call completed and additional fees for validating phone numbers dialed by inmates.
As a direct inmate call provider, we buy "wholesale" call services to be re-sold as collect calls. We use the services of third parties to bill the collect calls. We then enter into direct contracts with the correctional facilities and generally pay to the correctional facilities commissions on the gross billed revenue. The rates charged by us are consistent with the collect call rates charged by the incumbent local exchange carrier or "ILEC" in the same service area and the predominant interexchange carrier or "IXC". Since all calls originating from the inmate phones are collect calls, each phone generates higher-than-industry-average revenues. The uncertainty of the creditworthiness of the billed parties results however in a higher-than-industry-average uncollectible cost.
Equipment sales and other revenue includes the sales of our inmate calling system and the DRS system. The sales of the inmate calling system are generally made to only one customer. We then charge monthly maintenance fees to keep the system operational. Sales to this customer can vary depending upon the success of the customer in winning contracts with correctional facilities.
We experienced an increase in total revenue in 2000 from 1999 of approximately $10.2 million or an increase of 14% over 1999. This increase was primarily due to new pricing agreements negotiated with four of our major partners during the second half of 2000. We will continue to market our products and services to other telecommunication service providers; however, we expect growth in call processing volumes and corresponding telecommunications services revenue will come predominantly from adding new systems for existing customers and from the sale of other corrections related products and services. Systems that are currently scheduled for installation are not expected to contribute to significant call volume increases until the later half of fiscal 2001.
Internet Services Division
In December 1999, we entered into a master service agreement with US WEST !NTERPRISE America, Inc. (now named Qwest) to provide interLATA Internet services to Qwest customers. The contract, which commenced December 1, 1999, calls for us to buy, resell and process billing of Internet bandwidth to this customer. The contract is for a minimum of sixteen months.
We experienced a significant increase in Internet Services revenue and related costs in fiscal 2000. This was due to the contract being in place a full fiscal year versus one month in 1999. Our gross margin on these was 22% for 2000. We anticipate future margins to remain consistent through the remaining term of the contract. The costs associated with this contract are primarily the costs for Internet bandwidth. There were no capital outlays required to begin provisioning these services.
The contract with Qwest expires in March 2001, and although we expect to see month-to-month continuing revenues through September 2001, we anticipate operations for this division will cease after such time.
Speaker Verification Division
We completed consolidation of our SpeakEZ operations to our Englewood facility in February 1999. The reorganization at that time included a change in marketing strategy from a direct customer sales strategy to a technology licensing strategy. Our voice print revenue has been minimal to date and management is seeking strategic alternatives including the sale of this division. In the meantime this division will continue to incur its normal operating expenses. There is no assurance that the SpeakEZ products will be commercially accepted or profitable in the future and there is no assurance that we will be able to sell or otherwise divest the Company from this operation.
RESULTS OF OPERATIONS
Current Operations
We experienced a net loss during 2000 of $368,000. The loss increased our accumulated deficit to $15.5 million. This loss was approximately $10.0 million less than the previous year. The decreased loss resulted primarily from an increase in revenues due to new pricing agreements, a full year of internet services revenue and the effect of one time expenses related to the merger with Gateway incurred in 1999.
We continue to aggressively pursue new contracts in our corrections division through our sales and marketing efforts. Any new agreement will require investments in new installations that due to the long-term nature of our contracts do not produce immediate profitability but will contribute to future profitability. Additionally we have implemented a business plan that we believe will improve operational efficiencies and will help improve overall margins.
The following table sets forth certain statement of operations data as a percentage of total revenue for the years ended December 31, 2000, 1999 and 1998.
Total Revenue. Total revenue in 2000 was $103.3 million, an increase of 41% over $73.2 million in 1999. This increase was attributable to the Internet Services contract being in effect for the entire year of 2000 as well as increases in telecommunications services revenue and direct call provisioning revenue, offset in part by decreases in equipment sales and other. Total revenue in 1999 was $73.2 million, an increase of 10% over $68.2 million in 1998. This increase was primarily attributable to an increase in direct call provisioning revenue and equipment sales offset in part by decreases in telecommunications services revenue.
The 31% increase in telecommunications services revenue to $51.4 million in 2000, from $39.3 million in 1999, was due primarily to an increase in contract prices. In addition, we experienced an increase in revenue due to call volume increases, primarily due to the addition of new sites. We expect telecommunications revenue to increase with additional pricing modifications. However, as we shift our focus to being a direct call provider, we anticipate an offsetting decrease in the amount of telecommunications services revenue.
Telecommunications services revenue decreased 9% in 1999 to $39.3 million, from $43.1 million in 1998. The decrease was due primarily to a decrease in call volume at existing sites. The reduction in call volume is primarily due to price increases by our telecommunications provider customers to the end users. Additionally, reductions are also attributable to prisoner relocation programs and increased use of call control measures by correctional institutions at existing sites. In addition, non-renewal of some existing site-specific customer contracts in competitive bidding arrangements contributed to the reduction. These factors were partially offset by increases associated with the addition of new call processing systems.
Direct call provisioning revenue increased slightly to $28.1 million in 2000, from $27.5 million in 1999. This increase was due to the addition of sites for which we are provisioning the long distance service. The addition of sites is primarily a result of our being successful in competitive bidding arrangements for contracts directly with correctional institutions. We anticipate direct call processing revenue to increase and be a larger proportion of our total revenue as we direct our sales efforts towards direct provisioning of inmate calling services. Direct call provisioning revenue increased 21% to $27.5 million in 1999, from $22.7 million in 1998. This increase again was due to an increase in the number of sites serviced.
Equipment sales and other revenue decreased 51% to $2.4 million for 2000 from $4.9 million in 1999. Such sales are primarily associated with one telecommunications service provider customer. In 2000, this customer significantly reduced their purchasing quantities. We do not anticipate significant equipment sales to this or any other customer in the near future. Equipment sales and other revenue increased 103% to $4.9 million for 1999 from $2.4 million in 1998. In 1999 we had a single sale of $1.1 million for our DRS product to a telecommunications service provider customer for a state department of corrections. The remaining increase in 1999 from 1998 was due primarily to the timing of purchases from this customer.
We had SpeakEZ Voice Print(R) revenue of $121,000, $93,000 and $632,000 for 2000, 1999, and 1998, respectively. Such amounts are included in other revenue. The reduction in revenue is due to the change in strategy whereby small projects that were previously performed are no longer accepted. SpeakEZ Voice Print(R) revenue was derived primarily from the sale of software licenses and software development kits. Future amounts of voice print revenue are unpredictable and depend upon market acceptance, technological success, and the impact of new competition.
Operating costs and expenses. Total operating costs and expenses were $63.3 million in 2000, an increase of 38% from $46.3 million in 1999, which in turn was an increase of 15% from $37.9 million in 1998. The increase in 2000 was primarily due to the commencement of Internet services as well as increases in telecommunication services and direct call provisioning expenses offset by a reduction in the cost of equipment sold and other expenses. The increases in 1999 from 1998 were due to increased direct call provisioning expense related to increased direct call revenue, the cost of equipment sold and the initiation of the internet services contract.
Operating costs of telecommunications services primarily consist of service administration costs for correctional facilities, including salaries and related personnel expenses, communication costs and inmate calling systems repair and maintenance expense. Operating costs of telecommunications services also include costs associated with call verification procedures, primarily network expenses and database access charges. Operating costs associated with direct call provisioning include the costs associated with telephone line access, long distance charges, commissions paid to correctional facilities, costs associated with uncollectible accounts and billing charges. Internet Services operating expenses consist of purchased internet bandwidth costs.
The following table sets forth the operating costs and expenses for each type of revenue as a percentage of corresponding revenue for the years ended December 31, 2000, 1999 and 1998.
Operating costs and expenses associated with providing telecommunications services as a percentage of corresponding revenue was 41% in 2000, a decrease from 45% in 1999. The decrease in 2000 is primarily due to revenue increases from renegotiated pricing agreements with our telecommunications partners. The increase in 1999 was primarily due to the reduction in telecommunications services revenue primarily due to a reduction in call volumes, and increases in personnel costs.
Total telecommunications services operating expenses were $21.3 million, $17.7 million, and $17.0 million for 2000, 1999, and 1998, respectively. The increase from 1999 to 2000 was due primarily to new services being provisioned for a significant customer as part of a contract amendment and due to increases in personnel costs. The increase included bonus costs associated with our line installation bonus program. The bonus program ended June 30, 2000. Also, the addition of new personnel in the National Service Center and other operational support functions contributed to cost increases. To a lesser extent, increases in travel, consulting services, repairs and maintenance contributed to the overall cost increase. The increase from 1998 to 1999 was due primarily to personnel costs. We anticipate that we will continue to increase our personnel costs for our National Service Center, however, we believe this centralization of customer support will allow us to begin to reduce field operations costs.
Direct call provisioning costs as a percentage of applicable revenue was 87%, 91% and 88% of revenue in 2000, 1999, and 1998 respectively. The decrease in 2000 was primarily due to a reduction in bad debt expense because of improved collection efforts. The increase in 1999 from 1998 was primarily attributable to higher commission and telecommunications costs.
The contract for Internet services commenced in December 1999, thus accounting for the dramatic annual change in 2000 from 1999. Cost of equipment sold and other decreased for 2000 but compared to 1999, but increased as a percentage of corresponding revenue due to the change in the revenue mix for equipment sales and voice print sales. Cost of equipment sold and other increased in 1999 from 1998 primarily due the change in the revenue mix for equipment sales and voice print sales.
Selling, General and Administrative Expenses. Selling, general and administrative expenses were $19.7 million in 2000, compared to $13.8 million in 1999 and $13.4 million in 1998. Selling, general and administrative expenses associated with the Corrections Division were $19.2 million in 2000, $13.0 million in 1999 and $11.3 million in 1998. The increase in 2000 was primarily due to increases in salary and benefits for additional personnel and from raises for existing personnel and a bonus program. Other expenses increased due to travel, communications, and professional fees due to the integration of Gateway operations. The increase in 1999 from 1998 was primarily due to increases in salary and benefits for additional sales and marketing personnel and due from raises and cost of living adjustments for existing personnel. Other expenses, including travel and telecommunications cost increased due to the merger with Gateway and additional sales and marketing travel. Another component of the 1999 increase in selling, general and administrative expenses was professional services and consulting fees, which increased as a result of the implementation of a Year 2000 compliant internal accounting system.
Selling, general and administrative expenses for the SpeakEZ Division were $0.5 million for 2000 a decrease from $0.8 million in 1999 and $2.1 million in 1998. The decrease is due to the change in the SpeakEZ Division's organization in 1999 to reduce personnel and the marketing approach to a licensing approach versus a direct sales approach.
Research and Development Expenses. Research and development expenses were $5.8 million in 2000, $5.1 million in 1999 and $3.9 million in 1998. Research and development expenses for the Corrections Division were $5.0 million in 2000, $4.2 million in 1999 and $2.4 million in 1998. The increases were primarily due to an increase in personnel expenses and higher travel and consulting costs.
Research and development expenses for the SpeakEZ Division were $0.7 million for 2000, which is consistent with the $0.9 million reported for 1999. However, both amounts represent a significant decrease from the $1.5 million in 1998. The decrease in 2000 and 1999 was a result of a reduction in personnel and the consolidation of the research facilities into the corporate headquarters.
Impairment of Telecommunications Assets. During 1999, we recorded an impairment of telecommunications assets of $4.6 million. Impaired telecommunications assets consisted of software development costs, construction in progress, and inmate calling platform assets. Two events indicated that the carrying value of certain equipment and intangible assets might not be recoverable. In September 1999, we completed an evaluation of the future viability of our new inmate calling platform ("DL Platform") which we had been developing over the past two years. The merger with Gateway allowed us to consider an alternative to the DL Platform. We determined that the Gateway ComBridge Platform ("ComBridge"), would be the platform to install for both new customers and upgrades of existing customers. However, over the last year, we had been awarded certain contracts where the DL Platform was to be deployed. Since we believe that it would not be cost effective to maintain and support two separate systems, we proceeded to renegotiate all existing contracts to install ComBridge instead of the DL Platform. During the quarter ended September 30, 1999, we successfully completed these negotiations. Due to the abandonment of the DL Platform, we no longer have any anticipated cash flow to support the carrying value of assets related to the DL Platform. Capitalized costs relating to the DL Platform included the software development costs, components (consisting primarily of telephony cards) and other supporting computer peripheral equipment. As a result, software development costs at December 31, 1999 were impaired by $2.0 million and certain components of construction in progress relating to these products were impaired by $1.6 million. This charge was applicable to the Corrections Division.
In addition, we had deployed a version of our old inmate calling platform that resides in our customers' network locations. We have recently experienced a reduction in call volumes and revenues for this platform. The customer has indicated to us that it does not intend to use the platform as a source of future services. Additionally, since the platform was based on the predecessor to the DL Platform, there is not an upgrade path available for the platform. Any new feature or service offering would be evaluated based on the new ComBridge Platform. The reduction in call volumes caused the estimated fair value of these assets to be less than its existing book value. We estimated the fair value of these assets based on the discounted cash flows from each location. After consideration of minimal salvage value of these assets due to their specific use, we recorded an impairment charge of approximately $1.0 million. This charge was applicable to the Corrections Division.
Depreciation and Amortization Expenses. Depreciation and amortization expense was $12.5 million in 2000, an increase from $11.6 million in 1999 and $10.2 million in 1998. The increase was due primarily to the depreciation of fixed assets place in service in 2000. Depreciation and amortization expense for the SpeakEZ Division was $0.9 million, $1.0 million and $0.9 million for 2000, 1999 and 1998, respectively.
Merger Transaction Expenses. These expenses were directly related to the merger with Gateway and amounted to approximately $1.0 million in 1999. Merger transaction expenses consisted primarily of fees for investment bankers, attorneys, accountants, financial printing and other related charges.
Interest and Other Income (Expense), Net. Interest and other income (expense), net was $2.4 million in 2000, an increase from $2.1 million in 1999. Included in other income in 1999 is a gain of approximately $0.2 million on the sale of used telecommunications equipment. Interest expense was $2.8 million in 2000, $2.3 million in 1999 and $2.4 million in 1998. The increase in 2000 was attributable to an increase in the average amount of indebtedness outstanding and an increase in interest rates. The amounts in 1999 and 1998 remained consistent due to a consistent average debt level and interest rates. The average debt balance increased in 2000 primarily due to the increase in capital expenditures.
TRANSITIONAL PERIOD FOR T-NETIX, INC.
T-NETIX results of operations for the five month period ended December 31, 1998, have been excluded from the reported results of operations. The net loss for the period has been accounted for as an adjustment of the accumulated deficit at January 1, 1999. T-NETIX had revenue, expenses, and a net loss of $15.0 million, $17.6 million, and $2.2 million, respectively, for the five month period ended December 31, 1998.
LIQUIDITY AND CAPITAL RESOURCES
Cash Flows
We have historically relied upon operating cash flow, debt financing and the sale of equity securities to fund our operations and capital needs. Our capital needs consist primarily of additions to property and equipment for site telecommunication equipment and internal equipment requirements.
Cash Provided by operations decreased by 64% to $4.3 million for 2000 from $12.2 million in 1999, primarily due to reductions in accounts payable, and increases in accounts receivable. Cash provided by operations increased 17% to $12.2 million for 1999 from $10.4 million in 1998 primarily due to increases in accounts payable.
We anticipate that our capital expenditures in 2001 will be consistent with 2000 based on our anticipated growth in installed systems at correctional facilities. We believe our cash flows from operations and our availability under our credit facility will be sufficient in order for us to meet our anticipated cash needs for new installations of inmate call processing systems and upgrades of existing systems and to finance our operations for at least the next 12 months.
Cash used in investing activities consisted primarily of purchases of property and equipment of $11.0 million in 2000 compared to $14.6 million in 1999 and $6.3 million in 1998. The decrease in 2000 was the result of a decrease in calling system installations compared to 1999. The increase in purchases of property and equipment in 1999 was primarily due to additional inmate calling system installations and upgrades to existing systems in 1999. Cash used for acquisitions amounted to $1.4 million in 1999 and $2.7 million in 1998.
Cash provided by financing of $6.2 million in 2000 primarily consisted of net proceeds from issuance of redeemable convertible preferred stock of $3.5 million and subordinated debt of $3.7 million, less net payments on the Credit Facility and other debt of $1.0 million. Cash provided by financing of $3.7 million in 1999 primarily consisted of net proceeds from debt including the line of credit, of $3.4 million. Cash provided by financing of $1.0 million in 1998 primarily consisted of common stock issued for cash under options of $0.8 million and net proceeds from debt of $0.3 million.
Capital Resources
In September 1999, we entered into a Senior Secured Revolving Credit Facility ("Credit Facility") with a commercial bank. In July 2000 our lenders amended our credit agreement to revise certain financial covenants. The maximum available amount of credit under the credit facility available to us is dependent upon our financial performance. Based on the financial covenants, our maximum borrowings at December 31, 2000 were $40.0 million. In April 2001 our lenders extended the Credit Facility maturity date to March 31, 2002. The maximum available borrowing on the facility was reduced to $30 million consisting of a $10 million term portion and a $20 million line of credit. Interest was set at prime rate plus 1.25% effective March 31, 2001 increasing by 0.25% each quarter thereafter on June 30, September 30, and December 31, 2001. In addition, monthly payments of $200,000 on the term loan will commence on April 30, 2001.
In April 2000, we raised $7.5 million of debt and equity financing. The net proceeds of approximately $7.2 million were used to reduce the outstanding balance on the Credit Facility. The Company issued 3,750 shares of series A non-voting redeemable convertible preferred stock and five-year stock purchase warrants to acquire 340,909 common shares for net proceeds of $3.5 million. In November 2000, the holders of the preferred stock converted 500 shares of the Series A Preferred Stock into 250,630 shares of common stock at a conversion price of $2.09 per share. The unamortized discount on the preferred stock of $167,000 was recognized as a charge to income (loss) applicable to common stockholders. In February of 2001 the remaining 3,250 shares of preferred stock were converted into 1,770,179 shares of common stock at an average conversion price of $1.95. In April 2000, we also issued subordinated debt in the amount of $3.75 million which is payable to a director and significant shareholder. The maturity date of this note has been extended to April 30, 2002.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENT
In March 2000, the Financial Accounting Standards Board ("FASB") issued interpretation No. 44 "Accounting for Certain Transactions involving Stock Compensation -- an interpretation of APB Opinion No. 25 ("FIN 44"). This interpretation provides guidance on the accounting for certain stock option transactions and subsequent amendments to stock option transactions. FIN 44 is effective July 1, 2000, but certain provisions cover specific events that occur after either December 15, 1998 or January 12, 2000. The adoption of FIN 44 did not have a material effect on our financial position or results of our operations.
In December 1999, the SEC released Staff Accounting Bulletin ("SAB") No. 101, "Revenue Recognition in Financial Statements," which provides for guidance on the recognition, presentation, and disclosure of revenue in financial statements filed with the SEC. Subsequently, the SEC delayed the implementation date of SAB 101 until the quarter ended December 31, 2000. The adoption of SAB 101 did not have a material effect on our financial position or results of our operations.
Statement of Financial Accounting Standards No. 133, (SFAS 133), "Accounting for Derivative Instruments and Hedging Activities," as amended by SFAS No. 137 and SFAS No. 138. SFAS 137 is effective for us as of January 1, 2001 SFAS 133 establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts (collectively referred to as derivatives), and for hedging activities. SFAS 133 requires companies to recognize all derivatives as either assets or liabilities, with the instruments measured at fair value. The accounting for changes in fair value, gains or losses, depends on the intended use of the derivative and its resulting designation. The adoption of SFAS 133 will not have an effect on our financial position or results of our operations, since we currently do not use derivative instruments.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
We are exposed to interest rate risk as discussed below.
Interest Rate Risk
We have current debt outstanding under a credit facility of $25.5 million at December 31, 2000. The credit facility bears interest at differing rates including, $23.5 million at LIBOR plus 2.75% (8.7% at December 31, 2000) and the remaining balance at the prime rate plus 0.5%, (9.5% at December 31, 2000). Interest on LIBOR rate loans and prime rate loans are payable monthly. In April 2001 the credit facility was renewed and extended to March 31, 2002. The new interest rate is at prime rate plus 1.25%, effective March 31, 2001, increasing by 0.25% each quarter thereafter on June 30, September 30, and December 31, 2001. Outstanding amounts under the line of credit are payable on March 31, 2002. The term loan is payable in monthly installments of $200,000 beginning April 30, 2001. Since the interest rates on the loans outstanding are variable and are reset periodically, we are exposed to interest rate risk. An increase in interest rates of 1% would increase estimated annual interest expense by approximately $255,000 based on the amount of borrowings outstanding under the line of credit at December 31, 2000.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements required by Item 8 are included herein beginning on page.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not Applicable.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information regarding our directors and executive officers will be set forth in our Proxy Statement for use in connection with the Annual Meeting of Stockholders to be held on or about June 5, 2001. Such information is incorporated herein by reference.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
Information regarding executive compensation will be set forth in our Proxy Statement for use in connection with the Annual Meeting of Stockholders to be held on or about June 5, 2001. Such information is incorporated herein by reference.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information regarding security ownership of certain beneficial owners, our directors and our executive officers will be set forth in our Proxy Statement for use in connection with the Annual Meeting of Stockholders to be held on or about June 5, 2001. Such information is incorporated herein by reference.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information regarding certain relationships and related transactions will be set forth in our Proxy Statement for use in connection with the Annual Meeting of Stockholders to be held on or about June 5, 2001. Such information is incorporated herein by reference.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
EXHIBIT NUMBER DESCRIPTION OF EXHIBIT - ------- ---------------------- (2.1) -- Acquisition Agreement and Plan of Merger between Registrant and SpeakEZ, Inc. dated October 11, 1995. (4)
(2.2) -- Agreement and Plan of Merger of T-NETIX and Gateway dated February 10, 1999. (5)
(3.1) -- Articles of Amendment to the Articles of Incorporation of Registrant (4)
(3.2) -- Amended and Restated Articles of Incorporation of Registrant (2)
(3.3) -- Amended and Restated Bylaws of Registrant(1)
(10.1) -- 1991 Non-Qualified Stock Option Plan(3)
(10.2) -- Form of 1991 Non-Qualified Stock Option Agreement(3)
(10.3) -- 1991 Incentive Stock Option Plan(3)
(10.4) -- Form of 1991 Incentive Stock Option Agreement(3)
(10.5) -- 1993 Incentive Stock Option Plan(3)
(10.6) -- Form of 1993 Incentive Stock Option Agreement(3)
(10.7) -- Agreement between American Telephone and Telegraph Company and Registrant dated November 1, 1991(1)
(10.8) -- Loan Agreement between Registrant and Bank One, Colorado NA, COBANK, ACB, and INTRUST BANK, N.A., dated as of September 9, 1999.(7)
(10.9) -- Standard Industrial Lease between Pacifica Development Properties, II LLC and Registrant dated April 15, 1996 and Amendment Number One thereto, dated May 20, 1996.(4)
(10.10) -- Employment Agreement between Gateway and Richard E. Cree dated January 1, 1998.(7)
(10.11) -- Employment Agreement between T-NETIX, Inc. and Thomas E. Larkin dated March 3, 2000.(6)
(10.12) -- First Amendment to the Loan Agreement $40,000,000 Revolving Line of Credit from BankOne, Colorado, NA, COBANK, ACB and Intrust Bank, NA, dated July 11, 2000.(8)
(21) -- Subsidiaries of Registrant(1)
(23) -- Consent of KPMG LLP
- ----------
(1) Incorporated herein by this reference from the Exhibits to the Registrant's Registration Statement on Form S-1 filed with the Commission on September 8, 1994, SEC Registration No. 33-83844.
(2) Incorporated herein by this reference from the Exhibits to the Registrant's Amendment No. 1 to Registration Statement on Form S-1 filed with the Commission on October 11, 1994, SEC Registration No. 33-83844.
(3) Incorporated herein by this reference from the Exhibits to the Registrant's Registration Statement on Form S-8 filed with the Commission on May 23, 1995, SEC Registration No. 33-92642 and amended on May 3, 1996.
(4) Previously filed with the Commission as an exhibit to the Company's Annual Report on Form 10-K for fiscal year ended 1996.
(5) Previously filed with the Commission as an exhibit to the Company's Proxy Statement dated May 10, 1999.
(6) Previously filed with the Commission as an exhibit to the Company's Quarterly Report on Form 10-Q dated March 31, 2000.
(7) Previously filed with the Commission as an exhibit to the Company's Annual Report on Form 10-K for the fiscal year ended 1999.
(8) Previously filed with the Commission as an exhibit to the Company's Quarterly Report on Form 10-Q dated June 30, 2000.
(b) Reports on Form 8-K: There were no reports on Form 8-K filed during the fourth quarter of the year ended December 31, 2000.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned on April 16, 2001.
T-NETIX, INC.
By: /s/ THOMAS E. LARKIN ----------------------- Thomas E. Larkin, Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Shareholders T-NETIX, Inc.:
We have audited the accompanying consolidated balance sheets of T-NETIX, Inc. and subsidiaries as of December 31, 2000 and 1999, and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the years in the three-year period ended December 31, 2000. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of T-NETIX, Inc. and subsidiaries as of December 31, 2000 and 1999, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2000, in conformity with accounting principles generally accepted in the United States of America.
KPMG LLP
Denver, Colorado April 16, 2001
T-NETIX, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
See accompanying notes to consolidated financial statements.
T-NETIX, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
See accompanying notes to consolidated financial statements.
T-NETIX, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
See accompanying notes to consolidated financial statements.
T-NETIX, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
See accompanying notes to consolidated financial statements.
T-NETIX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2000 AND 1999
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
General
T-NETIX, Inc. and subsidiaries ("T-NETIX" or the "Company") was incorporated in Colorado in 1986. The Company has three reportable segments, the Corrections Division, the Internet Services Division and the SpeakEZ Division ("SpeakEZ").
The Corrections Division primarily manages its specialized telecommunications hardware and software systems for long distance and local exchange carriers on a contractual basis. The long distance and local exchange carriers in turn pay a percentage of revenue from or a fee per call to the Company for each billable call made from a phone subject to a contract with the Company. The Company also receives revenue from billing collect calls made from correctional facilities in which the Company's specialized telecommunications hardware and software systems are located. The Internet Services Division provides interLATA Internet services to Internet subscribers and buys and resells Internet bandwidth. SpeakEZ engages in the research and development and sales and marketing of speaker verification technology.
Basis of Presentation
On June 14, 1999, the Company completed a merger with Gateway Technologies, Inc. ("Gateway"), a privately held provider of inmate calling services. As a result of the merger, Gateway became a wholly owned subsidiary of the Company. Prior to the merger, the Company changed its year-end from July 31 to December 31. Gateway's year-end was December 31.
The merger was accounted for as a pooling of interests. As a result, the Company's financial statements have been restated to combine Gateway's financial statements as if the merger had occurred at the beginning of the earliest period presented. Information concerning common stock and per share data has been restated on an equivalent share basis.
The consolidated statements of operations and cash flows for the year ended December 31, 1998 has been recast to reflect the results of operations and cash flows for T-NETIX for the year ended July 31, 1998, combined with Gateway for the year ended December 31, 1998.
As a result of T-NETIX and Gateway having different fiscal year ends prior to 1999, the results of operations of T-NETIX for the five month period ended December 31, 1998, have been excluded from the reported results of operations. The net loss for the period and common stock transactions during that period have been accounted for as an adjustment of stockholders' equity at January 1, 1999. T-NETIX had revenue, expenses, and a net loss of $15.0 million, $17.6 million, and $2.2 million, respectively, for the five month period ended December 31, 1998.
Principles of Consolidation
The consolidated financial statements include the accounts of the Company and its subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation.
Accounting Estimates
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates.
Risks and Uncertainties
A majority of the Company's revenue is generated from services provided to significant telecommunications customers. The loss of a major customer could affect operating results adversely.
Cash Equivalents
Cash equivalents consist of highly liquid investments, such as certificates of deposit and money market funds, with original maturities of 90 days or less.
Fair Value of Financial Instruments
The reported amounts of the Company's financial instruments including cash and cash equivalents, receivables, accounts payable, and accrued liabilities approximate fair value due to their short maturities. The carrying amounts of debt approximate fair value since the debt agreements provide for interest rates that approximate market.
Concentrations of Credit Risk
Financial instruments which potentially expose the Company to concentrations of credit risk consist primarily of cash and cash equivalents and accounts receivable. The Company's revenue is primarily concentrated in the United States in the telecommunications industry. The Company had trade accounts receivable from 5 customers that comprised 33% and 28% of total trade accounts receivable at December 31, 2000 and 1999, respectively. The Company does not require collateral on accounts receivable balances and provides allowances for potential credit losses. An allowance for doubtful accounts has been established based on historical experience and management's evaluation of outstanding accounts receivable at the end of the accounting period.
Inventories
Inventories are stated at the lower of cost or market. Cost is determined using the first-in, first-out method. Provisions, when required, are made to reduce excess and obsolete inventories to their estimated net realizable values.
Property and Equipment
Property and equipment is stated at cost, including costs necessary to place such property and equipment in service. Major renewals and improvements are capitalized, while repairs and maintenance are charged to operations as incurred.
Construction in progress represents the cost of material purchases and construction costs, including interest capitalized during construction, for telecommunications hardware systems in various stages of completion. During the years ended December 31, 2000, 1999 and 1998, interest capitalized was insignificant.
Depreciation is computed on a straight-line basis using estimated useful lives of 3 to 7 years for telecommunications equipment and 5 to 10 years for office equipment. No depreciation is recorded on construction in progress until the asset is placed in service.
Intangible and Other Assets
Other assets include intellectual property assets, capitalized computer software, patent defense and costs of numerous patent applications, deposits and long-term prepayments and other intangible assets. Patents and intangible assets are stated at cost. Amortization is computed on the straight-line basis over 17 years for patent costs and periods ranging from 3 to 7 years for other intangibles. Amortization charged to expense was $2 million, $1.5 million, and $0.9 million for the years ended December 31, 2000, 1999 and 1998, respectively.
Goodwill
Goodwill, representing the excess of the cost over the net tangible and identifiable assets of the acquired businesses, is stated at cost and is amortized, principally on a straight-line basis, over the estimated future periods to be benefited 5 to 10 years. On an annual basis, the Company reviews the recoverability of goodwill based primarily on an analysis of undiscounted cash flows from the acquired business. Accumulated amortization amounted to $2 million and $1.1 million at December 31, 2000 and 1999, respectively.
Impairment of Long-Lived Assets
The Company reviews its property and equipment and unamortized intangible assets whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. The Company estimates the future cash flows expected to result from operations and if the sum of the expected undiscounted future cash flows is less than the carrying amount of the long-lived asset, the Company recognizes an impairment loss by reducing the unamortized cost of the long-lived asset to its estimated fair value.
During the year ended December 31, 1999, the Company recorded an impairment charge of telecommunications assets of $4.6 million. Impaired telecommunications assets consisted of software development costs, construction in progress, and inmate calling platform assets. Two events occurred in 1999 indicated that the carrying value of certain equipment and intangible assets may not be recoverable. Due to the abandonment of one of the Company's operating platforms, as a result of the Gateway merger, impairments were recorded for $2.1 million of software development and $1.6 million relating to construction in progress. In addition, certain assets in customer's network locations were impaired by $1.0 million due to declining call volumes.
Revenue Recognition
Revenue and expenses from telecommunications services and direct call provisioning are recognized at the time the telephone call is completed. Provision is made for estimated uncollectible accounts in the period direct call provisioning revenue is recorded. Revenue from equipment sales is recognized when the equipment is shipped to customers. Internet services are recognized as the services are provided. The Company records deferred revenue for advance billings to customers, or prepayments by customers prior to the completion of installation or prior to the provision of contractual bandwidth usage.
Research and Development
Costs associated with the research and development of new technology or significantly altering existing technology are charged to operations as incurred.. Capitalization of software development costs begins upon the establishment of technological feasibility, subject to net realizable value considerations. Capitalized software costs are amortized over the economic useful life of the software product, which is generally estimated to be three years.
401(k) Plan
The Company established a 401(k) plan for all of its full time employees effective January 1, 1994. In June 1998, the Company implemented a matching program. The program calls for the Company to match 25% of an employee's contribution up to 6% of the individual employee's total salary. Matching contributions and plan expenses were $148,000 and $111,000 for the years ended December 31, 2000 and 1999, and such expenses were not significant for the year ended December 31, 1998.
Income Taxes
The Company utilizes the asset and liability method of accounting for income taxes. Accordingly, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted income tax rates expected to apply to taxable income in the years in which those differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in income tax rates is recognized in the results of operations in the period that includes the enactment date.
Earnings (Loss) Per Common Share
Earnings (loss) per common share are presented in accordance with the provisions of Statement of Financial Accounting Standards No. 128, Earnings Per Share (SFAS 128). Basic earnings per share excludes the impact of potentially dilutive securities and is computed by dividing income or loss available to common shareholders by the weighted average number of common shares outstanding during the period. Diluted earnings per share reflect the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock. There is no difference between basic and diluted net loss per common share since potentially dilutive securities from the conversion of redeemable convertible preferred stock and the exercises of options and warrants are anti-dilutive for the years ended December 31, 2000 and 1999. The calculations or diluted net loss per common share for the years ended December 31, 2000 and 1999 do not include 317,000 and 375,000 respectively, of potentially dilutive securities, including common stock options and warrants and redeemable convertible preferred stock. For the years ended December 31, 1998 diluted common and common equivalent shares outstanding includes 758,000 of potentially dilutive securities, consisting of stock options, determined under the treasury stock method.
Stock Compensation
The Company accounts for employee stock options under the provisions APB Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB 25") and has adopted the "disclosure only" alternative described in Statement of Financial Accounting Standards No. 123, "Accounting for the Stock-Based Compensation" ("SFAS 123"), which requires pro forma disclosure of compensation expense using a fair value based method of accounting for stock-based compensation plans. Under APB 25, compensation expense is based on the difference, if any, between the exercise price and fair value of the Company's stock on the date of grant.
Recently Issued Accounting Pronouncement
In March 2000, the Financial Accounting Standards Board ("FASB") issued interpretation No. 44 "Accounting for Certain Transactions involving Stock Compensation -- an interpretation of APB Opinion No. 25 ("FIN 44"). This interpretation provides guidance on the accounting for certain stock option transactions and subsequent amendments to stock option transactions. FIN 44 is effective July 1, 2000, but certain provisions cover specific events that occur after either December 15, 1998 or January 12, 2000. The adoption of FIN 44 did not have a material effect on the financial position or results of operations of the Company.
In December 1999, the SEC released Staff Accounting Bulletin ("SAB") No. 101, "Revenue Recognition in Financial Statements," which provides for guidance on the recognition, presentation, and disclosure of revenue in financial statements filed with the SEC. Subsequently, the SEC delayed the implementation date of SAB 101 for the Company until the quarter ended December 31, 2000. The adoption of SAB 101 did not have a material effect on the financial position or results of operations of the company.
Statement of Financial Accounting Standards No. 133, (SFAS 133), "Accounting for Derivative Instruments and Hedging Activities," as amended by SFAS No. 137 and SFAS No. 138 is effective for the Company as of January 1, 2001. SFAS 133 establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts (collectively referred to as derivatives), and for hedging activities. SFAS 1333 requires companies to recognize all derivatives as either assets or liabilities, with the instruments measured at fair value. The accounting for changes in fair value, gains or losses, depends on the intended use of the derivative and its resulting designation. The adoption of SFAS 133 will not have an effect on the Company's financial position or results of operations, since the Company does not use derivative instruments.
Reclassification
Certain amounts in the 1999 and 1998 financial statements have been reclassified to conform to the 2000 presentation.
(2) BALANCE SHEET COMPONENTS
Accounts receivable consist of the following:
Bad debt expense was $3.2 million, $5.0 million, and $4.9 million for the years ended December 31, 2000, 1999 and 1998, respectively.
Property and equipment consist of the following:
Intangible and other assets consist of the following:
Accrued liabilities consist of the following:
(3) MERGERS AND ACQUISITIONS
Gateway
On June 14, 1999, the Company completed a merger with Gateway, by exchanging 3,672,234 shares of its common stock for all of the common stock of Gateway. Each share of Gateway was exchanged for 5.0375 shares of T-NETIX common stock. Outstanding Gateway stock options were also converted at the same exchange factor into options to purchase approximately 379,000 shares of T-NETIX common stock.
In addition, in connection with the merger transaction, T-NETIX issued 375,341 shares of common stock to certain shareholders of Gateway in exchange for terminating a royalty agreement. The royalty agreement related to automated call processing technology and intellectual property rights that were assigned to Gateway by the royalty owners in exchange for royalty payments. The termination of the royalty owners' interests resulted in the acquisition of an intangible asset. The asset has been recorded at fair value, or $2,487,000. The fair value is based on the value of T-NETIX common stock at February 10, 1999 (date of the Merger Agreement), or $6.625, times the number of shares issued in exchange for termination of the royalty owners' interests. The intangible asset has been recorded in patent license rights and has an estimated useful life of 10 years, the remaining term of the underlying patent.
In connection with the merger, the Company incurred merger transaction expenses of $1.0 million for the year ended December 31, 1999. Merger transaction expenses consisted primarily of fees for investment bankers, attorneys, accountants, financial printing and other related charges.
Evans and Ricker Acquisition
Effective October 28, 1999, the Company completed the acquisition of substantially all of the assets of Evans and Ricker ("E&R"), of Portland, Oregon. E&R specialize in software used to control and manage information for correctional facilities. E&R's product, Lock and Track Corrections Information System ("Lock & Track(TM)") is a comprehensive relational database designed to handle the operational control and reporting needs of municipal, state, federal, and/or private correctional facilities. The purchase price was approximately $1.4 million including acquisition costs. The acquisition has been accounted for using the purchase method of accounting. The results of operations associated with the assets acquired are included in the Company's financial statements beginning November 1, 1999. Assets acquired and liabilities assumed have been recorded at their fair values. The assets acquired were cash, accounts receivable and intangibles. The estimated excess of cost over the estimated fair value of the net assets acquired of approximately $1.3 million was allocated principally to goodwill, which will be amortized on a straight line basis over 7 years. The remaining net assets acquired were primarily current assets (cash and accounts receivable) net of current liabilities (accounts payable and accrued liabilities). The acquisition was funded by borrowings under the Company's line of credit. Pro forma information giving effect to this acquisition has been omitted as the pro forma results do not vary materially from the Company's recorded results, as E&R's operations were not significant in 1998.
(4) DEBT
Debt consists of the following:
In September 1999, the Company entered into a Senior Secured Revolving Credit Facility (the "Credit Facility") with its commercial bank. The Credit Facility provides for maximum credit of $40,000,000 subject to limitations based on certain financial covenants. Amounts outstanding under the Credit Facility consist of $23.5 million at an interest rate of LIBOR plus 2.75% (8.7% at December 31, 2000) and $2.0 million at the Bank's prime rate plus 0.5% (9.5% at December 31, 2000). The Company also pays a fee of 0.3% per annum on the unused portion of the line of credit.
The Credit Facility is collateralized by substantially all of the assets of the Company. Under the terms of the Credit Facility, the Company is required to maintain certain financial ratios and other financial covenants. These ratios include a debt to a four quarter rolling earnings before interest, taxes and depreciation and amortization (EBITDA) ratio, a ratio of fixed charges (interest and debt payments) to EBITDA, and minimum quarterly EBITDA. The Agreement also prohibits the Company from incurring additional indebtedness.
In July 2000, the Company and its lenders amended its credit agreement to provide for revised financial covenants and extended the maturity date until April 30, 2001. The maximum amount of credit under the credit facility available to the Company is dependent upon the Company's financial performance. Based on these financial covenants, the Company's maximum available borrowings at December 31, 2000 were $40 million.
In April 2001, the Company's lenders extended the maturity date on its credit agreement to March 31, 2002. The maximum available borrowings on the facility was reduced to $30 million and interest was set at prime rate plus 1.25% effective March 31, 2001 increasing by 0.25% each quarter thereafter on June 30, September 30 and December 31, 2001. Subordinated Note Payable
The Company issued a subordinated note payable of $3.75 million, due April 30, 2001, to a director and significant shareholder of the Company. The note bears interest at prime rate plus one percent per annum (10% at December 31, 2000) which is payable every six months beginning October 2000. The lender also received warrants, which are immediately exercisable, to purchase 25,000 shares of common stock at an exercise price of $6.05 per share for a period of five years. The estimated fair value of the stock purchase warrants, calculated using the Black-Scholes model, has been recorded as deferred financing fees and is being amortized over the term of the debt. This note was extended in April 2001, to April 30, 2002.
(5) STOCKHOLDERS' EQUITY
Stock Option Plans
The Company has reserved 3,850,000 shares of common stock for employees and non-employee directors under various stock option plans (collectively the "Plans"): the 1991 Incentive Stock Option Plan ("the 1991 ISO Plan"); the 1991 Non-Qualified Stock Option Plan ("the 1991 NSO Plan"); and the 1993 Incentive Stock Option Plan ("the 1993 ISO Plan"). The Plans provide for issuing both incentive stock options, and non-qualified stock options, which must be granted at not less than 100% of the fair market value of the stock on the date of grant. All options to date have been granted at the fair market value of the stock as determined by the Board of Directors. Options issued prior to 1994 had vesting terms of one to three years from the date of grant. Substantially all of the Incentive Stock Options issued after 1993 vest over four years from the date of grant. The options expire ten years from the date of grant.
A summary of the Company's stock option activity, and related information through December 31, 2000 is as follows:
The range of exercise prices for common stock options outstanding and options exercisable at December 31, 2000 is as follows:
The Company has not recorded compensation expense for stock options granted. The Company has computed the pro forma disclosures required under SFAS 123 for stock options granted using the Black-Scholes option-pricing model. The assumptions are as follows:
The pro forma effects of applying SFAS 123 for the years ended December 31, 2000, 1999, and 1998 are as follows:
The Black-Scholes option-pricing model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. In addition, option-pricing models require the input of highly subjective assumptions, including expected stock price volatility. Because the Company's employee stock options have characteristics significantly different from those of traded options, and because changes in subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models to not necessarily provide a reliable single measure of the fair value of its employee stock options.
Redeemable Convertible Preferred Stock
In April 2000, the Company issued 3,750 shares of series A non-voting redeemable convertible preferred stock, and five-year stock purchase warrants to acquire 340,909 common shares for net proceeds of $3.5 million. The Company accounted for the transaction in accordance with EITF 98-5, "Accounting for Convertible Securities with Beneficial Conversion Features or Contingently Adjustable Conversion Ratios " and EITF 00-27 "Application of EITF Issue No. 98-5 to Certain Convertible Securities." The Company recognized an increase in additional paid in capital in the amount of $1,112,000 for the value of warrants and $771,000 for the value of the beneficial conversion feature. The Company is accreting the resulting discount to income (loss) applicable to common
stockholders over a three-year period to the mandatory redemption date. The discount from the beneficial conversion feature was accreted over a six-month period to the date when the stock was first convertible into common stock. The Series A preferred stock does not bear dividends.
In November 2000, the holders of the preferred stock converted 500 shares of the Series A Preferred Stock into 250,630 shares of common stock at a conversion price of $2.09 per share. As a result of this transaction, the Company recognized a charge of $167,000 to income (loss) applicable to common stockholders, representing the pro-rata share if the remaining unamortized discount on the preferred stock.
In February of 2001 the remaining 3,250 shares of preferred stock were converted into 1,770,179 shares of common stock at an average conversion price of $1.95. The remaining unamortized discount on the preferred stock of $1,039,000 was recognized as a charge to income (loss) applicable to common stockholders.
(6) SEGMENT INFORMATION
Statement of Financial Accounting Standards No. 131, Disclosures About Segments of an Enterprise and Related Information, ("SFAS 131") establishes standards for reporting operating segments in annual financial statements. SFAS 131 also establishes standards for disclosures about products and services, geographic areas and major customers.
The Company has three reportable segments; the Corrections Divisions, the SpeakEZ Division, and Internet Services Division. The Company evaluates performance based on earnings (loss) before income taxes. Additional measures include operating income, depreciation and amortization, and interest expense. There are no intersegment sales. The Company's reportable segments are specific business units that offer different products and services. They are managed separately because each business requires different technology and marketing strategies. The accounting policies of the reportable segments are the same as those described in the summary of significant accounting policies. Segment information is as follows:
Substantially all of the Company's reportable segment revenue is derived within the United States. Revenue as a percentage of total revenue attributable to significant customers for the years ended December 31, 2000, 1999 and 1998 is as follows:
There was no intersegment revenue for the years ended December 31, 2000, 1999 and 1998. Consolidated total assets included eliminations of approximately $13.3 million and $13.0 million as of December 31, 2000 and 1999, respectively. Eliminations consist of intercompany receivables in the Corrections Division and intercompany payables in the SpeakEZ Division related solely to intercompany borrowing of the SpeakEZ Division.
(7) INCOME TAXES
Income tax expense for the years ended December 31, 2000, 1999 and 1998 is as follows (amounts in thousands):
Income taxes differ from the expected statutory income tax benefit, by applying the US federal income tax rate of 34% to pretax earnings for the years ended December 31, 2000, 1999 and 1998 due to the following:
The tax effects of temporary differences that give rise to significant portions of the deferred income tax assets and deferred income tax liabilities as of December 31, 2000 and 1999 are presented below:
At December 31, 2000, the Company had net operating loss carryforwards for tax purposes aggregating approximately $20.7 million which, if not utilized to reduce taxable income in future periods, expire at various dates through the year 2011. Approximately $1.3 million of the net operating loss carryforwards are subject to certain rules limiting their annual usage. The Company believes these annual limitations will not ultimately affect the Company's ability to use substantially all of its net operating loss carryforwards for income tax purposes.
A valuation allowance is provided when it is more likely than not that some portion or the entire net deferred tax asset will not be realized. The Company has offset a portion of its deferred tax assets with a valuation allowance. The valuation allowance will be adjusted in the future based on the Company's projected taxable income.
The exercise of stock options, which have been granted under the Company's 1991 NSO stock option plan gives rise to compensation which is included in the taxable income of the applicable option holder and is deductible by the Company for federal and state income tax purposes. The income tax benefit associated with the exercise of the NSO options is recorded as an adjustment to additional paid-in capital when realized.
(9) QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
Certain amounts for the three months ended September 30, 2000, June 30, 2000 and March 31, 2000 have been reclassified to conform with the presentation for the fourth quarter of 2000.
The internet services contract began in December, 1999. Revenue and expenses have increased significantly as a result of entering into this contract.
(10) COMMITMENTS AND CONTINGENCIES
The Company leases office space under operating lease agreements. Rent expense under operating lease agreements for the years ended December 31, 2000, 1999 and 1998 was approximately $1.0 million, $1.0 million, and $0.9 million, respectively. Future minimum lease payments under these lease agreements for each of the next five years are summarized as follows (amounts in thousands):
The Company is involved in various legal proceedings of a nature considered normal to its business. It is the Company's policy to accrue amounts related to these legal matters if it is probable that a liability has been incurred an amount that is reasonable estimable. In the opinion of management, all matters are of such a nature as would not have a material affect on the Company's financial position, results of operations and cash flows of the Company if resolved unfavorably.
INDEPENDENT AUDITORS' REPORT ON SCHEDULE
The Board of Directors and Shareholders T-NETIX, Inc.:
Under the date of April 16, 2001, we reported on the consolidated balance sheets of T-NETIX, Inc. and subsidiaries as of December 31, 2000 and 1999, and the related consolidated statements of operations, shareholders' equity, and cash flows for each of the years in the three-year period ended December 31, 2000. In connection with our audits of the aforementioned consolidated financial statements, we also audited the related consolidated financial statement Schedule II. This financial statement schedule is the responsibility of the Company's management. Our responsibility is to express an opinion on this financial statement schedule based on our audits.
In our opinion, such consolidated financial statement schedule, when considered in relation to the basic consolidated financial statements taken as whole, presents fairly, in all material respects, the information set forth therein.
KPMG LLP
Denver, Colorado April 16, 2001
S-1
SCHEDULE II T-NETIX, INC. AND SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998 (AMOUNTS IN THOUSANDS)
S-2
EXHIBIT INDEX
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(1) Incorporated herein by this reference from the Exhibits to the Registrant's Registration Statement on Form S-1 filed with the Commission on September 8, 1994, SEC Registration No. 33-83844.
(2) Incorporated herein by this reference from the Exhibits to the Registrant's Amendment No. 1 to Registration Statement on Form S-1 filed with the Commission on October 11, 1994, SEC Registration No. 33-83844.
(3) Incorporated herein by this reference from the Exhibits to the Registrant's Registration Statement on Form S-8 filed with the Commission on May 23, 1995, SEC Registration No. 33-92642 and amended on May 3, 1996.
(4) Previously filed with the Commission as an exhibit to the Company's Annual Report on Form 10-K for fiscal year ended 1996.
(5) Previously filed with the Commission as an exhibit to the Company's Proxy Statement dated May 10, 1999.
(6) Previously filed with the Commission as an exhibit to the Company's Quarterly Report on Form 10-Q dated March 31, 2000.
(7) Previously filed with the Commission as an exhibit to the Company's Annual Report on Form 10-K for the fiscal year ended 1999.
(8) Previously filed with the Commission as an exhibit to the Company's Quarterly Report on Form 10-Q dated June 30, 2000.