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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 June 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 August 4, 2002
- -------------------------------- -----------------------------
Common stock, $0.01 stated value 15,032,368
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FORM 10-Q CROSS REFERENCE INDEX
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.......................................... 14
Item 3 Quantitative and Qualitative Disclosure About Market Risk.......... 21
PART II OTHER INFORMATION
Item 1 Legal Proceedings.................................................. 22
Item 2 Changes in Securities and Use of Proceeds.......................... 23
Item 3 Defaults Upon Senior Securities.................................... 23
Item 4 Submission of Matters to a Vote of Security Holders................ 23
Item 5 Other Information.................................................. 23
Item 6 Exhibits and Reports on Form 8-K................................... 23
2
PART I
Item 1. Financial Statements
INDEX TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Condensed Consolidated Balance Sheets as of June 30, 2002 and December
31, 2001 (Unaudited) ................................................... 4
Condensed Consolidated Statements of Operations for the Three and Six
Months Ended June 30, 2002 and 2001 (Unaudited) ........................ 5
Condensed Consolidated Statements of Cash Flows for the Six Months
Ended June 30, 2002 and 2001 (Unaudited) ............................... 6
Notes to Condensed Consolidated Financial Statements (Unaudited) ............ 7
3
T-NETIX, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Amounts in Thousands, Except Per Share and Share Amounts)
(Unaudited)
June 30, December 31,
2002 2001
---------- ----------
ASSETS
Cash and cash equivalents ........................................................ $ 385 $ 995
Accounts receivable, net (note 2) ................................................ 20,725 18,030
Prepaid expenses ................................................................. 2,300 1,232
Inventories ...................................................................... 1,195 705
---------- ----------
Total current assets ................................................... 24,605 20,962
Property and equipment, net (note 2) ............................................. 28,921 30,217
Goodwill, net .................................................................... 2,393 2,245
Deferred tax asset ............................................................... 2,297 2,297
Intangible and other assets, net (note 2) ........................................ 7,300 7,476
---------- ----------
Total assets ........................................................... $ 65,516 $ 63,197
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Accounts payable ............................................................. $ 11,957 $ 10,795
Accrued liabilities (note 2) ................................................. 7,323 5,089
Subordinated note payable (note 3) ........................................... 3,750 3,750
Current portion of long-term debt (note 3) ................................... 15,231 18,436
---------- ----------
Total current liabilities .............................................. 38,261 38,070
Long-term debt (note 3) ...................................................... 132 218
---------- ----------
Total liabilities ...................................................... 38,393 38,288
Stockholders' equity:
Preferred stock, $.01 stated value, 10,000,000 shares authorized; no shares
issued or outstanding at June 30, 2002 and December 31, 2001, respectively -- --
Common stock, $.01 stated value, 70,000,000 shares authorized; 15,032,638
shares issued and outstanding at June 30, 2002 and December 31, 2001 ..... 150 150
Additional paid-in capital ................................................... 41,831 41,831
Accumulated deficit .......................................................... (14,858) (17,072)
---------- ----------
Total stockholders' equity
27,123 24,909
---------- ----------
Total liabilities and stockholders' equity ....................................... $ 65,516 $ 63,197
========== ==========
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)
Three Months Ended Six Months Ended
June 30, June 30,
-------------------------- --------------------------
2002 2001 2002 2001
-------- -------- -------- --------
Revenue:
Telecommunication services .............................. $ 15,105 $ 15,553 $ 30,369 $ 31,169
Direct call provisioning ................................ 14,001 6,601 22,218 13,081
Internet services ....................................... -- 7,893 -- 14,744
Equipment sales and other ............................... 2,440 1,780 3,417 1,838
-------- -------- -------- --------
Total revenue ..................................... 31,546 31,827 56,004 60,832
Operating Costs and Expenses:
Operating costs
Telecommunications services ........................... 5,349 6,530 10,833 13,065
Direct call provisioning .............................. 13,620 5,811 21,082 11,689
Internet services ..................................... -- 4,863 -- 9,779
Cost of equipment sold and other ...................... 1,061 1,049 1,593 1,090
-------- -------- -------- --------
Total operating costs ............................. 20,030 18,253 33,508 35,623
Selling, general and administrative ..................... 6,232 6,069 11,936 11,787
Research and development ................................ 730 1,394 1,430 2,609
Depreciation and amortization ........................... 2,755 3,155 5,412 6,102
-------- -------- -------- --------
Total operating costs and expenses ................ 29,747 28,871 52,286 56,121
-------- -------- -------- --------
Operating income .................................. 1,799 2,956 3,718 4,711
Interest and other expenses, net ........................... 584 666 890 1,376
-------- -------- -------- --------
Income from continuing operations
before income taxes ..................................... 1,215 2,290 2,828 3,335
Income tax expense ......................................... 45 222 180 222
-------- -------- -------- --------
Net income from continuing operations ................... 1,170 2,068 2,648 3,113
Loss from discontinued operations .......................... (85) (692) (433) (1,370)
-------- -------- -------- --------
Net income before accretion of discount on
redeemable convertible preferred stock .................. 1,085 1,376 2,215 1,743
Accretion of discount on redeemable
convertible preferred stock ............................. -- -- -- (1,077)
-------- -------- -------- --------
Net income applicable to common stockholders ............... $ 1,085 $ 1,376 $ 2,215 $ 666
======== ======== ======== ========
Income per common share from
continuing operations
Basic ................................................. $ 0.08 $ 0.14 $ 0.18 $ 0.21
======== ======== ======== ========
Diluted ............................................... $ 0.08 $ 0.14 $ 0.17 $ 0.21
======== ======== ======== ========
Loss per common share from
discontinued operations
Basic ................................................. $ (0.01) $ (0.05) $ (0.03) $ (0.09)
======== ======== ======== ========
Diluted ............................................... $ (0.01) $ (0.05) $ (0.03) $ (0.09)
======== ======== ======== ========
Income per common share applicable to
common shareholders
Basic ................................................. $ 0.07 $ 0.09 $ 0.15 $ 0.05
======== ======== ======== ========
Diluted ............................................... $ 0.07 $ 0.09 $ 0.14 $ 0.05
======== ======== ======== ========
Shares used in computing net income
per common share
Basic ................................................. 15,032 15,027 15,032 14,631
======== ======== ======== ========
Diluted ............................................... 15,484 15,192 15,467 14,797
======== ======== ======== ========
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)
Six Months Ended
June 30,
------------------
2002 2001
------- -------
Cash flows from continuing operating activities:
Net income from continuing operations ........................ $ 2,648 $ 3,113
Adjustments to reconcile net income to net cash provided
by operating activities from continuing operations:
Depreciation and amortization ................................ 5,412 6,102
Gain on the sale of property and equipment ................... (36) --
Changes in operating assets and liabilities:
Accounts receivable .................................... (2,819) (522)
Bad debts .............................................. 124 520
Prepaid expenses ....................................... (1,068) (640)
Inventories ............................................ (490) 793
Intangibles and other assets ........................... (140) (649)
Accounts payable ....................................... 1,162 (128)
Accrued liabilities .................................... 2,234 717
------- -------
Cash provided by operating activities of
continuing operations ............................ 7,027 9,306
------- -------
Cash used in investing activities of continuing operations:
Purchase of property and equipment ......................... (3,330) (3,284)
Acquisition of business or business assets ................. -- (1,654)
Other investing activities ................................. (183) --
------- -------
Cash used in investing activities of continuing
operations ........................................... (3,513) (4,938)
------- -------
Cash flows from financing activities of continuing operations:
Net proceeds from (payments on) line of credit ............. (2,405) (2,842)
Payments on loan and capital leases ........................ (1,286) (13)
------- -------
Cash used in financing activities of continuing
operations ........................................... (3,691) (2,855)
Cash used by discontinued operations ......................... (433) (971)
------- -------
Net increase (decrease) in cash and cash equivalents ......... (610) 542
Cash and cash equivalents at beginning of period ............. 995 102
------- -------
Cash and cash equivalents at end of period ................... $ 385 $ 644
======= =======
Supplemental Disclosures:
Cash paid during the period for:
Interest ............................................... $ 986 $ 643
======= =======
Income taxes ........................................... $ 124 $ 202
======= =======
Note received in exchange for assets ....................... $ 91 $ --
======= =======
Assets received in exchange for note ....................... $ 400 $ --
======= =======
See accompanying notes to unaudited condensed consolidated financial
statements.
6
T-NETIX, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(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:
Three Months Ended Six Months Ended
June 30, June 30,
------------------ -----------------
2002 2001 2002 2001
------- ------- ------- -------
Numerator:
Net income applicable to common stockholders ...... $ 1,085 $ 1,376 $ 2,215 $ 666
======= ======= ======= =======
Denominator:
Denominator for basic earnings per share .......... 15,032 15,027 15,032 14,631
Effect of dilutive securities:
Stock options .................................. 421 165 407 166
Warrants ....................................... 31 -- 28 --
------- ------- ------- -------
Denominator for diluted earnings per share ........ 15,484 15,192 15,467 14,797
======= ======= ======= =======
For the three and six months ended June 30, 2002 and 2001, common stock
equivalents of 1,533,000 and 1,072,000, 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
loss and loss per share for the three and six months ended June 30, 2001 would
have been as follows:
Three Months Six Months
Ended Ended
June 30, 2001 June 30, 2001
------------- -------------
Net income applicable to common stockholders, as reported .......... $ 1,376 $ 666
Add back: amortization of goodwill ................................. 261 488
Adjust amortization of other intangible assets ..................... -- --
------------ ------------
Net income applicable to common stockholders, as adjusted .......... $ 1,637 $ 1,154
============ ============
Per common share-diluted:
Net income applicable to common stockholders, as reported .... $ 0.09 $ 0.05
Amortization of goodwill ..................................... $ 0.02 $ 0.03
Adjustment for amortization of other intangible assets ....... -- --
------------ ------------
Net income applicable to common stockholders, as adjusted .......... $ 0.11 $ 0.08
============ ============
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
8
T-NETIX, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Amounts in Thousands, except per Share and Share Amounts)
(Unaudited)
of by sale, whether previously held and used or newly acquired, and broadens the
presentation of discontinued operations to include 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:
June 30, December 31,
2002 2001
-------- ------------
Accounts receivable, net:
Trade accounts receivable ......................... $ 13,723 $ 12,540
Direct call provisioning receivable ............... 9,268 7,040
Other receivables ................................. 438 1,030
-------- --------
23,429 20,610
Less: Allowance for doubtful accounts ....... (2,704) (2,580)
-------- --------
$ 20,725 $ 18,030
======== ========
Bad debt expense was $3.6 million and $1.5 million for the three months
ended June 30, 2002 and 2001, respectively, and $6.1 million and $2.7 million
for the six months ended June 30, 2002 and 2001, respectively.
Property and equipment consist of the following:
June 30, December 31,
2002 2001
-------- ------------
Property and equipment, net:
Telecommunications equipment ...................... $ 70,307 $ 67,615
Construction in progress .......................... 4,501 4,898
Office equipment .................................. 15,729 13,835
-------- --------
90,537 86,348
Less: Accumulated depreciation and
amortization ............................... (61,616) (56,131)
-------- --------
$ 28,921 $ 30,217
======== ========
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:
June 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 .............. 2,915 2,914
Deposits and long-term prepayments ................ 2,130 2,110
Other ............................................. 1,259 1,170
-------- --------
12,445 12,171
Less: Accumulated amortization ............... (5,145) (4,695)
-------- --------
$ 7,300 $ 7,476
======== ========
Accrued liabilities consist of the following:
June 30, December 31,
2002 2001
-------- ------------
Accrued liabilities:
Deferred revenue and customer advances ............ $ 2,676 $ 1,215
Compensation related .............................. 2,062 3,172
Other ............................................. 2,585 702
-------- --------
$ 7,323 $ 5,089
======== ========
(3) Debt
Debt consists of the following:
June 30, December 31,
2002 2001
-------- ------------
Debt:
Bank lines of credit .............................. $ 14,604 $ 18,247
Subordinated note payable ......................... 3,750 3,750
Other ............................................. 759 407
-------- --------
$ 19,113 $ 22,404
Less current portion ......................... 18,981 22,186
-------- --------
Non current portion .......................... $ 132 $ 218
======== ========
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 June 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. A portion of
this option fee will be refunded to the Company in the event the Credit Facility
is repaid in full on or before September 30, 2002. 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
10
T-NETIX, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Amounts in Thousands, except per Share and Share Amounts)
(Unaudited)
$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 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
believes it is in compliance with all debt covenants.
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:
Three Months Ended Six Months Ended
June 30, June 30,
------------------ -----------------
2002 2001 2002 2001
------- ------- ------- -------
Revenue ............................................... $ 22 $ -- $ 101 $ 28
Operating loss ........................................ (85) (692) (433) (1,370)
Net loss .............................................. (85) (692) (433) (1,370)
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,
subject to a 10% escrow provision. 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 will also retain 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
During 2001, the Company had two reportable business segments: the
Corrections and Internet Services divisions. Effective November 2001,
substantially all services under the Qwest Agreement (see ITEM 2. Management's
Discussion and Analysis of Financial Condition and Results of Operations)
ceased. Substantially all revenue of the Internet Services division was derived
through the Qwest Agreement. Currently, the Company derives substantially all of
its revenues from its Corrections division, which remains and is expected to
remain the core business focus. Accordingly, segment reporting has been
conformed to correspond to the current presentation.
The Company formerly reported a third business segment, the SpeakEZ
Speaker Verification division. In August 2001, the Company formalized its
decision to offer for sale its voice print business unit, which includes the
SpeakEZ speaker verification products. Pursuant to this strategy and due to the
subsequent sale of these assets in July 2002, related operating results of the
speaker verification business have been reflected as discontinued operations in
the accompanying consolidated financial statements.
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 six
months ended June 30, 2002 and the comparable 2001 periods is as follows:
Three Months Ended Six Months Ended
June 30, June 30,
------------------ -----------------
2002 2001 2002 2001
------- ------- ------- -------
Revenue from external customers:
Corrections Division ................................ $31,546 $23,934 $56,004 $46,088
Internet Services Division .......................... -- 7,893 -- 14,744
------- ------- ------- -------
$31,546 $31,827 $56,004 $60,832
======= ======= ======= =======
Research and Development
Corrections Division ................................ $ 730 $ 1,394 $ 1,430 $ 2,609
Internet Services Division .......................... -- -- -- --
------- ------- ------- -------
$ 730 $ 1,394 $ 1,430 $ 2.609
======= ======= ======= =======
Depreciation and amortization
Corrections Division ................................ $ 2,755 $ 3,155 $ 5,412 $ 6,102
Internet Services Division .......................... -- -- -- --
------- ------- ------- -------
$ 2,755 $ 3,155 $ 5,412 $ 6,102
======= ======= ======= =======
Interest and other expense
Corrections Division ................................ $ 584 $ 666 $ 890 $ 1,376
Internet Services Division .......................... -- -- -- --
------- ------- ------- -------
$ 584 $ 666 $ 890 $ 1,376
======= ======= ======= =======
Operating income (loss):
Corrections Division ................................ $ 1,799 $ (74) $ 3,718 (254)
Internet Services Division .......................... -- 3,030 -- 4,965
------- ------- ------- -------
$ 1,799 $ 2,956 $ 3,718 4,711
======= ======= ======= =======
Segment earnings (loss) from continuing operations
before income tax:
Corrections Division ................................ $ 1,215 $ (740) $ 2,828 $(1,630)
Internet Services Division .......................... -- 3,030 -- 4,965
------- ------- ------- -------
$ 1,215 $ 2,290 $ 2,828 $ 3,335
======= ======= ======= =======
12
T-NETIX, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Amounts in Thousands, except per Share and Share Amounts)
(Unaudited)
June 30, December 31,
2002 2001
------- ------------
Segment assets:
Corrections Division ...................... $65,516 $ 63,197
Internet Services Division ................ -- --
------- ------------
$65,516 $ 63,197
======= ============
Substantially all revenue reported by our Internet Services Division for
the three and six months ended June 30, 2001 was attributable to our GSP
agreement with Qwest which expired in November 2001. There was no intersegment
revenue for the three and six months ending June 30, 2002 and the comparable
2001 period. Consolidated total assets included eliminations of approximately
$0.1 million as of June 30, 2002. Eliminations consist of intercompany
receivables in the Corrections Division and intercompany payables in the
TELEQUIP Labs subsidiary related solely to intercompany borrowings.
13
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 we receive 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.
14
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 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. To date, SpeakEZ revenues have been insignificant and operations have
been substantially curtailed. Management of T-NETIX believes that its decision
to curtail operations of this portion of the Company will enhance overall
Company performance by reducing the negative impact on both the net earnings and
cash flow of the Company. Pursuant to this strategy and due to the subsequent
sale of the assets in July 2002, 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".
Results of Operations for the Three Months Ended June 30, 2002 Compared to June
30, 2001
The following table sets forth certain statement of operations data as a
percentage of total revenue for the three months ended June 30, 2002 and 2001.
2002 2001
---- ----
Revenue:
Telecommunications services .............................. 48 % 49%
Direct call provisioning ................................. 44 21
Internet services ........................................ 0 25
Equipment sales and other ................................ 8 5
---- ----
Total revenue ........................................... 100 100
Expenses:
Operating costs .......................................... 63 57
Selling, general and administrative ...................... 20 19
Research and development ................................. 2 5
Depreciation and amortization ............................ 9 10
---- ----
Operating income ........................................ 6 9
Interest and other expense ............................... (2) (2)
---- ----
Income from continuing operations before income taxes ... 4 7
Income tax expense ....................................... 0 (1)
---- ----
Net income from continuing operations ................... 4 6
Loss from discontinued operations ........................ 1 (2)
---- ----
Net Income (loss) applicable to common stock ............ 3% 4%
==== ====
Total Revenue. Total revenue for the three months ended June 30, 2002 was
$31.5 million, a decrease of 1% from $31.8 million for the corresponding 2001
period. This decrease was attributable to decreases in Internet services of $7.9
million and telecommunications services of $0.4 million, offset in part by
increases in direct provisioning of $7.4 million and equipment sales and other
of $0.7 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 segment had substantially ceased, including those under
the Qwest Agreement.
15
Telecommunications services revenue decreased 3% to $15.1 million for the
three months ended June 30, 2002, from $15.6 million for the corresponding prior
period. This decrease was primarily due to the transition of a department of
corrections contract to a direct call provisioning basis.
Direct call provisioning revenue increased 112% to $14.0 million for the
three months ended June 30, 2002, from $6.6 million in the corresponding prior
period. This increase was primarily due to the recent awarding of several
departments of corrections contracts for which we are provisioning comprehensive
or the long distance communication service. 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 37% to $2.4 million for the
three month period ended June 30, 2002 from $1.8 million in the corresponding
prior period. This increase was largely attributable to the acquisition of
TELEQUIP Labs, Inc., an inmate equipment provider, in January 2001. The TELEQUIP
sales of equipment 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 10% to $20.0 million for
the three months ended June 30, 2002 from $18.3 million in the corresponding
prior period. This increase was primarily due to an increase in direct call
provisioning expenses of $7.8 million, offset by decreases in Internet services
of $4.9 million and telecommunication services of $1.2 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 segment 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 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 June 30, 2002 and 2001.
2002 2001
------ -----
Operating costs and expenses:
Telecommunications services...................... 35% 42%
Direct call provisioning......................... 97 88
Internet services................................ -- 62
Cost of equipment sold and other................. 43 59
Operating costs associated with providing telecommunications services, as
a percentage of corresponding revenue, were 35% for the three months ended June
30, 2002, a decrease from 42% for the comparable 2001 period. Total
telecommunications services operating costs were $5.3 million for the three
months ended June 30, 2002 and $6.5 million for the corresponding prior period.
The decrease in 2002 was due to reductions in personnel and lower travel and
contract labor expenses, partially offset by increased repairs and maintenance.
Direct call provisioning costs, as a percentage of corresponding revenue,
were 97% of revenue for the three months ended June 30, 2002, an increase from
88% in 2001. Due to the awarding of several department of correction contracts,
total direct call provisioning operating costs increased to $13.6 million for
the three months ended June 30, 2002, compared to $5.8 million for the
corresponding prior period. This increase in costs as a percentage of applicable
revenue was due primarily to higher bad debt expenses and to a proportional
increase in commission expenses associated with the increase in direct call
provisioning revenue. Bad debt expense increased primarily due to the 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 43% of revenue for the three months ended June 30, 2002, a decrease from 59%
in 2001. Due to increased equipment sales of TELEQUIP Labs, Inc., total costs of
equipment sold and other were $1.1 million for the three months ended June 30,
2002 compared to $1.0 million for the corresponding 2001 period. The
16
decrease in costs as a percentage of applicable revenue was primarily due to the
change in the revenue mix for equipment and other sales.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses were $6.2 million and $6.1 million for the three months
ended June 30, 2002 and 2001, respectively.
Research and Development Expenses. Research and development expenses were
$0.7 million in the three months ended June 30, 2002 compared to $1.4 million
for the corresponding prior period. This decrease was primarily due to
reductions in personnel and related travel expenses in 2002, as compared to
2001.
Depreciation and Amortization Expenses. Depreciation and amortization
expense was $2.8 million for the three months ended June 30, 2002, a decrease
from $3.2 million for the comparable 2001 period. Depreciation expense for the
three months ended June 30, 2002 totaled $2.5 million and compared to $2.7
million in 2001. Amortization expense declined to $0.3 million in the three
months ended June 30, 2002 versus $0.5 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.
Interest and Other Expenses. Interest and other expense was $0.6 million
for the three months ended June 30, 2002 compared to $0.7 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 our Credit
Facility in March 2002. The average debt balance decreased primarily due to the
pay down of debt as the result of improved operating results.
Results of Operations for the Six Months Ended June 30, 2002 Compared to June
30, 2001
The following table sets forth certain statement of operations data as a
percentage of total revenue for the six months ended June 30, 2002 and 2001.
2002 2001
---- ----
Revenue:
Telecommunications services ................................... 54% 51%
Direct call provisioning ...................................... 40 22
Internet services ............................................. -- 24
Equipment sales and other ..................................... 6 3
---- ----
Total revenue ................................................ 100 100
Expenses:
Operating costs ............................................... 60 59
Selling, general and administrative ........................... 21 19
Research and development ...................................... 2 4
Depreciation and amortization ................................. 10 10
---- ----
Operating income ............................................. 7 8
Interest and other expense .................................... (2) (2)
---- ----
Income from continuing operations before income taxes ........ 5 6
Income tax expense ............................................ -- (1)
---- ----
Net income from continuing operations ........................ 5 5
Loss from discontinued operations ............................. (1) (2)
Accretion of discount as redeemable convertible preferred stock -- (2)
---- ----
Net Income (loss) applicable to common stock ................ 4% 1%
==== ====
Total Revenue. Total revenue for 2002 was $56.0 million, a decrease of 8%
from $60.8 million for the corresponding 2001 period. This decrease was
attributable to decreases in Internet services of $14.7 million and
telecommunications services of $0.8 million, offset in part by increases in
direct provisioning of $9.1 million and equipment sales and other of $1.6
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 segment had substantially ceased, including those under
the Qwest Agreement.
Telecommunications services revenue decreased 3% to $30.4 million for the
six months ended June 30, 2002, from $31.2 million for the corresponding prior
period. This decrease was primarily due to a decline in call volumes and the
transition of a department of corrections contract to a direct call provisioning
basis.
17
Direct call provisioning revenue increased 70% to $22.2 million for the
six months ended June 30, 2002, from $13.1 million in the corresponding prior
period. This increase was primarily due to the recent awarding of several
departments of corrections contracts for which we are provisioning comprehensive
or the long distance communication service. 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 86% to $3.4 million for the
six month period ended June 30, 2002 from $1.8 million in the corresponding
prior period. This increase was largely attributable to the acquisition of
TELEQUIP Labs, Inc., an inmate equipment provider, in January 2001. The TELEQUIP
sales of equipment 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 decreased 6% to $33.5 million for
the six months ended June 30, 2002 from $35.6 million in the corresponding prior
period. The decrease was primarily due to decreases in Internet services of $9.8
million and telecommunication services of $2.2 million, offset partially by an
increase in direct call provisioning expenses of $9.4 million and the cost of
equipment sold of $0.5 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 segment 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 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 six months
ended June 30, 2002 and 2001.
2002 2001
---- ----
Operating costs and expenses:
Telecommunications services...................... 36% 42%
Direct call provisioning......................... 95 89
Internet services................................ -- 66
Cost of equipment sold and other................. 47 59
Operating costs associated with providing telecommunications services as a
percentage of corresponding revenue was 36% for the six months ended June 30,
2002, a decrease from 42% for the comparable 2001 period. Total
telecommunications services operating costs were $10.8 million for the six
months ended June 30, 2002 and $13.1 million for the corresponding prior period.
The decrease in 2002 was due to reductions in personnel costs and lower contract
labor, travel and communications expenses, partially offset by increased repairs
and maintenance.
Direct call provisioning costs, as a percentage of applicable revenue,
were 95% of revenue for the six months ended June 30, 2002 compared to 89% in
the comparable 2001 period. Due to the awarding of several department of
correction contracts, total direct call provisioning operating costs increased
to $21.1 million for the six months ended June 30, 2002 from $11.7 million for
the corresponding 2001 period. This increase in costs as a percentage of
applicable revenue was due primarily to higher bad debt expenses and to a
proportional increase in commission expenses associated with the increase in
direct call provisioning revenue. Bad debt expense increased primarily due to
the 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 47% of revenue for the six months ended June 30, 2002 from 59% for
the corresponding prior period. Due to increased equipment sales of TELEQUIP
Labs, Inc., total costs of equipment sold and other were $1.6 million for the
six months ended June 30, 2002 compared to $1.1 million for the corresponding
2001 period. The decrease in costs as a percentage of applicable revenue was
primarily due to the change in the revenue mix for equipment and other sales.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses were $11.9 million and $11.8 million for the six months
ended June 30, 2002 and 2001, respectively.
18
Research and Development Expenses. Research and development expenses were
$1.4 million in the six months ended June 30, 2002 compared to $2.6 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 $5.4 million for the six months ended June 30, 2002, a decrease from
$6.1 million for the comparable 2001 period. Depreciation expense declined to
$5.0 million in the six months ended June 30, 2002 compared to $5.2 million in
2001. Amortization expense declined to $0.4 million in the six months ended June
30, 2002 versus $0.9 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 six months ended June 30, 2002 compared to $1.4 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 March 2002. The average debt balance decreased primarily due
to the pay down of debt as the result of improved operating results.
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 $7.0 million for the six months
ended June 30, 2002 compared to $9.3 million in the corresponding 2001 period.
This decrease was primarily due to a $1.1 million increase in net working
capital, combined with a $0.5 million decline in net income from continuing
operations and a $0.7 million decline in depreciation and amortization expense.
As part of the Company's on-going effort to dispose of underperforming assets,
in June 2002 we completed the sale of assets associated with our Lock &
Track(TM) jail management system product.
Net cash used in investing activity of continuing operations was $3.5
million for the six months ended June 30, 2002 compared to $4.9 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 $3.3 million for
the six month period ended June 30, 2002 and 2001, respectively.
We anticipate that our capital expenditures in 2002 will increase over
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 six
months.
Cash used in financing activities of continuing operations consisted
primarily of net payments on the Company's Credit Facility of $3.7 million
during the six months ended June 30, 2002 compared to net payments of $2.9
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
19
reduced to $21.8 million and interest was set at prime plus 2.25% (7.0% at June
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. A portion of this option
fee will be refunded to the Company in the event the Credit Facility is repaid
in full on or before September 30, 2002. 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
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 June 30, 2002, the Company had a total of $19.1
million of total indebtedness, including approximately $14.6 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. We cannot assure you that we will be able to obtain new
financing or refinance our existing indebtedness when required or that
satisfactory terms of any refinancing will be available. If we were not able to
obtain new financing or refinance our indebtedness under these circumstances, we
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, we raised $7.5 million of debt and equity financing. The
net proceeds of approximately $7.2 million were used to reduce the outstanding
balance on the Credit Facility. The Company issued 3,750 shares of series A
non-voting redeemable convertible preferred stock and five-year stock purchase
warrants to acquire 340,909 common shares for net proceeds of $3.5 million. In
November 2000, 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 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 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 $2.75 per share have been issued
to the lender on terms similar to previous warrants; however, shares will vest
proportionately over the term of the note extension.
20
Contractual Obligations and Commitments
Set forth below is a summary of the Company's material contractual
obligations and commitments as of June 30, 2002:
Due in One Due in Due in Due After
Year or Less 2-3 Years 4-5 Years 5 Years Total
------------ --------- --------- ------- -----
($ In thousands)
Bank credit facility............................. $14,604 $ -- $ -- -- $ 14,604
Subordinated note payable........................ 3,750 -- -- -- 3,750
Operating leases................................. 730 868 277 -- 1,875
Capital lease and other.......................... 664 132 -- -- 796
------- ------ ----- ---- --------
Total contractual obligations and commitments.... $19,748 $1,000 $ 277 -- $ 21,025
======= ====== ===== ==== ========
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 June 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.
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 $14.6
million at June 30, 2002. Under the terms of the debt agreement the maximum
credit available at June 30, 2002 is $18.7 million. The loan bears interest at
prime rate plus 2.25% (7.0% at June 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 $0.1
million based on the amount of borrowings outstanding under the Credit Facility
at June 30, 2002.
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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 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.
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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 2, 2002, T-NETIX 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 vendor (Illuminet, Inc.) notified
the Company in November 2001 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
June 30, 2002 (See Note 2 of "Notes to Condensed Consolidated Financial
Statements"). 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.
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
On May 28, 2002 the Company held its Annual Meeting of Shareholders.
Matters voted on and the results of such voting are as follows:
1. The election of three directors to hold office for a term
of three years or until their respective successors shall be elected
and qualified. The following persons were elected as directors and
received the number of votes set forth below:
Director For Against Abstain
-------- --- ------- -------
Daniel M. Carney ........ 12,426,672 0 13,600
Robert A. Geist ......... 12,426,672 0 13,600
James L. Mann ........... 12,419,872 0 20,400
ITEM 5. Other Information
None
ITEM 6. Exhibits and Reports on Form 8-K
None.
23
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: August 14, 2002
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