================================================================================
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
----------
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarter ended September 30, 2002
Commission file number 0-25016
T-NETIX, INC.
(Exact name of registrant as specified in its charter)
DELAWARE
(State or Other Jurisdiction of 84-1037352
Incorporation) (I.R.S. Employer Identification No.)
2155 CHENAULT DRIVE, SUITE 410
CARROLLTON, TEXAS 75006 75006
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (972) 241-1535
----------
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities and Exchange Act
of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practical date.
CLASS OUTSTANDING AT NOVEMBER 4, 2002
- -------------------------------- -------------------------------
Common stock, $0.01 stated value 15,051,460
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FORM 10-Q CROSS REFERENCE INDEX
<Table>
<Caption>
PAGE
----
PART I FINANCIAL INFORMATION
Item 1 Condensed Financial Statements (Unaudited)................................................... 4
Item 2 Management's Discussion and Analysis of Financial Condition and Results of Operations........ 16
Item 3 Quantitative and Qualitative Disclosure About Market Risk.................................... 24
Item 4 Controls and Procedures....................................................................... 24
PART II OTHER INFORMATION
Item 1 Legal Proceedings............................................................................. 25
Item 2 Changes in Securities and Use of Proceeds..................................................... 26
Item 3 Defaults Upon Senior Securities............................................................... 26
Item 4 Submission of Matters to a Vote of Security Holders........................................... 26
Item 5 Other Information............................................................................. 26
Item 6 Exhibits and Reports on Form 8-K.............................................................. 26
Signatures.................................................................................... 27
Certification by Chief Executive Officer...................................................... 28
Certification by Chief Financial Officer...................................................... 29
</Table>
2
PART I
ITEM 1. FINANCIAL STATEMENTS
INDEX TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
<Table>
Condensed Consolidated Balance Sheets as of September 30, 2002 and December 31, 2001
(Unaudited)......................................................................................................... 4
Condensed Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2002 and 2001
(Unaudited)......................................................................................................... 5
Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2002 and 2001
(Unaudited)......................................................................................................... 6
Notes to Condensed Consolidated Financial Statements (Unaudited)......................................................... 7
</Table>
3
T-NETIX, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AND SHARE AMOUNTS)
(UNAUDITED)
<Table>
<Caption>
SEPTEMBER 30, DECEMBER 31,
2002 2001
-------------- --------------
ASSETS
Cash and cash equivalents .................................................................. $ 473 $ 995
Accounts receivable, net (note 2) .......................................................... 23,038 18,030
Prepaid expenses ........................................................................... 2,334 1,232
Inventories ................................................................................ 895 705
-------------- --------------
Total current assets ............................................................. 26,740 20,962
Property and equipment, net (note 2) ....................................................... 27,714 30,217
Goodwill, net .............................................................................. 2,245 2,245
Deferred tax asset ......................................................................... 2,297 2,297
Intangible and other assets, net (note 2) .................................................. 7,271 7,476
-------------- --------------
Total assets ..................................................................... $ 66,267 $ 63,197
============== ==============
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Accounts payable ....................................................................... $ 9,164 $ 10,795
Accrued liabilities (note 2) ........................................................... 8,604 5,089
Subordinated note payable (note 3) ..................................................... 3,750 3,750
Current portion of long-term debt (note 3) ............................................. 16,878 18,436
-------------- --------------
Total current liabilities ........................................................ 38,396 38,070
Long-term debt (note 3) ................................................................ 90 218
-------------- --------------
Total liabilities ................................................................ 38,486 38,288
Stockholders' equity:
Preferred stock, $.01 stated value, 10,000,000 shares authorized; no shares
issued or outstanding at September 30, 2002 and December 31, 2001, respectively .... -- --
Common stock, $.01 stated value, 70,000,000 shares authorized; 15,051,460 and 15,032,638
shares issued and outstanding at September 30, 2002 and December 31, 2001,
respectively ....................................................................... 151 150
Additional paid-in capital ............................................................. 41,846 41,831
Accumulated deficit .................................................................... (14,216) (17,072)
-------------- --------------
Total stockholders' equity ....................................................... 27,781 24,909
-------------- --------------
Total liabilities and stockholders' equity ................................................. $ 66,267 $ 63,197
============== ==============
</Table>
See accompanying notes to unaudited condensed consolidated
financial statements.
4
T-NETIX, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AND SHARE AMOUNTS)
(UNAUDITED)
<Table>
<Caption>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------- --------------------
2002 2001 2002 2001
-------- -------- -------- --------
Revenue:
Telecommunication services .............................. $ 14,218 $ 15,529 $ 44,587 $ 46,697
Direct call provisioning ................................ 12,736 6,753 34,954 19,834
Internet services ....................................... -- 7,377 -- 22,121
Equipment sales and other ............................... 4,710 1,752 8,127 3,590
-------- -------- -------- --------
Total revenue ..................................... 31,664 31,411 87,668 92,242
Operating Costs and Expenses:
Operating costs (exclusive of depreciation and
amortization shown separately below)
Telecommunications services ........................... 6,266 5,212 17,010 18,277
Direct call provisioning .............................. 12,126 6,490 33,208 18,180
Internet services ..................................... -- 5,572 -- 15,350
Cost of equipment sold and other ...................... 939 476 2,532 1,566
-------- -------- -------- --------
Total operating costs ............................. 19,331 17,750 52,750 53,373
Selling, general and administrative ..................... 6,854 6,094 18,789 17,881
Research and development ................................ 799 992 2,320 3,601
Depreciation and amortization ........................... 3,267 3,138 8,678 9,240
-------- -------- -------- --------
Total operating costs and expenses ................ 30,251 27,974 82,537 84,095
-------- -------- -------- --------
Operating income .................................. 1,413 3,437 5,131 8,147
Interest and other expenses, net ........................... (897) (590) (1,823) (1,965)
Gain on sale of assets ..................................... -- -- 36 --
-------- -------- -------- --------
Income from continuing operations before income taxes ...... 516 2,847 3,344 6,182
Income tax expense ......................................... -- (111) (180) (333)
-------- -------- -------- --------
Net income from continuing operations ................... 516 2,736 3,164 5,849
Loss from discontinued operations .......................... (182) (580) (615) (1,950)
Gain on the sale of assets of discontinued operations ... 308 -- 308 --
-------- -------- -------- --------
Income (loss) from discontinued operations ................. 126 (580) (307) (1,950)
-------- -------- -------- --------
Net income before accretion of discount on
redeemable convertible preferred stock .................. 642 2,156 2,857 3,899
Accretion of discount on redeemable
convertible preferred stock ............................. -- -- -- (1,077)
-------- -------- -------- --------
Net income applicable to common stockholders ............... $ 642 $ 2,156 $ 2,857 $ 2,822
======== ======== ======== ========
Income per common share from
continuing operations
Basic ................................................. $ 0.03 $ 0.18 $ 0.21 $ 0.39
======== ======== ======== ========
Diluted ............................................... $ 0.03 $ 0.18 $ 0.21 $ 0.39
======== ======== ======== ========
Income (loss) per common share from
discontinued operations
Basic ................................................. $ 0.01 $ (0.04) $ (0.02) $ (0.13)
======== ======== ======== ========
Diluted ............................................... $ 0.01 $ (0.04) $ (0.02) $ (0.13)
======== ======== ======== ========
Income per common share applicable to
common shareholders
Basic ................................................. $ 0.04 $ 0.14 $ 0.19 $ 0.19
======== ======== ======== ========
Diluted ............................................... $ 0.04 $ 0.14 $ 0.19 $ 0.19
======== ======== ======== ========
Shares used in computing net income
per common share
Basic ................................................. 15,049 15,032 15,038 14,844
======== ======== ======== ========
Diluted ............................................... 15,359 15,199 15,434 15,032
======== ======== ======== ========
</Table>
See accompanying notes to unaudited condensed consolidated
financial statements.
5
T-NETIX, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AND SHARE AMOUNTS)
(UNAUDITED)
<Table>
<Caption>
NINE MONTHS ENDED
SEPTEMBER 30,
--------------------
2002 2001
-------- --------
Cash flows from continuing operating activities:
Net income from continuing operations ................................ $ 3,164 $ 5,849
Adjustments to reconcile net income to net cash provided
by operating activities from continuing operations:
Depreciation and amortization ........................................ 8,678 9,240
Gain on the sale of property and equipment ........................... (344) --
Changes in operating assets and liabilities:
Accounts receivable ............................................ (6,500) (5,708)
Bad debts ...................................................... 1,492 584
Prepaid expenses ............................................... (1,102) (465)
Inventories .................................................... (190) 757
Intangibles and other assets ................................... (668) (1,414)
Loss on write-down of investments .............................. 158 --
Accounts payable ............................................... (1,631) 2,105
Accrued liabilities ............................................ 3,515 1,182
-------- --------
Cash provided by operating activities of
continuing operations .................................... 6,572 12,130
-------- --------
Cash used in investing activities of continuing operations:
Purchase of property and equipment ................................. (5,029) (4,205)
Proceeds from sale of assets ....................................... 638 --
Acquisition of business or business assets ......................... -- (1,654)
Other investing activities ......................................... (325) (410)
-------- --------
Cash used in investing activities of continuing
operations ............................................... (4,716) (6,269)
-------- --------
Cash flows from financing activities of continuing operations:
Net proceeds from (payments on) line of credit ..................... (1,849) (3,877)
Payments on loan and capital leases ................................ (237) (43)
Common stock issued for cash under Employee Stock Option Plan ...... 15 --
-------- --------
Cash used in financing activities of continuing
operations ............................................... (2,071) (3,920)
Cash used by discontinued operations ................................. (307) (1,322)
-------- --------
Net increase (decrease) in cash and cash equivalents ................. (522) 619
Cash and cash equivalents at beginning of period ..................... 995 102
-------- --------
Cash and cash equivalents at end of period ........................... $ 473 $ 721
======== ========
Supplemental Disclosures:
Cash paid during the period for:
Interest ....................................................... $ 1,861 $ 2,357
======== ========
Income taxes ................................................... $ 144 $ 222
======== ========
Note received in exchange for assets ............................... $ 91 $ --
======== ========
Assets received in exchange for note ............................... $ 300 $ --
======== ========
Common stock received in exchange for assets ....................... $ 278 $ --
======== ========
</Table>
See accompanying notes to unaudited condensed consolidated
financial statements.
6
T-NETIX, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AND SHARE AMOUNTS)
(UNAUDITED)
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Unaudited Financial Statements
The accompanying unaudited consolidated financial statements reflect all
adjustments which, in the opinion of management, are necessary to reflect a fair
presentation of the financial position and results of operations of T-NETIX,
Inc. and subsidiaries (the "Company") for the interim periods presented. All
adjustments, in the opinion of management, are of a normal and recurring nature.
Some adjustments involve estimates, which may require revision in subsequent
interim periods or at year-end. The financial statements have been presented in
accordance with generally accepted accounting principles. Refer to notes to
consolidated financial statements, which appear in the 2001 Annual Report on
Form 10-K for the Company's accounting polices, which are pertinent to these
statements.
Acquisitions
In January 2001, the Company completed the purchase of all the outstanding
shares of common stock, not already owned, of TELEQUIP Labs, Inc., a provider of
inmate calling systems. The purchase price was $605 per share, of which $573 per
share was paid upon closing. The remaining $32 per share, payable on the first
anniversary of the closing date upon determination that all representations and
warranties were materially true and accurate as of the closing date and all
covenants have been substantially fulfilled, has been paid. The excess of the
purchase price over the fair value of the net identifiable assets acquired has
been recorded as goodwill. The total cash paid in January 2001 was $1.5 million.
The acquisition has been accounted for as a purchase and, accordingly, the
results of operations of TELEQUIP Labs, Inc. have been included in the Company's
consolidated financial statements from January 2001.
In June 2002, the Company purchased substantially all of the assets of ACT
Telecom, Inc., a Houston, Texas based prepaid calling platform provider and
wholly-owned subsidiary of ClearMediaOne, Inc. Assets included a
telecommunication switch, prepaid calling platform and associated software. The
purchase price was approximately $0.7 million, including $0.3 million in cash
and the issuance of a $0.4 million note due and payable on or before June 2003.
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 dilution for common stock
equivalents 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.
The following is a reconciliation of the numerators and denominators of the
basic and diluted earnings per share computations:
<Table>
<Caption>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------- -------------------
2002 2001 2002 2001
-------- -------- -------- --------
Numerator:
Net income applicable to common stockholders ...... $ 642 $ 2,156 $ 2,857 $ 2,822
======== ======== ======== ========
Denominator:
Denominator for basic earnings per share .......... 15,049 15,032 15,038 14,844
Effect of dilutive securities:
Stock options .................................. 277 142 366 163
Warrants ....................................... 33 25 30 25
-------- -------- -------- --------
Denominator for diluted earnings per share ........ 15,359 15,199 15,434 15,032
======== ======== ======== ========
</Table>
For the three and nine months ended September 30, 2002 and 2001, common
stock equivalents of 1,920,000, 1,722,000, 1,619,000 and 1,127,000,
respectively, were not included in the diluted earnings per share calculation,
as their effect would be anti-dilutive.
7
T-NETIX, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AND SHARE AMOUNTS)
(UNAUDITED)
Recently Issued or Adopted Accounting Pronouncements
In July 2001, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 141, "Business
Combinations", which requires the use of the purchase method and eliminates the
option of using pooling-of-interests method of accounting for all business
combinations. The provisions in this statement apply to all business
combinations initiated after June 30, 2001, and to all business combinations
accounted for using the purchase method for which the date of acquisition is on
or near July 1, 2001. As the Company did not have any significant business
acquisitions, the adoption of this statement did not have a material impact on
the Company's financial position, results of operations, or cash flows.
In July 2001, the FASB issued SFAS No. 142, "Goodwill and Other Intangible
Assets" ("SFAS 142"). In general, SFAS No. 142 is effective for fiscal years
beginning after December 15, 2001. SFAS No. 142 addresses financial accounting
and reporting for acquired goodwill and other intangible assets, and requires
that all intangible assets acquired, other than those acquired in a business
combination, be initially recognized and measured based on fair value. In
addition, the intangible assets should be amortized based on useful life. If the
intangible asset is determined to have an indefinite useful life, it should not
be amortized, but shall be tested for impairment at least annually. The Company
adopted the provisions of SFAS No. 142 on January 1, 2002. The effect of
adoption was the cessation of amortization of goodwill recorded on previous
purchase business combinations. The Company reviewed the recorded goodwill for
impairment upon adoption of SFAS No. 142. To accomplish this, we identified the
reporting units and determined the carrying value of each reporting unit. The
Company defines its reporting unit to be the same as the reportable segments
(see note 5). To the extent a reporting unit's carrying amount exceeds its fair
value, the reporting unit's cost in excess of fair value of net assets acquired
may be impaired and we must perform the second step of the transitional
impairment test. In the second step, we must compare the implied fair value of
the reporting unit's fair value to all of its assets (recognized and
unrecognized) and liabilities in a manner similar to a purchase price allocation
in accordance with SFAS No. 141, to its carrying amount, both of which would be
measured as of January 1, 2002. Any transitional impairment loss is recognized
as the cumulative effect of a change in accounting principle in our statement of
operations. The Company has completed its transitional impairment tests and has
determined that no impairment losses for goodwill and other intangible assets
will be recorded as a result of the adoption of SFAS No. 142. The Company
expects that its depreciation and amortization expense will decrease by
approximately $0.8 million annually as a result of the adoption of SFAS No. 142.
If amortization of goodwill had not been recorded, and if amortization of other
intangible assets had been recorded using the revised life, the Company's net
income and income per share for the three and nine months ended September 30,
2001 would have been as follows:
<Table>
<Caption>
THREE MONTHS NINE MONTHS
ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30,
2001 2001
-------------- --------------
Net income applicable to common stockholders, as reported ....... $ 2,156 $ 2,822
Add back: amortization of goodwill .............................. 227 715
-------------- --------------
Net income applicable to common stockholders, as adjusted ....... $ 2,383 $ 3,537
============== ==============
Per common share-diluted:
Net income applicable to common stockholders, as reported ....... $ 0.14 $ 0.19
Amortization of goodwill ........................................ $ 0.02 $ 0.05
-------------- --------------
Net income applicable to common stockholders, as adjusted ....... $ 0.16 $ 0.24
============== ==============
</Table>
In August 2001, the FASB issued SFAS No. 143, "Accounting for Asset
Retirement Obligations". This statement addresses the financial accounting and
reporting for obligations associated with the retirement of tangible long-lived
assets and the associated asset retirement costs. SFAS 143 requires that the
fair value of a liability for an asset retirement obligation be recognized in
the period in which it is incurred if a reasonable estimate of fair value can be
made. The associated asset retirement costs are capitalized as part of the
carrying amount of the long-lived asset and reported as a liability. This
statement is effective for fiscal years beginning after June 15, 2002. The
Company is currently evaluating the impact of the adoption of SFAS 143.
In October 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets". This statement establishes a
single accounting model, based on the framework established in SFAS 121, for
long-lived assets to be disposed of by sale, whether previously held and used or
newly acquired, and broadens the presentation of discontinued operations to
include
8
T-NETIX, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AND SHARE AMOUNTS)
(UNAUDITED)
more disposal transactions. This statement is effective for fiscal years
beginning after December 15, 2001. The adoption of this statement had no
material impact upon the Company's financial position or results of operations.
In May 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements
No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical
Corrections." Under the provisions of SFAS No. 145, gains and losses from the
early extinguishment of debt are no longer classified as an extraordinary item,
net of income taxes, but are included in the determination of pretax earnings.
The effective date for SFAS No. 145 is for fiscal years beginning after May 15,
2002, with early application encouraged.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities." SFAS No. 146 addresses accounting and
reporting for costs associated with exit or disposal activities by requiring
that a liability for a cost associated with an exit or disposal activity be
recognized and measured at fair value only when the liability is incurred. SFAS
No. 146 also nullifies EITF Issue 94-3, "Liability Recognition for Certain
Employee Termination Benefits and Other Costs to Exit an Activity (including
Certain Costs Incurred in a Restructuring)." The provisions of SFAS No. 146 are
effective for exit or disposal activities that are initiated after December 31,
2002.
Reclassification
Certain amounts in the 2001 financial statements have been reclassified to
conform to the 2002 presentation.
(2) BALANCE SHEET COMPONENTS
Accounts receivable consist of the following:
<Table>
<Caption>
SEPTEMBER 30, DECEMBER 31,
-------------- --------------
2002 2001
-------------- --------------
Accounts receivable, net:
Trade accounts receivable ..................... $ 14,728 $ 12,540
Direct call provisioning receivable ........... 12,020 7,040
Other receivables ............................. 362 1,030
-------------- --------------
27,110 20,610
Less: Allowance for doubtful accounts .... (4,072) (2,580)
-------------- --------------
$ 23,038 $ 18,030
============== ==============
</Table>
Bad debt expense was $3.5 million and $1.7 million for the three months
ended September 30, 2002 and 2001, respectively, and $9.5 million and $4.4
million for the nine months ended September 30, 2002 and 2001, respectively.
Property and equipment consist of the following:
<Table>
<Caption>
SEPTEMBER 30, DECEMBER 31,
2002 2001
-------------- --------------
Property and equipment, net:
Telecommunications equipment ............................ $ 71,640 $ 67,615
Construction in progress ................................ 3,954 4,898
Office equipment ........................................ 15,826 13,835
-------------- --------------
91,420 86,348
Less: Accumulated depreciation and amortization .... (63,706) (56,131)
-------------- --------------
$ 27,714 $ 30,217
============== ==============
</Table>
9
T-NETIX, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AND SHARE AMOUNTS)
(UNAUDITED)
Intangible and other assets consist of the following:
<Table>
<Caption>
SEPTEMBER 30, DECEMBER 31,
-------------- --------------
2002 2001
-------------- --------------
Intangible and other assets, net:
Purchased technology assets ............... $ 2,487 $ 2,487
Capitalized software development costs .... 1,843 1,690
Acquired software technologies ............ 420 409
Acquired contract rights .................. 1,391 1,391
Patent defense and application costs ...... 2,914 2,914
Deposits and long-term prepayments ........ 2,414 2,110
Other ..................................... 1,271 1,170
-------------- --------------
12,740 12,171
Less: Accumulated amortization ....... (5,469) (4,695)
-------------- --------------
$ 7,271 $ 7,476
============== ==============
</Table>
Accrued liabilities consist of the following:
<Table>
<Caption>
SEPTEMBER 30, DECEMBER 31,
-------------- --------------
2002 2001
-------------- --------------
Accrued liabilities:
Deferred revenue and customer advances .... $ 2,260 $ 1,215
Compensation related ...................... 2,709 3,172
Accrued site commissions.................... 2,442 131
Other ..................................... 1,193 571
-------------- --------------
$ 8,604 $ 5,089
============== ==============
</Table>
(3) DEBT
Debt consists of the following:
<Table>
<Caption>
SEPTEMBER 30, DECEMBER 31,
-------------- --------------
2002 2001
-------------- --------------
Debt:
Bank lines of credit ........... $ 16,359 $ 18,208
Subordinated note payable ...... 3,750 3,750
Other .......................... 609 446
-------------- --------------
$ 20,718 $ 22,404
Less current portion ...... 20,628 22,186
-------------- --------------
Non current portion ....... $ 90 $ 218
============== ==============
</Table>
In September 1999, the Company entered into a Senior Secured Revolving
Credit Facility (the "Credit Facility") with its commercial bank. The Credit
Facility provided for maximum credit of $40.0 million subject to limitations
based on certain financial covenants. In April 2001, the Company's lenders
extended the maturity date on its credit agreement to March 2002. The maximum
available borrowings on the Credit Facility was reduced to $30.0 million and
interest was set at prime rate plus 1.25% effective June 30, 2001 increasing by
0.25% each quarter thereafter on June 30, September 30 and December 31, 2001. In
addition, monthly payments of $0.2 million on the term loan commenced in April
2001. In March 2002, the maturity date of the Credit Facility was extended to
June 26, 2002. Effective with the March 2002 extension, the maximum available
borrowings on the Credit Facility was reduced to $21.8 million and interest was
set at prime plus 2.25% (7.0% at September 30, 2002). The Company also pays a
fee of 0.40% per annum on the unused portion of the line of credit.
In April 2002, the Company obtained a further commitment from its lenders to
extend, at the option of the Company, the Credit Facility beyond June 26, 2002
to January 2003. Effective June 2002, the Company elected to extend the existing
Credit Facility and paid an option exercise fee to its lenders equal to 3.0% of
the maximum available borrowing on the Credit Facility. This fee has been
recorded as a pre-paid financing fee and will be expensed over the remaining
term of the Credit Facility. Under the terms of the April 2002 extension, the
maximum available borrowings on the Credit Facility was reduced to $18.7
million, consisting of a $7.2 million
10
T-NETIX, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AND SHARE AMOUNTS)
(UNAUDITED)
term portion and an $11.5 million line of credit. Further, maximum available
borrowing under the line of credit will be reduced by $0.3 million per month
beginning in August 2002 and monthly payments of $0.2 million on the term loan
will continue through the maturity date. To facilitate the refinancing of the
Credit Facility, the Company has retained J.P. Morgan Securities, Inc. to
explore and advise us on various financing opportunities and strategies.
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. The Company is in
compliance with all debt covenants at September 30, 2002.
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 plus one percent per annum (5.75% at June 30, 2002)
which is payable every six months. The lender 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. This note was
extended in April 2001 to April 2002 at which time the lender received
additional warrants, which are immediately exercisable, to purchase 25,000
shares of common stock at an exercise price of $2.75 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. In March 2002 this note was
extended to July 30, 2002. In April 2002 this note was further extended to
February 2003 to facilitate the refinancing of our overall financing structure.
Warrants to purchase 25,000 shares of common stock at an exercise price of $2.75
per share have been issued to the lender on terms similar to previous warrants;
however, shares will vest proportionately over the term of the note extension.
(4) DISCONTINUED OPERATIONS AND NET ASSETS FOR SALE
In August 2001, the Company formalized the decision to offer for sale its
voice verification business unit, which includes the SpeakEZ speaker
verification products. The SpeakEZ Voice Print technology is proprietary
software that compares the speech pattern of a current speaker with a stored
digital voiceprint of the authorized person to confirm or reject claimed
identity. To date, SpeakEZ revenues have been insignificant and operations have
been substantially curtailed. Accordingly, related operating results have been
reported as discontinued operations. The financial information for the
discontinued speaker verification operations is as follows:
<Table>
<Caption>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------- --------------------
2002 2001 2002 2001
-------- -------- -------- --------
Revenue ................................ $ -- $ 10 $ 101 $ 31
Operating loss ......................... (182) (580) (615) (1,950)
Gain on sale of discontinued assets .... 308 -- 308 --
Net income/(loss) ...................... 126 (580) (307) (1,950)
</Table>
In September 2001, the Company announced that it had entered into an
agreement to sell all of the assets of the SpeakEZ division; however, the
transaction was not completed and the agreement was terminated. As of December
31, 2001, the Company had not sold the SpeakEZ speaker verification assets. For
this reason, a one-time charge of $1.1 million, net of taxes, was recognized in
2001 related to the write off of the voice print patent and license assets
related to the SpeakEZ product line. This write-off was based on an analysis
which concluded that the carrying value of our voice print assets exceeded the
present value of estimated future cash flows given current operating results and
the absence of a definitive agreement to sell these assets.
In July 2002, the Company completed the sale of the SpeakEZ speaker
verification assets to SpeechWorks International, Inc. ("SpeechWorks") for $0.4
million cash and approximately 130,000 shares of SpeechWorks common stock valued
at $0.3 million, subject to a 10% escrow provision and recognized a gain on the
sale of discontinued operations of $0.3 million. In addition, SpeechWorks will
pay the Company an earn-out fee based on the sale over the next two years of
future SpeechWorks products incorporating the SpeakEZ technology. Payment of the
earn-out fee, if any, will be made through the issuance of additional shares of
SpeechWorks common stock. As part of the sales agreement, the Company retained
the right to utilize the speech recognition technology in the corrections
industry. SpeechWorks stock received by the Company will not be registered.
11
T-NETIX, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AND SHARE AMOUNTS)
(UNAUDITED)
(5) SEGMENT INFORMATION - CONTINUING OPERATIONS
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 two reportable segments: the Corrections and Internet
Services Divisions. Through its Corrections Division, the Company provides
inmate telecommunication products and services for correctional facilities,
including security enhanced call processing, call validation and billing
services for inmate calling. Depending upon the contractual relationship at the
site and the type of customer, the Company provides these products and services
through service agreements with other telecommunications service providers,
including Verizon, AT&T, SBC Communications, Sprint and Qwest and through direct
contracts between the Company and correctional facilities. In addition,
primarily through its subsidiary TELEQUIP Labs, the Company sells inmate call
processing systems to certain telecommunication providers. Through its Internet
Service Division, the Company provided interLATA Internet services to Qwest
customers through a master service agreement, the "Qwest Agreement". Effective
November 2001, substantially all services and associated revenue under this
agreement ceased due to the expiration of this contract.
Formerly, the Company reported a third business segment, the SpeakEZ Speaker
Verification division. The SpeakEZ Voice Print technology is proprietary
software that compares the speech pattern of a current speaker with a stored
digital voiceprint of the authorized person to confirm or reject claimed
identity. In August 2001, the Company formalized its decision to offer for sale
its voice print business unit, which included the SpeakEZ speaker verification
products. Accordingly, related operating results of this business unit have been
reported as discontinued operations in the consolidated financial statements.
Segment reporting has been conformed to correspond to the current presentation.
As described in Note 4 of "Notes to Condensed Consolidated Financial
Statements," the Company completed the sale of SpeakEZ assets in July 2002.
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 for the three and nine
months ended September 30, 2002 and the comparable 2001 periods is as follows:
12
T-NETIX, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AND SHARE AMOUNTS)
(UNAUDITED)
<Table>
<Caption>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------- -------------------
2002 2001 2002 2001
-------- -------- -------- --------
REVENUE FROM EXTERNAL CUSTOMERS:
Corrections Division ................................ $ 31,664 $ 24,034 $ 87,668 $ 70,121
Internet Services Division .......................... -- 7,377 -- 22,121
-------- -------- -------- --------
$ 31,664 $ 31,411 $ 87,668 $ 92,242
======== ======== ======== ========
RESEARCH AND DEVELOPMENT
Corrections Division ................................ $ 799 $ 992 $ 2,320 $ 3,601
Internet Services Division .......................... -- -- -- --
-------- -------- -------- --------
$ 799 $ 992 $ 2,320 $ 3,601
======== ======== ======== ========
DEPRECIATION AND AMORTIZATION
Corrections Division ................................ $ 3,267 $ 3,138 $ 8,678 $ 9,240
Internet Services Division .......................... -- -- -- --
-------- -------- -------- --------
$ 3,267 $ 3,138 $ 8,678 $ 9,240
======== ======== ======== ========
INTEREST AND OTHER EXPENSE
Corrections Division ................................ $ 897 $ 590 $ 1,823 $ 1,965
Internet Services Division .......................... -- -- -- --
-------- -------- -------- --------
$ 897 $ 590 $ 1,823 $ 1,965
======== ======== ======== ========
OPERATING INCOME (LOSS):
Corrections Division ................................ $ 1,413 $ 1,632 $ 5,131 1,376
Internet Services Division .......................... -- 1,805 -- 6,771
-------- -------- -------- --------
$ 1,413 $ 3,437 $ 5,131 $ 8,147
======== ======== ======== ========
SEGMENT EARNINGS (LOSS) FROM CONTINUING OPERATIONS
BEFORE INCOME TAX:
Corrections Division ................................ $ 516 $ 1,041 $ 3,344 $ (589)
Internet Services Division .......................... -- 1,806 -- 6,771
-------- -------- -------- --------
$ 516 $ 2,847 $ 3,344 $ 6,182
======== ======== ======== ========
</Table>
<Table>
<Caption>
SEPTEMBER 30, DECEMBER 31,
2002 2001
-------------- --------------
SEGMENT ASSETS:
Corrections Division .......... $ 66,267 $ 63,197
Internet Services Division .... -- --
-------------- --------------
$ 66,267 $ 63,197
============== ==============
</Table>
Substantially all revenue reported by our Internet Services Division for the
three and nine months ended September 30, 2001 was attributable to our GSP
agreement with Qwest which expired in November 2001. There was no intersegment
revenue for the three and nine months ending September 30, 2002 and the
comparable 2001 period. Consolidated total assets included eliminations of
approximately $0.7 million as of September 30, 2002. Eliminations consist of
intercompany receivables in the Corrections Division and intercompany payables
in the TELEQUIP Labs subsidiary related solely to intercompany borrowings.
(6) COMMITMENTS AND CONTINGENCY
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 adverse affect on our financial condition, liquidity,
or results of operations.
During 2000 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 certified and is still pending. 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 suit. In August 2002, the New Mexico State
Supreme Court affirmed the District Court's dismissal of the plaintiffs' case.
T-NETIX is a defendant in a 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 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 dismissed all claims with
prejudice against all defendants except T-NETIX and AT&T. Plaintiffs have
appealed the dismissal of the other defendants and T-NETIX has cross appealed.
The T-NETIX and AT&T claims have been referred to the Washington Utilities and
Transportation Commission while the trial court proceeding is in abeyance. The
Commission has not yet commenced any proceedings.
Gateway has been 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. Plaintiffs, a class of relatives of prisoners incarcerated in
Kentucky correctional facilities, sued the Commonwealth of Kentucky, the
Kentucky Department of Corrections, the state of Missouri, several municipal
entities in the states of Kentucky, Missouri, Arizona and Indiana and various
private telephone providers alleging antitrust violations and excessive rates
in connection with the provision of telephone services to inmates. The
plaintiffs alleged Sherman Act, Robinson-Patman Act, and Equal Protection
violations. 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 petition for injunctive relief,
despite these findings. Recently, the appeal brought by the Plaintiffs has been
dismissed and no further action has been taken.
In another case styled Robert E. Lee Jones, Jr. v. 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. This case was dismissed on all counts
in November 2001 and plaintiffs appealed. The dismissal was affirmed by the
Fourth Circuit in July 2002.
In October 2001, relatives of prisoners incarcerated in Oklahoma Department
of Correctional facilities filed a putative class action against T-NETIX, AT&T,
Evercom and the Oklahoma Department of Corrections for claims in anti-trust,
under due process, equal protection and the First Amendment. This case, styled
Kathy Lamon, et al v. Ron Ward, et al, was dismissed by the Plaintiffs in July
2002.
In September 2001, T-NETIX filed patent litigation against MCI WorldCom,
Inc. and Global Tel*Link Corporation. The lawsuit, filed in the Eastern
District of Texas, alleges infringement of six United States patents protecting
call processing equipment and services for the inmate calling industry. The
case is in its discovery stages. In July 2002, MCI WorldCom, Inc. filed a
Chapter XI bankruptcy proceeding that automatically stayed any further
proceeding against them. On August 7, 2002, T-NETIX subsequently filed its
motion to server MCI WorldCom from the patent litigation, which motion has not
yet been ruled on.
From September 1997 and through October 2001, pursuant to a written
agreement entered into in connection with settlement of an arbitration
proceeding, the Company was making monthly payments to a vendor of query
transport services with the understanding that the payments were for future
services to be utilized by the Company. The services to be provided by
Illuminet under the contract were in the nature of the transport of queries by
Illuminet to a certain database maintained by and available to Illuminet. In
order to utilize such transport the queries were to be directed from the
Company for connection to Illuminet utilizing certain technologies. Attempts
were continually made by the Company over the time period to complete
connectivity but connectivity was never accomplished. In November 2001, the
vendor (Illuminet, Inc.) notified the Company that no credits for such services
would be honored. In January 2002 Illuminet filed a claim before the original
arbitration panel in Fairway, Kansas requesting money damages for T-NETIX'
breach and declaratory relief that no credits are due T-NETIX. The Company has
made payments totaling approximately $2.1 million pursuant to this written
agreement. The payments are classified as a long-term prepayment included in
Intangible and Other Assets at September 30, 2002 (See Note 2 of "Notes to
Condensed Consolidated Financial Statements"). It is the contention of the
Company, in the arbitration proceeding, that the fault in the lack of
connectivity, be it the lack of proper technology, proper responsiveness on the
part of Illuminet, or otherwise, was that of Illuminet. The Company intends to
vigorously pursue its rights under the agreement. In the event the company is
not supported in the arbitration or any related litigation, the prepaid expense
of $2.1 million could be impaired. The arbitration hearing is currently set
for the week of December 9, 2002.
In August 2001, the U.S. Bankruptcy Court for the Central District of
California approved the sale of assets of OAN Services, Inc. ("OAN"), a Chapter
11 debtor and the primary billing agent of the Company. The Company and about 20
other customers received a portion of the proceeds. The sole objecting customer
appealed to the Bankruptcy Appellate Panel but it was dismissed as moot. In
December 2001, the Bankruptcy Court granted OAN's Summary Judgment Motion and
ruled against the objecting customer. In late August 2002, the United States
District Court reversed the summary judgment and remanded the case to the
Bankruptcy Court. The objecting customer has notified the other customers,
including the Company, that if it ultimately prevails, it intends to pursue
available claims against the bankruptcy estate and the customers receiving the
portion of the proceeds.
We believe the ultimate disposition of the foregoing matters will not have
a material affect on our financial condition, liquidity, or results of
operations.
(7) SUBSEQUENT EVENTS
In November 2002, the Company obtained new financing (the "New Credit
Facility"). Net proceeds of this New Credit Facility were utilized to repay in
full the existing Senior Secured Revolving Credit Facility (the "Credit
Facility") with its commercial bank and the Subordinated Note Payable (see Note
3 of "Notes to Condensed Consolidated Financial Statements"). The New Credit
Facility provides for maximum credit availability of $31.0 million, subject to
limitations based on certain financial covenants, and consists of a $14.0
million Senior Secured Term Loan, a $9.0 million Senior Subordinated Promissory
Note and a Revolving Credit Facility with an availability of up to $8.0 million.
The Senior Secured Term Loan bears interest at LIBOR plus 6.0%, with 16
equal quarterly principal installment payments thorough December 2006. Due in
2008, the Senior Subordinated Promissory Note bears interest at a fixed rate of
13%, payable on a quarterly basis, with an additional 4.75% of payment in kind
interest. In addition, the lender received warrants, which are immediately
exercisable, to purchase 186,792 shares of common stock at an exercise price of
$0.01 per share. The expiration date of these warrants is November 2010.
Availability under the Revolving Credit Facility is based on the lesser of
eligible accounts receivable or a calculated
13
T-NETIX, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AND SHARE AMOUNTS)
(UNAUDITED)
maximum leverage ratio. Interest on the Revolving Credit Facility is set at
prime plus 3.5% with a 0.75% annual commitment fee assessed on the unused
portion of this Facility.
The New Credit Facility is collateralized by substantially all of the assets
of the Company. Under the terms of the New Credit Facility, the Company is
required to maintain certain financial ratios and other financial covenants.
These ratios include a debt to four-quarter rolling earnings before interest,
taxes and depreciation and amortization (EBITDA) ratio, a ratio of EBITDA less
capital expenditures to fixed charges (interest, taxes and scheduled debt
service payments), and a minimum capitalization ratio. The Agreement also places
limits on the amount of additional indebtedness the Company can incur.
14
ITEM 2. 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 in the context of the
condensed 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-Q 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" in the Company's Form 10-K for the year
ended December 31, 2001 which may affect the potential technological
obsolescence of existing systems, the renewal of existing site specific
Corrections 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 of our existing telecommunications service provider
customers such as Verizon, AT&T and SBC Communications, to win new contracts for
our products and services to maintain their market share of the inmate calling
market, 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 in 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.
We make forward-looking statements in this report and may make such
statements in future filings with the Securities and Exchange Commission. We
also may make forward-looking statements in press releases or other public
communications. These forward-looking statements are subject to risks and
uncertainties and include information about our expectations and possible or
assumed future results of operations. When we use any of the words "believe",
"expect", "anticipate", "estimate" or similar expressions, we are making a
forward-looking statement. While we believe that forward-looking statements are
reasonable, you should not place undue reliance in such forward-looking
statements, which speak only as of the date made.
Other factors not currently anticipated by management may also materially
and adversely affect our results of operations. Except as required by applicable
law, we do not undertake any obligation to publicly release any revisions which
may be made to any forward-looking statements to reflect events or circumstances
occurring after the date of this report.
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
(generally, three to five years) with our telecommunications service provider
customers including Verizon, AT&T, SBC Communications, Qwest and Sprint. Here,
we provide the equipment, security enhanced call processing, call validation,
and service and support through the provider, rather than directly to the
facility. The provider does the billing. We are paid a prescribed fee by our
telecommunications services providers for each call completed. We receive
additional fees for validating the phone numbers dialed by inmates.
Our Corrections Division also provides our inmate calling services directly
as a telecommunications provider to correctional facilities, or "Direct
Customers". In a typical arrangement, we operate under site-specific contracts,
generally for a period of two to three years. We provide the equipment, security
enhanced call processing, call validation, and customer service and support
directly to the facility. We then use the services of third parties to bill the
calls on the called party's local exchange carrier bill. Direct call
provisioning revenue is substantially higher than the percentage of revenue or
transaction based pricing compensation associated with telecommunications
services because the Company receives the entire retail value of the collect
call. Due to commissions and other operating costs, including uncollectible
costs, the gross margin percentage from this model is lower than our
telecommunication service arrangements.
15
Under the direct call-provisioning model, the Company provides
inmate-calling services directly to a correctional facility as a certificated
telecommunications provider. In a typical arrangement, the Company operates
under site-specific contracts with terms of generally two to three years. After
the initial term of the contract, the correctional facility may choose to renew
the contract with the existing provider or initiate a formal competitive bid
process. The telecommunications industry, particularly the inmate calling
market, is and can be expected to remain highly competitive. While the Company
has historically maintained a high rate of retention of existing inmate calling
service contracts, the Company may not be able to compete effectively with our
current or future competitors for these contracts, which would have a material
adverse effect on our business, operating results, and financial condition.
Equipment sales and other revenue include the sales of our inmate calling
system (primarily the systems of our wholly owned subsidiary, TELEQUIP Labs,
Inc.) and digital recording systems. Currently, sales of inmate calling systems
are generally made by TELEQUIP to a limited number of telecommunication service
provider customers.
INTERNET SERVICES DIVISION
In December 1999, the Company entered into a master service agreement with
US WEST ENTERPRISE (now named Qwest America, Inc.) (The "Qwest Agreement") to
provide interLATA Internet services to Qwest customers. The Qwest Agreement,
which commenced December 1, 1999, called for us to buy, resell and process
billing of Internet bandwidth to these customers. The initial term of the Qwest
Agreement was for a minimum of sixteen months until March 2001. Although the
Qwest Agreement expired on March 2001, we continued providing services under the
Qwest Agreement through October 2001. Effective November 2001, substantially all
services and associated revenue under this agreement had ceased. The Company may
incur additional costs in connection with the termination of the business of
this Internet service division.
Factors affecting margin include a negotiated base management fee and
contract incentive payments based on cost savings. The costs associated with
this contract are primarily the costs for Internet bandwidth. There were no
capital outlays required to begin provisioning these services.
SPEAKER VERIFICATION DIVISION
The Company formerly reported a third business segment, the SpeakEZ Speaker
Verification division. The SpeakEZ Voice Print technology is proprietary
software that compares the speech pattern of a current speaker with a stored
digital voiceprint of the authorized person to confirm or reject claimed
identity. In August 2001, management of T-NETIX made the decision to curtail
operations of this portion of the Company in order to enhance overall Company
performance by reducing the negative impact of SpeakEZ operations on both the
net earnings and cash flow. SpeakEZ assets were sold in July 2002 and the
Company retained a license to use the technology in its corrections business.
Pursuant to this strategy and due to the subsequent sale of the assets, related
operating results of our SpeakEZ voice verification division have been recorded
as discontinued operations in the consolidated financial statements. See Note 4
of "Notes to Condensed Consolidated Financial Statements".
16
RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2002 COMPARED TO
SEPTEMBER 30, 2001
The following table sets forth certain statement of operations data as a
percentage of total revenue for the three months ended September 30, 2002 and
2001.
<Table>
<Caption>
2002 2001
---- ----
Revenue:
Telecommunications services .............................. 45% 49%
Direct call provisioning ................................. 40 22
Internet services ........................................ -- 23
Equipment sales and other ................................ 15 6
---- ----
Total revenue ........................................... 100 100
Expenses:
Operating costs .......................................... 61 57
Selling, general and administrative ...................... 22 19
Research and development ................................. 2 3
Depreciation and amortization ............................ 10 10
---- ----
Operating income ........................................ 5 11
Interest and other expense ............................... 3 2
---- ----
Income from continuing operations before income taxes ... 2 9
Income tax expense ....................................... -- --
---- ----
Net income from continuing operations ................... 2 9
Loss from discontinued operations ........................ -- 2
---- ----
Net Income (loss) applicable to common stock ............ 2% 7%
==== ====
</Table>
Total Revenue. Total revenue for the three months ended September 30, 2002
was $31.7 million, an increase of 1% from $31.4 million for the corresponding
2001 period. This increase was attributable to increases in direct provisioning
of $6.0 million and equipment sales and other of $3.0 million offset in part by
decreases in Internet services of $7.4 million and telecommunications services
of $1.3 million,. The decline in revenues from the Internet services segment was
the result of the expiration of the Qwest Agreement in 2001. Effective November
2001, operations of this single purpose division had substantially ceased,
including those under the Qwest Agreement.
Telecommunications services revenue decreased 8% to $14.2 million for the
three months ended September 30, 2002 from $15.5 million for the corresponding
prior period. This decrease was primarily due to a one-time software upgrade
service performed in the 2001 period and the transition of a department of
corrections contract in 2002 to a direct call provisioning basis.
Direct call provisioning revenue increased 89% to $12.7 million for the
three months ended September 30, 2002 from $6.8 million in the corresponding
prior period. This increase was primarily due to the recent awarding of several
department of corrections contracts for which the Company is provisioning call
processing services. The addition of these sites is a result of the Company's
success in competitive bidding arrangements for contracts directly with
correctional facilities.
Equipment sales and other revenue increased 169% to $4.7 million for the
three month period ended September 30, 2002 from $1.7 million in the
corresponding prior period. This increase was largely attributable to the
finalization of certain financial aspects associated with the Qwest Agreement in
2002. Equipment sales of TELEQUIP Labs, Inc., an inmate equipment provider, also
increased in the 2002 period. Equipment sales of TELEQUIP are primarily
associated with a single telecommunication service provider and revenue
associated with such sales are dependent upon the timing of sales and
installations for this customer.
Operating costs. Total operating costs increased 9% to $19.3 million for the
three months ended September 30, 2002 from $17.8 million in the corresponding
prior period. This increase was primarily due to an increase in direct call
provisioning expenses of $5.6 million, cost of equipment sold and other of $0.5
million and telecommunication services of $1.1 million offset partially by a
decrease in Internet services of $5.6 million. The decline in operating costs
for the Internet services segment was the result of the expiration of the Qwest
Agreement in 2001. Effective November 2001, operations of this single purpose
division had substantially ceased, including those under the Qwest Agreement.
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 expenses. Operating costs of telecommunications services also
includes costs associated with call validation procedures, primarily network
17
expenses and database access charges. Operating costs associated with direct
call provisioning also 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 costs 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 three months
ended September 30, 2002 and 2001.
<Table>
<Caption>
2002 2001
---- ----
Operating costs and expenses:
Telecommunications services .......... 44% 34%
Direct call provisioning ............. 95 96
Internet services .................... -- 76
Cost of equipment sold and other ..... 20 27
</Table>
Operating costs associated with providing telecommunications services, as a
percentage of corresponding revenue, were 44% for the three months ended
September 30, 2002, an increase from 34% for the comparable 2001 period. Total
telecommunications services operating costs were $6.3 million for the three
months ended September 30, 2002 and $5.2 million for the corresponding prior
period. The increase in operating costs and costs as a percentage of applicable
revenue in 2002 was due to increased repairs and maintenance and personnel
costs, offset partially by lower communication expenses.
Direct call provisioning costs, as a percentage of corresponding revenue,
were 95% of revenue for the three months ended September 30, 2002, a decrease
from 96% in 2001. Due to the awarding of several department of correction
contracts, total direct call provisioning operating costs increased to $12.1
million for the three months ended September 30, 2002, compared to $6.5 million
for the corresponding prior period. This decrease in costs as a percentage of
applicable revenue was due primarily to lower communication expenses, offset
partially by a proportional increase in commission and bad debt expenses
associated with the increase in direct call provisioning revenue. Bad debt
expense increased primarily due to a greater volume of calls being processed to
Competitive Local Exchange Carriers ("CLEC") where the Company does not have
billing arrangements. The Company, beginning in the first quarter of 2002,
modified its call handling processes to block certain of these CLEC calls,
thereby reducing its unbillable call volume.
Cost of equipment sold and other as a percentage of corresponding revenue
was 20% of revenue for the three months ended September 30, 2002, a decrease
from 27% in 2001. Due to increased equipment sales of TELEQUIP Labs, Inc., total
costs of equipment sold and other were $0.9 million for the three months ended
September 30, 2002 compared to $0.5 million for the corresponding 2001 period.
The decrease in costs as a percentage of applicable revenue was primarily due to
the favorable impact of the settlement of certain claims and liabilities
associated with the Qwest Agreement in 2002.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses were $6.9 million and $6.1 million for the three months
ended September 30, 2002 and 2001, respectively. The increase in 2002 was
primarily due to increased contract labor, professional consulting fees and
legal fees, offset partially by a deduction of an expense associated with the
2002 executive incentive compensation plan.
Research and Development Expenses. Research and development expenses were
$0.8 million and $1.0 million for the three months ended September 30, 2002 and
2001, respectively.
Depreciation and Amortization Expenses. Depreciation and amortization
expense was $3.3 million for the three months ended September 30, 2002, an
increase from $3.1 million for the comparable 2001 period. Depreciation expense
for the three months ended September 30, 2002 totaled $3.0 million and compared
to $2.5 million in 2001. The increase was due to increased capital spending
associated with system upgrades during 2002. Amortization expense declined to
$0.3 million in the three months ended September 30, 2002 versus $0.6 million
for the corresponding 2001 period. This decrease in amortization expense was
primarily due to the impairment charge in 2001 related to the Contain(R) and
Lock&Track(TM) jail management system products and to the adoption of SFAS 142,
"Goodwill and Other Intangible Assets" in 2002.
Interest and Other Expenses. Interest and other expense was $0.9 million for
the three months ended September 30, 2002 compared to $0.6 million for the
corresponding prior period. The increase in 2002 was attributable to fees
associated with the extension of our Credit Facility in April 2002, offset
partially by a decrease in the average amount of indebtedness outstanding and
lower applicable interest rates. The average debt balance decreased primarily
due to the pay down of debt as the result of improved
18
operating results. Other Expenses for the three months ended September 30, 2002
also included $0.2 million loss related to the writedown of an investment.
RESULTS OF OPERATIONS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2002 COMPARED TO
SEPTEMBER 30, 2001
The following table sets forth certain statement of operations data as a
percentage of total revenue for the nine months ended September 30, 2002 and
2001.
<Table>
<Caption>
2002 2001
---- ----
Revenue:
Telecommunications services ........................................ 51% 51%
Direct call provisioning ........................................... 40 21
Internet services .................................................. -- 24
Equipment sales and other .......................................... 9 4
---- ----
Total revenue ..................................................... 100 100
Expenses:
Operating costs .................................................... 60 58
Selling, general and administrative ................................ 21 19
Research and development ........................................... 3 4
Depreciation and amortization ...................................... 10 10
---- ----
Operating income .................................................. 6 9
Interest and other expense ......................................... 2 2
---- ----
Income from continuing operations before income taxes ............. 4 7
Income tax expense ................................................. -- --
---- ----
Net income from continuing operations ............................. 4 7
Loss from discontinued operations .................................. 1 2
Accretion of discount as redeemable convertible preferred stock .... -- 2
---- ----
Net Income (loss) applicable to common stock ...................... 3% 3%
==== ====
</Table>
Total Revenue. Total revenue for 2002 was $87.7 million, a decrease of 5%
from $92.2 million for the corresponding 2001 period. This decrease was
attributable to decreases in Internet services of $22.1 million and
telecommunications services of $2.1 million, offset in part by increases in
direct provisioning of $15.1 million and equipment sales and other of $4.5
million. The decline in revenues from the Internet services segment was the
result of the expiration of the Qwest Agreement in 2001. Effective November
2001, all services of this single purpose division had substantially ceased,
including those under the Qwest Agreement.
Telecommunications services revenue decreased 5% to $44.6 million for the
nine months ended September 30, 2002 from $46.7 million for the corresponding
prior period. This decrease was primarily due to a decline in call volumes and
the transition of certain department of corrections contract to a direct call
provisioning basis.
Direct call provisioning revenue increased 76% to $35.0 million for the nine
months ended September 30, 2002 from $19.8 million in the corresponding prior
period. This increase was primarily due to the recent awarding of several
department of corrections contracts for which the Company is provisioning call
processing services. The addition of these sites is a result of our being
successful in providing competitive bidding arrangements for contracts directly
with correctional facilities.
Equipment sales and other revenue increased 126% to $8.1 million for the
nine month period ended September 30, 2002 from $3.6 million in the
corresponding prior period. This increase was largely attributable to increased
equipment sales of TELEQUIP Labs, Inc., an inmate equipment provider. Sales of
equipment at TELEQUIP are primarily associated with a single telecommunication
service provider and revenue associated with such sales are dependent upon the
timing of sales and installations for this customer. In addition, 2002 results
include the finalization of certain financial aspects associated with the Qwest
Agreement.
Operating costs. Total operating costs decreased 1% to $52.7 million for the
nine months ended September 30, 2002 from $53.4 million in the corresponding
prior period. The decrease was primarily due to decreases in Internet services
of $15.4 million and telecommunication services of $1.3 million, offset
partially by an increase in direct call provisioning expenses of $15.0 million
and the cost of equipment sold of $1.0 million. The decline in operating costs
for the Internet services segment was the result of the expiration of the Qwest
Agreement in 2001. Effective November 2001, substantially all services of this
single purpose division had substantially ceased, including those under the
Qwest Agreement.
19
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 expenses. Operating costs of telecommunications services also
includes costs associated with call validation procedures, primarily network
expenses and database access charges. Operating costs associated with direct
call provisioning also 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 costs 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 nine months
ended September 30, 2002 and 2001.
<Table>
<Caption>
2002 2001
---- ----
Operating costs and expenses:
Telecommunications services .......... 38% 39%
Direct call provisioning ............. 95 92
Internet services .................... -- 69
Cost of equipment sold and other ..... 31 44
</Table>
Operating costs associated with providing telecommunications services, as a
percentage of corresponding revenue, was 38% for the nine months ended September
30, 2002, a decrease from 39% for the comparable 2001 period. Total
telecommunications services operating costs were $17.0 million for the nine
months ended September 30, 2002 and $18.3 million for the corresponding prior
period. The decrease in 2002 was primarily due to reductions in personnel costs
and lower contract labor, call validation fees, travel and communications
expenses, partially offset by increased repairs and maintenance costs.
Direct call provisioning costs, as a percentage of applicable revenue, were
95% of revenue for the nine months ended September 30, 2002 compared to 92% in
the comparable 2001 period. Due to the awarding of several department of
correction contracts, total direct call provisioning operating costs increased
to $33.2 million for the nine months ended September 30, 2002 from $18.2 million
for the corresponding 2001 period. This increase in costs as a percentage of
applicable revenue was due primarily to a proportional increase in bad debt
expense and commission expenses associated with the increase in direct call
provisioning revenue. Bad debt expense increased primarily due to a greater
volume of calls being processed to Competitive Local Exchange Carriers ("CLEC")
where the Company does not have billing arrangements. The Company, beginning in
the first quarter of 2002, modified its call handling processes to block certain
of these CLEC calls, thereby reducing its unbillable call volume.
Cost of equipment sold and other as a percentage of applicable revenue
decreased to 31% of revenue for the nine months ended September 30, 2002 from
44% for the corresponding prior period. Due to increased equipment sales of
TELEQUIP Labs, Inc., total costs of equipment sold and other were $2.5 million
for the nine months ended September 30, 2002 compared to $1.6 million for the
corresponding 2001 period. The decrease in costs as a percentage of applicable
revenue was primarily due to the favorable impact of the settlement of certain
claims and liabilities associated with the Qwest Agreement in 2002.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses were $18.8 million and $17.9 million for the nine months
ended September 30, 2002 and 2001, respectively. This increase was primarily due
to increases in personnel costs, professional services fees and legal fees,
offset partially by a deduction of an expense associated with the 2002 executive
incentive compensation plan.
Research and Development Expenses. Research and development expenses were
$2.3 million in the nine months ended September 30, 2002 compared to $3.6
million for the corresponding prior period. This decrease was primarily due to
reductions in personnel and contract labor expense in 2002, as compared to 2001
levels.
Depreciation and Amortization Expenses. Depreciation and amortization
expense was $8.7 million for the nine months ended September 30, 2002, a
decrease from $9.2 million for the comparable 2001 period. Depreciation expense
increased to $7.9 million in the nine months ended September 30, 2002 compared
to $7.7 million in 2001. Amortization expense declined to $0.8 million in the
nine months ended September 30, 2002 versus $1.5 million for the corresponding
2001 period. This decrease in amortization expense was primarily due to the
impairment charge in 2001 related to the Contain(R) and Lock & Track(TM) jail
management system products and to the adoption of SFAS 142, "Goodwill and Other
Intangible Assets" in 2002.
20
Interest and Other Expenses. Interest and other expense was $1.8 million for
the nine months ended September 30, 2002 compared to $2.0 million for the
corresponding prior period. The decrease in 2002 was attributable to a decrease
in the average amount of indebtedness outstanding and lower applicable interest
rates, offset partially by fees associated with the extension of the Company's
Credit Facility in April 2002. The average debt balance decreased primarily due
to the pay down of debt as the result of improved operating results. Other
Expenses for the nine months ended September 30, 2002 included a $0.2 million
loss related to the writedown of an investment.
LIQUIDITY AND CAPITAL RESOURCES
Cash Flows
The Company has historically relied upon operating cash flow, debt financing
and the sale of equity securities to fund operations and capital needs. Our
capital needs consist primarily of additions to property and equipment for site
telecommunication equipment, upgrades to existing systems and to fund
acquisitions.
Cash provided by continuing operations was $6.6 million for the nine months
ended September 30, 2002 compared to $12.1 million in the corresponding 2001
period. This decrease was primarily due to a $1.9 million increase in net
working capital, combined with a $2.7 million decline in net income from
continuing operations and a $0.6 million decline in depreciation and
amortization expense.
Net cash used in investing activity of continuing operations was $4.7
million for the nine months ended September 30, 2002 compared to $6.3 million in
the corresponding 2001 period. This decrease was primarily due to the
acquisition of TELEQUIP Labs, Inc. in 2001 for $1.7 million. Cash used in
investing activities consisted primarily of purchases of property and equipment
of $5.0 million for the nine month period ended September 30, 2002 compared to
$4.2 million for the corresponding 2001 period. As part of the Company's
on-going effort to dispose of underperforming assets, we completed the sale of
assets associated with our Lock & Track(TM) jail management system product and
the SpeakEZ speaker verification assets for $0.6 million during 2002.
We anticipate that our capital expenditures in 2002 will exceed 2001 levels
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, upgrades of existing
systems, and to finance our operations for at least the next twelve months.
Cash used in financing activities of continuing operations consisted
primarily of net payments on the Company's Credit Facility of $1.8 million
during the nine months ended September 30, 2002 compared to net payments of $3.9
million in the corresponding 2001 period.
Capital Resources
In September 1999, the Company entered into a Senior Secured Revolving
Credit Facility (the "Credit Facility") with its commercial bank. The Credit
Facility provided for maximum credit of $40.0 million subject to limitations
based on certain financial covenants. In April 2001, the Company's lenders
extended the maturity date on its credit agreement to March 2002. The maximum
available borrowings on the Credit Facility was reduced to $30.0 million and
interest was set at prime rate plus 1.25% effective June 30, 2001 increasing by
0.25% each quarter thereafter on June 30, September 30 and December 31, 2001. In
addition, monthly payments of $0.2 million on the term loan commenced in April
2001. In March 2002, the maturity date of the Credit Facility was extended to
June 26, 2002. Effective with the March 2002 extension, the maximum available
borrowings on the Credit Facility was reduced to $21.8 million and interest was
set at prime plus 2.25% (7.0% at September 30, 2002). The Company also pays a
fee of 0.40% per annum on the unused portion of the line of credit.
In April 2002, the Company obtained a further commitment from its lenders to
extend, at the option of the Company, the Credit Facility beyond June 26, 2002
to January 2003. Effective June 2002, the Company elected to extend the existing
Credit Facility and paid an option exercise fee to its lenders equal to 3.0% of
the maximum available borrowing on the Credit Facility. To facilitate the
refinancing of the Credit Facility, the Company has retained J.P. Morgan
Securities, Inc. to explore and advise us on various financing opportunities and
strategies. Under the terms of the April 2002 extension, the maximum available
borrowings on the Credit Facility was reduced to $18.7 million, consisting of a
$7.2 million term portion and an $11.5 million line of credit. Further, maximum
available borrowing under the line of credit will be reduced by $0.3 million per
month beginning in August 2002 and monthly
21
payments of $0.2 million on the term loan will continue through the maturity
date. The Company believes it is in compliance with all debt covenants.
In June 2002, the Company elected to extend its existing Credit Facility to
January 3, 2003. As of September 30, 2002, the Company had a total of $20.7
million of total indebtedness, including approximately $16.7 million in senior
indebtedness outstanding under this Credit Facility. To facilitate the
refinancing of this Credit Facility, the Company has retained J.P. Morgan
Securities Inc. to explore and advise us on various financing opportunities and
strategies in the private placement market. Our ability to refinance our
existing Credit Facility is dependent on many factors, including our future
financial and operational performance and the general state of the US economy
and capital markets. The Company cannot provide any assurance that new financing
can be obtained, that our existing indebtedness can be refinanced when required,
or that satisfactory terms of any refinancing would be available. If we were not
able to obtain new financing or refinance our indebtedness under these
circumstances, the Company would have to consider other options, such as: sale
of some assets; sales of equity; negotiations with other lenders to restructure
applicable indebtedness; or other options available to us under applicable laws.
In April 2000, the Company 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, 500 shares of the preferred stock were converted into
250,630 shares of common stock at a conversion price of $2.09 per share. 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 unamortized discount on the preferred stock of $1.1 million was recognized
as a charge to income (loss) applicable to common stockholders.
The Company also 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 (5.75% at September
30, 2002) which is payable every six months. The lender 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. This note was
extended in April 2001 to April 30, 2002, at which time the lender received
additional warrants, which are immediately exercisable, to purchase 25,000
shares of common stock at an exercise price of $2.75 per share for a period of
five years. In March 2002, this note was extended to July 30, 2002. In April
2002 this note was further extended to February 2003 to facilitate the
refinancing of our overall financing structure. Warrants to purchase 25,000
shares of common stock at an exercise price of $2.75 per share have been issued
to the lender on terms similar to previous warrants; however, shares will vest
proportionately over the term of the note extension.
CONTRACTUAL OBLIGATIONS AND COMMITMENTS
Set forth below is a summary of the Company's material contractual
obligations and commitments as of September 30, 2002:
<Table>
<Caption>
DUE IN ONE DUE IN DUE IN DUE AFTER
YEAR OR LESS 2-3 YEARS 4-5 YEARS 5 YEARS TOTAL
------------ --------- --------- --------- ---------
($ IN THOUSANDS)
Bank credit facility ............................. $ 16,359 $ -- $ -- -- $ 16,359
Subordinated note payable ........................ 3,750 -- -- -- 3,750
Operating leases ................................. 836 790 237 -- 1,863
Capital lease and other .......................... 519 90 -- -- 609
------------ --------- --------- --------- ---------
Total contractual obligations and commitments .... $ 21,464 $ 880 $ 237 -- $ 22,581
============ ========= ========= ========= =========
</Table>
Under the Company's existing Credit Facility, acceleration of principal
payments would occur upon payment default, violation of debt covenants not cured
within 30 days or breach of certain other conditions set forth in this Credit
Facility. Subject to certain subordination terms, the subordinated note payable
is subject to the same conditions of the Company's Credit Facility through cross
default provisions. At September 30, 2002, the Company was in compliance with
all of its debt covenants. There are no provisions within the Company's leasing
arrangements that would trigger acceleration of future lease payments. (See Note
3 of "Notes to Condensed Consolidated Financial Statements").
The Company does not use securitization of trade receivables, affiliation
with special purpose entities or synthetic leases to finance its operations.
Additionally, the Company has not entered into any arrangement requiring the
Company to guarantee payment of third party debt or to fund losses of an
unconsolidated special purpose entity.
22
ITEM 3. 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 the Credit Facility of $16.7 million
at September 30, 2002. Under the terms of the debt agreement the maximum credit
available at September 30, 2002 is $17.5 million. The loan bears interest at
prime rate plus 2.25% (7.0% at September 30, 2002) with interest payable
monthly. Since the interest rate on the loan outstanding is variable and is
reset periodically, we are exposed to interest risk. An increase in interest
rates of 1% would increase estimated annual interest expense by approximately
$0.2 million based on the amount of borrowings outstanding under the Credit
Facility at September 30, 2002.
ITEM 4. CONTROLS AND PROCEDURES
Within the 90-day period prior to the filing of this report, an evaluation
was performed under the supervision and with the participation of our
management, including the Chief Executive Officer ("CEO") and Chief Financial
Officer ("CFO"), of the effectiveness of the design and operation of our
disclosure controls and procedures (as defined in Rule 13a-14(c) under the
Securities Exchange Act of 1934).
Based on that evaluation, our management, including the CEO and CFO,
concluded that our disclosure controls and procedures were effective. There have
been no significant changes in our internal controls or in other factors that
could significantly affect these controls subsequent to the date of their
evaluation.
23
PART II
OTHER INFORMATION
ITEM 1. 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 adverse affect on our financial condition, liquidity,
or results of operations.
During 2000 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 certified and is still pending. 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 suit. In August 2002, the New Mexico State Supreme Court affirmed the
District Court's dismissal of the plaintiffs' case.
T-NETIX is a defendant in a 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 dismissed all claims with prejudice against
all defendants except T-NETIX and AT&T. Plaintiffs have appealed the dismissal
of the other defendants and T-NETIX has cross appealed. The T-NETIX and AT&T
claims have been referred to the Washington Utilities and Transportation
Commission while the trial court proceeding is in abeyance. The Commission has
not yet commenced any proceedings.
Gateway has been 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. Plaintiffs, a class of relatives of prisoners incarcerated in
Kentucky correctional facilities, sued the Commonwealth of Kentucky, the
Kentucky Department of Corrections, the state of Missouri, several municipal
entities in the states of Kentucky, Missouri, Arizona and Indiana and various
private telephone providers alleging antitrust violations and excessive rates in
connection with the provision of telephone services to inmates. The plaintiffs
alleged Sherman Act, Robinson-Patman Act, and Equal Protection violations. 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 petition for injunctive relief, despite these
findings. Recently, the appeal brought by the Plaintiffs has been dismissed and
no further action has been taken.
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. This case was dismissed on all counts in
November 2001 and plaintiffs appealed. The dismissal was affirmed by the Fourth
Circuit in July 2002.
In October 2001, relatives of prisoners incarcerated in Oklahoma Department
of Correctional facilities filed a putative class action against T-NETIX, AT&T,
Evercom and the Oklahoma Department of Corrections for claims in anti-trust,
under due process, equal protection and the First Amendment. This case, styled
Kathy Lamon, et al v. Ron Ward, et al, was dismissed by the Plaintiffs in July
2002.
24
In September 2001, T-NETIX filed patent litigation against MCI WorldCom,
Inc. and Global Tel*Link Corporation. The lawsuit, filed in the Eastern District
of Texas, alleges infringement of six United States patents protecting call
processing equipment and services for the inmate calling industry. The case is
in its discovery stages. In July 2002, MCI WorldCom, Inc. filed a Chapter XI
bankruptcy proceeding that automatically stayed any further proceeding against
them. On August 7, 2002, T-NETIX subsequently filed its motion to sever MCI
WorldCom from the patent litigation, which motion has not yet been ruled on.
From September 1997 and through October 2001, pursuant to a written
agreement entered into in connection with settlement of an arbitration
proceeding, the Company was making monthly payments to a vendor of query
transport services with the understanding that the payments were for future
services to be utilized by the Company. The services to be provided by Illuminet
under the contract were in the nature of the transport of queries by Illuminet
to a certain database maintained by and available to Illuminet. In order to
utilize such transport the queries were to be directed from the Company for
connection to Illuminet utilizing certain technologies. Attempts were
continually made by the Company over the time period to complete connectivity
but connectivity was never accomplished. In November 2001, the vendor
(Illuminet, Inc.) notified the Company that no credits for such services would
be honored. In January 2002 Illuminet filed a claim before the original
arbitration panel in Fairway, Kansas requesting money damages for T-NETIX'
breach and declaratory relief that no credits are due T-NETIX. The Company has
made payments totaling approximately $2.1 million pursuant to this written
agreement. The payments are classified as a long-term prepayment included in
Intangible and Other Assets at September 30, 2002 (See Note 2 of "Notes to
Condensed Consolidated Financial Statements"). It is the contention of the
Company, in the arbitration proceeding, that the fault in the lack of
connectivity, be it the lack of proper technology, proper responsiveness on the
part of Illuminet, or otherwise, was that of Illuminet. The Company intends to
vigorously pursue its rights under the agreement. In the event the Company is
not supported in the arbitration or any related litigation, the prepaid expense
of $2.1 million could be impaired. The arbitration hearing is currently set for
the week of December 9, 2002.
In August 2001, the U.S. Bankruptcy Court for the Central District of
California approved the sale of assets of OAN Services, Inc. ("OAN"), a Chapter
11 debtor and the primary billing agent of the Company. The Company and about 20
other customers received a portion of the proceeds. The sole objecting customer
appealed to the Bankruptcy Appellate Panel but it was dismissed as moot. In
December 2001, the Bankruptcy Court granted OAN's Summary Judgment Motion and
ruled against the objecting customer. In late August 2002, the United States
District Court reversed the summary judgment and remanded the case to the
Bankruptcy Court. The objecting customer has notified the other customers,
including the Company, that if it ultimately prevails, it intends to pursue
available claims against the bankruptcy estate and the customers receiving the
portion of the proceeds.
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 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
None.
25
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
T-NETIX, INC.
By: /s/ THOMAS E. LARKIN
-------------------------
Thomas E. Larkin,
Chief Executive Officer
By: /s/ HENRY G. SCHOPFER
-------------------------
Henry G. Schopfer,
Chief Financial Officer
Date: November 14, 2002
26
CERTIFICATION
I, Thomas E. Larkin, certify that:
1. I have reviewed this quarterly report on Form 10-Q of T-NETIX, Inc.
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of and for the periods presented in this
quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly report
is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of the registrant's board of directors:
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal control; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officer and I have indicated in this
quarterly report whether or not there were significant changes in internal
control or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
Dated: November 14, 2002
By: /s/ THOMAS E. LARKIN
-------------------------
Thomas E. Larkin
Chief Executive Officer
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CERTIFICATION
I, Henry G. Schopfer, certify that:
1. I have reviewed this quarterly report on Form 10-Q of T-NETIX, Inc.
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of and for the periods presented in this
quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly report
is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of the registrant's board of directors:
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal control; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officer and I have indicated in this
quarterly report whether or not there were significant changes in internal
control or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
Dated: November 14, 2002
By: /s/ HENRY G. SCHOPFER
-----------------------
Henry G. Schopfer
Chief Financial Officer
28