Attached files
UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
WASHINGTON,
D.C. 20549
FORM
10-K
x |
ANNUAL
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
|
For the
fiscal year ended December 31, 2009
or
o |
TRANSITION
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
|
For the
transition period from to
Commission
file number 333-124962
SECURUS
TECHNOLOGIES, INC.
(Exact
name of registrant as specified in its charter)
Delaware
|
20-0673095
|
|
State
or other jurisdiction of
incorporation
or organization
|
(I.R.S.
Employer
Identification
Number)
|
14651
Dallas Parkway, Suite 600
Dallas,
Texas 75254-8815
(972) 277-0300
(Address,
including zip code, and telephone number, including area code, of Registrant’s
principal executive offices)
Securities
registered pursuant to Section 12(b) of the Act:
None
Securities
registered pursuant to Section 12(g) of the Act:
11%
Second-priority Senior Secured Notes due 2011
Indicate by check mark if the registrant is a well-known
seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No
x
Indicate by check mark if the registrant is not required
to file reports pursuant to Section 13 or Section 15(d) of the Act.
Yes o No
x
Indicate by check mark whether the registrant
(1) has filed all reports required to be filed by Section 13 or 15(d)
of the Securities Exchange Act of 1934 during the preceding 12 months (or
for such shorter period that the registrant was required to file such reports),
and (2) has been subject to such filing requirements for the past
90 days. Yes x No
o
Indicate by check mark whether the registrant has
submitted electronically and posted on its corporate Website, if any, every
Interactive Date File required to be submitted and posted pursuant to Rule 405
of Regulation S-T (§229.405 of this chapter) during the preceding 12 months (or
for such shorter period that the registrant was required to submit and post such
files). Yes o No
o
Indicate by check mark if disclosure of delinquent filers
pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not
contained herein, and will not be contained, to the best of the registrant’s
knowledge, in definitive proxy or information statements incorporated by
reference in Part III of this Form 10-K or any amendment to this Form
10-K. x
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer, or a smaller reporting company.
See the definitions of “large accelerated filer,” “accelerated filer” and
“smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer o
Accelerated filer o
Non-accelerated filer x Smaller
reporting company o
Indicate by check mark whether the registrant is a shell
company (as defined in Rule 12b-2 of the Act) Yes o No
x
No
established published trading market exists for either the common stock, par
value $0.001 per share, of Securus Technologies, Inc. or the Class B common
stock, par value $0.001 per share, of Securus Technologies, Inc.
Shares
outstanding of each of the registrant’s classes of common stock:
Class
|
Outstanding
at March 1, 2010
|
||
Class
A Common Stock
|
14,132
|
shares
|
|
Class
B Common Stock
|
135,221
|
shares
|
Documents
Incorporated By Reference
1
TABLE
OF CONTENTS
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2
Overview
We are
one of the largest independent providers of inmate telecommunications services
to correctional facilities operated by city, county, state and federal
authorities and other types of confinement facilities, such as juvenile
detention centers and private jails, in the United States and Canada. With 66
patents and and approximately 55 patent applications filed or in process, we
believe we are the leading technology innovator in the correctional industry. As
of December 31, 2009, we provided service to approximately 2,400 correctional
facilities in the United States and Canada, and processed over 10 million calls
per month during 2009.
Our core
business consists of installing, operating, servicing and maintaining
sophisticated call processing systems in correctional facilities and providing
related services. We enter into multi-year agreements (generally three to five
years) directly with the correctional facilities in which we serve as the
exclusive provider of telecommunications services to inmates. In exchange for
the exclusive service rights, we pay a negotiated commission to the correctional
facility based upon revenues generated by actual inmate telephone use. On a
limited basis, we may also partner with other telecommunications companies
whereby we provide our equipment and, as needed, back office support including
validation, billing and collections services, and charge a fee for such
services. Based on the particular needs of the corrections industry and the
requirements of the individual correctional facility, we also sell platforms and
specialized equipment and services such as law enforcement management systems
and call activity reporting.
We
sell information management systems that work in conjunction with our
communications systems and allow facilities managers and law enforcement
personnel to analyze and manage data to reduce costs, prevent and solve crimes
and facilitate inmate rehabilitation through a single user interface. We also
offer investigative tools and bad debt risk management services based on the
particular needs of the corrections industry and the requirements of the
individual correctional facility.
In
addition, we sell offender management systems and related systems and services
through our wholly-owned subsidiary Syscon Holdings, Ltd. (“Syscon”). Syscon is
an enterprise software development company for the correctional facility
industry. Syscon’s core product is a sophisticated and comprehensive software
system utilized by correctional facilities and law enforcement agencies for
complete offender management. Syscon’s system provides correctional facilities
with the ability to manage and monitor inmate parole and probation activity and
development at a sophisticated level. We believe our offender management
software represents the leading enterprise solution for the corrections
industry. Our offender management software is operating in more than 500
correctional facilities and probation offices maintaining records for over
400,000 offenders in the United States, Canada, the United Kingdom and
Australia.
The
inmate telecommunications industry requires highly specialized systems and
related services in order to address the unique needs of the corrections
industry. Security and public safety concerns require that correctional
facilities have the ability to control inmate access to telephones and certain
telephone numbers and to monitor inmate telephone activity. In addition,
concerns regarding fraud and the credit quality of the parties billed for inmate
telephone usage have led to the development of billing and validation systems
and procedures unique to this industry.
We
estimate that the inmate telecommunications market opportunity for city, county,
state and federal correctional facilities in the United States is approximately
$1.2 billion and the offender management technology market opportunity is
approximately $1.0 billion worldwide.
Our
business is conducted primarily through our three principal subsidiaries:
T-Netix, Inc. (“T-Netix”), acquired in March 2004, Evercom Holdings, Inc.
(“Evercom”), acquired in September 2004, and Syscon, acquired in June
2007.
For the
year ended December 31, 2009, our revenues were $363.4 million, of
which approximately 86% represented direct call provisioning to correctional
facilities, 6% represented sales and services related to our offender management
software and 8% represented the wholesale service provision of solutions,
telecommunications and billing services to our telecommunication carrier
partners.
Securus
was incorporated in Delaware on January 12, 2004. We maintain a web site
with the address www.securustech.net. We are not including the information
contained on our web site as a part of, or incorporating it by reference into,
this Annual Report on Form 10-K.
3
Industry
Overview
The
corrections industry has experienced sustained growth over the last two decades
as a result of societal and political trends. Anti-crime legislation,
limitations on parole and spending authorizations for crime prevention and
construction of additional correctional facilities have contributed to this
industry growth.
The
United States has one of the highest incarceration rates of any country in the
world. The U.S. Department of Justice estimates that as of year end 2008, there
were approximately 2.3 million inmates housed in U.S. correctional
facilities, or approximately one inmate for every 133 U.S. residents. Of this
total, approximately two-thirds were housed in federal and state prisons and
approximately one-third were housed in city and county correctional
facilities. According to U.S. Department of Justice statistics, the
inmate population in federal and state prisons, which generally house inmates
for longer terms than city and county facilities, increased from approximately
1.2 million at December 31, 1998 to approximately 1.5 million at
December 31, 2008, representing an average annual growth rate of approximately
2.2%. The inmate population in city and county facilities, which generally house
inmates for terms of one year or less, increased from approximately 0.6 million
at December 31, 1998 to approximately 0.8 million at December 31, 2008, an
average annual growth rate of approximately 2.9%. Between December 31, 1998 and
December 31, 2008, the overall incarcerated population grew an average of 2.4%
annually. Population growth during the 12-month period ending December 31, 2008
was higher in local jails (up 0.7%) than in federal prisons (up 0.6%), and state
prisons showed no growth.
The
corrections industry requires specialized information technology,
telecommunications systems and related services. Security and public safety
concerns associated with inmate telephone use require that correctional
facilities have the ability to control inmate access to telephones and to
certain telephone numbers and to monitor inmate telephone activity. In addition,
concerns regarding fraud and the credit quality of the parties billed for inmate
telephone usage have also led to the development of systems and procedures
unique to this industry. Correctional facilities also have unique information
technology requirements relating to managing and monitoring inmate (and
probation) activity and development. These include offender management,
financial applications, health and activity records as well as predictive tools
for future inmate behavior. Facilities are increasingly seeking to utilize
enhanced automated systems to offset the challenges of budget cuts,
understaffing and prison overpopulation.
Within
the inmate telecommunications industry, companies compete for the right to serve
as the exclusive provider of inmate calling services within a particular
correctional facility. Contracts may be awarded on a facility-by-facility basis,
such as for most city or county correctional systems, which generally include
small and medium-sized facilities, or system-wide, such as for most state and
the federal prison
systems. Generally, contracts for federal facilities and state systems are
awarded pursuant to a competitive bidding process, while contracts for city and
county facilities are awarded both through competitive bidding and negotiations
with a single party. Contracts generally have multi-year terms and typically
contain renewal options. As part of the service contract, the service provider
generally installs, operates and maintains all inmate telecommunications
equipment. In exchange for the exclusive contract rights, the service provider
pays a commission to the operator of the correctional facility based upon inmate
telephone use. These commissions have historically been used by the facilities
to support their law enforcement activities.
Historically,
offender management systems have been developed independently and internally by
government agencies to provide basic information management capabilities to run
the business of an incarceration facility. Often, these agencies have outsourced
design, or certain aspects thereof, to third party consultants. We are one of a
very small group of providers offering a comprehensive off-the-shelf software
package for offender management and related activities. The market is highly
fragmented and it is our belief that most of the “home-grown” systems may not
effectively manage the inmate, parole and probation populations. We believe that
only a fraction of the market has been outsourced to firms that develop
enterprise inmate systems like we do, and that we have the largest portion of
the outsourced market. Our systems currently track over 400,000 of the
approximate 10 million people estimated to be incarcerated worldwide. For
extremely large projects, we often partner with larger systems integrators, such
as IBM and Hewlett Packard (formerly Electronic Data Systems).
4
Competition
In the
inmate telecommunications business, we historically have competed with numerous
independent providers of inmate telephone systems such as Global Tel*Link, as
well as regional bell operating companies (“RBOCs”), local exchange carriers
(“LECs”) and interexchange carriers (“IXCs”) that include AT&T and Embarq.
Unisys also has recently entered the market. We believe that the
principal competitive factors in the inmate telecommunications industry are
system features and functionality, system reliability and service, the ability
to customize inmate call processing systems to the specific needs of the
particular correctional facility, relationships with correctional facilities,
rates of commissions paid to the correctional facilities, end-user rates, called
party and inmate customer satisfaction levels and the ability to identify and
manage credit risks and bad debt. We seek to compete for business on local,
county, state and federal levels, and in privately managed correctional
facilities.
We believe
that we are well positioned to expand our market share by offering new and
enhanced products to our existing customers, and attracting new facilities with
“one stop shopping” for their communications and technology needs at a lower
cost than our competitors. We believe we are well positioned relative to our
competitors because of our belief that our costs are lower as a result of our
packet-based architecture and proprietary bad debt risk management systems.
These lower costs coupled with our technological capabilities and robust patent
portfolio enable us to make attractive bids to our prospective or existing
customers.
In the
offender management market, we compete with a small group of offender management
software providers, each of whom we believe is smaller than we are. We also
compete with large and small software consultant organizations who do not offer
off-the-shelf prepackaged software, but who can develop systems from scratch to
the client’s specifications.
Primary
Sources of Revenues
The
following chart summarizes the primary sources of our revenues by reportable
segment for the year ended December 31, 2009. See Note 5, Segment
Information, in the Notes to the Consolidated Financial Statements in Part II of
this report for financial information about each of our
segments.
%
of Total
|
|||||
Revenue
Source
|
Revenues
|
Description
|
|||
Direct
Call Provisioning
|
86
|
%
|
Direct
call provisioning services through multi-year contracts directly to local
correctional facilities as well as large county jails and state
departments of corrections facilities. No direct customer accounted for
more than 6% of our total direct call provisioning revenues for the year
ended December 31, 2009.
|
||
Wholesale
Services
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8
|
%
|
Wholesale
Services include both solutions and billing services (validation, fraud
management and billing and collection services to third parties including
some of the world’s largest communication service providers) and
telecommunications services (equipment, security enhanced call processing,
validation and customer service and support to corrections facilities
through contracts with other inmate telecommunications
providers).
|
||
Offender
Management Software
|
6
|
%
|
Software
sales and development services for complete offender management, providing
correctional facilities with the ability to manage and monitor inmate,
parole and probation activity and development at a sophisticated
level.
|
5
Direct
Call Provisioning
We
provide inmate telecommunications services directly as a state-certificated
telecommunications provider to correctional facilities. In a typical
arrangement, we operate under a site-specific, exclusive contract, generally for
a period of three to five years. We provide the equipment, security-enhanced
call processing, validation, and customer service and support directly to the
facility. We bill calls via the called party’s local telephone bill, via our own
proprietary billing platform or through prepaid products purchased by the inmate
or the inmate’s called party. Direct call provisioning margins are substantially
higher than that of our wholesale services because we receive the entire retail
value of the call. In our direct call provisioning business, we are
responsible for paying customer commissions, line charges and other operating
costs, including billing and bad debt costs. Consequently, our gross profit
dollars are higher compared to our wholesale services.
Wholesale
Services
Our
wholesale services business consists of (1) validation, uncollectible
account management and billing services (solutions services), (2) equipment,
security enhanced call processing, call validation and service and support
through the primary inmate telecommunications providers (telecommunications
services) and (3) the sale of equipment to other telecommunications companies as
customers or service partners. In 2009, we decided to no longer
pursue a wholesale strategy but rather will pursue business on a direct call
provisioning basis only.
In our
direct call provisioning and wholesale services businesses, we accumulate call
activity data from our various installations and bill our revenues related to
this call activity against prepaid customer accounts or through direct billing
agreements with LEC billing agents, or in some cases through billing aggregators
that bill end users. We also receive payment on a prepaid basis for the majority
of our services and record deferred revenue until the prepaid balances are used.
In each case, we recognize revenue when the calls are completed and record the
related telecommunication costs for validating, transmitting, billing and
collection, bad debt, and line and long-distance charges, along with commissions
payable to the facilities. In our telecommunications services business, our
service partner bills the called party and we either share the revenues with our
service partner or receive a prescribed fee for each call completed. We also
charge fees for additional services such as customer support and advanced
validation.
Offender
Management Software
We
develop enterprise software for the correctional facility industry. We believe
that we have the most functionally complete offender management system available
on the market. Our core product is a sophisticated and comprehensive software
system, “ELITE,” utilized by correctional, probation and parole agencies for
complete offender management. Our system enables these clients to address the
increasing challenge of managing an ever-growing number of offenders in
confinement and in the community on a cost-efficient basis.
Our
offender management software is the centerpiece for the United Kingdom’s
National Offender Management Information System for Her Majesty’s Prison Service
project, with Hewlett Packard (formerly Electronic Data Systems Inc. (“EDS”)
providing overall project management and certain testing and consulting
services. Our offender management software operates in more than 500
correctional facilities and probation and parole offices maintaining records for
over 400,000 offenders in the United States, Canada, the United Kingdom and
Australia.
Our
offender management revenues have four main components:
•
|
License
fees: The product purchase cost, providing clients with the license to use
the core platform;
|
•
|
Implementation
fees: The revenue associated with the physical installation of the
system;
|
•
|
Consulting
fees: Most of this work is done prior to implementation. The primary
activities include: planning, design, consultation, debugging,
customization, etc.
|
•
|
Software
maintenance and support: These post-sale fees provide a future annuity
stream as we continue to generate fees from assistance with new modules,
training, version upgrades, etc.
|
Customers
We have
direct contracts with federal, state and local agencies to provide inmate
telecommunications services on either an exclusive basis or jointly with another
provider to approximately 2,400 correctional facilities ranging in size from
small municipal jails to large, state-operated facilities, as well as other
types of confinement facilities, including juvenile detention centers
and private jails.
Most of
our direct call provisioning contracts have multi-year terms (generally three to
five years) and typically contain renewal options. We often seek to negotiate
extensions of our contracts before the end of their stated terms. For the year
ended December 31, 2009, we retained approximately 84% of our annualized
revenue up for renewal. Many of our contracts provide for automatic renewal
unless terminated by written notice within a specified period of time before the
end of the current term.
6
In the
offender management software segment, our customers consist typically of large
national and state or provincial incarceration agencies, including Her Majesty’s
Prison Service in the United Kingdom via a sub-contracting agreement with
Hewlett Packard (formerly EDS), along with several states and provinces in the
United States, Canada and Australia. We believe that once a customer has
selected us for offender management software and related services, it is less
likely to switch systems due to the high cost of switching. As a result, we have
a strong growing base of customers for our new versions, modules and ongoing
maintenance. We believe that this allows us to derive sustainable revenue from
new modules and versions of our software rather than from long-term
contracts.
Sales
and Marketing
We seek
new direct contracts by participating in competitive bidding processes and by
negotiating directly with the individuals or entities responsible for operating
correctional facilities. We market our inmate telecommunications services
through a sales staff largely made up of former law enforcement officials and
others with experience in the corrections and telecommunications industries who
understand the specialized needs of correctional facilities. Our marketing
strategy emphasizes our specialized products and services, our proprietary
technology, our knowledge, experience and reputation in the inmate
telecommunications industry and our high level of service. We believe we have
the largest national sales force dedicated to serving the inmate
telecommunications industry, and we rely on the experience and
background of this sales staff to effectively communicate our capabilities to
both existing and potential customers. In addition to conducting in-person sales
calls to the operators of correctional facilities, we participate in trade shows
and are active in local law enforcement associations.
Principal
Products and Services
We
believe that the specialized products and services we offer differentiate us
from our competitors. Unlike many of our competitors who specialize in specific
segments of the market (such as call management systems, jail management
systems, etc.), our strategy is centered on the production and distribution of
applications and services focused on the entire operation of a facility.
Our applications are designed to streamline the operations of corrections
facilities and empower administrators with administrative, investigative and
economic capabilities. Additionally, we believe that the timely development of
new products and enhancements to existing products is essential to maintain our
competitive position. We conduct ongoing development of new products and
enhancement of existing products that are complementary to our existing product
line. Our principal specialized applications and services include:
SCA
Architecture™
Our SCA Architecture™ is
comprised of a robust data repository housing multiple data marts, each holding
billions of bytes of stored information gathered from multiple sources. SCA’s
intelligent retrieval system retrieves all this information and processes all
user requests through a cross application, cross data-mart retrieval process.
The backbone of our entire system, SCA is expected to result in significantly
lower operating and capital costs as its full implementation is realized.
We currently operate numerous inmate calling applications that preceded
our development of this architecture. We are migrating the majority of our
customer installations to our new systems utilizing this architecture as current
contracts expire, a process likely to take several years.
SCN
Secure Connect Network™
Our SCN Secure Connect Network™
is a packet-based, digital transmission system for all communications transport.
SCN allows our calling platform to provide real-time turn-on/turn-off
flexibility for most system features, 24-7 offsite monitoring, immediate system
upgrades and repairs from one central location.
Secure
Call Platform™
Our SCP Secure Call Platform™ call
management system services correctional facilities as well as detainees and
friends and family members. Utilizing SCP allows this fully integrated inmate
calling applications manager to offer innovative feature applications that give
facilities extensive administrative and investigative control. The system offers
networking functions, robust system and application stability and redundancy,
heightened security features, user auditing and password-specific
utilities.
7
The Securus User Interface
Access to
many of our applications is accomplished through our S-GATE™ user interface. This
portal provides single point access to programs, applications and
services.
Securus
Support
We
provide support through our own professional, dedicated customer support
centers:
•
|
Accessible
24-7
|
•
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Independent
visibility into customers’ account activity and
information
|
•
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Site
status is monitored continuously by support systems and proactive actions
are instituted to correct issues before customers are
impacted
|
•
|
Our
field support services provides nationwide support by local area
responsive technicians
|
Prepaid
Calling Programs
Inmate
telecommunications systems historically allowed calls to be placed as collect
only, without the involvement of a live operator. Our prepaid calling systems
offer a paperless, card-free prepaid calling solution for called parties or
inmates. Because prepayment greatly reduces bad debt, fewer calls are blocked
and correctional facilities recognize the financial benefits of higher call
volumes. Our prepaid products include Advanced Connect, Inmate Debit
and Prepaid Calling Cards.
Correctional
Billing Services (CBS)
We are
one of the few companies in the industry to provide an in-sourced, nationwide
customer care and billing center dedicated to the inmate’s friends and family
members. We offer multiple payment options including prepayment of charges,
remittance directly to the local phone company, credit card payments and check
by phone.
Intelligent
Call and Billing Management Solution (ICBS)
We
develop and provide our customers with an Intelligent Call and Billing
Management Solution, or ICBS system, which is a proprietary call validation and
billing technology that is designed to minimize bad debt expense. ICBS allows us
to rapidly identify and block collect calls from being connected to potential
non-paying call recipients through a continuously growing and improving
database. As an enhancement to revenues, the blocked call recipient is notified
that an inmate has attempted contact and, upon request, can receive inmate calls
through various prepaid methods. We believe our technology provides us with
generally lower bad debt expense as a percentage of revenues, while offering the
broadest, most sophisticated suite of payment method alternatives in the
industry.
Additional
Securus Applications
We also
offer a multitude of additional applications and features that provide
task-specific solutions designed to satisfy focused areas of a facility’s
operations. These applications assist correctional facility investigators,
administrators, and support personnel with investigative capabilities,
recidivism programs, fraud prevention and detainee identifications. In addition,
we partner with other companies to offer value-added services that create
operational efficiencies within the facilities we serve, including providing
two-way interactive voice response capabilities that allow routine questions to
be answered without using staff resources, installing jail management software
to meet the software needs of smaller sites and adding e-mail, voice mail and
video conferencing capabilities to improve security and provide better labor
utilization for correctional facilities.
8
“ELITE”
Software
The ELITE
system provides correctional facilities with the ability to manage inmates and
monitor parole and probation activity and development at a very sophisticated
level. The key functions of the system include management of incarcerated
prisoners, management and monitoring of offenders on parole and probation,
financial applications and electronic health records. The ELITE system has more
than 40 different modules and is a “smart” application that not only provides
monitoring tools, but has predictive tools for future inmate
behavior.
We are
continually developing new suites of applications that are designed to provide a
wide array of solutions-based, technologically advanced, fully integrated,
industry best-practices applications and services for the criminal justice
community. These applications and services are focused on providing solutions
targeted at the identified needs of the criminal justice
community.
Systems
and Equipment
We
currently utilize automated operator calling systems that consist of third-party
and internally developed software applications installed on specialized
equipment. We have transitioned the majority of our customer installations from
these legacy systems to our Secure Connect Network as existing contracts expire.
Our specialized systems limit inmates to collect calls or prepaid calls,
validate and verify the payment history of each number dialed for billing
purposes, and confirm that the destination number has not been blocked. If the
number is valid and has not been blocked, the system automatically requests the
inmate’s name, records the inmate’s response, and waits for the called party to
answer. When the call is answered the system informs the called party that there
is a collect call, plays back the name of the inmate in the inmate’s voice, and
instructs the called party to accept or reject the call. The system completes
calls that have been accepted by the called party.
The
system automatically records the number called and the length of the call and
transmits the data to our centralized billing center for bill processing and
input into our call activity database. Our database of telephone numbers and
call activity allows us to provide extensive call activity reports to
correctional facilities and law enforcement authorities, in addition to
identifying numbers appropriate for blocking, thus helping to reduce the number
of uncollectible calls. These include reports that can further assist law
enforcement authorities in connection with ongoing investigations. We believe
this database offers competitive advantages, particularly within states in which
we have achieved substantial market penetration.
Maintenance,
Service and Support Infrastructure
We
provide and install telephone systems in correctional facilities at no cost to
the facility and generally perform all maintenance activities. We maintain a
geographically dispersed staff of trained field service technicians and
independent contractors, which allows us to respond quickly to service
interruptions and perform on-site repairs and maintenance. In addition, we have
the ability to make certain repairs remotely through electronic communication
with the installed equipment without the need of an on-site service call. We
believe that system reliability and service quality are particularly important
in the inmate telecommunications industry because of the potential for
disruptions among inmates if telephone service remains unavailable for extended
periods.
Billing
and Collection
For
some services, we use LEC and third-party clearinghouse billing agreements to
bill and collect phone charges. Under these agreements, the LEC includes collect
call charges for our services on the local telephone bill sent to the recipient
of the inmate collect call. We generally receive payment from the LEC for such
calls 50 to 60 days after the end of the month in which the call is
submitted to the LEC for billing. The payment that we receive is net of a
service fee and net of write-offs of uncollectible accounts for which we
previously received payment, or net of a reserve for future uncollectible
accounts.
Unlike
many smaller independent service providers with lower telecommunications
traffic, we have been able to enter into direct billing agreements with LECs in
most of our markets because of our high market penetration. We believe that
direct billing agreements with LECs decrease bad debt expense and billing
expenses by eliminating an additional third-party billing entity, while
expediting and increasing collectibility. In addition, direct billing agreements
help us resolve disputes with billed parties by facilitating direct
communication between us and the called party, thereby reducing the number of
charge-offs.
9
In the
absence of a LEC direct billing arrangement, we bill and collect our collect
calls through third-party billing and collection clearinghouses that have
billing and collection agreements with LECs, or through our proprietary direct
billing. When we employ third-party billing and collection clearinghouses, the
account proceeds are forwarded by the various LECs to the clearinghouses, which
then forward the proceeds to us, less a processing fee. With both LEC direct and
third-party billing and collection agreements, we reconcile our call records
with collections and write-offs on a regular basis. The entire billing and
collection cycle (including reconciliation), takes on average, between six to
nine months after we submit the call record to the LEC or to third-party billing
and collection clearinghouses.
Our
specialized billing and bad debt management system integrates our LEC direct
billing arrangements with our call blocking, validation and customer inquiry
procedures.
Patents
and Other Proprietary Rights
We rely
on a combination of patents, copyrights and trade secrets to establish and
protect our intellectual property rights. We have 66 patents issued and
approximately 55 patents pending. We believe that our intellectual property
portfolio provides our customers leading edge technology that is recognized as
technologically superior within the inmate telecommunications industry. We
consider any patents issued or licensed to us to be a significant factor in
enabling us to more effectively compete in the inmate calling industry, and we
vigorously defend our patents from infringement by other inmate
telecommunications providers.
Although
we have filed many patent applications and hold several patents related to our
internally developed call processing and other technology, such technology and
intellectual property rights could be contested or challenged or deemed to
infringe on other parties’ intellectual property rights. Should our call
processor or any material feature of our call processor or other proprietary
technology be determined to violate applicable patents, we may be required to
cease using these features or to obtain appropriate licenses for the use of that
technology, and we could be subject to material damages if our infringement were
determined to be lengthy or willful.
Regulation
The
inmate telecommunications industry is subject to varying degrees of federal,
state and local regulation. Regulatory actions have affected, and are likely to
continue to affect, our correctional facility customers, our telecommunications
service provider customers, our competitors and us.
The inmate telecommunications market is
regulated at the federal level by the Federal Communications Commission (“FCC”)
and at the state level by public utilities commissions or equivalent agencies
(“PUCs”) of the various states. In addition, from time to time, Congress or the
various state legislatures may enact legislation that affects the
telecommunications industry generally and the inmate telecommunications industry
specifically. Court decisions interpreting applicable laws and regulations may
also have a significant effect on the inmate telecommunications industry.
Changes in existing laws and regulations, as well as the adoption of new laws
and regulations applicable to our activities or other telecommunications
businesses, could have a material adverse effect on us. See “Risk Factors —
Regulatory Risks.”
Federal
Regulation
Prior to
1996, the federal government’s role in the regulation of the inmate
telecommunications industry was relatively limited. The enactment of the
Telecommunications Act of 1996 (the “Telecom Act”), however, marked a
significant change in scope of federal regulation of the inmate
telecommunications service. Generally, the Telecom Act (i) opened local
exchange service to competition and preempted states from imposing barriers
preventing such competition, (ii) imposed new unbundling and
interconnection requirements on incumbent local exchange carrier networks,
(iii) removed prohibitions on inter-local access and transport area
services (“LATA”) and manufacturing when certain competitive conditions are met,
(iv) transferred any remaining requirements of the consent decree governing
the 1984 Bell System divestiture (including its nondiscrimination provisions) to
the FCC’s jurisdiction, (v) imposed requirements to conduct certain
competitive activities only through structurally separate affiliates, and
(vi) eliminated many of the remaining cable and telephone company
cross-ownership restrictions.
This
legislation and related rulings significantly changed the competitive landscape
of the telecommunications industry as a whole. For the inmate telecommunications
industry, the Telecom Act added Section 276 to the principal U.S. federal
communications statute, the Communications Act of 1934. Section 276 directed the
FCC to implement rules to overhaul the regulation of the provisioning of pay
phone service, which Congress defined to include the provisioning of inmate
telecommunications service in correctional institutions.
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Before
the adoption of the Telecom Act, the regulatory landscape allowed the LECs to
subsidize their inmate telecommunications operations from regulated revenues.
This allowed the LECs to offer commissions to correctional facilities that were
often significantly higher than those that independent inmate telecommunications
service providers can offer. The Telecom Act directed the FCC to adopt
regulations to end the subsidization. Congress also directed the FCC to ensure
that the RBOCs could not discriminate in favor of their own operations to the
competitive detriment of independent inmate telecommunications service
providers.
State
Regulation
In most
states, inmate telecommunications service providers must obtain prior
authorization from, or register with, the PUC and file tariffs or price lists of
their rates. The most significant state involvement in the economic regulation
of inmate telecommunications service is the limit on the maximum rates that can
be charged for intrastate collect calls set by many states, referred to as “rate
caps.” Since collect calls are the only kind of calls that can be made by
inmates at many facilities, such state-imposed rate caps can have a significant
effect on our business.
In many
states, the rate caps on inmate collect calls are tied to the rates charged by
the LEC or “dominant” long distance carrier and subject to state regulatory
approval. Thus, where the LEC or dominant long distance carrier chooses not to
raise their rates, independent inmate telecommunications service providers are
precluded from raising theirs. Prior to the passage of the Telecom Act, the LECs
and dominant long distance carriers had less incentive to raise their rates than
independent inmate telecommunications service providers because they were able
to subsidize their inmate telecommunications service operations and discriminate
in their favor, as described above. See “Federal Regulation.”
In its
rulemaking in implementing the Telecom Act, the FCC declined to address these
state rate caps. The FCC ruled that inmate telecommunications providers must
first seek relief from the state rate caps at the state level. The outcome of
any such proceedings at the state level, if undertaken, is uncertain. Further,
despite reserving the right to do so, it is uncertain whether the FCC would
intervene or if so, how, in the event a state failed to provide
relief.
In
addition to imposing rate caps, the states may regulate various other aspects of
the inmate telecommunications industry. While the degree of regulatory oversight
varies significantly from state to state, state regulations generally establish
minimum technical and operating standards to ensure that public interest
considerations are met. Among other things, most states have established rules
that govern the service provider in the form of postings or verbal
announcements, and requirements for rate quotes upon request.
The
foregoing discussion does not describe all present and proposed federal, state
and local regulations, legislation, and related judicial or administrative
proceedings relating to the telecommunications industry, including inmate
telecommunications services, and thereby affecting our business. The effect of
increased competition on our operations will be influenced by the future actions
of regulators and legislators, who are increasingly advocating competition.
While we would attempt to modify our customer relationships and our service
offerings to meet the challenges resulting from changes in the
telecommunications competitive environment, there is no assurance we would be
able to do so.
Employees
As of
December 31, 2009, we employed 736 full-time equivalent employees, of which
422 are salaried and 314 are hourly employees. None of our employees are
represented by a labor union, and we have not experienced any material work
stoppages to date. We believe that management has a good relationship with our
employees.
11
FORWARD
LOOKING STATEMENTS
This
Annual Report on Form 10-K and, in particular, the description of our Business
set forth in Item 1 and our Management’s Discussion and Analysis of
Financial Condition and Results of Operations set forth in Item 7 contain
or incorporate a number of forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933 and Section 21E of the
Securities Exchange Act of 1934, including statements regarding:
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projected
future sales growth;
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expected
future revenues, operations, expenditures and cash
needs;
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estimates
of the potential for our products and services, including the anticipated
drivers for future growth;
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sales
and marketing plans; and
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assessment
of competitors and potential
competitors.
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In addition, any statements contained in or incorporated by reference into this
report that are not statements of historical fact should be considered
forward-looking statements. You can identify these forward-looking statement by
use of the words “thinks,” “believes,” “expects,” “anticipates,” “plans,” “may,”
“will,” “would,” “intends,” “estimates” and other similar expressions, whether
in the negative or affirmative. We cannot guarantee that we actually will
achieve the plans, intentions or expectations disclosed in the forward looking
statements made. There are a number of important risks and uncertainties that
could cause our actual results to differ materially from those indicated by such
forward-looking statements. These risks and uncertainties include, without
limitation, those set forth below under the heading “Risk Factors.” We do not
intend to update publicly any forward-looking statements whether as a result of
new information, future events or otherwise.
You
should carefully consider the risks described below, together with all of the
other information contained in this Form 10-K, before making an investment
decision. The risks described below are not the only ones facing us. Additional
risks and uncertainties not currently known to us or that we currently deem to
be immaterial may also materially and adversely affect our financial condition,
results of operations or cash flow. Any of the following risks could materially
and adversely affect our financial condition or results of
operations.
Risks
Related to our Senior Notes
We
have a substantial amount of debt outstanding and have significant interest
payments.
We have a
significant amount of debt outstanding. As of December 31, 2009, we had
$287.8 million of long-term debt outstanding (net of $1.6 million of
OID for our 11% Second-priority Senior Secured Notes due 2011 and
$2.0 million of fair value attributable to warrants) and stockholders’
deficit of $148.2 million.
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Our
substantial debt could have significant consequences. For example, it
could:
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require
us to dedicate a substantial portion of our cash flow from operations to
make payments on our debt, thereby reducing funds available for
operations, future business opportunities and other
purposes;
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limit
our flexibility in planning for, or reacting to, changes in our business
and the industry in which we operate;
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make
it more difficult for us to satisfy our obligations with respect to our
debt obligations;
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limit
our ability to borrow additional funds, or to sell assets to raise funds,
if needed, for working capital, capital expenditures, acquisitions or
other purposes;
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increase
our vulnerability to general adverse economic and industry conditions,
including changes in interest rates;
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place
us at a competitive disadvantage compared to our competitors that have
less debt; and
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prevent
us from raising the funds necessary to repurchase notes tendered to us if
there is a change of control, which would constitute a default under the
indenture governing the notes and our revolving credit
facility.
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We cannot
assure you that we will generate sufficient cash flow to service and repay our
debt and have sufficient funds left over to achieve or sustain profitability in
our operations, meet our working capital and capital expenditure needs or
compete successfully in our markets. If we cannot meet our debt service and
repayment obligations, we would be in default under the terms of the agreements
governing our debt, which would allow the lenders under our revolving credit
facility to declare all borrowings outstanding to be due and payable, which
would in turn trigger an event of default under the indenture and the agreements
governing our senior subordinated debt. In addition, our lenders could compel us
to apply all of our available cash to repay our borrowings. If the amounts
outstanding under our revolving credit facility or the notes were to be
accelerated, we cannot assure you that our assets would be sufficient to repay
in full the money owed to the lenders or to our other debt holders. In addition,
we may need to refinance our debt, obtain additional financing or sell assets,
which we may not be able to do on commercially reasonable terms or at all. Any
failure to do so on commercially reasonable terms could have a material adverse
effect on our business, operations and financial condition.
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We may be able to
incur more debt, including secured debt, and some or all of this debt may
effectively rank senior to the notes and the guarantees.
Subject
to the restrictions in our revolving credit facility, the indenture governing
the notes and the senior subordinated debt financing agreements, we may be able
to incur additional debt, including secured debt that would effectively rank
senior to the notes. As of December 31, 2009, we would have been able to incur
approximately $30.0 million of additional secured debt under our revolving
credit facility. Although the terms of our revolving credit facility, the
indenture and the senior subordinated debt financing agreements contain
restrictions on our ability to incur additional debt, these restrictions are
subject to a number of important exceptions. If we incur additional debt, the
risks associated with our substantial leverage, including our ability to service
our debt, would increase.
There
may not be sufficient collateral to pay all or any of the notes.
Indebtedness
under our revolving credit facility (referred to herein as the “First-Priority
Lien Obligations”) is secured by a first-priority lien on substantially all of
our and our subsidiary guarantors’ tangible and intangible assets, except for
certain excluded collateral. The notes are secured by a second-priority lien on
the assets that secure the First-Priority Lien Obligations, other than our
current assets. In the event of a bankruptcy, liquidation, dissolution,
reorganization or similar proceeding against us or any future domestic
subsidiary, the assets that are pledged as shared collateral securing the
First-Priority Lien Obligations and the notes must be used first to pay the
First-Priority Lien Obligations, as well as any other obligation secured by a
priority lien on the collateral, in full before making any payments on the
notes.
At
December 31, 2009, we had no outstanding balance under the senior
indebtedness (excluding the notes and guarantees); however, as of the same date,
we could have borrowed approximately $30.0 million additional
First-Priority Lien Obligations under our revolving credit
facility.
Certain
of our assets, such as our accounts receivable and inventory and any proceeds
thereof, are not part of the collateral securing the notes, but do secure the
First-Priority Lien Obligations. With respect to those assets that are not part
of the collateral securing the notes but that secure other obligations, the
notes will be effectively junior to these obligations to the extent of the value
of such assets. There is no requirement that the lenders of the First-Priority
Lien Obligations first look to these excluded assets before foreclosing, selling
or otherwise acting upon the collateral shared with the notes.
The value
of the collateral for our indebtedness at any time will depend on market and
other economic conditions, including the availability of suitable buyers for the
collateral. By their nature, some or all of the pledged assets may be illiquid
and may have no readily ascertainable market value. The value of the assets
pledged as collateral for the notes could be impaired in the future as a result
of changing economic conditions, our failure to implement our business strategy,
competition and other future trends. In the event of a foreclosure, liquidation,
bankruptcy or similar proceeding, no assurance can be given that the
proceeds from any sale or liquidation of the collateral will be
sufficient to pay our obligations under the notes, in full or at all, after
first satisfying our obligations in full under the First-Priority Lien
Obligations and any other obligations secured by a priority lien on the
collateral.
Accordingly,
there may not be sufficient collateral to pay all or any of the amounts due on
the notes. Any claim for the difference between the amount, if any, realized by
holders of the notes from the sale of the collateral securing the notes and the
obligations under the notes will rank equally in right of payment with all of
our other unsecured unsubordinated indebtedness and other obligations, including
trade payables.
Holders
of notes do not control decisions regarding collateral.
The
holders of the First-Priority Lien Obligations control substantially all matters
related to the collateral securing the First-Priority Lien Obligations and the
notes. The holders of the First-Priority Lien Obligations may cause their
administrative agents to dispose of, release or foreclose on, or take other
actions with respect to the shared collateral with which holders of the notes
may disagree or that may be contrary to the interests of holders of the notes.
The security documents generally provide that, so long as the First-Priority
Lien Obligations are in effect, the holders of the First-Priority Lien
Obligations may change, waive, modify or vary the security documents without the
consent of the holders of the notes, provided that any such change, waiver or
modification does not disproportionately affect the rights of the holders of the
notes relative to the other secured creditors. Furthermore, as long as no event
of default under the indenture governing the notes has occurred, the security
documents generally allow us and our subsidiaries to remain in possession of,
retain exclusive control over, to freely operate, and to collect, invest and
dispose of any income from, the collateral securing the notes.
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The
capital stock securing the notes will automatically be released from the
second-priority lien and no longer be deemed to be collateral to the extent the
pledge of such capital stock would require the filing of separate financial
statements for any of our subsidiaries with the SEC.
The
indenture governing the notes and the security documents provide that, to the
extent that separate financial statements of any of our subsidiaries would be
required by the rules of the SEC (or any other governmental agency) due to the
fact that such subsidiary’s capital stock or other securities secure the notes,
then such capital stock or other securities will automatically be deemed not to
be part of the collateral securing the notes to the extent necessary to not be
subject to such requirement. As a result, holders of the notes could lose a
portion of their security interest in the capital stock or other securities
while any such rule is in effect. Currently, the provisions described above
would have the effect of limiting the amount of capital stock of T-Netix,
Evercom and Syscon that constitutes collateral to, in each case, 19.9% of the
outstanding capital stock.
The
indenture and revolving credit facility contain covenants that can limit the
discretion of our management in operating our business and could prevent us from
capitalizing on business opportunities and taking other corporate
actions.
The
indenture, our revolving credit facility and the senior subordinated debt
financing agreements impose significant operating and financial restrictions on
us. These restrictions will limit or restrict, among other things, our and most
of our subsidiaries’ ability to:
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incur
additional debt and issue certain types of preferred
stock;
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make
restricted payments, including paying dividends on, redeeming,
repurchasing or retiring our capital stock;
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make
investments and prepay or redeem debt;
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enter
into agreements restricting our subsidiaries’ ability to pay dividends,
make loans or transfer assets to us;
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create
liens;
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sell
or otherwise dispose of assets, including capital stock of
subsidiaries;
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engage
in transactions with affiliates;
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engage
in sale and leaseback transactions;
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make
capital expenditures; and
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consolidate
or merge.
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In
addition, the indenture governing the notes, our revolving credit facility and
our senior subordinated debt financing agreements require, and any future credit
facilities may require, us to comply with specified financial covenants,
including, in each case, interest coverage ratios and, in the case of our
revolving credit facility, minimum EBITDA levels and capital expenditure limits.
Our ability to comply with these covenants may be affected by events beyond our
control. Furthermore, the indenture governing the notes may require us to use a
significant portion of our cash generated from operations to make an offer to
purchase notes on a pro rata basis. The restrictions contained in the indenture,
our revolving credit facility and the senior subordinated debt financing
agreements could:
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limit
our ability to plan for or react to market conditions, meet capital needs
or otherwise restrict our activities or business
plans; and
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adversely
affect our ability to finance our operations, enter into acquisitions or
engage in other business activities that would be in our
interest.
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A breach
of any of the covenants contained in our revolving credit facility, debt
agreements or any other future credit facilities, or our inability to comply
with the financial ratios could result in an event of default, which would allow
the lenders to declare all borrowings outstanding to be due and payable, which
would in turn trigger an event of default under the indenture. In addition, our
lenders could compel us to apply all of our available cash to repay our
borrowings. If the amounts outstanding under our revolving credit facility or
the notes were to be accelerated, we cannot assure you that our assets would be
sufficient to repay in full the money owed to the lenders or to our other debt
holders. As of December 31, 2009, we were in compliance with all debt covenants.
We
are a holding company and we may not have access to sufficient cash to make
payments on the notes. In addition, the notes are effectively subordinated to
the liabilities of our subsidiaries.
Securus
Technologies, Inc., the issuer of the notes, is a holding company with no direct
operations. Its principal assets are the equity interests it holds, directly and
indirectly, in its subsidiaries. Since all of our operations are conducted
through our subsidiaries, our ability to service our indebtedness, including the
notes, will be dependent upon the earnings of our subsidiaries and the
distribution of those earnings, or upon loans or other payments of funds, by our
subsidiaries to us. Our subsidiaries are legally distinct from us and have no
obligation to pay amounts due on our debt or to make funds available to us for
such payment. The payment of dividends and the making of loans and advances to
us by our subsidiaries may be subject to various restrictions, including
restrictions under our revolving credit facility more fully described below. In
addition, the ability of our subsidiaries to make such payments or advances to
us may be limited by the laws of the relevant jurisdictions in which our
subsidiaries are organized or located, including, in some instances, by
requirements imposed by regulatory bodies that oversee the telecommunications
industry in such jurisdictions. In certain circumstances, the prior or
subsequent approval of such payments or advances by our subsidiaries to us is
required from such regulatory bodies or other governmental entities. The notes,
therefore, without giving effect to any guarantees of the notes, will be
effectively subordinated to creditors (including trade creditors) of our
subsidiaries. Although the indenture contains limitations on the amount of
additional indebtedness that we and our restricted subsidiaries may incur, the
amounts of such indebtedness could be substantial and such indebtedness may be
First-Priority Lien Obligations. In addition, each of our subsidiaries has other
liabilities, including contingent liabilities (including the guarantee
obligations under our revolving credit facility and the senior subordinated debt
financing) that may be significant.
In
addition, our revolving credit facility will restrict all payments from our
subsidiaries to us during the continuance of a payment default and will also
restrict payments to us for a period of up to 180 days during the
continuance of a non-payment default.
Our
revolving credit facility is, and future credit facilities may be, guaranteed by
our domestic restricted subsidiaries and certain foreign subsidiaries. Although
the indenture contains limitations on the amount of additional indebtedness that
we and our restricted subsidiaries may incur, the amounts of such indebtedness
could be substantial and such indebtedness may be secured. As of December 31,
2009, we would have been able to incur approximately $30.0 million of
additional secured debt constituting First-Priority Lien Obligations under our
revolving credit facility.
U.S.
bankruptcy or fraudulent conveyance law may interfere with the payment of the
notes and the guarantees and the enforcement of the security
interests.
Our
incurrence of debt, such as the notes and the guarantees, as well as the
security interests related to the notes and the guarantees, may be subject to
review under U.S. federal bankruptcy law or relevant state fraudulent
conveyance laws if a bankruptcy proceeding or lawsuit is commenced by us or on
behalf of our unpaid creditors. Under these laws, if in such a proceeding or
lawsuit a court were to find that, at the time we incurred debt (including debt
represented by the notes and the guarantees),
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we
incurred such debt with the intent of hindering, delaying or defrauding
current or future creditors; or
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we
received less than reasonably equivalent value or fair consideration for
incurring such debt
and we:
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were
insolvent or were rendered insolvent by reason of any of the
transactions;
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were
engaged, or about to engage, in a business or transaction for which our
remaining assets constituted unreasonably small capital to carry on our
business;
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intended
to incur, or believed that we would incur, debts beyond our ability to pay
as these debts matured (as all of the foregoing terms are defined in or
interpreted under the relevant fraudulent transfer or conveyance
statutes); or
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were
defendants in an action for money damages or had a judgment for money
damages entered against us (if, in either case, after final judgment such
judgment is unsatisfied);
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then that
court could avoid or subordinate the amounts owing under the notes to our
presently existing and future debt, void or decline to enforce the security
interest and take other actions detrimental to you.
The
measure of insolvency for purposes of the foregoing considerations will vary
depending upon the law of the jurisdiction that is being applied in any
proceeding. Generally, a company would be considered insolvent if, at the time
it incurred the debt:
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the
sum of its debts (including contingent liabilities) was greater than its
assets, at fair valuation;
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the
present fair saleable value of its assets was less than the amount
required to pay the probable liability on its total existing debts and
liabilities (including contingent liabilities) as they became absolute and
mature; or
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it
could not pay its debts as they became
due.
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We
cannot predict what standards a court would use to determine whether we or our
subsidiary guarantors were solvent at the relevant time, or whether the notes,
the guarantees or the security interests would be avoided or further
subordinated on another of the grounds set forth above.
We
may be unable to repurchase the notes upon a change of control as required by
the indenture.
Upon the
occurrence of a change of control, we will be required to make an offer to
repurchase all outstanding notes. In addition, our revolving credit facility
contains prohibitions of certain events that would constitute a change of
control or require such senior indebtedness to be repurchased or repaid upon a
change of control. Moreover, the exercise by the holders of their right to
require us to repurchase the notes could cause a default under such agreements,
even if the change of control itself does not, due to the financial effect of
such repurchase on us. Under any of these circumstances, we cannot assure you
that we will have sufficient funds available to repay all of our senior debt and
any other debt that would become payable upon a change of control and to
repurchase the notes. Our failure to purchase the notes would be a default under
the indenture, which would in turn trigger a default under our revolving credit
facility. We would need to refinance our revolving credit facility or cure the
defaults thereunder before making the change of control offer.
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The
definition of change of control includes a phrase relating to the sale or other
transfer of “all or substantially all” of our assets. There is no precise
definition of the phrase under applicable law. Accordingly, in certain
circumstances there may be a degree of uncertainty in ascertaining whether a
particular transaction would involve a disposition of “all or substantially all”
of our assets, and therefore it may be unclear as to whether a change of control
has occurred and whether the holders of the notes have the right to require us
to repurchase such notes.
Rights of holders
of notes in the collateral may be adversely affected by bankruptcy
proceedings.
The right
of the administrative agent of the First Lien Priority Obligations to repossess
and dispose of the collateral securing the notes upon acceleration is likely to
be significantly impaired by federal bankruptcy law if bankruptcy proceedings
are commenced by or against us or any of our subsidiaries prior to or possibly
even after the administrative agent has repossessed and disposed of the
collateral. Under the U.S. Bankruptcy Code, a secured creditor, such as the
administrative agent, is prohibited from repossessing its security from a debtor
in a bankruptcy case, or from disposing of security repossessed from a debtor,
without bankruptcy court approval. Moreover, bankruptcy law permits the debtor
to continue to retain and to use collateral, and the proceeds, products, rents
or profits of the collateral, even though the debtor is in default under the
applicable debt instruments, provided that the secured creditor is given
“adequate protection.” The meaning of the term “adequate protection” may vary
according to circumstances, but it is intended in general to protect the value
of the secured creditor’s interest in the collateral and may include cash
payments or the granting of additional security, if and at such time as the
court in its discretion determines, for any diminution in the value of the
collateral as a result of the stay of repossession or disposition or any use of
the collateral by the debtor during the pendency of the bankruptcy case. In view
of the broad discretionary powers of a bankruptcy court, it is impossible to
predict how long payments under the notes could be delayed following
commencement of a bankruptcy case, whether or when the administrative agent
would repossess or dispose of the collateral, or whether or to what extent
holders of the notes would be compensated for any delay in payment or loss of
value of the collateral through the requirements of “adequate protection.”
Furthermore, in the event the bankruptcy court determines that the value of the
collateral is not sufficient to repay all amounts due on the notes, the holders
of the notes would have “undersecured claims” as to the difference. Federal
bankruptcy laws do not permit the payment or accrual of interest, costs and
attorneys’ fees for “undersecured claims” during the debtor’s bankruptcy
case.
Risk
Factors Relating to Our Business
Economic
conditions, particularly the continued economic slowdown, could adversely impact
our financial condition and results of operations.
Our
business is directly affected by market conditions, trends in our industry and
finance, legislative and regulatory changes, and changes in the economy, all of
which are beyond our control. Continued deterioration in economic conditions
could result in the following consequences, among others, any of which could
have an adverse impact on our business operations, results of operations and
financial condition:
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Demand
for our products and services may continue to decline, resulting in lower
billed calls and
minutes, revenues and operating income;
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Our
bad debt may rise and we may be required to further limit credit to billed
parties, which would
reduce our revenues;
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Our
existing and prospective software customers may continue to delay or defer
spending on
software and services;
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Volatile
credit markets can impact borrowing
availability.
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These
risks are not the only risks facing us. Additional risks and uncertainties not
currently known to us or those we currently view to be immaterial may also
materially and adversely affect our business, financial condition, or results of
operations.
18
Our
financial results are dependent on the success of our billing and bad debt risk
management systems.
The
inmate telecommunications business is subject to significant risk of bad debt or
uncollectible accounts receivable. In 2009, our direct provisioning bad debt
expense was approximately 8% of our direct provisioning revenues. Many calls are
collect calls paid by the called or billed party. Historically, such billed
party’s ability to pay for collect calls has been tied to economic conditions,
and unemployment rates in particular, that exist in their community. However, we
have developed statistical methods to identify high risk customers who we
require to prepay. In 2008, approximately 46% of our direct call provisioning
revenue was prepaid, while over 55% of our direct provisioning revenue was
prepaid in 2009. Due to current economic conditions in the country
and high unemployment rates, it is possible that bad debt results could
deteriorate. Because our bad debt visibility is delayed by six to
nine months for calls that are placed on LEC bills, risks exists that we will
incur future write-offs causing bad debt to increase.
We bill
our direct and wholesale services call records through LECs and billing
aggregators, which aggregate our charges with other service providers and bill
through the applicable LEC. Our agreements with the LECs and the billing
aggregators specify that the LECs get paid their portion of a bill prior to ours
and we share the remaining risk of nonpayment with other non-LEC service
providers. In certain circumstances, LECs are unable to trace the collect call
to a proper billed number and the call is unbillable. We are also subject to the
risks that the LEC decides not to charge for a call on the basis of billing or
service error and that we may be unable to retain our current billing collection
agreements with LECs, many of which are terminable at will.
There is
a significant lag time (averaging six to nine months) between the time a call is
made and the time we learn that the billed party has failed to pay for a call
when we bill through LECs and billing aggregators. During this period, we may
continue to extend credit to the billed party prior to terminating service and
thus increase our exposure to bad debt. Additionally, because of the significant
lag time, deteriorating trends in collection rates may not be immediately
visible and bad debt may therefore increase prior to our ability to adjust our
algorithms and reduce credit limits. This risk is heightened in light of the
recent economic downturn. We seek to minimize our bad debt expense by using
multi-variable algorithms to adjust our credit policies and billing. We have
enhanced our bad debt management systems by reducing the processing time of call
records through our back office systems. However, we cannot assure you that
these initiatives will always be successful or that our algorithms will remain
accurate as circumstances change. Moreover, to the extent we overcompensate for
bad debt exposure by limiting credit to billed parties, our revenues and
profitability may decline as we allow fewer calls to be made. To the extent our
billing and bad debt risk management systems are less than effective or we are
otherwise adversely affected by the foregoing factors, our results of operations
could be negatively impacted.
We
expect significant declines in our wholesale revenues, which if not replaced by
direct call provisioning or other revenues, could have an adverse impact on our
financial condition.
Our
wholesale revenues, which accounted for approximately 8% of our revenues in
2009, are expected to continue to decline over the next few
years. Our wholesale customers have historically been comprised of
large telecommunications carriers, which began exiting the inmate
telecommunications business in early 2005. Since their exit, the larger county
and state facilities that they served are increasingly being serviced by
independent inmate communications companies. As a result, our wholesale revenues
decreased by approximately $1.8 million, or 5.9%, from 2008 to 2009. Global
Tel*Link comprised 31% of our wholesale revenue in 2009. Global’s master
agreement with us expired on March 1, 2008 and we will stop providing services
to them as their underlying contracts at the individual facilities
expire.
We
are dependent on third party vendors for our information, billing and offender
management systems.
Sophisticated
information and billing systems are vital to our ability to monitor and control
costs, bill customers, process customer orders, provide customer service and
achieve operating efficiencies. We currently rely on internal systems and third
party vendors to provide all of our information and processing systems. Some of
our billing, customer service and management information systems have been
developed by third parties for us and may not perform as anticipated. In
addition, our plans for developing and implementing our information and billing
systems rely substantially on the delivery of products and services by third
party vendors.
We also
license critical third-party software for our offender management products that
we incorporate into our own software products and are likely to incorporate
additional third-party software into our new product offerings. The operation of
our products would be impaired if errors occur in the third-party software that
we utilize. It may be more difficult for us to correct any defects in
third-party software because the software is not within our control.
Accordingly, our business could be adversely affected in the event of any errors
in this software. There can be no assurance that these third parties will
continue to
invest
the appropriate levels of resources in their products and services to maintain
and enhance the capabilities of their software. If the cost of licensing any of
these third-party software products significantly increases, our gross margin
levels could significantly decrease.
19
Our right to use these systems is dependent upon license agreements with third
party vendors. Some of these agreements are cancelable by the vendor, and the
cancellation or nonrenewable nature of these agreements could impair our ability
to process orders, bill our customers or sell our offender management products.
Since we rely on third party vendors to provide some of these services or
products, any switch in vendors could be costly and could affect operating
efficiencies.
Additionally,
if our relations with any of our third-party information and offender management
systems providers are impaired or the third-party software infringes upon
another party’s intellectual property rights, our business could be harmed.
Although these third party software vendors generally indemnify us against
claims that their technology infringes on the proprietary rights of others, such
indemnification is not always available for all types of intellectual property.
Sometimes software vendors are not well capitalized and may not be able to
indemnify us in the event that their technology infringes on the proprietary
rights of others. Defending such infringement claims, regardless of their
validity, could result in significant cost and diversion of resources. As a
result, we may face substantial exposure to liability in the event that
technology we license from a third-party infringes on another party’s
proprietary rights.
We
face challenges in growing our offender management software
business.
Our
future success and our ability to meet forecasted operating results and pay
interest and principal on the notes will depend in part on our ability to
sustain our market share of the offender management software business. In 2009
and prior years, the majority of these revenues were associated with our ongoing
implementation of our software for Her Majesty’s Prison Service in the United
Kingdom, through a sub-contracting agreement with Hewlett Packard (formerly
EDS). We will need to continue to generate new contracts to compensate for the
loss of this revenue.
Our
offender management software business has been affected by the poor economy as
government budgets have been negatively impacted. Corrections agencies have
increased the amount of time they take to evaluate proposals, process contracts
and change orders, and in some cases have deferred or cancelled orders for the
purchase of technology solutions. Agencies are being extremely careful as all
purchases are under increased scrutiny and require additional steps before
approval. If we are unable to continue to generate new contracts we will
face the risk of not meeting our targeted revenue goals for 2010, which could
further reduce profitability or operating losses and may materially and
adversely affect our business, financial condition and results of
operations.
A
number of our customers individually account for a large percentage of our
revenues, and therefore the loss of one or more of these customers could harm
our business.
If we
lose existing customers and do not replace them with new customers, our revenues
will decrease and may not be sufficient to cover our costs. For the year ended
December 31, 2009, our top five customers accounted for approximately 20%
of our total revenues. If we lose one or more of these customers our revenues
will be adversely affected, which could harm our business.
Our
success depends on our ability to protect our proprietary technology and ensure
that our systems are not infringing on the proprietary technology of other
companies.
Our
success depends to a significant degree on our protection of our proprietary
technology, particularly in the areas of three-way call prevention, automated
operators and call processing technology, bad debt risk management, revenue
generation and ancillary products and services. The unauthorized reproduction or
other misappropriation of our proprietary technology could enable third parties
to benefit from our technology without paying us for it. Although we have taken
steps to protect our proprietary technology, these steps may be inadequate. We
rely on a combination of patent and copyright law and non-disclosure agreements
to establish and protect our proprietary rights in our systems. However,
existing trade secret, patent, copyright and trademark laws offer only limited
protection. Despite our efforts to protect our proprietary rights, unauthorized
parties may attempt to copy aspects of our products or obtain and use trade
secrets or other information we regard as proprietary. If we resort to legal
proceedings to enforce our intellectual property rights, the proceedings would
be burdensome and expensive and could involve a high degree of
risk.
We cannot
assure you that a third party will not accuse us of infringement on its
intellectual property rights. There has been litigation in the
telecommunications industry regarding alleged infringement of certain of the
technology used in internet telephony services. Although this litigation
involves companies unrelated to us, and we believe, technology different from
ours, it is possible that similar litigation could be brought against us in the
future. Certain parties to such litigation have significantly greater financial
and other resources than us. Any claim of infringement could cause us to incur
substantial costs defending against the claim, even if the claim is not valid,
and could perhaps prevent us from adequately defending the claim. Such a claim
would also distract our management from our business. A claim may also result in
a judgment involving substantial damages or an injunction or other court order
that could prevent us from selling our products and services or operating our
network architecture. Any of these events could have a material adverse effect
on our business, operating results and financial condition.
20
We
may not be able to adapt successfully to new technologies, to respond
effectively to customer requirements or to provide new
services.
The
communications and software industries, including inmate communications and
offender management systems, are subject to rapid and significant changes in
technology, frequent new service introductions and evolving industry standards.
As a result, it is difficult for us to estimate the life cycles of our products.
Technological developments may reduce the competitiveness of our services and
require unbudgeted upgrades, significant capital expenditures and the
procurement of additional services that could be expensive and time consuming.
To the extent our existing or future competitors are successful in developing
competitive technologies, including through deployment of the packet based
architecture that we believe provides us with a competitive advantage, our
competitive position, market share and the price we receive for services may be
adversely affected. To be competitive, we must develop and introduce product
enhancements and new products. New products and new technology often render
existing information services or technology infrastructure obsolete, excessively
costly, or otherwise unmarketable. As a result, our success depends on our
ability to create and integrate new technologies into our current products and
services and to develop new products. If we fail to respond successfully to
technological changes or obsolescence or fail to obtain access to important new
technologies, we could lose customers and be limited in our ability to attract
new customers or sell new services to our existing customers. The failure to
adapt to new technologies could have a material adverse effect on our business,
financial condition and results of operations.
The
successful development of new services, which is an element of our business
strategy, is uncertain and dependent on many factors, and we may not generate
anticipated revenues from such services. In addition,
as communications networks are modernized and evolve from analog-based to
digital-based systems, certain features offered by us may diminish in value. We
cannot guarantee that we will have sufficient technical, managerial or financial
resources to develop or acquire new technology or to introduce new services or
products that would meet our customers’ needs in a timely manner.
Our
business could be adversely affected if our products and services fail to
perform or be performed properly.
Products
as complex as ours may contain undetected errors or “bugs,” which could result
in product failures or security breaches and render us unable to satisfy
customer expectations. Further, our products must integrate with the many
computer systems and software programs of our customers. Any failure of our
systems or an inability of our customer to implement or integrate our products
could result in a claim for substantial damages against us, regardless of our
responsibility for the failure. Although we test our products and maintain
general liability insurance, including coverage for errors and omissions, we
cannot assure you that we will detect every error or that our existing coverage
will continue to be available on reasonable terms or will be available in
amounts sufficient to cover one or more large claims, or that the insurer will
not disclaim coverage as to any future claim. The occurrence of errors could
result in a loss of data to us or our customers, which could cause a loss of
revenues, failure to achieve acceptance, diversion of development resources,
injury to our reputation, or damages to our efforts to build brand awareness,
any of which could have a material adverse effect on our market share and, in
turn, our operating results and financial condition.
A
system failure could cause delays or interruptions of service, which could cause
us to lose customers.
To be
successful, we will need to continue to provide our customers with reliable
service. Some of the events that could adversely affect our ability to deliver
reliable service include:
•
|
physical
damage to our network operations centers;
|
•
|
disruptions
beyond our control;
|
•
|
power
surges or outages; and
|
•
|
software
defects.
|
Disruptions
may cause interruptions in service or reduced capacity for customers, either of
which could cause us to lose customers and incur unexpected
expenses.
21
We
are dependent on the communications industry, which subjects our business to
risks affecting the communications industry generally.
Although
we focus on the inmate communications industry, our business is directly
affected by risks facing the communications industry in general. The
communications industry has been, and we believe it will continue to be,
characterized by several trends, including the following:
•
|
rapid
development and introduction of new technologies and
services;
|
•
|
increased
competition within established markets from current and new market
entrants that may provide competing or alternative
services;
|
•
|
the
increase in mergers and strategic alliances that allow one
telecommunications provider to offer increased services or access to wider
geographic markets; and
|
•
|
continued
changes in the laws and regulations affecting rates for collect and
prepaid calls.
|
The
market for communications services is highly competitive. Our ability to compete
successfully in our markets will depend on several factors, including the
following:
•
|
how
well we market our existing services and develop new
technologies;
|
•
|
the
quality and reliability of our network and service;
|
•
|
our
ability to anticipate and respond to various competitive factors affecting
the communications industry, including a changing regulatory environment
that may affect us differently from our competitors, pricing strategies
and the introduction of new competitive services by our competitors,
changes in consumer preferences, demographic trends and economic
conditions; and
|
•
|
our
ability to successfully defend claims against
us.
|
Competition
could intensify as a result of new competitors and the development of new
technologies, products and services. Some or all of these risks may cause us to
have to spend significantly more in capital expenditures than we currently
anticipate in order to retain existing and attract new customers.
Some of
our competitors have brand recognition and financial, personnel, marketing and
other resources that are significantly greater than ours. In addition, due to
consolidation and strategic alliances within the communications industry, we
cannot predict the number of competitors that will emerge, especially as a
result of existing or new federal and state regulatory or legislative actions.
Increased competition from existing and new entities could lead to higher
commissions paid to correctional facilities, loss of customers, reduced
operating margins or loss of market share.
Most
of our customers are governmental entities that require us to adhere to certain
policies that may limit our ability to attract and retain
customers.
Our
customers include U.S. and foreign federal, state and local governmental
entities responsible for the administration and operation of correctional
facilities. We are subject, therefore, to the administrative policies and
procedures employed by, and the regulations that govern the activities of, these
governmental entities, including policies, procedures, and regulations
concerning the procurement and retention of contract rights and the provision of
services. Our operations may be adversely affected by the policies and
procedures employed by, or the regulations that govern the activities of, these
governmental entities and we may be limited in our ability to secure additional
customer contracts, renew and retain existing customer contracts, and consummate
acquisitions as a result of such policies, procedures and
regulations.
22
Our
offender management software’s lengthy sales cycle and limited number of large
non-recurring licenses sales make it difficult to predict quarterly revenue
levels and operating results.
It is
difficult for us to forecast the timing and recognition of revenues from sales
of our offender management products because our existing and prospective
customers often take significant time evaluating our products before licensing
them. The sales process for our offender management software products is lengthy
and can exceed one year. License and implementation fees for our offender
management software products tend to be substantial when they occur.
Additionally, the purchasing of our offender management software products is
relatively discretionary and the purchasing decision typically involves members
of our customers’ senior management. Accordingly, the timing of our license
revenues is difficult to predict. The delay of an order could cause our
quarterly revenues to fall substantially below our expectations and those of
public market analysts and investors.
Moreover,
to the extent that we succeed in shifting customer purchases away from
individual software products and toward more costly integrated suites of
software and services, our sales cycle may lengthen, which could increase the
likelihood of delays and cause the effect of a delay to become more pronounced.
Delays in our offender management software sales could cause significant
shortfalls in our revenues and operating results for any particular period and
could lead to future impairment of goodwill or long-lived assets. The period
between initial customer contact and a purchase by a customer may vary from nine
months to more than one year. During the evaluation period, prospective
customers may decide not to purchase or may scale down proposed orders of our
products for various reasons, including:
•
|
reduced
demand for offender management software solutions;
|
•
|
introduction
of products by our competitors;
|
•
|
lower
prices offered by our competitors; and
|
•
|
reduced
need to upgrade existing systems.
|
Additionally,
because our customers and potential customers are federal, state and local
government agencies that may have limited funds allocated to information
technology, decreases in any of our customers’ budgets for information
technology could result in order cancellations that could have a significant
adverse affect on our revenues and quarterly results.
We
may not be successful in convincing potential customers to migrate to our
offender management software products.
Many
correctional institutions have historically used internally developed software
for their offender management systems and to manage other resources. These
institutions may not be willing to incur the costs or invest the resources
necessary to initially implement our software products or complete upgrades to
current or future releases of our products. Consequently, it may be difficult
for us to convince these institutions to make substantial capital expenditures
to migrate to our products. This may impede our ability to increase our market
share in existing markets as well as penetrate other geographic markets or to
generate new or recurring revenues.
Our
international operations and sales subject us to risks associated with
unexpected events.
The
international reach of our business could cause us to be subject to unexpected,
uncontrollable and rapidly changing events and circumstances. The following
factors, among others, could adversely affect our business and
earnings:
23
•
|
failure
to properly comply with foreign laws and regulations applicable to our
foreign activities including, without limitation, software localization
requirements;
|
•
|
compliance
with multiple and potentially conflicting regulations in Europe, Australia
and North America, including export requirements, tariffs, import duties
and other trade barriers, as well as intellectual property
requirements;
|
•
|
difficulties
in managing foreign operations and appropriate levels of
staffing;
|
•
|
longer
collection cycles;
|
•
|
seasonal
reductions in business activities, particularly throughout
Europe;
|
•
|
reduced
protection for intellectual property rights in some
countries;
|
•
|
proper
compliance with local tax laws, which can be complex and may result in
unintended adverse tax consequences;
|
•
|
anti-American
sentiment due to the wars in Iraq and Afghanistan and other American
policies that may be unpopular in certain countries;
|
•
|
difficulties
in enforcing agreements through foreign legal systems;
|
•
|
fluctuations
in exchange rates may affect product demand and may adversely affect the
profitability in U.S. dollars of products and services provided by us
in foreign markets where payment for our products and services is made in
the local currency;
|
•
|
changes
in general economic and political conditions in countries where we
operate; and
|
•
|
restrictions
on downsizing operations in Europe and expenses and delays associated with
any such activities.
|
Regulatory
Risks
The
FCC is currently reviewing challenges and alternatives to the rates applicable
to interstate inmate telecommunications service that, if implemented, could have
an adverse effect on our business.
The FCC
has opened several rulemaking proceedings that question whether the current
regulatory regime applicable to the rates for interstate inmate
telecommunications services is responsive to the needs of correctional
facilities, inmate telecommunications service providers, the inmates and their
families. Parties participating in these proceedings generally include prison
inmates and their families, parties receiving calls from inmates, several
national inmate advocacy organizations such as Citizens United for the
Rehabilitation of Errants and providers of inmate telecommunications services.
In general, the position of those challenging the current regulatory regime is
that inmate telecommunications service rates are excessive due to compensation
paid to correctional facilities in the form of “commissions” and that the FCC
should establish rate caps, prohibit commissions to correctional facilities and
mandate the offering by inmate telecommunications service providers of inmate
debit or prepaid card alternatives to collect calling. Such a regime would
require a new and complex set of federal regulations that, if adopted, could
reduce our revenues derived from existing contracts and could lead to increased
costs associated with regulatory compliance. Moreover, if implementation of
these regulations leads to technological or structural changes in the industry,
it could diminish the value of our intellectual property and our customer
relationships and lead to a reduction in profitability of calls originating from
correctional facilities.
24
We
operate in a highly regulated industry, and are subject to restrictions in the
manner in which we conduct our business and a variety of claims relating to such
regulation.
Our
operations are subject to federal regulation, and we must comply with the
Communications Act of 1934, as amended, and FCC regulations promulgated there
under. We are also subject to the applicable laws and regulations of various
states and other state agencies, including regulation by public utility
commissions. Federal laws and FCC regulations generally apply to interstate
telecommunications (including international telecommunications that originate or
terminate in the United States), while state regulatory authorities generally
have jurisdiction over telecommunications that originate and terminate within
the same state. Generally, we must obtain and maintain prior authorization from
and/or register with, regulatory bodies in most states where we offer intrastate
services and must obtain or submit prior regulatory approval of rates, terms and
conditions for our intrastate services in many of these jurisdictions. We are
also in some cases required, along with other telecommunications providers, to
contribute to federal and state funds established for universal service, number
portability, payphone compensation and related purposes. Laws and regulations in
this industry such as those identified above, and others including those
regulating call recording and call rate announcements, and billing, collection,
customer collection management, and solicitation practices are all highly
complex and burdensome, making it difficult to be in complete compliance. The
difficulty is sometimes exacerbated by technology issues. Although we actively
seek to comply with all laws and regulations and remedy areas in which we become
aware of inadvertent non-compliance, we may not always be in full compliance
with all regulations applicable to us. Once non-compliance is identified,
remedies are sought and implemented as quickly as possible. Failure to comply
with these requirements can result in potentially significant fines, penalties,
regulatory sanctions and claims for substantial damages. Claims may be
widespread, as in the case of class actions commenced on behalf of inmates or
the called parties of inmates. Significant fines, penalties, regulatory
sanctions and damage claims could be material to our business, operating results
and financial condition. Additionally, regulation of the telecommunications
industry is changing rapidly, and the regulatory environment varies
substantially from state to state. Future regulatory, judicial or legislative
activities may have an adverse effect on our operations or financial condition,
and domestic or international regulators or third parties may raise material
issues with regard to our compliance or non-compliance with applicable
regulations.
None.
Our
principal executive office is located in, and a portion of our operations are
conducted from, leased premises located at 14651 Dallas Parkway, Suite 600,
Dallas, Texas 75254-8815. We also lease additional regional facilities located
in Carrollton, Texas, from which we conduct our technical support operations,
in-sourced call center, and warehouse operations, and our data centers located
in Allen and Dallas, Texas and Atlanta, Georgia. We have offices in Richmond,
British Columbia and London, United Kingdom. We believe that our facilities are
suitable and the space contained by them adequate for their respective
operations.
We have
been, and expect to continue to be, subject to various legal and administrative
proceedings or various claims in the normal course of business. We believe the
ultimate disposition of these matters will not have a material effect on our
financial condition, liquidity, or results of operations.
From time
to time, inmate telecommunications providers, including the Company, are parties
to judicial and regulatory complaints and proceedings initiated by inmates,
consumer protection advocates or individual called parties alleging, among other
things, that excessive rates are being charged with respect to inmate collect
calls, that commissions paid by inmate telephone service providers to the
correctional facilities are too high, that a call was wrongfully disconnected,
that security notices played during the call disrupt the call, that the billed
party did not accept the collect calls for which they were billed or that rate
disclosure was not provided or was inadequate. On occasion, we are also the
subject of regulatory complaints regarding our compliance with various matters
including tariffing, access charges, payphone compensation requirements and rate
disclosure issues. In March 2007, the FCC asked for public comment on a proposal
from an inmate advocacy group to impose a federal rate cap on interstate inmate
calls. This proceeding could have a significant impact on the rates that we and
other companies in the inmate telecommunications industry may
charge. Similar proposals have been pending before the FCC for more
than four years without action by the agency. This newest proceeding remains
under review by the FCC and has received strong opposition from the inmate
telecommunications industry. In August 2008, a group of inmate telephone service
providers provided the FCC with an "industry wide" cost of service study for
their consideration. That proceeding remains ongoing and we have no
information as to when, if ever, it will be resolved. We cannot
predict the outcome at this time.
25
In June
2000, T-Netix was named, along with AT&T, in a lawsuit in the Superior
Court of King County, Washington, in which two private citizens allege
violations of state rules requiring pre-connect audible disclosure of rates as
required by Washington statutes and regulations. T-Netix and other
defendants successfully obtained dismissal and a "primary jurisdiction" referral
in 2002. In 2005, after several years of inactivity before the Washington
Utilities and Transportation Commission (“WUTC”), the state telecommunications
regulatory agency, T-Netix prevailed at the trial court in securing an
order entering summary judgment on grounds of lack of standing, but that
decision was reversed by an intermediate Washington state appellate court in
December 2006. T-Netix’s subsequent
petition for review by the Washington Supreme Court was denied in January 2008,
entitling plaintiffs to continue to pursue their claims against T-Netix and
AT&T. This matter was referred to the WUTC on the grounds of primary
jurisdiction, in order for the WUTC to determine various regulatory issues. On
May 22, 2008, AT&T filed with the trial court a cross-claim against T-Netix
seeking indemnification. T-Netix moved to dismiss AT&T’s cross-claim, but
the court denied that motion and deferred resolution of whether
AT&T's belated indemnification claim is within the statute of
limitations for summary judgment. Motions by both T-Netix and
AT&T for summary determination were briefed to the WUTC in September 2009
and remain pending before an administrative law judge. As merits and
damages discovery are not completed, however, we cannot estimate the
Company's potential exposure or predict the outcome of this
dispute.
In July
2009, Evercom filed a complaint against Combined Public Communications,
Inc. ("CPC"), alleging tortious interference with Evercom’s
contracts for the provision of telecommunications services with correctional
facilities in the Commonwealth of Kentucky and the State of
Indiana. Evercom claims CPC has misrepresented that the correctional
facility has a statutory right to terminate its contract with Evercom upon the
election of a new Sheriff. Accordingly, Evercom
seeks a declaration that under Kentucky law its contracts with
its customers are not personal services contracts and that under both Indiana
and Kentucky law, its contracts with correctional facilities are not void
for not being terminable within thirty days, as well as an award
of compensatory and punitive damages. On July 29,
2009, CPC filed a motion to dismiss for failure to state a
claim. On August 14, 2009, Evercom filed its response in
opposition to dismiss, and on September 9, 2009, the court denied CPC's
motion to dismiss. On January 8, 2009, the court entered a scheduling
order setting forth the pre-trial deadlines. This matter is in its
early stages and we cannot predict the outcome at this time.
In July
2009, the Company filed a petition with the Federal Communications Commission
(“FCC”) seeking affirmation of the Company’s right to block attempts by inmates
to use services, which the Company calls “call diversion schemes,” designed to
circumvent its secure calling platforms. These illicit services are not
permitted to carry calls from any correctional facility, and the Company has
received strong support from its correctional authority clients to stop this
activity. The FCC has long-standing precedent that permits inmate
telecommunications service providers to block such attempts. The FCC had
asked that interested parties file comments to the Company’s petition by August
31, 2009; and thereafter, the Company filed reply comments. This matter is
in its early stages and we cannot predict the outcome at this time.
In
September 2009, T-Netix filed suit against Combined Public Communications, Inc.
in the United States Federal District Court for the Western District of
Kentucky, for patent infringement of various T-Netix patents. The
court has scheduled a Rule 26(f) scheduling conference for February 10, 2010 and
the parties are negotiating an agreed discovery plan to present at the
hearing. This matter is in its early stages and we cannot predict the
outcome at this time.
In
October 2009, T-Netix filed suit in the United States Federal District Court for
the Eastern District of Texas against Pinnacle Public Services, LLC for patent
infringement of various T-Netix patents. Pinnacle has served its
answer and filed a motion to transfer venue to the Northern District of
Texas. This matter is in its early stages and we cannot predict the
outcome at this time.
In
October 2009, the Company, along with Evercom and T-Netix, and one of the
Company’s competitors were sued in the Federal District Court for the Southern
District of Florida by Millicorp d/b/a ConsCallHome. Millicorp, a
proprietor of what the Company has described to the FCC as a call diverter, has
sued these companies under the Communications Act of 1934, alleging that the
companies have no right to block attempts by inmates to use the call diversion
scheme. The FCC has permitted inmate telecommunications service
providers to block such attempts since 1991, and the Company had sought
re-affirmance of that permission in the petition for declaratory ruling
described above. All defendants have filed motions to dismiss all
claims with prejudice. Discovery has not yet commenced. This
matter is in its early stages and we cannot predict the outcome at this
time.
In
October 2009, the Company filed suit in the District Court of Dallas County,
Texas, against Lattice Incorporated (“Lattice”, formerly known as Science
Dynamics Corporation) alleging breach of contract, tortious interference, unfair
competition, damage to goodwill and injunctive relief as a result of Lattice’s
breach of certain provisions of a December 2003 asset purchase agreement between
Evercom and Science Dynamics Corporation. On October 2, 2009, the court issued a
temporary restraining order against Lattice, and ordered Lattice to immediately
cease and desist from, among other things, (i) renewing any customer contracts
in the law enforcement industry; (ii) marketing, selling or soliciting, directly
or indirectly, any of its products and/or services to any customers in the law
enforcement industry; and (iii) interfering with any of the Company’s business
relationships in the law enforcement industry in the United
States. On January 4, 2010, the parties entered into a settlement
agreement and mutual release, and a patent license agreement wherein Lattice was
granted a license to use one (1) of the Company’s patents.
In
January 2010, T-Netix and Evercom filed suit in the United States
Federal District Court for the Eastern District of Texas against Legacy Long
Distance International, Inc. dba Legacy International, Inc. and Legacy Inmate
Communications for patent infringement of various T-Netix’s
and Evercom’s patents. This matter is in its early stages
and we cannot predict the outcome at this time.
26
Market
Information. Our common stock is not registered and there is
currently no established public trading market for our issued and outstanding
equity securities.
Holders of
Record. As of March 1,
2010, we had three holders of Series A Redeemable Convertible Preferred Stock,
seven holders of Class A Common Stock and twenty-two holders of Class B Common
Stock. In December 2007, we effected a 1 for 1,000 reverse stock split for our
Class A Common Stock and Class B Common Stock in connection with the issuance of
the Series A Redeemable Convertible Preferred Stock.
Dividends. We have never
declared or paid any cash dividends on our Common Stock. Our Series A
Redeemable Convertible Preferred Stock accrues dividends at 12.5% annually. We
currently intend to retain earnings, if any, to support our business strategy
and do not anticipate paying cash dividends in the foreseeable
future. Payment of future dividends, if any, will be at the sole
discretion of our board of directors after taking into account various factors,
including restrictions on our ability to pay dividends, our financial condition,
operating results, capital requirements and any plans for
expansion. Our revolving credit facility, the indenture governing our
Second-priority Senior Secured Notes, and the note purchase agreement governing
our senior subordinated notes contain certain negative covenants that restrict
our ability to declare dividends. See “Management’s Discussion and Analysis of
Financial Conditions and Results of Operations—Debt and Other
Obligations.”
Securities
Authorized for Issuance Under Equity Compensation Plans. The following
table provides information about the securities authorized for issuance under
our equity compensation plans as of December 31, 2009:
Equity
Compensation Plan Information
|
|||||||
(a)
|
(b)
|
(c)
|
|||||
Number
of
|
|||||||
Number
of
|
Securities
|
||||||
securities
|
Weighted-
|
remaining
available
|
|||||
to
be issued
|
average
|
for
future issuance
|
|||||
upon
exercise
|
exercise
price
|
under
equity
|
|||||
of
outstanding
|
of
outstanding
|
compensation
plans
|
|||||
options,
|
Options,
|
(excluding
securities
|
|||||
warrants
|
warrants
|
reflected
in
|
|||||
Plan
category
|
and
rights (1)
|
and
rights
|
column
(a))
|
||||
Equity
compensation plans approved by security holders(2)
|
126,660
|
$
|
.01
|
48,340
|
|||
Equity
compensation plans not approved by security holders
|
-
|
-
|
-
|
||||
Total
|
126,660
|
$
|
.01
|
48,340
|
|||
(1) Includes
126,660 shares of restricted stock issued under the 2004 Restricted Stock
Plan.
|
|||||||
(2) In
March 2009, the Company filed a Fourth Amendment and Restated Certificate
of Incorporation which 1,685,000 shares of stock were authorized, of which
10,000 shares are designated Preferred Stock, $.001 par value per share
(the “Preferred Stock”), 1,500,000 shares are designated Common Stock,
$.001 par value per share (the “Common Stock”), and 175,000 shares are
designated Class B Common Stock, $.001 par value per share (the “Class B
Common Stock”).
|
Unregistered
Sales of Equity Securities. As of December 31,
2009, we had sold to certain members of management and our board of directors a
total of 126,660 restricted shares of Class B Common Stock at a purchase price
of $.01 per share pursuant to the 2004 Restricted Stock Plan. In
2009, we issued 4,566 shares and 2,000 shares of Class B Common Stock on
February 19, 2009 and March 1, 2009, respectively. The shares are
subject to certain contractual limitations, including provisions regarding
forfeiture and disposition, as provided in each executive’s restricted stock
purchase agreement and the 2004 Restricted Stock Plan. The restricted period
ends upon the occurrence of certain events or the lapse of time. The
sale of the Class B Common Stock was made pursuant to the exemption set forth in
Section 4(2) of the Securities Act of 1933 for transactions not involving a
public offering, and regulations promulgated thereunder.
27
On March 25, 2009, the Company filed a Fourth Amended and Restated Certificate
of Incorporation, which authorized 1,685,000 shares of capital stock.
Additionally, the Board of Directors issued a unanimous resolution to adopt a
Fourth Amendment to the 2004 Restricted Stock Plan which increased the number of
shares of Class B Common Stock authorized for issuance thereunder from 165,000
to 175,000 shares. The Fourth Amended and Restated Certificate of Incorporation
designated 1,500,000 shares as Class A Common Stock, 10,000 shares as Preferred
Stock, of which 5,100 were designated as Series A Convertible Preferred Stock,
and 175,000 shares as Class B Common Stock. All issued shares of Common Stock
are entitled to vote on a one share/one vote basis.
The
following selected consolidated historical financial data should be read in
conjunction with “Management’s Discussion and Analysis of Financial Condition
and Results of Operations” and the consolidated financial statements and the
related notes thereto appearing elsewhere in this Form 10-K. The selected
historical consolidated financial and other data presented below for the fiscal
years ended December 31, 2007, 2008 and 2009 have been derived from our
audited consolidated financial statements.
For
the Year Ended December 31,
|
|||||||||||||||||||
2005
|
2006
|
2007
|
2008
|
2009
|
|||||||||||||||
Consolidated
Statement of Operations
|
|||||||||||||||||||
Operating
revenues (1)
|
$
|
377.4
|
$
|
401.9
|
$
|
391.9
|
$
|
388.6
|
$
|
363.4
|
|||||||||
Cost
of service (1)
|
279.7
|
293.1
|
286.8
|
271.9
|
247.2
|
||||||||||||||
Selling,
general and administrative expenses (1)
|
57.9
|
69.4
|
74.4
|
74.7
|
66.1
|
||||||||||||||
Depreciation
and amortization
|
23.9
|
30.3
|
37.1
|
34.4
|
31.4
|
||||||||||||||
Other
operating expenses (2)
|
0.6
|
-
|
0.6
|
0.2
|
-
|
||||||||||||||
Operating
income (loss)
|
15.3
|
9.1
|
(7.0
|
)
|
7.4
|
18.7
|
|||||||||||||
Other
Income Expense:
|
|||||||||||||||||||
Interest
and other expenses, net
|
(26.6
|
)
|
(27.8
|
)
|
(31.5
|
)
|
(41.9
|
)
|
(39.1
|
)
|
|||||||||
Loss
before income taxes
|
(11.3
|
)
|
(18.7
|
)
|
(38.5
|
)
|
(34.5
|
)
|
(20.4
|
)
|
|||||||||
Income
tax expense (benefit)
|
(2.2
|
)
|
1.4
|
1.9
|
(0.5
|
)
|
0.7
|
||||||||||||
Net
loss
|
(9.1
|
)
|
(20.1
|
)
|
(40.4
|
)
|
(34.0
|
)
|
(21.1
|
)
|
|||||||||
Accrued
dividends on preferred stock
|
-
|
-
|
-
|
(1.4
|
)
|
(1.5
|
)
|
||||||||||||
Net
loss available to common stockholders
|
$ |
(9.1
|
)
|
$ |
(20.1
|
)
|
$ |
(40.4
|
)
|
$ |
(35.4
|
)
|
$ |
(22.6
|
)
|
||||
Other
Financial Data:
|
|||||||||||||||||||
Direct
provisioning revenues (1)
|
$
|
303.3
|
$
|
341.2
|
$
|
338.7
|
$
|
333.6
|
$
|
312.6
|
|||||||||
Wholesale
services revenues (1)
|
74.1
|
60.7
|
45.2
|
29.9
|
28.1
|
||||||||||||||
Offender
management software
|
-
|
-
|
7.9
|
25.1
|
22.7
|
28
For
the Year Ended December 31,
|
|||||||||||||||||||
2005
|
2006
|
2007
|
2008
|
2009
|
|||||||||||||||
Other
Data:
|
|||||||||||||||||||
Deficiency
of earnings to fixed charges
|
$
|
9.1
|
$
|
20.1
|
$
|
40.4
|
$
|
35.4
|
$
|
22.6
|
|||||||||
Consolidated
Cash Flow Data:
|
|||||||||||||||||||
Cash
flows from operating activities
|
$
|
29.8
|
$
|
19.1
|
$
|
20.5
|
$
|
17.4
|
$
|
26.8
|
|||||||||
Cash
flows from investing activities
|
(26.3
|
)
|
(27.1
|
)
|
(64.0
|
)
|
(17.0
|
)
|
(16.3
|
)
|
|||||||||
Cash
flows from financing activities (3)
|
(2.8
|
)
|
6.0
|
46.5
|
1.1
|
(12.3
|
)
|
||||||||||||
Capital
Expenditures
|
26.3
|
27.2
|
21.4
|
17.0
|
16.5
|
||||||||||||||
Balance
Sheet Data (End of Period)
|
|||||||||||||||||||
Cash
and cash equivalents and restricted cash
|
$
|
4.0
|
$
|
2.0
|
$
|
3.6
|
$
|
8.2
|
$
|
4.0
|
|||||||||
Total
current assets (4)
|
80.7
|
76.4
|
62.9
|
61.6
|
51.7
|
||||||||||||||
Net
property and equipment
|
43.9
|
46.4
|
40.8
|
35.4
|
28.8
|
||||||||||||||
Total
assets
|
266.9
|
259.6
|
292.1
|
259.0
|
240.1
|
||||||||||||||
Total
long-term debt (including current portion)
|
198.0
|
210.6
|
263.3
|
288.3
|
287.8
|
||||||||||||||
Stockholders’
deficit
|
$
|
(31.9
|
)
|
$
|
(51.9
|
)
|
$
|
(88.9
|
)
|
$
|
(128.8
|
)
|
$
|
(148.2
|
)
|
(1)
|
Includes
reclassification of certain amounts in prior years to conform with current
period presentation. No impact on operating income (loss), net
loss, cash flows or the financial position of the Company for the prior
periods presented.
|
(2)
|
Includes
gain on sale of assets, compensation expense on employee restricted stock,
severance and restructuring costs.
|
(3)
|
The
2007 amount reflects $40 million of indebtedness incurred through the
issuance of additional Second-priority Senior Secured Notes in connection
with our acquisition of Syscon.
|
(4)
|
Current
assets decreased in 2007, 2008, and 2009 primarily as a result of a
decline in receivables due to a significant increase in prepaid revenues
as a percentage of total revenues, coupled with a decline in overall
direct call provisioning and wholesale services
revenues.
|
The
following information should be read in conjunction with our historical
consolidated financial statements and related notes, our audited consolidated
financial data and related notes and other financial information included
elsewhere in this Form 10-K.
Overview
We are
one of the largest independent providers of inmate telecommunications services
to correctional facilities operated by city, county, state and federal
authorities and other types of confinement facilities such as juvenile detention
centers and private jails in the United States and Canada. As of December 31,
2009, we provided service to approximately 2,400 correctional
facilities.
Our core
business consists of installing, operating, servicing and maintaining
sophisticated call processing systems in correctional facilities and providing
related services. We enter into multi-year agreements (generally three to five
years) directly with the correctional facilities in which we serve as the
exclusive provider of telecommunications services to inmates. In exchange for
the exclusive service rights, we pay a negotiated commission to the correctional
facility based upon revenues generated by actual inmate telephone use. In
addition, on a limited basis we may partner with other telecommunications
companies whereby we provide our equipment and, as needed, back office support
including validation, billing and collections services, and charge a fee for
such services. Based on the particular needs of the corrections industry and the
requirements of the individual correctional facility, we also sell platforms and
specialized equipment and services such as law enforcement management systems,
call activity reporting and call blocking.
Our
subsidiary Syscon is an enterprise software development company for the
correctional facility industry. Syscon’s core product is a sophisticated and
comprehensive software system utilized by correctional facilities and law
enforcement agencies for complete offender management. Syscon’s system provides
correctional facilities with the ability to manage and monitor inmate parole and
probation activity and development at a sophisticated level.
Certain
amounts in the prior periods’ consolidated financial statements have been
reclassified to conform to the current period presentation. We
believe this reclassification will result in a clearer presentation of our
results of operations. As a result, we have revised our Management’s Discussion
and Analysis of Financial Condition and Results of Operations for prior periods
to reflect this reclassification.
Revenues
We
derived approximately 86% of our revenues for each of the years ended December
31, 2008 and 2009 from our direct operation of inmate telecommunication systems
and the provision of related services located in correctional facilities within
43 states and the District of Columbia. We enter into multi-year agreements
under direct or “prime” contracts with the correctional facilities, pursuant to
which we serve as the exclusive provider of telecommunications services to
inmates within each facility. In exchange for the exclusive service rights, we
pay a commission to the correctional facility based upon inmate telephone use.
We install and generally retain ownership of the telephones and the associated
equipment and provide additional services tailored to the specialized needs of
the corrections industry and to the requirements of each individual correctional
facility, such as call activity recording and call blocking. In our direct call
provisioning business, we earn the full retail value of the call and pay
corresponding line charges and commissions.
We
derived approximately 6% of our revenues from our offender management software
business for each of the years ended December 31, 2008 and December 31, 2009.
Offender management systems are platforms that allow facilities managers and law
enforcement personnel to analyze data to reduce costs, prevent and solve crimes
and facilitate rehabilitation through a single user interface. Revenue related
to the offender management software business is recognized using the residual
method when the fair value of vendor specific objective evidence (“VSOE”) of the
undelivered element is determined. If the VSOE of fair value cannot be
determined for any undelivered element or any undelivered element is essential
to the functionality of the delivered element, revenue is deferred until such
criteria are met or recognized as the last element is delivered. Under the
residual method, the fair value of the undelivered elements is deferred and the
difference between the total arrangement fee and the amount recorded as deferred
revenue for the undelivered elements is recognized as revenue related to the
delivered elements.
30
We
derived approximately 8% of our revenues for each of the years ended December
31, 2008 and 2009 from the wholesale services business. We derive this revenue
through (1) validation, uncollectible account management and billing services
(solutions services), (2) providing equipment, security enhanced call
processing, call validation and service and support through the primary inmate
telecommunications providers (telecommunications services), and (3) the sale of
equipment to other telecommunications companies as customers or service
partners.
In our
direct call provisioning and wholesale services business, we accumulate call
activity data from our various installations and bill our revenues related to
this call activity against prepaid customer accounts or through direct billing
agreements with local exchange carrier (“LEC”) billing agents, or in some cases
through billing aggregators that bill end users. We receive payment on a prepaid
basis for the majority of our services and record deferred revenue until the
prepaid balances are used. In each case, we recognize revenue when the calls are
completed and record the related telecommunication costs for validating,
transmitting, billing and collection, bad debt, and line and long-distance
charges, along with commissions payable to the facilities. In our wholesale
services business, our service partner may bill the called party and we either
share the revenues with our service partner or receive a prescribed fee for each
call completed. We also charge fees for additional services such as customer
support and advanced validation.
Cost
of Service
Our
principal cost of service for our direct call provisioning business consists of
commissions paid to correctional facilities, which are typically expressed as a
percentage of either gross or net direct call provisioning revenues and are
typically fixed for the term of the agreements. Our cost of service for direct
call provisioning also includes (1) bad debt expense from uncollectible
accounts; (2) billing and collection charges; (3) telecommunication costs such
as telephone line access, long distance and other charges; (4) call validation
costs; and (5) field operations and maintenance costs for service on our
installed base of inmate telephones. We pay monthly line and usage charges to
Regional Bell Operating Companies (“RBOCs”) and other LECs for interconnection
to local networks to complete local calls. We also pay fees to interexchange and
long distance carriers for long distance calls completed. Third-party
billing charges consist of payments to LECs and other billing service providers
for billing and collecting revenues from called parties.
Cost of
service associated with our offender management software business primarily
includes salaries and related costs of employees and contractors that provide
technological services to develop, customize or enhance the software for our
clients.
Cost of
service for our wholesale service business includes billing and collection, call
validation, bad debt expense and service costs for correctional facilities,
including salaries and related personnel expenses, inmate calling systems repair
and maintenance expenses and the cost of equipment sold to service
partners.
Facility Commissions. In our
direct call provisioning business, we pay a facility commission typically based
on a percentage of our billed revenues from such facility. Commissions are set
at the beginning of each facility contract.
Bad Debt. We account for bad
debt as a direct cost of providing telecommunications services. We accrue the
related telecommunications cost charges along with an allowance for
uncollectible calls, based on historical experience. We use a proprietary,
specialized billing and bad-debt management system to integrate our billing with
our call blocking, validation and customer inquiry procedures. We seek to manage
our higher risk revenues by proactively requiring certain billed parties to
prepay collect calls or be directly billed by us. This system utilizes
multi-variable algorithms to minimize bad debt expense by adjusting our credit
policies and billing. For example, when unemployment rates are high, we may
decrease credit to less creditworthy-billed parties or require them to purchase
prepaid calling time in order to receive inmate calls.
Bad debt
expense tends to rise with higher unemployment rates and as the economy worsens,
and is subject to other factors, some of which may not be known. To the extent
our bad debt management system overcompensates for bad debt exposure by limiting
credit to billed parties, our revenues and profitability may decline as fewer
calls are permitted to be made. In 2008, we tightened our credit policy to
reduce our risk of loss from bad debts. Consequently, billed minutes and
associated revenues may have been negatively impacted in the latter part of 2008
and in 2009. Since our bad debt visibility is delayed an average of
six to nine months, risk exists that future write-offs may be
incurred.
Field Operations and Maintenance
Costs. Field operations and maintenance costs consist of service
administration costs for correctional facilities. These costs include salaries
and related personnel expenses, communication costs, and inmate calling systems
repair and maintenance expenses.
31
Selling,
General & Administrative Expenses
Selling,
general and administrative (“SG&A”) expenses consist of corporate overhead
and selling expenses, including accounting, marketing, legal, regulatory, and
research and development costs.
Industry
Trends
The
corrections industry, which includes the inmate calling and offender management
software markets, is and can be expected to remain highly
competitive. We compete directly with numerous other suppliers of
inmate call processing systems and other corrections-related products (including
our own wholesale service provider customers) that market their products to our
same customer base. Contracts to service correctional facilities are typically
subject to competitive bidding, and as we seek to secure inmate
telecommunications contracts with larger county and state departments of
corrections, we may be required to provide surety bonds or significant up-front
payments such as signing bonuses and guaranteed commissions, as well as incur
the cost of equipment and installation costs. We provide our wholesale products
and services to inmate telecommunications service providers, such as Global
Tel*Link, Embarq, AT&T, and FSH Communications.
Our
offender management software business has been affected by the poor economy and
government budget shortfalls. As corrections agencies have increased the amount
of time they take to evaluate proposals, process contracts and change orders,
and in some cases have deferred or cancelled orders for the purchase of
technology solutions. Agencies are being extremely careful, as all purchases are
under increased scrutiny and many require additional steps before
approval. The U.S. federal government economic stimulus programs have
provided some relief domestically. The global nature of the downturn is having a
similar impact overseas.
Results of
Operations for the Year Ended December31, 2009 Compared
to December 31,
2008
The
following table sets forth the primary components of revenue for 2008 and
2009.
For
the Twelve Months Ended
|
|||||||||||||
December
31,
|
December
31,
|
||||||||||||
2008
|
2009
|
Variance
|
%
Change
|
||||||||||
(Dollars
in thousands)
|
|||||||||||||
Direct
call provisioning
|
$
|
333,564
|
$
|
312,614
|
$
|
(20,950
|
)
|
(6.3
|
)%
|
||||
Offender
management software
|
25,137
|
22,698
|
(2,439
|
)
|
(9.7
|
)
|
|||||||
Wholesale
services
|
29,902
|
28,124
|
(1,778
|
)
|
(5.9
|
)
|
|||||||
Total
revenue
|
$
|
388,603
|
$
|
363,436
|
$
|
(25,167
|
)
|
(6.5
|
)%
|
Revenues
Compared
to the year ended December 31, 2008, consolidated revenues decreased for the
year ended December 31, 2009 by $25.2 million, or 6.5 %, to $363.4 million.
The primary components of the decrease in revenues are discussed
below:
Direct
call provisioning revenues decreased $21.0 million, or 6.3%, to
$312.6 million resulting primarily from lower call volumes and revenues per
call due primarily to the economic recession. Additionally, in 2009
we experienced a change in revenue recognition from a partnering arrangement
that reduced our revenues by approximately $8.2 million from the prior
year. In 2008, inmate calls were processed on our platforms and
revenues and expenses were recorded on a gross basis. The new
equipment owned and managed by our partner was installed at the various sites
and, accordingly, our share of revenue is now recorded net of
expenses. This change in revenue recognition from a gross to net
basis will continue to affect revenues over the term of the underlying facility
contract.
32
Offender management software revenues decreased $2.4 million, or 9.7%, to $22.7
million. The majority of our offender management revenues have been associated
with the implementation of our software for Her Majesty’s Prison Service in the
United Kingdom through a sub-contracting agreement with HP Enterprise Services
(formerly EDS). The implementation phase of this contract was successfully
completed during the second quarter of 2009 causing the expected decline in
revenues. During the fourth quarter of 2009, we started to generate
revenues from new contracts in the United States as well as extended our work in
the United Kingdom and Australia, and we continually seek to win new
contracts. We were impacted by the global economic recession in 2009
which has affected government budgets causing corrections agencies to delay or
defer technology spending or cancel orders altogether, which, in turn, made it
more difficult to generate new contracts during this recessionary
period. In connection with the acquisition of Syscon we valued the
existing customer contracts and related deferred revenues at fair value, which
impacted the amount of revenue and profit recognized on the acquired
contracts. Our 2008 offender management software revenues and
operating profits were $3.5 million lower than what would have been reported
resulting from the amortization of acquired customer contracts, as required by
purchase accounting. 2009 revenues and operating profits were not significantly
impacted by the amortization of acquired customer
contracts.
Wholesale
services revenues decreased by $1.8 million, or 5.9%, due to the ongoing trend
of our wholesale partners, who also compete directly with us, not renewing our
services as their underlying facility contracts expire. This revenue
attrition was partially offset by a $7.1 million increase in revenues related to
installation and project management services associated with the Texas
Department of Criminal Justice (TDCJ) contract. With the exception of the TDCJ
contract, we expect our wholesale services revenues to continue to decline in
the future as wholesale contracts expire.
Cost of
Service. Total
cost of service for the year ended December 31, 2009 decreased by
$24.7 million, or 9.1%, from the year ended December 31, 2008 due to lower
direct call provisioning and offender management software revenues and the
implementation of direct cost reduction initiatives. A comparison of
the components of our business segment gross margins is provided below (dollars
in thousands):
Year
Ended December 31,
|
||||||||||||||||
2008
|
2009
|
|||||||||||||||
Direct
Call Provisioning
|
||||||||||||||||
Revenue
|
$ | 333,564 | $ | 312,614 | ||||||||||||
Cost
of service
|
243,807 | 73.1 | % | 221,572 | 70.9 | % | ||||||||||
Segment
gross margin
|
$ | 89,757 | 26.9 | % | $ | 91,042 | 29.1 | % | ||||||||
Offender
Management Software
|
||||||||||||||||
Revenue
|
$ | 25,137 | $ | 22,698 | ||||||||||||
Cost
of service
|
13,540 | 53.9 | % | 9,624 | 42.4 | % | ||||||||||
Segment
gross margin
|
$ | 11,597 | 46.1 | % | $ | 13,074 | 57.6 | % | ||||||||
Wholesale
Services
|
||||||||||||||||
Revenue
|
$ | 29,902 | $ | 28,124 | ||||||||||||
Cost
of service
|
14,543 | 48.6 | % | 16,032 | 57.0 | % | ||||||||||
Segment
gross margin
|
$ | 15,359 | 51.4 | % | $ | 12,092 | 43.0 | % |
Cost of
service in our direct call provisioning segment decreased as a percentage of
revenue to 70.9% from 73.1% due to efficiencies gained from our packet-based
architecture, cost savings initiatives implemented during 2008 and 2009, as well
as our strategy to shift customers to our prepaid products, which carry a higher
gross margin since bad debt risk is greatly reduced. In 2008,
approximately 46% of our direct call provisioning revenues were prepaid while
55% of our direct call provisioning revenues were prepaid in 2009, generating an
improvement in bad debt expense as a percentage of revenues even in the current
recessionary environment. Because our bad debt visibility is delayed
an average of six to nine months, risk exists that we may incur future
write-offs.
Cost
of service in our offender management software segment as a percentage of
revenue decreased to 42.4 % from 53.9%. Excluding the impact of the
amortization of acquired contracts on revenues in the prior year, cost of
service as a percentage of revenues would have been 47.3% of revenues in
2008. The cost improvement in 2009 is primarily due to more efficient
utilization of personnel coupled with the completion and delivery of several
older projects that had yielded lower margins. Cost of service for
the offender software segment primarily represents salaries and related costs of
employees and contractors, who provide technological services to develop,
customize or enhance the software for our clients.
Cost of
service in our wholesale services segment as a percentage of our revenue
increased to 57.0% from 48.6% as a result of low margins for project management
and installation labor revenues associated with the TDCJ contract. The wholesale
services cost structure currently includes a mix of field service costs
resulting from implementation of the TDCJ sites. Margins related to the TDCJ
contract are expected to improve in 2010 as we generate a higher mix of billing
and collection revenues from this contract.
33
SG&A. SG&A expenses of $66.1 million were $8.6 million, or 11.5%,
lower than the prior year primarily due to cost reduction initiatives
implemented beginning in the third quarter of 2008 that have allowed us to
reduce our administrative expenses by over $7.4 million in 2009. Both
2008 and 2009 include non-recurring executive reorganization costs of $1.2
million and $0.5 million, respectively. Proceeds from favorable
intellectual property dispute settlements were recorded against SG&A expense
in both 2008 and 2009 as we had previously incurred substantial legal and other
professional service fees related to these settlements.
Depreciation and
Amortization Expenses. Depreciation and amortization expenses were $31.3
million for the year ended December 31, 2009, a decrease of $3.1 million,
or 9%, from the year ended December 31, 2008. The decrease is primarily
attributable to assets that became fully depreciated or amortized as well as
lower capital spending in 2008 and 2009 versus previous years.
Interest and
Other Expenses, net. Interest and other expenses, net of $39.1 million
decreased by $2.8 million, or 7%, from the prior year due to foreign
exchange gains of $2.3 million in 2009 compared to foreign exchange losses of
$3.8 million in 2008. Offsetting this gain was an increase in
interest expense of $3.4 million due primarily to the increasing principal on
the Senior Subordinated Notes from paid-in-kind interest
accumulation.
Income Tax
Expense. Income
tax expense for the year ended December 31, 2009 was $0.7 million compared to a
benefit of $0.5 million for the year ended December 31, 2008 and principally
arose from changes in valuation allowances on our deferred tax assets. The
Company’s net operating losses are fully reserved by valuation allowances since
the Company has a history of generating net losses.
Results of
Operations for the Year Ended December31, 2008 Compared
to December 31,
2007
The
following table sets forth the primary components of revenue for 2007 and
2008
For
the Twelve Months Ended
|
|||||||||||||
December
31,
|
December
31,
|
||||||||||||
2007
|
2008
|
Variance
|
%
Change
|
||||||||||
(Dollars
in thousands)
|
|||||||||||||
Direct
call provisioning
|
$
|
338,703
|
$
|
333,564
|
$
|
(5,139
|
)
|
(1.5
|
)%
|
||||
Offender
management software
|
7,933
|
25,137
|
17,204
|
216.9
|
|||||||||
Wholesale
services
|
45,214
|
29,902
|
(15,312
|
)
|
(33.9
|
)
|
|||||||
Total
revenue
|
$
|
391,850
|
$
|
388,603
|
$
|
(3,247
|
)
|
(0.8
|
)%
|
Revenues
Compared
to the year ended December 31, 2007, consolidated revenues decreased for the
year ended December 31, 2008 by $3.2 million, or 0.8 %, to $388.6 million.
The primary components of the decrease in revenues are discussed
below:
Direct call provisioning revenues decreased $5.1 million, or 1.5%, to $333.6 million. This resulted from a decrease of $20 million due primarily to the loss of direct business contracts with several departments of corrections that expired during the second half of 2007, combined with the lower revenues due to the worsening economy, which caused us to tighten credit controls in an effort to reduce our bad debt exposure. In addition, in 2008 we sought to improve our margins in bidding for new state and county contracts, which resulted in the loss of some contracts that did not meet acceptable profitability standards. We monitor contracts coming up for renewal on the same basis. The decrease in revenue was partially offset by $14.9 million of revenues from department of corrections and mega-county contracts won from competitors, net of accounts not renewed. Large accounts installed in 2008 generated $7.3 million in 2008, and are expected to generate $16 million annually over the term of the contracts.
Offender
management software revenues increased $17.2 million or 216.9% to $25.1 million
primarily due to only two quarters of operations in 2007 compared to a full year
in 2008. The majority of our offender management revenues were
associated with the implementation of our software for Her Majesty’s Prison
Service in the United Kingdom, through a sub-contracting agreement with
Electronic Data Systems, Inc. In connection with the Syscon acquisition, we
valued Syscon’s existing customer contracts and related deferred revenues at
fair value, which impacted the amount of revenue and profit we
recognized. As a result, for the years ended December 31, 2008 and
2007, respectively, our offender management software revenues and operating
profits were reduced by $3.5 million and $1.4 million related to the
amortization of acquired customer contracts, as required by purchase
accounting.
Wholesale
services revenues decreased by $15.3 million, or 33.9%, primarily due to
terminations of service by AT&T and Global Tel*Link as their underlying
facility contracts expire.
34
Cost of
Service. Total
cost of service for the year ended December 31, 2008 decreased by
$14.9 million over cost of service for the year ended December 31, 2007, or
5.2%, to $271.9 million.
Cost of
service in our direct call provisioning segment decreased as a percentage of
revenue to 73.1% from 75.8% due to lower bad debt, commission and field
operations expenses, offset slightly by higher billing and collection fees and
network costs. Bad debt expense declined 31.5%, from 11.2 % to 7.8% as a
percentage of direct call provisioning revenues, as a result of our shift to
selling products on our prepaid platforms, further tightening of our credit
policies due to the deteriorating economy, and the impact of a one-time
write-off of $1.7 million in 2007 related to complications arising from our
billing system conversion. Historically, our bad debt has been highly correlated
to unemployment rates; however, we have developed statistical methods to
identify high risk customers who we require to prepay for services. In 2007,
approximately 35% of our direct provision revenues were prepaid, while 46% of
our direct provisioning revenues were prepaid in 2008. Field operations expense
declined $0.9 million year over year due to efficiencies gained from our
packet-based architecture.
Cost
of service in our offender management software segment as a percentage of
revenue decreased to 53.9 % from 77.0% mainly due to more efficient utilization
of personnel in 2008. Cost of service for the offender software segment
primarily represents salaries and related costs of employees and contractors who
provide technological services to develop, customize or enhance the software for
our clients. Time incurred for research and development or administrative
activities by these employees is classified as SG&A expense in
2008.
Cost of
service in our wholesale services segment as a percentage of our revenue
decreased to 48.6% from 53.3% as a result of our bad debt savings initiatives
discussed above. Cost of service is a more volatile component of wholesale
services relative to our direct call provisioning business because most of the
cost is comprised of bad debt expense. Therefore, a rise in unemployment rates
may cause a significant erosion of wholesale profitability should bad debt
results deteriorate.
SG&A.
SG&A expenses of $74.7 million were $0.4 million, or 0.5%, higher than the
year ended December 31, 2007. The increase was due primarily to $6.3
million in additional SG&A expenses in our offender management software
segment as 2007 results included only two quarters of Syscon expenses compared
to a full reporting year in 2008. Additionally, we incurred $1.2 million related
to the reorganization of the executive team of the Company. These increases were
offset by a decrease of approximately $1.0 million related to one-time costs
incurred in 2007 for bonuses tied to the closing of the Syscon acquisition,
severance and death benefits paid to the family of an executive and lease exit
costs. Legal fees were lower in 2008 as a result of settling several
intellectual property lawsuits during the third quarter of 2008. Proceeds from
the intellectual property settlements were recorded against SG&A costs, as
we had incurred substantial legal and other professional service fees related to
these settlements in SG&A expense since the fourth quarter of 2006. In the
third quarter of 2008, we implemented cost cutting initiatives which lowered
administrative costs by approximately $0.7 million during the last six months of
2008.
Restructuring
Costs. During 2008, we incurred $0.2 million related to the realignment
of our field service organization because of efficiencies gained from our
packet-based architecture, which we began to install in 2006 and will continue
to install as customer contracts are renewed. In 2007, restructuring charges of
$0.6 million were incurred related to the consolidation of our customer care
function into the Dallas office, comprised of $0.2 million of severance expense
and $0.4 million of facility exit costs for the Selma, Alabama
location.
Depreciation and
Amortization Expenses. Depreciation and amortization expenses were $34.4
million for the year ended December 31, 2008, a decrease of $2.6 million or
7.1% over the year ended December 31, 2007. The decrease was primarily
attributable to lower amortization of intangibles related to the Evercom
acquisition that became fully amortized in 2007. This was partially offset by an
increase in amortization of new software development and purchases and four
quarters of depreciation and amortization related to Syscon verses two quarters
in 2007.
Interest and
Other Expenses, net. Interest and other expenses, net, of $41.9 million
for the year ended December 31, 2008, increased by $10.4 million or 33.1%
over the year ended December 31, 2007. The increase relates primarily to
the increasing principal on the Senior Subordinated Notes due to the
accumulation of interest being paid-in-kind and
additional interest expense on the $40 million 11% Second-priority
Senior Secured Notes due 2011 issued on June 29, 2007. Additionally, we
experienced a foreign exchange transaction loss of $3.8 million during the year
ended December 31, 2008 compared to a gain of $1.5 million in 2007.
35
Income Tax
Expense. We had
an income tax benefit of $0.5 million for the year ended December 31, 2008 and
an expense of $1.9 million for the year ended December 31, 2007. In 2007, we
generated tax expense as a result of changes in valuation allowances on our
deferred tax assets. In 2008, a tax benefit of $2.5 million was recorded related
to our foreign operations, offset by $2.0 million in expense as a result of
changes in valuation allowances on deferred tax assets in the United
States.
Accrued Dividends
on Redeemable Preferred Stock. Dividends accrue on the Series
A Redeemable Preferred Stock issued in December 2007. Each share of the
preferred stock has a stated value of $2,000 and accrues dividends annually at
12.5% of the stated value. As of December 31, 2008, the Company had
accrued dividends of $1.3 million for the Series A Preferred Stock.
Liquidity
and Capital Resources
General
Our
principal liquidity requirements are to service and repay debt and meet our
capital expenditure and operating needs. We are significantly leveraged. Our
ability to make payments on and to refinance indebtedness and to fund planned
capital expenditures will depend on our ability to generate cash in the future
and our ability to maintain compliance with covenants in our credit facilities,
which, to a certain extent, is subject to general economic, financial,
competitive, legislative, regulatory and other factors that are beyond our
control. Based on our current and expected level of operations, we believe our
cash flow from operations, available cash and available borrowings under our
$30.0 million revolving credit facility will be adequate to make required
capital expenditures, service our indebtedness and meet our other working
capital needs for at least twelve months from our balance sheet dated December
31, 2009. However, due to the economy and other uncertainties referred to above,
there are no assurances that our available sources of cash will be sufficient to
enable us to make such capital expenditures, service our indebtedness or to fund
our other working capital needs. Further, in the event we wish to make
additional acquisitions, we may need to seek additional financing. We are
continuing to evaluate alternatives to refinance our existing debt arrangements
in an effort to provide greater flexibility to meet long-term capital
requirements, reduce interest expense and extend maturity dates.
As of
December 31, 2009, we had a total stockholders’ deficit of $148.2 million
and $291.4 million in total debt outstanding before considering
$1.6 million of original issue discount on our Second-Priority Senior
Secured Notes and $2.0 million of fair value attributable to warrants issued in
connection with our Senior Subordinated debt financing, both of which are
reflected as discounts to outstanding long-term debt in our consolidated
financial statements (see additional information on our long and short-term
debt under "Debt and Other Obligations" below). As of December 31, 2009, we had
availability of $30 million under our working capital facility (See Note
4).
Cash
Flows
The
following table provides our cash flow data for the years ended
December 31, 2007, 2008 and 2009 (in thousands):
For
the Year Ended December 31,
|
||||||||||||
2007
|
2008
|
2009
|
||||||||||
Net
cash provided by operating activities
|
$
|
20,459
|
$
|
17,406
|
$
|
26,752
|
||||||
Net
cash used in investing activities
|
$
|
(64,000
|
)
|
$
|
(17,046
|
)
|
$
|
(16,253
|
)
|
|||
Net
cash provided by (used in) financing activities
|
$
|
46,506
|
$
|
1,094
|
$
|
(12,313
|
)
|
Net cash
provided by operating activities was $20.5 million, $17.4 million, and
$26.8 million for the years ended December 31, 2007, 2008 and 2009,
respectively. Net cash provided by operating activities of $26.8 million
consisted of operating income of $50.1 million before considering non-cash
expenses, such as depreciation and amortization of $31.3 million, offset by
$22.8 million of cash paid for interest and $0.5 million of working capital use.
In 2008, lower wholesale services volumes caused the payable to our partners to
decline, thus using working capital. In 2009, we experienced a
reduction in receivables and accrued liabilities arising from an increased
percentage of calls made on a prepaid basis, lower call volumes and differences
in the timing of cash payments made.
36
Net cash
used in investing activities was $64.0 million, $17.0 million and $16.3
million for the years ended December 31, 2007, 2008 and 2009, respectively. The
$16.3 million spending in 2009 was utilized primarily for investments in
infrastructure technology, equipment and intangibles to maintain and grow the
direct call provisioning business. The decline in spending from 2008 was
principally due to less tangible equipment installed at customer sites and
improved management oversight of our capital spending.
Net
cash provided by financing activities was $46.5 million and $1.1 million for the
years ended December 31, 2007 and 2008, respectively, and net cash used in
financing activities was $12.3 million for the year ended December 31,
2009. The 2009 use of $12.3 million primarily related to $16.5
million in net payments on the Company's revolving credit facility, offset
partially by a $4.3 million benefit from a timing difference in outstanding
checks. In 2008, $11.5 million in net advances on the revolver funded
cash used to pay outstanding checks and repay a loan to Syscon’s former
stockholder. As of March 10, 2010, there were no borrowings and $30.0
million of availability under the revolving credit
facility.
Debt
and other Obligations
Revolving Credit Facility —
On September 30, 2008, we and certain of our subsidiaries entered into a senior
credit agreement with a lending institution and the other lenders party thereto
(the “Credit Agreement”) to refinance our existing revolving credit facility.
The Credit Agreement provides us with a $10.0 million letter of credit facility
and a revolving facility of up to the lesser of (i) $30.0 million and (ii) 125%
of consolidated EBITDA (as defined in the Credit Agreement) for the preceding 12
months less the face amount of outstanding letters of credit. The Credit
Agreement expires on June 9, 2011. Advances bear interest at an annual rate of
our option equal to either: (a) LIBOR plus 4.0%, or (b) a rate equal to the Base
Rate plus 3.0%. The Base Rate is the greater of (i) 5%, (ii) the Federal Funds
rate plus 0.5%, or (iii) the prime rate (as defined in the Credit Agreement),
which was 3.25% as of December 31, 2009. Interest is payable in arrears on the
first day of each month. The unused availability under the Credit Agreement is
subject to a fee based on a per annum rate of 0.375% due
monthly. Borrowings under the Credit Agreement are secured by a first
lien on substantially all of our and certain of our subsidiaries’ assets. We
draw from the available credit under the Credit Agreement to cover normal
business cash requirements. As of December 31, 2009, we had $30.0 million of
borrowing availability under the Credit Agreement.
Second-priority Senior Secured
Notes — We have $194.0 million of the 11% Second-priority Senior
Secured Notes outstanding. These notes were issued at a discount of
$4.5 million, or 97.651% of face value. The Second-priority Senior Secured
Notes are secured by a second lien on substantially all of our and certain of
the subsidiaries’ assets other than accounts receivable, inventory and real
property.
All
$194.0 million of principal is due September 9, 2011. To the extent we
generate excess cash flow (as defined in the indenture) in any calendar year, we
are required by the Second-priority Senior Secured Notes to offer to repay
principal equal to 75% of such excess cash flow at a rate of 102.75% of face
value through September 1, 2010 and 100.00% therafter. No excess cash
flow payment was due for the year ended December 31, 2009, because an
Excess Cash Flow Amount (as defined in the Indenture governing the terms of the
Second-priority Senior Secured Notes) was not generated. In the event we
determine that the Excess Cash Flow Amount is likely to exceed $5.0 million in
2010, we may purchase Second-priority Senior Secured Notes in the open market,
by negotiated private transactions or otherwise, to reduce the aggregate Excess
Cash Flow Amount to less than $5.0 million. We and our affiliates may from
time to time seek to retire or purchase our outstanding debt, including the
Notes, through cash purchases and/or exchanges, in open market purchases,
privately negotiated transactions or otherwise. Such repurchases or exchanges,
if any, will depend on prevailing market conditions, our liquidity requirements,
contractual restrictions and other factors. The amounts involved may be
material. Interest is payable semiannually on March 1 and September 1.
The effective interest rate is 11.3% on the Second-priority Senior Secured
Notes.
The fair
values associated with our Senior Secured Notes were quoted as of December 31,
2009, at trading prices of $96.00 and $80.00, increases of 80.3% and 22.1%,
respectively, from the quoted values at December 31, 2008. We believe the
increase in fair values was due to our improved operating performance and an
improvement in the credit markets in 2009.
37
Senior Subordinated Notes — We have outstanding $97.4 million of
Senior Subordinated Notes that are unsecured and subordinate to the revolving
credit facility, and bear interest at an annual rate of 17%. Interest is payable
at the end of each calendar quarter, or, as restricted by our revolving credit
facility, is paid-in-kind by adding accrued interest to the principal balance of
the Senior Subordinated Notes. All outstanding principal, including interest
paid-in-kind, is due on September 9, 2014 and a mandatory prepayment equal
to $20.0 million plus 50% of all outstanding interest paid-in-kind is due
on September 9, 2013. In connection with the issuance of the Senior
Subordinated Notes, we issued warrants to acquire 51.01 shares of our common
stock at an exercise price of $10 per share to the Senior Subordinated
Noteholders. As a result, we discounted the face value of the Senior
Subordinated Notes by $2.9 million, representing the estimated fair value
of the warrants at the time of issuance. For the twelve months ended December
31, 2009, $14.9 million of paid-in-kind interest was added to the principal
balance of the Senior Subordinated Notes. The effective interest rate is 18.5%
on the Senior Subordinated Notes.
All of
our domestic subsidiaries and certain of our foreign subsidiaries (the
“Subsidiary Guarantors”) are jointly and severally liable for the working
capital facility, Senior Subordinated Notes and Second-priority Senior Secured
Notes. The Subsidiary Guarantors are wholly-owned. We have not included separate
financial statements of our subsidiaries because (a) our aggregate assets,
liabilities, earnings and equity are presented on a consolidated basis, and
(b) we believe that separate financial statements and other disclosures
concerning subsidiaries are not material to investors.
Our
credit facilities contain financial and operating covenants that require the
maintenance of certain financial ratios, including specified fixed interest
coverage ratios, maintenance of minimum levels of operating cash flows and
maximum capital expenditure limitations. These covenants also limit our ability
to incur additional indebtedness, make certain payments including dividends to
shareholders, invest and divest company assets, and sell or otherwise dispose of
capital stock. In the event that we fail to comply with the covenants and
restrictions, as specified in the credit agreements, we may be in default, at
which time payment of the long term debt and unpaid interest may be accelerated
and become immediately due and payable. As of December 31, 2009, we were in
compliance with all covenants associated with our credit
facilities.
Capital
Requirements
As of
December 31, 2009, our contractual obligations and commitments on an
aggregate basis were as follows:
Payments
by Period
|
||||||||||||||||||||||||
2010
|
2011
|
2012
|
2013
|
2014
|
Thereafter
|
|||||||||||||||||||
Long-term
debt (1)
|
$ | - | $ | 194,000 | $ | - | $ | 48,714 | $ | 48,713 | $ | - | ||||||||||||
Unrecognized
tax benefits
|
- | - | - | - | - | 357 | ||||||||||||||||||
Operating
leases
|
3,518 | 2,144 | 2,016 | 1,779 | 1,794 | 450 | ||||||||||||||||||
Minimum
commission payments
|
3,367 | 720 | 488 | 98 | - | - | ||||||||||||||||||
Minimum
purchase guarantees
|
2,087 | 155 | - | - | - | - | ||||||||||||||||||
Other
long-term liabilities
|
290 | 290 | 290 | 240 | 540 | - | ||||||||||||||||||
Total
contractual cash obligations and commitments
|
$ | 9,262 | $ | 197,309 | $ | 2,794 | $ | 50,831 | $ | 51,047 | $ | 807 |
|
|
(1)
|
Does not include any
amounts that may be drawn under our Credit Agreement, which expires on
June 9, 2011, or accrued interest under our long-term debt. Assumes
no repurchases of second-priority senior secured notes or senior
subordinated notes during such period whether or not
mandatory.
|
Critical Accounting
Policies
A
“critical accounting policy” is one that is both important to the portrayal of a
company’s financial condition and results and requires management’s most
difficult, subjective or complex judgments, often as a result of the need to
make estimates about the effect of matters that are inherently uncertain. Our
financial statements prepared in accordance with generally accepted accounting
principles in the United States, or GAAP. The process of preparing financial
statements in conformity with GAAP requires us to use estimates and assumptions
to determine certain of our assets, liabilities, revenues and expenses. We base
these determinations upon the best information available to us during the period
in which we are accounting for our results. Our estimates and assumptions could
change materially as conditions within and beyond our control change or as
further information becomes available. Further, these estimates and assumptions
are affected by management’s application of accounting policies. Changes in our
estimates are recorded in the period the change occurs. Our critical accounting
policies include, among others:
38
•
|
Revenue
recognition and bad debt reserve estimates;
|
•
|
goodwill
and other intangible assets;
|
•
|
accounting
for income taxes; and
|
•
|
capitalization
of internally developed software
costs.
|
The
following is a discussion of our critical accounting policies and the related
management estimates and assumptions necessary for determining the value of
related assets or liabilities.
Revenue
Recognition and Bad Debt Reserve Estimates
Revenues
related to collect and prepaid calling services generated by the direct call
provisioning segment are recognized during the period in which the calls are
made. In addition, during the same period, we accrue the related
telecommunication costs for validating, transmitting, billing and collection,
and line and long distance charges, along with commissions payable to the
facilities and allowances for uncollectible calls, based on historical
experience.
Revenues
related to the wholesale services segments are recognized in the period in which
the calls are processed through the billing system, or when equipment and
software is sold. During the same period, we accrue the related
telecommunications costs for validating, transmitting, and billing and
collection costs, along with allowances for uncollectible calls, as applicable,
based on historical experience.
We record
call revenues related to the wholesale services segment at the net amount since
we are acting as an agent on behalf of another provider. For records processed
through our billing system, this is the amount charged to the end user customer
less the amount paid to the inmate telecommunications provider.
Revenues
associated with multiple-deliverable arrangements are recognized using the
residual method when the fair value of vendor specific objective evidence
(“VSOE”) of the undelivered element is determined. If the VSOE of fair value
cannot be determined for any undelivered element or any undelivered element is
essential to the functionality of the delivered element, revenue is deferred
until such criteria are met or recognized as the last element is delivered.
Under the residual method, the fair value of the undelivered elements is
deferred and the difference between the total arrangement fee and the amount
recorded as deferred revenue for the undelivered elements is recognized as
revenue related to the delivered elements.
Services
related to the implementation, customization, and modification of software are
not separable and are essential to the functionality for the customer.
Accordingly, we account for the combined upfront software license fee and
customization revenue under contract accounting, recognizing revenue and related
costs using the percentage-of-completion method. The percentage of completion is
calculated using hours incurred to date compared to total estimated hours to
complete the project. Our estimates are based upon the knowledge and experience
of project managers and other personnel, who review each project to assess the
contract’s schedule, performance, technical matters and estimated hours to
complete. When the total cost estimate exceeds revenue, the estimated project
loss is recognized immediately. Support contracts, which require our ongoing
involvement, are billed in advance and recorded as deferred revenue and
amortized over the term of the contract, typically one year.
In
evaluating the collectibility of our trade receivables, we assess a number of
factors including historical cash reserves held by our LEC billing agents,
collection rates with our billing agents and a specific customer’s ability to
meet the financial obligations to us, as well as general factors, such as the
length of time the receivables are past due, historical collection experience
and economic conditions including unemployment rates. Based on these
assessments, we record reserves for uncollectible receivables to reduce the
related receivables to the amount we ultimately expect to collect from our
customers.
If
circumstances related to specific customers change or economic conditions worsen
such that our past collection experience is no longer relevant, our estimate of
the recoverability of our trade receivables could be further reduced or
increased from the levels provided for in our financial statements. Because the
majority of our receivables are collected through our LEC billing agents and
such agents typically do not provide us with visibility as to collection results
for an average six to nine month period, our bad debt reserves are estimated and
may be subject to substantial variation.
39
Goodwill
and Other Intangible Assets
The
calculation of amortization expense is based on the cost and estimated economic
useful lives of the underlying intangible assets, intellectual property assets,
capitalized computer software, and patent license rights. Goodwill represents
the excess of costs over fair value of assets of businesses acquired. Goodwill
and intangible assets acquired in a purchase business combination and determined
to have an indefinite useful life are not amortized, but instead tested for
impairment at least annually. Intangible assets with estimable useful
lives are amortized over their respective estimated useful lives to their
estimated residual values, and reviewed for impairment. We review our
unamortized intangible assets whenever events or changes in circumstances
indicate that the carrying amount may not be recoverable or the estimated useful
life has been reduced. We estimate the future cash flows expected to result from
operations, and if the sum of the expected undiscounted future cash flows is
less than the carrying amount of the intangible asset, we recognize an
impairment loss by reducing the unamortized cost of the long-lived asset to its
estimated fair value.
We
perform an annual impairment test of goodwill and other intangible assets with
indefinite useful lives as of the last day of each fiscal year. The goodwill
test is a two-step process and requires goodwill to be allocated to our
reporting units. Reporting units are defined by us to be the same as the
reportable segments (see Note 5). In the first step, the fair value of the
reporting unit is compared with the carrying value of the reporting unit. If the
fair value of the reporting unit is less than the carrying value, a goodwill
impairment may exist and the second step of the test is performed. In the second
step, the implied fair value of the goodwill is compared with the carrying value
of the goodwill. An impairment loss is recognized to the extent that the
carrying value of the goodwill exceeds the implied fair value of the goodwill.
An impairment loss is recognized by reducing the carrying value of the asset to
its estimated fair value.
Accounting
for Income Taxes
We
recognize deferred tax assets and liabilities for the expected future tax
consequences of transactions and events. Under this method, deferred tax assets
and liabilities are determined based on the difference between the financial
statement and tax bases of assets and liabilities using enacted tax rates in
effect for the year in which the differences are expected to reverse. If
necessary, deferred tax assets are reduced by a valuation allowance to an amount
that is determined to be more likely than not recoverable. We must make
significant estimates and assumptions about future taxable income and future tax
consequences when determining the amount of the valuation
allowance.
We
account for the uncertainty in income taxes on the determination of whether tax
benefits claimed or expected to be claimed on a tax return should be recorded in
the financial statements. The tax benefit from an uncertain tax position may be
recognized only if it is more likely than not that the tax position will be
sustained on examination by the taxing authorities. The determination is based
on the technical merits of the position and presumes that each uncertain tax
position will be examined by the relevant taxing authority that has full
knowledge of all relevant information.
Capitalization
of Internally Developed Software Costs
We
capitalize labor associated with software developed for internal use. Software
is considered for internal use if acquired, internally developed or modified
solely to meet the entity’s internal needs and if during the software’s
development or modification, no plan exists to market the software
externally. Costs incurred during the application development stage
are capitalized. Capitalization of cost begins when the preliminary project
stage is completed and management with the relevant authority authorizes and
commits to funding a computer software project and believes that it is probable
that the project will be completed and the software will be used to perform the
function intended. Capitalization ceases when the project is complete or it is
no longer probable that the project will be completed.
Financial Reporting
Changes
See Note
1, paragraph (v) of the Consolidated Financial Statements for information about
recent accounting pronouncements.
We are
exposed to market rate risk for changes in interest rates related to our
revolving line of credit. Our market risks as of December 31, 2009 were
substantially equivalent, in all material aspects, to the market risks we faced
in 2008. Interest expense on our floating rate debt will increase if interest
rates rise. Our $30.0 million revolving line of credit bears an interest rate
equal to one of the following, at our option: (a) LIBOR plus 4.0%, or (b) a rate
equal to the Base Rate plus 3.0%. The Base Rate is the greater of (i) 5%, (ii)
the Federal Funds rate plus 0.5%, or (iii) the prime rate (as defined in the
Credit Agreement). The effect of a 10% fluctuation in the interest rate on our
revolving line of credit would have had a negligible impact on our interest
expense for the twelve months ended December 31, 2008 and 2009. There
were no borrowings outstanding at December 31, 2009 related to our variable rate
debt.
We are
exposed to foreign currency exchange rates on the earnings, cash flows and
financial position of our international operations. We are not able to project
the possible effect of these fluctuations on translated amounts or future
earnings due to our constantly changing exposure to various currencies, the fact
that all foreign currencies do not react in the same manner in relation to the
U.S. dollar and each other, and the number of currencies involved; however we do
not believe the effect of this exposure would materially impact our financial
position. Our most significant exposure is to the British
pound.
40
Report
of Independent Registered Public Accounting Firm
To the
Board of Directors and Stockholders
Securus
Technologies, Inc.
We have
audited the accompanying consolidated balance sheet of Securus Technologies,
Inc. and Subsidiaries as of December 31, 2009, and the related consolidated
statements of operations, stockholders' deficit and comprehensive loss, and cash
flows for the year then ended. These financial statements are the
responsibility of the Company's management. Our responsibility is to
express an opinion on these financial statements based on our
audit.
We
conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require
that we plan and perform the audit to obtain reasonable assurance about whether
the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement
presentation. We believe that our audit provides a reasonable basis
for our opinion.
In our
opinion, the consolidated financial statements referred to above present fairly,
in all material respects, the financial position of Securus Technologies, Inc.
and Subsidiaries as of December 31, 2009, and the results of their operations
and their cash flows for the year then ended, in conformity with United States
generally accepted accounting principles.
We have
also audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), Securus Technologies, Inc. and Subsidiaries’
internal control over financial reporting as of December 31, 2009, based on
criteria established in Internal Control — Integrated
Framework issued by the Committee of Sponsoring Organizations of the
Treadway Commission, and our report dated March 15, 2010 expressed an
unqualified opinion on the effectiveness of Securus Technologies, Inc. and
Subsidiaries’ internal control over financial reporting.
McGladrey & Pullen,
LLP
Dallas,
Texas
March 15,
2010
41
Report
of Independent Registered Public Accounting Firm
The Board
of Directors and Stockholders
Securus
Technologies, Inc.:
We have
audited the accompanying consolidated balance sheet of Securus Technologies,
Inc. and subsidiaries as of December 31, 2008 and the related consolidated
statements of operations, stockholders’ deficit and comprehensive loss, and cash
flows for each of the years in the two-year period ended December 31, 2008.
These consolidated financial statements are the responsibility of the Company’s
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.
We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our
opinion, the consolidated financial statements referred to above present fairly,
in all material respects, the financial position of Securus Technologies, Inc.
and subsidiaries as of December 31, 2008, and the results of their
operations and their cash flows for each of the years in the two-year period
ended December 31, 2008, in conformity with U.S. generally accepted
accounting principles.
KPMG
LLP
Dallas,
Texas
March 27,
2009
42
SECURUS TECHNOLOGIES,
INC.AND
SUBSIDIARIES
CONSOLIDATED
BALANCE SHEETS
(Dollars
in thousands, except per share amounts)
December
31,
|
|||||||
2008
|
2009
|
||||||
ASSETS
|
|||||||
Cash
and cash equivalents
|
$
|
6,576
|
$
|
2,668
|
|||
Restricted
cash
|
1,599
|
1,366
|
|||||
Accounts
receivable, net
|
45,316
|
40,010
|
|||||
Prepaid
expenses
|
6,116
|
6,183
|
|||||
Current
deferred income taxes
|
1,973
|
1,487
|
|||||
Total
current assets
|
61,580
|
51,714
|
|||||
Property
and equipment, net
|
35,364
|
28,767
|
|||||
Intangibles
and other assets, net
|
98,550
|
92,207
|
|||||
Goodwill
|
63,468
|
67,386
|
|||||
Total
assets
|
$
|
258,962
|
$
|
240,074
|
|||
LIABILITIES,
REDEEMABLE CONVERTIBLE PREFERRED STOCK AND STOCKHOLDERS’
DEFICIT
|
|||||||
Accounts
payable
|
$
|
14,743
|
$
|
19,010
|
|||
Accrued
liabilities
|
44,371
|
38,285
|
|||||
Deferred
revenue and customer advances
|
15,069
|
14,755
|
|||||
Current
deferred income taxes
|
817
|
893
|
|||||
Total
current liabilities
|
75,000
|
72,943
|
|||||
Deferred
income taxes
|
10,893
|
11,306
|
|||||
Long-term
debt
|
288,341
|
287,802
|
|||||
Other
long-term liabilities
|
2,238
|
3,357
|
|||||
Total
liabilities
|
376,472
|
375,408
|
|||||
Commitments
and contingencies
|
|||||||
Series
A redeemable convertible preferred stock, stated value $2,253 and $2,534
at December 31, 2008 and December 31, 2009; total redemption value $11,489
and $12,925 at December 31, 2008 and December 31, 2009; 5,100 shares
authorized and outstanding at December 31, 2008 and 2009.
|
11,321
|
12,820
|
|||||
Stockholders’
deficit:
|
|||||||
Common
stock, $0.001 stated value; 1,355,000 and 1,675,000 shares authorized at
December 31, 2008 and 2009; 161,037 and 140,792 shares issued and
outstanding at December 31, 2008 and 2009, respectively.
|
8
|
8
|
|||||
Additional
paid-in capital
|
34,304
|
32,806
|
|||||
Accumulated
other comprehensive income (loss)
|
(2,701)
|
560
|
|||||
Accumulated
deficit
|
(160,442
|
)
|
(181,528
|
)
|
|||
Total
stockholders’ deficit
|
(128,831
|
)
|
(148,154
|
)
|
|||
Total
liabilities, redeemable convertible preferred stock and stockholders’
deficit
|
$
|
258,962
|
$
|
240,074
|
See
accompanying notes to consolidated financial statements.
43
SECURUS
TECHNOLOGIES, INC. AND
SUBSIDIARIES
CONSOLIDATED
STATEMENTS OF OPERATIONS
For the Years Ended
December31, 2007, 2008
and 2009
(Dollars
in thousands)
For
the Year Ended December 31,
|
|||||||||||
2007
|
2008
|
2009
|
|||||||||
Revenue:
|
|||||||||||
Direct
call provisioning
|
$
|
338,703
|
$
|
333,564
|
$
|
312,614
|
|||||
Offender
management software
|
7,933
|
25,137
|
22,698
|
||||||||
Wholesale
services
|
45,214
|
29,902
|
28,124
|
||||||||
Total
revenue
|
391,850
|
388,603
|
363,436
|
||||||||
Cost
of service (exclusive of depreciation and amortization shown separately
below):
|
|||||||||||
Direct
call provisioning, exclusive of bad debt expense
|
218,824
|
217,918
|
197,713
|
||||||||
Direct
call provisioning bad debt expense
|
37,776
|
25,889
|
23,859
|
||||||||
Offender
management software expense
|
6,110
|
13,540
|
9,624
|
||||||||
Wholesale
services expense
|
24,104
|
14,543
|
16,032
|
||||||||
Total
cost of service
|
286,814
|
271,890
|
247,228
|
||||||||
Selling,
general and administrative expenses
|
74,369
|
74,721
|
66,128
|
||||||||
Restructuring
costs
|
614
|
224
|
-
|
||||||||
Depreciation
and amortization
|
37,048
|
34,400
|
31,333
|
||||||||
Total
operating costs and expenses
|
398,845
|
381,235
|
344,689
|
||||||||
Operating
income (loss)
|
(6,995
|
)
|
7,368
|
18,747
|
|||||||
Interest
and other expenses, net
|
31,487
|
41,896
|
39,114
|
||||||||
Loss
before income taxes
|
(38,482
|
)
|
(34,528
|
)
|
(20,367
|
)
|
|||||
Income
tax expense (benefit)
|
1,922
|
(509
|
)
|
719
|
|||||||
Net
loss
|
(40,404
|
)
|
(34,019
|
)
|
(21,086
|
)
|
|||||
Accrued
dividends on redeemable convertible
|
|||||||||||
preferred
stock
|
-
|
(1,351
|
)
|
(1,499
|
)
|
||||||
Net
loss available to common stockholders
|
$
|
(40,404
|
)
|
$
|
(35,370
|
)
|
$
|
(22,585
|
)
|
See
accompanying notes to consolidated financial statements.
44
SECURUS TECHNOLOGIES,
INC. AND
SUBSIDIARIES
CONSOLIDATED
STATEMENTS OF STOCKHOLDERS’ DEFICIT
AND
COMPREHENSIVE LOSS
For the Years Ended
December31, 2007, 2008
and 2009
(Dollars
in thousands)
|
|
Accumulated
|
|
|||||||||||||||||||
Additional
|
Other
|
Total
|
||||||||||||||||||||
Common
|
Paid-In
|
Accumulated
|
Comprehensive
|
Stockholders’
|
||||||||||||||||||
Shares
|
Amount
|
Capital
|
Deficit
|
Income
(Loss)
|
Deficit
|
|||||||||||||||||
Balance
at December 31, 2006
|
610
|
$
|
6
|
$
|
34,140
|
$
|
(86,019
|
)
|
$
|
-
|
$
|
(51,873
|
)
|
|||||||||
Issuance
of common stock in conjunction with Syscon acquisition
|
45
|
1
|
1,413
|
-
|
-
|
1,414
|
||||||||||||||||
Stock
based compensation
|
-
|
-
|
67
|
-
|
-
|
67
|
||||||||||||||||
Exercise
of warrants
|
14
|
-
|
-
|
-
|
-
|
-
|
||||||||||||||||
Restricted
stock grants
|
11
|
-
|
-
|
-
|
-
|
-
|
||||||||||||||||
Forfeitures
of restricted stock
|
(3
|
)
|
-
|
-
|
-
|
-
|
-
|
|||||||||||||||
Foreign
currency translation
|
-
|
-
|
-
|
-
|
1,935
|
1,935
|
||||||||||||||||
Net
loss
|
-
|
-
|
-
|
(40,404
|
)
|
-
|
(40,404
|
)
|
||||||||||||||
Total
comprehensive loss
|
(38,469
|
)
|
||||||||||||||||||||
Balance
at December 31, 2007
|
677
|
$
|
7
|
$
|
35,620
|
$
|
(126,423
|
)
|
$
|
1,935
|
$
|
(88,861
|
)
|
|||||||||
Stock
based compensation
|
-
|
-
|
35
|
-
|
-
|
35
|
||||||||||||||||
Restricted
stock grants
|
160,364
|
1
|
-
|
-
|
-
|
1
|
||||||||||||||||
Forfeitures
of restricted stock
|
(2
|
)
|
-
|
-
|
-
|
-
|
-
|
|||||||||||||||
Purchase
of common stock
|
(2
|
)
|
-
|
|||||||||||||||||||
Accrued
dividends on preferred stock
|
-
|
-
|
(1,351
|
)
|
-
|
-
|
(1,351
|
)
|
||||||||||||||
Foreign
currency translation
|
-
|
-
|
-
|
-
|
(4,636
|
)
|
(4,636
|
)
|
||||||||||||||
Net
loss
|
-
|
-
|
-
|
(34,019
|
)
|
-
|
(34,019
|
)
|
||||||||||||||
Total
comprehensive loss
|
(38,655
|
)
|
||||||||||||||||||||
Balance
at December 31, 2008
|
161,037
|
$
|
8
|
$
|
34,304
|
$
|
(160,442
|
) |
$
|
(2,701
|
)
|
$
|
(128,831
|
)
|
||||||||
Stock
based compensation
|
-
|
-
|
1
|
-
|
-
|
1
|
||||||||||||||||
Restricted
stock grants
|
6,566
|
-
|
-
|
-
|
-
|
-
|
||||||||||||||||
Forfeitures
of restricted stock
|
(40,341
|
) |
-
|
-
|
-
|
-
|
-
|
|||||||||||||||
Issuance
of common stock
|
13,576
|
-
|
-
|
-
|
-
|
-
|
||||||||||||||||
Purchase
of common stock
|
(46
|
)
|
-
|
-
|
-
|
-
|
-
|
|||||||||||||||
Accrued
dividends on preferred stock
|
-
|
-
|
(1,499
|
)
|
-
|
-
|
(1,499
|
)
|
||||||||||||||
Foreign
currency translation
|
-
|
-
|
-
|
-
|
3,261
|
3,261
|
||||||||||||||||
Net
loss
|
-
|
-
|
-
|
(21,086
|
)
|
-
|
(21,086
|
)
|
||||||||||||||
Total
comprehensive loss
|
(17,825
|
)
|
||||||||||||||||||||
Balance
at December 31, 2009
|
140,792
|
$
|
8
|
$
|
32,806
|
$
|
(181,528
|
)
|
$
|
560
|
$
|
(148,154
|
)
|
See
accompanying notes to consolidated financial statements.
45
SECURUS TECHNOLOGIES, INC.
AND
SUBSIDIARIES
CONSOLIDATED
STATEMENTS OF CASH FLOWS
For the Years Ended
December31, 2007, 2008
and 2009
(Dollars
in thousands)
For
the Year Ended
|
|||||||||||
2007
|
2008
|
2009
|
|||||||||
CASH
FLOWS FROM OPERATING ACTIVITIES:
|
|||||||||||
Net
loss
|
$
|
(40,404
|
)
|
$
|
(34,019
|
)
|
$
|
(21,086
|
)
|
||
Adjustments
to reconcile net loss to net cash provided by operating
activities:
|
|||||||||||
Depreciation
and amortization
|
37,048
|
34,400
|
31,333
|
||||||||
Amortization
of fair value of contracts acquired
|
1,360
|
3,489
|
-
|
||||||||
Deferred
income taxes
|
922
|
(2,365
|
)
|
323
|
|||||||
Conversion
of interest paid “in kind” to secured subordinated notes
|
10,678
|
12,650
|
14,943
|
||||||||
Amortization
of deferred financing costs and debt discounts
|
2,251
|
3,542
|
4,170
|
||||||||
Other
operating activities, net
|
169
|
(25)
|
(49
|
)
|
|||||||
Changes
in operating assets and liabilities, net of effects of
acquisitions:
|
|||||||||||
Restricted
cash
|
(74
|
)
|
(68
|
)
|
237
|
||||||
Accounts
receivable
|
20,459
|
3,813
|
5,988
|
||||||||
Prepaid
expenses and other current assets
|
191
|
(862
|
)
|
4
|
|||||||
Other
assets
|
376
|
654
|
(2,885
|
)
|
|||||||
Accounts
payable
|
(11,251
|
)
|
(9,057
|
)
|
(210
|
)
|
|||||
Accrued
liabilities
|
(1,266
|
)
|
5,254
|
(6,016
|
)
|
||||||
Net
cash provided by operating activities
|
$
|
20,459
|
$
|
17,406
|
$
|
26,752
|
|||||
CASH
FLOWS FROM INVESTING ACTIVITIES:
|
|||||||||||
Purchase
of property and equipment and intangible assets
|
$
|
(21,356
|
)
|
$
|
(17,046
|
)
|
$
|
(16,453
|
)
|
||
Cash
consideration paid for acquired business
|
(43,717
|
)
|
-
|
-
|
|||||||
Proceeds
from sale of asset
|
-
|
-
|
200
|
||||||||
Proceeds
from sale of unconsolidated affiliate
|
985
|
-
|
-
|
||||||||
Property
insurance proceeds
|
88
|
-
|
-
|
||||||||
Net
cash used in investing activities
|
$
|
(64,000
|
)
|
$
|
(17,046
|
)
|
$
|
(16,253
|
)
|
See
accompanying notes to consolidated financial statements.
46
SECURUS TECHNOLOGIES,
INC.AND
SUBSIDIARIES
CONSOLIDATED
STATEMENTS OF CASH FLOWS — (Continued)
For the Years Ended
December 31, 2007, 2008 and
2009
(Dollars
in thousands)
For the Year Ended December
31,
|
||||||||||||
2007
|
2008
|
2009
|
||||||||||
CASH
FLOWS FROM FINANCING ACTIVITIES:
|
||||||||||||
Proceeds
from issuance of second-priority senior secured notes
|
$
|
39,060
|
$
|
-
|
$
|
-
|
||||||
Cash
overdraft
|
(3,958
|
)
|
(4,151
|
)
|
4,275
|
|||||||
Net
advances (payments) on revolving credit facility
|
1,775
|
11,511
|
(16,511
|
)
|
||||||||
Debt
issuance costs
|
(4,853
|
)
|
(1,757
|
)
|
(77
|
)
|
||||||
Proceeds
(payments) related to loan payable to related party, net
|
4,510
|
(4,510
|
)
|
-
|
||||||||
Proceeds
from issuance of common stock
|
1
|
1
|
-
|
|||||||||
Proceeds
from issuance of Series A preferred stock
|
10,200
|
-
|
-
|
|||||||||
Series
A preferred stock issuance costs
|
(229
|
)
|
-
|
-
|
||||||||
Net
cash provided by (used in) financing activities
|
$
|
46,506
|
$
|
1,094
|
$
|
(12,313
|
)
|
|||||
Effect
of exchange rates on cash and cash equivalents
|
(1,451
|
)
|
3,050
|
(2,094
|
)
|
|||||||
Increase
(decrease) in cash and equivalents
|
$
|
1,514
|
$
|
4,504
|
$
|
(3,908
|
)
|
|||||
Cash
and cash equivalents at beginning of year
|
558
|
2,072
|
6,576
|
|||||||||
Cash
and cash equivalents at end of year
|
$
|
2,072
|
$
|
6,576
|
$
|
2,668
|
||||||
SUPPLEMENTAL
DISCLOSURES:
|
||||||||||||
Cash
paid during the period for:
|
||||||||||||
Interest
|
$
|
18,715
|
$
|
22,207
|
$
|
22,797
|
||||||
Income
taxes
|
$
|
239
|
$
|
846
|
$
|
1,228
|
||||||
NONCASH
FINANCING AND INVESTING ACTIVITIES:
|
||||||||||||
Non-cash
consent fee
|
$
|
400
|
$
|
-
|
$
|
-
|
||||||
Leasehold
improvements
|
$
|
-
|
$
|
710
|
$
|
155
|
See
accompanying notes to consolidated financial statements.
47
SECURUS
TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
(1)
|
BUSINESS
AND SUMMARY OF SIGNIFICANT ACCOUNTING
POLICIES
|
Securus Technologies, Inc. and its
subsidiaries (“Securus” or the “Company”) provide inmate telecommunications
services and software solutions to correctional facilities operated by city,
county, state and federal authorities and other types of confinement facilities
in 43 states and the District of Columbia. Securus also provides offender
management and other software solutions to U.S. and foreign correctional
facilities and law enforcement agencies. The Company was incorporated in
Delaware on January 12, 2004, and on March 3, 2004 and
September 9, 2004, the Company acquired all of the outstanding equity
interests of T-Netix, Inc. (“T-Netix”) and Evercom Holdings, Inc. (“Evercom”),
respectively. On June 29, 2007, the Company acquired Syscon Holdings, Ltd.
and certain of its affiliates (“Syscon”).
(a)Basis of
Presentation
The
Company has three reportable segments: direct call provisioning, offender
management software and wholesale services. These segments are the determinants
for how management makes operating decisions, assesses performance and allocates
resources. These three segments each demonstrate similar economic
characteristics and are similar in the nature, class of customer, distribution
methods, and regulatory environment for their products and
services.
In the
direct call provisioning segment, the Company bills call revenue to established
prepaid accounts of end users, or bills through major local exchange carriers
(“LECs”) or through third-party billing services for smaller volume LECs. The
Company performs ongoing customer credit evaluations and maintains allowances
for uncollectible amounts based on historical experience, changes in economic
conditions including unemployment rates and other factors. Over half of
direct call provisioning revenue is paid for on a prepaid basis. Deferred
revenue is recorded for customer prepayments prior to usage.
In the
offender management software segment, the Company provides platform systems that
allow facility managers and law enforcement personnel to analyze data to reduce
costs, prevent and solve crimes, and facilitate rehabilitation through a single
user interface. The system provides correctional facilities and law enforcement
with the ability to manage and monitor inmate parole and probation activity and
development at a sophisticated level. The Company generates revenues through
license fees, software implementation and consulting fees, and software
maintenance and support.
In the
wholesale services segment, the Company provides both solutions and billing
services (validation, fraud management and billing and collection services) and
telecommunications services (equipment, security enhanced call processing,
validation and customer service and support) to corrections facilities through
contracts with other inmate telecommunications providers.
(b)Reclassification
Certain
amounts in the prior periods’ consolidated financial statements have been
reclassified to conform to the current period presentation. This
reclassification had no impact on operating income (loss), net loss, cash flows
or the financial position of the Company for the prior periods
presented.
(c)Principles of
Consolidation
The
accompanying consolidated financial statements include the accounts of Securus
Technologies, Inc. and its wholly-owned subsidiaries, T-Netix, Inc., Evercom
Holdings, Inc., and Syscon Holdings, Ltd. All significant intercompany accounts
and transactions have been eliminated in consolidation.
48
(d)Liquidity
The
Company’s principal liquidity requirements are to service and repay debt and
meet the Company’s capital expenditure and operating needs. The Company’s
ability to make payments on and to refinance indebtedness, and to fund planned
capital expenditures will depend on the Company’s ability to generate cash in
the future and its ability to maintain compliance with covenants in its credit
facilities, which, to a certain extent, is subject to general economic,
financial, competitive, legislative, regulatory and other factors that are
beyond the Company’s control. Based on the current and expected level of
operations, management believes the Company’s cash flow from operations,
available cash and available borrowings under the $30.0 million revolving credit
facility will be adequate to make required capital expenditures,
service indebtedness and meet the Company’s other working capital
needs for at least twelve months from the balance sheet dated December 31, 2009.
However, due to the economy and other uncertainties referred to above, there are
no assurances that available sources of cash will be sufficient to enable the
Company to make such capital expenditures, service indebtedness or to fund other
working capital needs. If the Company cannot meet covenants, debt service and
repayment obligations, the debt would be in default under the governing terms of
the agreements, which would allow the lenders under the credit facilities to
declare all borrowings outstanding to be due and payable, which would in turn,
trigger an event of default under the indenture agreement and the agreement
governing the Company’s senior subordinated debt. In the event that
cash in excess of the amounts generated from on-going business operations and
available under the credit facilities or through equity contributions from
stockholders is required to fund operations, the Company may be required to
reduce or eliminate discretionary selling, general and administrative costs, and
sell or close certain operations.
(e)Accounting
Estimates
The
preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America (“GAAP”) requires management
to make estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosures of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenue and expenses during
the reporting period. Significant items subject to such estimates include the
valuation allowances for receivables, the recoverability of property and
equipment, goodwill, intangible and other assets, and deferred income
taxes.
Management
evaluates its estimates and assumptions on an ongoing basis using historical
experience and other factors, including the current economic environment, which
management believes to be reasonable under the circumstances. Management adjust
such estimates and assumptions when facts and circumstances dictate. As future
events and their effects cannot be determined with precision, actual results
could differ significantly from these estimates. Changes in those estimates
resulting from continuing changes in the economic environment will be reflected
in the financial statements in future periods.
(f)Risks and
Uncertainties
The
Company generated approximately 20% of its revenues from its five largest
customers during the year ended December 31, 2009. If the Company loses one
or more significant customers, revenues and our ability to comply with our debt
covenants could be adversely affected.
The
majority of offender management revenues have been associated with the
implementation of software for one major customer. The implementation phase of
this contract was completed during the second quarter of 2009, causing a
subsequent decline in revenue. Revenues are currently being generated from new
contracts with other customers; however, we will need to continue to generate
new contracts to compensate for the loss of this revenue.
(g)Cash and Cash
Equivalents and Restricted Cash
Cash
equivalents consist of highly liquid investments, such as certificates of
deposits, money market funds and short term treasury instruments, with original
maturities of 90 days or less. Restricted cash accounts hold amounts
established for the benefit of certain customers in the event the Company does
not perform under the provisions of the respective underlying contract with
these customers. Restricted cash was $1.6 million and $1.4 million at
December 31, 2008 and December 31, 2009, respectively.
49
(h)Trade Accounts
Receivable
Trade
accounts receivable are recorded at the invoice amount and do not bear interest.
The majority of trade accounts receivable represent amounts billed or that will
be billed for calls placed through the Company’s telephone systems. The majority
of these receivables are billed using various LECs or third-party billing
services and are reported net of an allowance for uncollectible calls for
estimated chargebacks to be made by the LECs and clearinghouses. The Company
maintains an allowance for doubtful accounts for estimated losses resulting from
a customer’s inability to make payments on accounts, and this allowance is net
of amounts held by the LECs for estimated charge backs. The Company analyzes the
collectibility of a majority of its accounts receivable based on a 12-month
average of historical collections. The allowance for doubtful accounts is the
Company’s best estimate of the amount of probable credit losses in its existing
accounts receivable. The Company’s policy is to write-off accounts after
180 days from invoice date, or after all collection efforts have
failed.
The
following table includes the activity related to the Company’s allowance for
doubtful accounts (in thousands):
For
the Year Ended December 31,
|
|||||||||||
2007
|
2008
|
2009
|
|||||||||
Balance
beginning of period
|
$
|
15,045
|
$
|
11,506
|
$
|
5,180
|
|||||
Opening
balance of acquired business
|
115
|
-
|
-
|
||||||||
Additions
charged to expense
|
52,062
|
33,094
|
29,676
|
||||||||
Accounts
written-off
|
(55,716
|
)
|
(39,420
|
)
|
(29,115)
|
|
|||||
Balance
at end of period
|
$
|
11,506
|
$
|
5,180
|
$
|
5,741
|
(i)Fair Value of
Financial Instruments
The
Company is required to include certain disclosures regarding the fair value of
financial instruments. Cash and cash equivalents, receivables, accounts payable,
and accrued liabilities approximate fair value due to their short maturities.
Carrying amounts and estimated fair value of debt are presented in Note
4.
(j)Concentrations of
Credit Risk
Financial
instruments, which potentially expose the Company to concentrations of credit
risk, consist primarily of cash and cash equivalents and accounts receivable.
The Company’s revenues are primarily concentrated in the United States in the
telecommunications industry. The Company had trade accounts receivable from two
customers that, when combined, comprised 29.7% (two telecommunications
companies) of all trade accounts receivable at December 31, 2009. The
Company does not require collateral on accounts receivable balances and provides
allowances for potential credit losses.
The
Company has significant revenue contracts denominated in US dollars and UK
pounds. Syscon uses the Canadian dollar as its functional currency. Fluctuations
in exchange rates between these currencies and the Canadian dollar could have an
effect on the Company’s financial condition and results of operations. The
Company has not entered into any derivative contracts to mitigate the impact of
foreign currency fluctuations.
(k)Property and
Equipment
Property
and equipment is stated at cost and includes costs necessary to place such
property and equipment in service. Major renewals and improvements that extend
an asset’s useful life are capitalized, while repairs and maintenance are
charged to operations as incurred. Construction in progress represents the cost
of material purchases and construction costs for telecommunications hardware
systems in various stages of completion.
Depreciation
is computed by the straight-line basis using estimated useful lives of 3 to
5 years for telecommunications equipment, office and computer equipment and
furniture and fixtures. No depreciation is recorded on construction in progress
until the asset is placed in service.
(l)Goodwill and
Intangible and Other Assets
Goodwill
represents the excess of the purchase price over the fair value of identifiable
net assets acquired in business combinations accounted for as purchases.
Intangible and other assets include acquired operating contracts and customer
agreements, capitalized computer software, patents and license rights, patent
application costs, trademarks, trade names and other intellectual property,
capitalized loan costs, deposits and long-term prepayments and other intangible
assets. The Company capitalizes interest costs associated with internally
developed software based on the effective interest rate on aggregate borrowings.
The Company capitalized interest in the amount of $0.2 million for each of the
years ended December 31, 2007, 2008 and 2009, respectively. The Company
capitalizes contract acquisition costs representing up-front payments required
by customers as part of the competitive process to award a contract. These
capitalized costs are included in operating contracts and customer agreements
within the balance sheet caption “Intangibles and other assets, net” and are
commonly referred to as signing bonuses in the industry.
50
The
Company performs an annual impairment test of goodwill and other intangible
assets with indefinite useful lives as of the last day of each fiscal year. The
goodwill test is a two-step process and requires goodwill to be allocated to the
Company’s reporting units. Reporting units are defined by the Company to be the
same as the reportable segments (see Note 5). In the first step, the fair value
of the reporting unit is compared with the carrying value of the reporting unit.
If the fair value of the reporting unit is less than the carrying value, a
goodwill impairment may exist and the second step of the test is performed. In
the second step, the implied fair value of the goodwill is compared with the
carrying value of the goodwill. An impairment loss is recognized to the extent
that the carrying value of the goodwill exceeds the implied fair value of the
goodwill. An impairment loss is recognized by reducing the carrying value of the
asset to its implied fair value.
Other intangible
assets with indefinite useful lives are tested for impairment annually or more
frequently if events or changes in circumstances indicate that the asset may be
impaired. For this impairment test, the carrying value of the intangible
asset is compared to its fair value. If the carrying value exceeds the
fair value, an impairment loss is recognized by reducing the carrying value of
the intangible asset to its fair value.
Amortization
is computed on the straight-line basis over 3 to 12 years for operating
contracts and customer agreements and patents and license rights. The weighted
average amortization period for all of the intangible assets, which are subject
to amortization as of the year ended December 31, 2009, is approximately
ten years. Amortization expense was $18.9 million, $16.7 million and $17.5
million for the years ended December 31, 2007, 2008 and 2009,
respectively.
(m)Impairment of
Long-Lived Assets
Long-lived
assets, such as property, equipment and purchased intangibles subject to
amortization, are grouped with other assets producing the same cash flow streams
and are reviewed for impairment as a group whenever events or changes in
circumstances indicate that the carrying amount of an asset may not be
recoverable. Recoverability of assets to be held and used is measured by a
comparison of the carrying value of the assets to the estimated undiscounted
future cash flows expected to be generated by the assets. If the carrying value
of the assets exceed their estimated future cash flows, an impairment charge is
recognized by the amount by which the carrying value of the assets exceed the
fair value of the assets.
(n)401(k)
Plan
The
Company sponsors 401(k) savings plans for the benefit of eligible full-time
employees in the United States, Canada and the United Kingdom. The U.S.
plan is a qualified benefit plan in accordance with the Employee
Retirement Income Security Act. Employees participating in the plans
can generally make contributions to the plan of up to 15% of their compensation,
with the exception of employees in Canada, which jurisdiction does not have
a maximum on the total amount of contributions. In the U.S., the
401(k) plan provides for the Company to make discretionary matching
contributions of up to 50% of an eligible employee’s contribution for up to 6%
of their salary. In Canada and the United Kingdom, the Company makes
discretionary matching contributions up to 5% of an eligible employee’s
contributions, dependent on the employees’ tenure with the Company. Matching
contributions and plan expenses were $0.6 million, $0.7 million, and
$0.8 million for the years ended December 31, 2007, 2008 and 2009,
respectively.
(o)Income
Taxes
The
Company records deferred tax assets and liabilities at an amount equal to the
expected future tax consequences of transaction and events. Deferred tax assets
and liabilities are determined based on the future tax consequences attributable
to the differences between the financial statement carrying amounts of existing
assets and liabilities and their respective tax bases and operating loss and tax
credit carryforwards. Deferred tax assets and liabilities are measured using
enacted income tax rates expected to apply to taxable income in the years in
which those differences are expected to be recovered or settled. The effect on
deferred tax assets and liabilities of a change in income tax rates is
recognized in the results of operations in the period that includes the
enactment date.
(p)Stock-Based
Compensation
The
Company accounts for its restricted stock plan based on the grant date estimated
fair value of each award, net of estimated forfeitures or cancellations, over
the employee’s requisite service period, which is generally the vesting period
of the equity grant. The Company recorded compensation expense of less than $0.1
million for each of the years ended December 31, 2007, 2008, and 2009
related to purchases of restricted stock by certain executives and members of
the board of directors (See Note 8).
(q)Revenue
Recognition
Revenues
related to collect and prepaid calling services generated by the direct call
provisioning segment are recognized during the period in which the calls are
made. In addition, during the same period, the Company records the related
telecommunication costs for validating, transmitting, billing and collection,
and line and long distance charges, along with commissions payable to the
facilities and allowances for uncollectible calls, based on historical
experience.
Revenues
related to the wholesale services segment are recognized in the period in which
the calls are processed through the billing system, or when equipment and
software is sold. During the same period, the Company records the related
telecommunications costs for validating, transmitting, and billing and
collection costs, along with allowances for uncollectible calls, as applicable,
based on historical experience.
51
The
Company records call revenues related to the wholesale services segment at the
net amount since the Company is acting as an agent on behalf of another
provider. For records processed through the billing system, this is the amount
charged to the end user customer less the amount paid to the inmate
telecommunications provider.
Revenues
related to the offender management software segment are recognized using the
residual method when the fair value of vendor specific objective evidence
(“VSOE”) of the undelivered elements is determined. If the VSOE of fair value
cannot be determined for any undelivered element or any undelivered element is
essential to the functionality of the delivered element, the arrangement fee is
deferred until such criteria are met or recognized as the last element is
delivered. Under the residual method, the fair value of the undelivered elements
is recorded as deferred and the difference between the total arrangement fee and
the amount recorded as deferred revenue for the undelivered elements is
recognized as revenue related to the delivered elements.
Services
related to the implementation, customization, and modification of software are
not separable and are essential to the functionality for the customer.
Accordingly, the Company accounts for the combined upfront software license fee
and customization revenue under contract accounting, recognizing revenue and
related costs using the percentage-of-completion method. The percentage of
completion is calculated using hours incurred to date compared to total
estimated hours to complete the project. The Company’s estimates are based upon
the knowledge and experience of its project managers and other personnel, who
review each project at each reporting date to assess the contract’s schedule,
performance, technical matters and estimated hours to complete. When the total
cost estimate exceeds revenue, the estimated project loss is recognized
immediately. Support contracts, which require our ongoing involvement, are
billed in advance and recorded as deferred revenue and amortized to revenue over
the terms of the contract, typically one year.
The
Company accounts for multiple deliverables for arrangements under which it will
perform multiple revenue-generating activities. In an arrangement
with multiple deliverables, the delivered items are considered a separate unit
of accounting. These arrangements are evaluated to ensure they add standalone
value to the customer, there is objective and reliable evidence of the fair
value of the undelivered items, and the arrangements include only a general
right of return relative to the delivered items and the delivery of the
undelivered items is probable and substantially controlled by the vendor. The
arrangement considerations are then allocated to the separate units of
accounting based on the relative fair value.
(r)Capitalization of
Internal Software Development Costs
We capitalize labor associated with software developed for internal use. Software is considered for internal use if acquired, internally developed or modified solely to meet the entity’s internal needs and if during the software’s development or modification, no plan exists to market the software externally. Costs incurred during the application development stage are capitalized. Capitalization of cost begins when the preliminary project stage is completed and management with the relevant authority authorizes and commits to funding a computer software project and believes that it is probable that the project will be completed and the software will be used to perform the function intended. Capitalization ceases when the project is complete or it is no longer probable that the project will be completed.
(s)Foreign Currency
Translation and Transaction Gains and Losses
Assets
and liabilities of a non-U.S. subsidiary whose functional currency is not the
U.S. dollar are translated at current exchange rates. Revenue and expense
accounts are translated using an average rate for the period. Translation gains
and losses are not included in determining net income (loss), but are reflected
in the comprehensive income (loss) component of shareholders’
deficit.
The
Company has transactions in currencies other than its functional currency.
Transaction gains and losses are recorded in the consolidated statement of
operations relating to the recurring remeasurement and settlement of such
transactions. Included in “Interest and other expenses, net” on the Company’s
consolidated statement of operations was a $1.5 million gain, $3.8
million loss and $2.3 million gain related to foreign currency transactions for
the years ended December 31, 2007, 2008 and 2009, respectively.
(t)Comprehensive
Income/Loss
Reporting
comprehensive income/loss requires that certain items such as foreign currency
translation adjustments be presented as separate component of shareholders’
equity. Total comprehensive loss for the years ended December 31,
2007, 2008 and 2009 was $38.5 million, $38.7 million, and $17.8 million,
respectively. Other comprehensive income or loss includes a $1.9 million foreign
currency translation gain, $4.6 million foreign currency translation loss and
$3.3 million foreign currency translation gain in 2007, 2008 and 2009,
respectively.
52
(u)Commitments and
Contingencies
Liabilities
for loss contingencies arising from claims, assessments, litigation, fines, and
penalties and other sources are recorded when it is probable that a liability
has been incurred and the amount of the assessment and/or remediation can be
reasonably estimated. Legal fees related to loss contingencies are expensed as
services are received.
(v)Recently Issued
Accounting Pronouncements
In
May 2009, the Financial Accounting Standards Board (“FASB”) issued guidance
which established general standards of accounting disclosures of events that
occur after the balance sheet date but before financial statements are issued or
are available to be issued. The FASB requires entities to disclose the date
through which subsequent events were evaluated as well as the rationale for why
that date was selected. The guidance was effective for interim and annual
periods ending after June 15, 2009. Accordingly, the Company adopted the
provision; however, the adoption had no material impact on the Company’s
consolidated financial condition, results of operations, cash flows, or
disclosures.
In July
2009, the FASB issued new guidance on the Accounting Standards Codification
(“Codification”). With the issuance of this new guidance, the FASB Codification
becomes the single source of authoritative U.S. accounting and reporting
standards applicable for all nongovernmental entities, with the exception of
guidance issued by the U.S. Securities and Exchange Commission. The Codification
does not change current GAAP, but changes the referencing of financial
standards, and is intended to simplify user access to authoritative GAAP by
providing all the authoritative literature related to a particular topic in one
place. The Codification is effective for interim and annual periods ending after
September 15, 2009. The Company adopted the provision; however, the
adoption had no material impact on the Company’s consolidated financial
condition, results of operations or cash flows.
In
September 2009, the FASB issued new accounting guidance related to the revenue
recognition of multiple element arrangements. The new guidance states that if
vendor specific objective evidence or third party evidence for deliverables in
an arrangement cannot be determined, companies will be required to develop a
best estimate of the selling price to separate deliverables and allocate
arrangement consideration using the relative selling price method. The
accounting guidance will be applied prospectively for revenue arrangements
entered into or materially modified in fiscal years beginning on or after June
15, 2010. Early adoption is allowed. We are currently evaluating the impact of
this accounting guidance on our consolidated financial statements.
In
September 2009, the FASB issued new accounting guidance related to certain
revenue arrangements that include software elements. Previously, companies that
sold tangible products with “more than incidental” software were required to
apply software revenue recognition guidance. This guidance often delayed revenue
recognition for the delivery of the tangible product. Under the new guidance,
tangible products that have software components that are “essential to the
functionality” of the tangible product will be excluded from the software
revenue recognition guidance. The new guidance will include factors to help
companies determine what is “essential to the functionality.” Software-enabled
products will now be subject to other revenue guidance and will likely follow
the guidance for multiple deliverable arrangements issued by the FASB in
September 2009. The new guidance is to be applied on a prospective basis for
revenue arrangements entered into or materially modified in fiscal years
beginning on or after June 15, 2010, with earlier application permitted.
The adoption of this accounting guidance will not have an impact on our
consolidated financial statements.
(2)BALANCE SHEET
COMPONENTS
Accounts
receivables, net consist of the following at December 31 (in
thousands):
2008
|
2009
|
|||||||
Accounts
receivable, net:
|
||||||||
Trade
accounts receivable
|
$
|
50,129
|
$
|
44,564
|
||||
Other
receivables
|
367
|
1,187
|
||||||
50,496
|
45,751
|
|||||||
Less:
Allowance for doubtful accounts
|
(5,180
|
)
|
(5,741
|
)
|
||||
$
|
45,316
|
$
|
40,010
|
53
Direct
call provisioning bad debt expense for the year ended December 31, 2007 was
$37.8 million or 11.2% of direct call provisioning revenue of $338.7 million.
For the year ended December 31, 2008, direct call provisioning bad debt
expense was $25.9 million or 7.8% of direct call provisioning revenue of
$333.6 million. Direct call provisioning bad debt expense for the year
ended December 31, 2009 was $23.9 million or 7.6% of direct call provisioning
revenue of $312.6 million.
Property
and equipment, net consists of the following at December 31 (in
thousands):
2008
|
2009
|
|||||||
Property
and equipment, net:
|
||||||||
Telecommunications
equipment
|
$
|
60,291
|
$
|
59,418
|
||||
Leasehold
improvements
|
3,860
|
4,445
|
||||||
Construction
in progress
|
3,348
|
1,660
|
||||||
Office
equipment
|
19,215
|
23,275
|
||||||
86,714
|
88,798
|
|||||||
Less:
Accumulated depreciation and amortization
|
(51,350
|
)
|
(60,031
|
)
|
||||
$
|
35,364
|
$
|
28,767
|
Intangibles
and other assets, net consist of the following at December 31 (in
thousands):
2008
|
||||||||||||||||
Gross
|
|
Weighted
|
||||||||||||||
Carrying
|
Accumulated
|
Average
|
||||||||||||||
Value
|
Amortization
|
Net
|
Life
|
|||||||||||||
Patents
and trademarks
|
$ | 24,129 | $ | (8,351 | ) | $ | 15,778 | 9.8 | ||||||||
Deferred
financing costs
|
15,308 | (5,499 | ) | 9,809 | 5.8 | |||||||||||
Capitalized
software development costs
|
25,964 | (13,495 | ) | 12,469 | 4.5 | |||||||||||
Custom
software development costs
|
6,698 | (1,060 | ) | 5,638 | 10.0 | |||||||||||
Acquired
contract rights
|
96,714 | (44,645 | ) | 52,069 | 9.9 | |||||||||||
Deposits
and other long-term assets
|
1,846 | - | 1,846 | - | ||||||||||||
Non-compete
and employment agreements
|
1,540 | (599 | ) | 941 | 4.3 | |||||||||||
$ | 172,199 | $ | (73,649 | ) | $ | 98,550 |
2009
|
||||||||||||||||
Gross
|
|
|
Weighted
|
|||||||||||||
Carrying
|
Accumulated
|
Average
|
||||||||||||||
Value
|
Amortization
|
Net
|
Life
|
|||||||||||||
Patents
and trademarks
|
$ | 24,706 | $ | (10,041 | ) | $ | 14,665 | 9.8 | ||||||||
Deferred
financing costs
|
15,385 | (8,640 | ) | 6,745 | 5.8 | |||||||||||
Capitalized
software development costs
|
32,931 | (17,273 | ) | 15,658 | 4.6 | |||||||||||
Custom
software development costs
|
7,885 | (2,063 | ) | 5,822 | 10.0 | |||||||||||
Acquired
contract rights
|
98,312 | (54,387 | ) | 43,925 | 9.8 | |||||||||||
Deposits
and other long-term assets
|
4,758 | - | 4,758 | - | ||||||||||||
Non-compete
and employment agreements
|
1,802 | (1,168 | ) | 634 | 4.3 | |||||||||||
$ | 185,779 | $ | (93,572 | ) | $ | 92,207 |
At
December 31, 2008 and December 31, 2009, the carrying amount of trademarks
assigned to patents and trademarks that were not subject to amortization was
$2.7 million.
54
Amortization
of intangibles and other assets for the year ended December 31, 2007 was $21.8
million (of which $1.5 million was included in interest expense and $1.4 million
was amortized against revenue). Amortization of intangibles and other
assets for the year ended December 31, 2008 was $22.7 million (of which $2.5
million was included in interest expense and $3.5 million was amortized against
revenue). Amortization of intangibles and other assets for the year
ended December 31, 2009 was $20.6 million (of which $3.1 million was included in
interest expense). Estimated amortization expense related to intangibles,
excluding deferred financing costs and other assets, as of December 31, 2009 and
for each of the next five years through December 31, 2014 and thereafter is
summarized as follows (in thousands):
Year
Ended December 31:
|
||||
2010
|
$ | 18,151 | ||
2011
|
15,331 | |||
2012
|
13,256 | |||
2013
|
8,248 | |||
2014
|
7,557 | |||
Thereafter
|
15,461 | |||
$ | 78,004 |
Accrued
liabilities consist of the following at December 31 (in
thousands):
2008
|
2009
|
|||||||
Accrued
liabilities:
|
||||||||
Accrued
expenses
|
$
|
26,433
|
$
|
21,904
|
||||
Accrued
compensation
|
6,287
|
4,569
|
||||||
Accrued
severance and facility exit costs
|
207
|
150
|
||||||
Accrued
taxes
|
4,187
|
4,512
|
||||||
Accrued
interest and other
|
7,257
|
7,150
|
||||||
$
|
44,371
|
$
|
38,285
|
The
Company incurred restructuring charges of $0.2 million during the first quarter
of 2008 related to the realignment of the field service organization because of
efficiencies gained from our packet-based architecture. In July 2008, the
Company entered into a separation agreement with an executive and, in 2009, the
Company entered into separation agreements with two executives. For the twelve
months ended December 31, 2008 and 2009, the Company accrued approximately $0.2
million and $0.4 million and paid $0.2 million and $0.3 million in severance
costs, respectively.
(3)GOODWILL
The
Company performed annual impairment tests as of each balance sheet date. No
impairment was recorded as a result of the testing performed at
December 31, 2007, 2008 and 2009.
Goodwill
allocated to our reportable segments is summarized as follows (in
thousands):
Offender
|
||||||||||||
Direct
Call
|
Management
|
|||||||||||
Provisioning
|
Software
|
Total
|
||||||||||
Balance
at December 31, 2007
|
$ | 37,936 | $ | 31,099 | $ | 69,035 | ||||||
Foreign
currency translation
|
- | (5,567 | ) | (5,567 | ) | |||||||
Balance
at December 31, 2008
|
$ | 37,936 | $ | 25,532 | $ | 63,468 | ||||||
Foreign
currency translation
|
- | 3,918 | 3,918 | |||||||||
Balance
at December 31, 2009
|
$ | 37,936 | $ | 29,450 | $ | 67,386 |
55
(4)DEBT
Debt
consists of the following at December 31 (in thousands):
2008
|
2009
|
|||||||
Revolving
credit facility
|
$
|
16,511
|
$
|
-
|
||||
Second-priority
senior secured notes
|
194,000
|
194,000
|
||||||
Senior
subordinated notes
|
82,484
|
97,427
|
||||||
292,995
|
291,427
|
|||||||
Less
unamortized discount on senior secured notes and senior subordinated
notes
|
(4,654
|
)
|
(3,625
|
)
|
||||
288,341
|
287,802
|
|||||||
Less
current portion of long-term debt
|
-
|
-
|
||||||
$
|
288,341
|
$
|
287,802
|
Revolving Credit Facility —
On September 30, 2008, the Company and certain of its subsidiaries entered into
a senior credit agreement with a lending institution and the other lenders party
thereto (the “Credit Agreement”) to refinance its existing revolving credit
facility. The Credit Agreement provides the Company with a $10.0 million letter
of credit facility and a revolving facility of up to the lesser of (i) $30.0
million and (ii) 125% of the Company’s consolidated EBITDA (as defined in the
Credit Agreement) for the preceding 12 months less the face amount of
outstanding letters of credit. The Credit Agreement expires on June 9, 2011.
Advances bear interest at an annual rate of the Company’s option equal to
either: (a) LIBOR plus 4.0%, or (b) a rate equal to the Base Rate plus 3.0%. The
Base Rate is the greater of (i) 5%, (ii) the Federal Funds rate plus 0.5%, or
(iii) the prime rate (as defined in the Credit Agreement), which was 3.25% as of
December 31, 2009. Interest is payable in arrears on the first day of each
month. The unused availability under the Credit Agreement is subject to a fee
based on a per annum rate of 0.375% due monthly. Borrowings under the
Credit Agreement are secured by a first lien on substantially all of the
Company’s and certain of the Company’s subsidiaries’ assets. The Company draws
from the available credit under the Credit Agreement to cover normal business
cash requirements. As of December 31, 2008 and December 31, 2009, the
Company had $13.5 million and $30.0 million, respectively, of borrowing
availability under the Credit Agreement.
Second-Priority Senior Secured
Notes — The Company has $194.0 million of 11% Second-priority Senior
Secured Notes outstanding. These notes were issued at a discount of
$4.5 million, or 97.651% of face value. The Second-priority Senior Secured
Notes are secured by a second lien on substantially all of the Company’s and
certain of the Company’s subsidiaries’ assets other than accounts receivable,
inventory and real property.
All
$194.0 million of principal is due September 9, 2011. To the extent the
Company generates excess cash flow (as defined in the indenture) in any calendar
year, the Company is required by the Second-priority Senior Secured Notes to
offer to repay principal equal to 75% of such excess cash flow at a rate of
102.75% of face value through September 1, 2010 and 100.00%
thereafter. No excess cash flow payment was due for the year ended
December 31, 2009 because an Excess Cash Flow Amount (as defined in the
Indenture governing the terms of the Second-priority Senior Secured Notes) was
not generated. In the event we determine that the Excess Cash Flow Amount is
likely to exceed $5.0 million in 2010, we may purchase Second-priority Senior
Secured Notes in the open market, by negotiated private transactions or
otherwise, to reduce the aggregate Excess Cash Flow Amount to less than $5.0
million. The Company and its affiliates may from time to time
seek to retire or purchase the outstanding debt, including the notes, through
cash purchases and/or exchanges, in open market purchases, privately negotiated
transactions or otherwise. Such repurchases or exchanges, if any, will depend on
prevailing market conditions, our liquidity requirements, contractual
restrictions and other factors. The amounts involved may be material. Interest
is payable semiannually on March 1 and September 1. The effective
interest rate is 11.3% on the Second-priority Senior Secured Notes.
Senior Subordinated Notes
—The Company has outstanding $97.4 million of Senior Subordinated Notes,
unsecured and subordinate to the revolving credit facility, that bear interest
at an annual rate of 17%. Interest is payable at the end of each calendar
quarter, or, as restricted by the revolving credit facility, is paid-in-kind by
adding accrued interest to the principal balance of the Senior Subordinated
Notes. All outstanding principal, including interest paid-in-kind, is due on
September 9, 2014 and a mandatory prepayment equal to $20.0 million
plus 50% of all outstanding interest paid-in-kind is due on September 9,
2013. In connection with the issuance of the Senior Subordinated Notes, the
Company issued warrants to acquire 51.01 shares of its common stock at an
exercise price of $10 per share to the Senior Subordinated Noteholders. As a
result, the Company discounted the face value of the Senior Subordinated Notes
by $2.9 million representing the estimated fair value of the warrants at
the time of issuance. For the twelve months ended December 31, 2007, 2008 and
2009 respectively, $10.7 million, $12.6 million and $14.9 million of
paid-in-kind interest was added to the principal balance of the Senior
Subordinated Notes. The effective interest rate is 18.5% on the Senior
Subordinated Notes.
56
All of
the Company’s domestic subsidiaries and certain of its foreign subsidiaries
(collectively, the “Subsidiary Guarantors”) are fully, unconditionally, and
jointly and severally liable for the revolving credit facility, Senior
Subordinated Notes and Second-priority Senior Secured Notes. The Subsidiary
Guarantors are wholly-owned. The Company has not included separate financial
statements of guarantors because (a) their aggregate assets, liabilities,
earnings and equity are presented on a consolidated basis and (b) the
Company believes that separate financial statements and other disclosures
concerning subsidiaries are not material to investors.
The
Company’s credit facilities contain financial and operating covenants that
require the maintenance of certain financial ratios, including specified fixed
charge interest coverage ratios, maintenance of minimum levels of operating cash
flows and maximum capital expenditure limitations. These covenants also limit
the Company’s ability to incur additional indebtedness, make certain payments
including dividends to shareholders, invest and divest company assets, and sell
or otherwise dispose of capital stock. In the event that the Company fails to
comply with these covenants and restrictions, it may be in default, at which
time payment of the long term debt and unpaid interest may be accelerated by the
Company’s lenders and become immediately due and payable.
Based on
the Company’s current and expected levels of operations, cash flow from
operations, available cash and available borrowings under the $30.0 million
revolving credit facility will be adequate to continue to operate for at least
twelve months from the Company’s balance sheet dated December 31,
2009.
The fair
value of our debt instruments is as follows (in thousands):
December
31, 2008
|
December
31, 2009
|
|||||||
Revolving
Credit Facility
|
$ | 16,511 | $ | - | ||||
Second-priority
Senior Secured Notes
|
108,205 | 179,840 | ||||||
Senior
Subordinated Notes
|
82,484 | 97,427 | ||||||
$ | 207,200 | $ | 277,267 |
The fair
value of the revolving credit facility is equal to its carrying value and is
considered a Level 2 fair value measurement (defined as inputs other than quoted
prices in active markets that are either directly or indirectly observable) due
to the variable nature of its interest rate. The fair values associated
with the Second–priority Senior Secured Notes were quoted as of December 31,
2009 at trading prices of $96.00 and $80.00, increases of 80.3% and 22.1%,
respectively, from the quoted values at December 31, 2008. The fair value
of the Second-priority Senior Secured Notes is considered a Level 2 fair value
measurement (defined as inputs other than quoted prices in active markets that
are either directly or indirectly observable) of the fair value hierarchy
determined on their quoted market value. The fair value of the Senior
Subordinated Notes is based on their book value since these notes are not
publicly traded and it is not practical to measure their fair value. These notes
would be valued within Level 3 on the fair value hierarchy as little or no
market data exists related to these notes.
Future
maturities of debt for each of the following five years and thereafter are as
follows (in thousands):
Year
Ended December 31:
|
||||
2010
|
$ | - | ||
2011
|
194,000 | |||
2012
|
- | |||
2013
|
48,714 | |||
2014
|
48,713 | |||
Thereafter
|
- | |||
$ | 291,427 |
(5)SEGMENT
INFORMATION
The
Company organizes its segments around differences in products and services and
has three reportable segments: direct call provisioning, offender management
software and wholesale services. Through these segments, the Company provides
inmate telecommunications products and services for correctional facilities,
including security enhanced call processing, call validation and billing
services for inmate calling, and software solutions to manage and monitor
inmate, parole and probation activity. Depending upon the contractual
relationship at the site and the type of customer, the Company provides these
products and services primarily through direct contracts between the Company and
correctional facilities. A smaller portion of the business is provided through
wholesale service agreements with other telecommunications service providers and
system sales to certain telecommunications providers. The Company’s foreign
operations, revenues and long-lived assets are reported in the offender
management software segment.
57
The
Company evaluates performance of each segment based on operating results. Total
assets are those owned by or allocated to each segment. Assets included in the
“Corporate & Other” column of the following table include all assets not
specifically allocated to a segment. There are no intersegment sales. The
Company’s reportable segments are specific business units that offer different
products and services and have varying operating costs associated with such
products. The accounting policies of the reportable segments are the same as
those described in the summary of significant accounting policies. The Company
uses estimates to allocate certain direct costs and selling, general and
administrative costs, as well as for depreciation and amortization, goodwill,
and capital expenditures. Estimation is required in these cases because the
Company does not have the capability to specifically attribute such costs to a
particular segment. The estimation is based on relevant factors such as
proportionate share of revenue of each segment to the total
business.
Segment information for the twelve
months ended December 31, 2007 is as follows (in thousands):
Direct
|
Offender
|
|||||||||||||||||||
Call
|
Management
|
Wholesale
|
Corporate
|
|||||||||||||||||
Provisioning
|
Software
|
Services
|
&
Other
|
Total
|
||||||||||||||||
Revenue
from external customers
|
$ | 338,703 | $ | 7,933 | $ | 45,214 | $ | - | $ | 391,850 | ||||||||||
Segment
gross margin
|
$ | 82,103 | $ | 1,823 | $ | 21,110 | $ | - | $ | 105,036 | ||||||||||
Depreciation
and amortization
|
33,137 | 1,908 | 1,880 | 123 | 37,048 | |||||||||||||||
Other
operating costs and expenses
|
19,624 | 2,555 | 5,513 | 47,291 | 74,983 | |||||||||||||||
Operating
income (loss)
|
$ | 29,342 | $ | (2,640 | ) | $ | 13,717 | $ | (47,414 | ) | $ | (6,995 | ) | |||||||
Interest
and other expenses, net
|
31,487 | 31,487 | ||||||||||||||||||
Segment
loss before income taxes
|
(38,482 | ) | ||||||||||||||||||
Capital
expenditures
|
$ | 21,231 | $ | 20 | $ | - | $ | 105 | $ | 21,356 | ||||||||||
December
31, 2007:
|
||||||||||||||||||||
Total
assets
|
$ | 199,071 | $ | 63,626 | $ | 15,767 | $ | 13,661 | $ | 292,125 | ||||||||||
Goodwill
|
$ | 37,936 | $ | 31,099 | $ | - | $ | - | $ | 69,035 |
Segment
information for the twelve months ended December 31, 2008 is as follows (in
thousands):
Direct
|
Offender
|
|||||||||||||||||||
Call
|
Management
|
Wholesale
|
Corporate
|
|||||||||||||||||
Provisioning
|
Software
|
Services
|
&
Other
|
Total
|
||||||||||||||||
Revenue
from external customers
|
$
|
333,564
|
$
|
25,137
|
$
|
29,902
|
$
|
-
|
$
|
388,603
|
||||||||||
Segment
gross margin
|
$
|
89,757
|
$
|
11,597
|
$
|
15,359
|
$
|
-
|
$
|
116,713
|
||||||||||
Depreciation
and amortization
|
26,736
|
3,679
|
3,862
|
123
|
34,400
|
|||||||||||||||
Other
operating costs and expenses
|
20,617
|
8,820
|
4,109
|
41,399
|
74,945
|
|||||||||||||||
Operating
income (loss)
|
$
|
42,404
|
$
|
(902
|
)
|
$
|
7,388
|
$
|
(41,522
|
)
|
$ |
7,368
|
|
|||||||
Interest
and other expenses, net
|
41,896
|
41,896
|
||||||||||||||||||
Segment
loss before income taxes
|
(34,528
|
)
|
||||||||||||||||||
Capital
expenditures
|
$
|
15,522
|
$
|
90
|
$
|
100
|
$
|
1,334
|
$
|
17,046
|
||||||||||
December
31, 2008:
|
||||||||||||||||||||
Total
assets
|
$
|
187,786
|
$
|
46,072
|
$
|
13,338
|
$
|
11,766
|
$
|
258,962
|
||||||||||
Goodwill
|
$
|
37,936
|
$
|
25,532
|
$
|
-
|
$
|
-
|
$
|
63,468
|
58
Segment
information for the twelve months ended December 31, 2009 is as follows (in
thousands):
Direct
|
Offender
|
|||||||||||||||||||
Call
|
Management
|
Wholesale
|
Corporate
|
|||||||||||||||||
Provisioning
|
Software
|
Services
|
&
Other
|
Total
|
||||||||||||||||
Revenue
from external customers
|
$
|
312,614
|
$
|
22,698
|
$
|
28,124
|
$
|
-
|
$
|
363,436
|
||||||||||
Segment
gross margin
|
$
|
91,042
|
$
|
13,074
|
$
|
12,092
|
$
|
-
|
$
|
116,208
|
||||||||||
Depreciation
and amortization
|
27,568
|
3,482
|
160
|
123
|
31,333
|
|||||||||||||||
Other
operating costs and expenses
|
18,198
|
9,425
|
1,807
|
36,698
|
66,128
|
|||||||||||||||
Operating
income (loss)
|
$
|
45,276
|
$
|
167
|
|
$
|
10,125
|
$
|
(36,821
|
)
|
$ |
18,747
|
|
|||||||
Interest
and other expenses, net
|
39,114
|
39,114
|
||||||||||||||||||
Segment
loss before income taxes
|
(20,367
|
)
|
||||||||||||||||||
Capital
expenditures
|
$
|
15,100
|
$
|
228
|
$
|
558
|
$
|
567
|
$
|
16,453
|
||||||||||
December
31, 2009:
|
||||||||||||||||||||
Total
assets
|
$
|
168,625
|
$
|
53,015
|
$
|
10,319
|
$
|
8,115
|
$
|
240,074
|
||||||||||
Goodwill
|
$
|
37,936
|
$
|
29,450
|
$
|
-
|
$
|
-
|
$
|
67,386
|
(6)INCOME TAXES
Income
tax expense (benefit) is as follows (in thousands):
Year
Ended
|
Year
Ended
|
Year
Ended
|
||||||||||
December
31,
|
December
31,
|
December
31,
|
||||||||||
2007
|
2008
|
2009
|
||||||||||
Current:
|
||||||||||||
US
Federal
|
$ | - | $ | 330 | $ | (88 | ) | |||||
US
State
|
965 | 486 | 324 | |||||||||
Foreign
|
35 | 848 | 440 | |||||||||
Total
|
1,000 | 1,664 | 676 | |||||||||
Deferred:
|
||||||||||||
US
Federal
|
2,260 | 1,696 | 993 | |||||||||
US
State
|
(996 | ) | (552 | ) | 117 | |||||||
Foreign
|
(342 | ) | (3,317 | ) | (1,067 | ) | ||||||
Total
|
922 | (2,173 | ) | 43 | ||||||||
Total
income tax expense (benefit)
|
$ | 1,922 | $ | (509 | ) | $ | 719 |
Following
is a summary of the components of loss before income taxes for the years ended
December 31, 2007, 2008 and 2009 (in thousands):
2007
|
2008
|
2009
|
||||||||||
U.S.
income
|
$ | (37,125 | ) | $ | (29,013 | ) | $ | (21,371 | ) | |||
Non-U.S.
income
|
(1,357 | ) | (5,515 | ) | 1,004 | |||||||
Total
|
$ | (38,482 | ) | $ | (34,528 | ) | $ | (20,367 | ) | |||
59
Income
taxes differ from the expected statutory income tax benefit, by applying the
U.S. federal income tax rate of 35% to pretax earnings due to the following (in
thousands):
Year
Ended
|
Year
Ended
|
Year
Ended
|
||||||||||
December
31,
|
December
31,
|
December
31,
|
||||||||||
2007
|
2008
|
2009
|
||||||||||
Expected
statutory income tax benefit
|
$ | (13,469 | ) | $ | (12,085 | ) | $ | (7,128 | ) | |||
Amounts
not deductible for income tax
|
1,556 | 1,894 | 1,529 | |||||||||
State
taxes, net of federal benefit
|
(171 | ) | (66 | ) | (48 | ) | ||||||
Change
in valuation allowance
|
14,332 | 9,749 | 5,738 | |||||||||
Effect
of different tax rates in various jurisdictions
|
25 | 349 | (52 | ) | ||||||||
Impact
of changes in tax rates in foreign jurisdictions
|
- | (1,841 | ) | 415 | ||||||||
Tax
credits in foreign jurisdiction
|
- | (188 | ) | (368 | ) | |||||||
Other
|
(351 | ) | 1,679 | 633 | ||||||||
Total
income tax expense (benefit)
|
$ | 1,922 | $ | (509 | ) | $ | 719 |
The tax
effects of temporary differences that give rise to significant portions of the
deferred income tax assets and deferred income tax liabilities as of
December 31, 2008 and 2009, respectively, are presented below (in
thousands):
2008
|
2009
|
||||||
Net
current deferred income tax assets:
|
|||||||
Allowance
for doubtful accounts
|
$
|
1,945
|
$
|
2,188
|
|||
Accrued
expenses
|
2,055
|
845
|
|||||
Deferred revenue | 4,354 | 4,295 | |||||
Other
|
581
|
13
|
|||||
Current
deferred income tax assets
|
8,935
|
7,341
|
|||||
Deferred
income tax liabilities-other
|
(939
|
)
|
(1,063
|
)
|
|||
Current
deferred income tax liabilities
|
(939
|
)
|
(1,063
|
)
|
|||
Less:
valuation allowance
|
(6,840
|
)
|
(5,684
|
)
|
|||
Net
current deferred income tax asset
|
$
|
1,156
|
$
|
594
|
|||
Net
non-current deferred income tax assets (liabilities):
|
|||||||
Deferred
income tax assets:
|
|||||||
Net
operating loss and tax credit carryforwards
|
34,504
|
37,339
|
|||||
Accrued
interest
|
9,738
|
13,436
|
|||||
Other
|
200
|
74
|
|||||
Non-current
deferred income tax assets
|
44,442
|
50,849
|
|||||
Deferred
income tax liabilities:
|
|||||||
Property and equipment principally due to differences in
depreciation
|
(2,716
|
)
|
(2,561
|
)
|
|||
Goodwill | (5,164 | ) | (6,402 | ) | |||
Intangible assets
|
(14,627
|
)
|
(13,564
|
)
|
|||
Non-current
deferred income tax liabilities
|
(22,507
|
)
|
(22,527
|
)
|
|||
Less:
valuation allowance
|
(32,828
|
)
|
(39,628
|
)
|
|||
Net
non-current deferred income tax liability
|
(10,893
|
)
|
(11,306
|
)
|
|||
Net
deferred income tax liability
|
$
|
(9,737
|
)
|
$
|
(10,712
|
)
|
60
At
December 31, 2009, the Company had U.S. federal net operating loss
carryforwards for tax purposes aggregating approximately $109.9 million the
majority of which, if not utilized to reduce taxable income in future periods,
will expire from 2024 through 2029. Approximately $9.3 million of these net
operating loss carryforwards are subject to certain rules under Internal Revenue
Code Section 382 limiting their annual usage. The Company believes these
annual limitations will not ultimately affect its ability to use substantially
all of the net operating loss carry forwards for income tax purposes. As a
result of the change of control related to certain acquisitions, the use of the
net operating losses may be limited going forward under Internal Revenue Code
382. At December 31, 2009, the Company had net operating loss carryforwards for
tax purposes in Australia aggregating less than $0.1 million, which do not
expire, and no operating loss carryforwards in the remaining foreign tax
jurisdictions.
The
Company accounts for the uncertainty in income taxes on the determination of
whether tax benefits claimed or expected to be claimed on a tax return should be
recorded in the financial statements. The tax benefit from an uncertain tax
position may be recognized only if it is more likely than not that the tax
position will be sustained on examination by the taxing authorities. The
determination is based on the technical merits of the position and presumes that
each uncertain tax position will be examined by the relevant taxing authority
that has full knowledge of all relevant information.
The
Company’s unrecognized tax benefits of $0.7 million and $0.4 million at
December 31, 2008 and 2009, respectively, relate to various foreign
jurisdictions.
The
following table summarizes the activity related to the Company’s unrecognized
tax benefits ( in thousands):
Total
|
||||
Balance
at December 31, 2007
|
$ | 663 | ||
Increases
related to prior year’s tax positions
|
27 | |||
Foreign
currency translation
|
(22 | ) | ||
Balance
at December 31, 2008
|
668 | |||
Decreases
related to prior year’s tax positions
|
(316 | ) | ||
Increases
related to current year’s tax positions
|
23 | |||
Foreign
currency translation
|
(18 | ) | ||
Balance
at December 31, 2009
|
$ | 357 |
Included
in the unrecognized tax benefits of $0.4 million at December 31, 2009
was a $0.3 million tax expense that, if recognized, would impact the annual
effective tax rate. The Company also accrued potential interest of $0.1 million
in 2007, and less than $0.1 million during both 2008 and 2009,
respectively, related to these unrecognized tax benefits. The Company does not
expect unrecognized tax benefits to change significantly over the next
12 months. The Company classified interest and penalties on
income tax-related balances as income tax expense.
The
Company or one of its subsidiaries file income tax returns in the U.S. federal
jurisdiction, Canada, the United Kingdom, Australia and various states. The
Company has open tax years for the U.S. federal return from 1996 forward with
respect to its net operating loss carryforwards, where the IRS may not raise tax
for these years, but can reduce net operating loss carryforwards. Otherwise,
with few exceptions, the Company is no longer subject to federal, foreign,
state, or local income tax examinations for years prior to 2005.
A
valuation allowance is provided when it is more likely than not that some
portion or the entire net deferred tax asset will not be realized. The Company
calculated the deferred tax liability, deferred tax asset, and the related
valuation of net deferred tax assets, including net operating loss
carryforwards, for the taxable temporary differences on a jurisdiction by
jurisdiction basis. The valuation allowance represents the excess deferred tax
assets including the net operating loss carryforwards, over the net deferred tax
liabilities, excluding deferred liabilities that are not available to offset
deferred tax assets. The Company has offset the net deferred tax assets,
including net operating loss carryforwards, with a valuation allowance of
$39.7 million and $45.3 million at December 31, 2008 and 2009,
respectively. The Company increased the valuation allowance because future
taxable income may not be realized to utilize net operating losses.
61
At
December 31, 2009, the Company had 5,100 shares of Series A Redeemable
Convertible Preferred Stock (“Preferred Stock”), which was issued in December
2007. Each share of the Preferred Stock has a stated value of $2,534 and accrues
dividends annually at 12.5% of the stated value. The Preferred Stock has a
liquidation preference equal to the greater of its per share purchase price plus
any accrued but unpaid dividends and the amount the holder would receive if such
share were converted to shares of common stock. At the election of the Board of
Directors, the Company may redeem shares of Preferred Stock at any time on or
after January 1, 2010. The redemption price is equal to the greater of the
liquidation amount or the fair market value as of the redemption
date.
Each
share of Preferred Stock is convertible into 200 shares of Class A Common Stock,
as adjusted for certain events. The intrinsic value of the conversion option was
zero as the fair value of the Class A Common Stock was less than the conversion
price at the commitment date.
The
Company accrues dividends on the Preferred Stock; however the Company’s Credit
Agreement contains financial and operating covenants which limit the ability to
make dividend payments to the Company’s shareholders. As of December
31, 2009, the Company had accrued but unpaid dividends of $2.7 million for the
Series A Preferred Stock. The accrued but unpaid dividends are included in the
redemption amount of the Preferred Stock at December 31, 2009.
(8)STOCKHOLDERS’
EQUITY
Common
Stock
In 2007,
in conjunction with the issuance of the Preferred Stock (see Note 7), the
Company’s shareholders approved a 1 for 1,000 reverse stock split for the Class
A Common Stock and Class B Common Stock. Except as otherwise noted, all shares,
options and warrants have been restated to give retroactive effect to the
reverse split. In connection with the reverse split, authorized shares of common
stock were reduced to 1,300,000 shares of capital stock with a par-value of
$0.001.
In
2008, the Company authorized an additional 65,000 shares of Class B Common Stock
and filed a Third Amended and Restated Certificate of Incorporation, which
authorized 1,365,000 shares of capital stock with a par value of $0.001.
1,190,000 shares were designated Class A Common Stock, 10,000 were designated
Preferred Stock, of which 5,100 were designated as Series A Convertible
Preferred Stock, and 165,000 were designated Class B Common Stock.
On March
25, 2009, the Company filed a Fourth Amended and Restated Certificate of
Incorporation, which authorized 1,685,000 shares of capital stock with a par
value of $0.001. Additionally, the board of directors issued a unanimous
resolution to adopt a Fourth Amendment to the 2004 Restricted Stock Plan which
increased the number of shares of Class B Common Stock authorized for issuance
thereunder from 165,000 to 175,000 shares. The Fourth Amended and Restated
Certificate of Incorporation designated 1,500,000 shares as Class A Common
Stock, 10,000 shares as Preferred Stock, of which 5,100 were designated as
Series A Convertible Preferred Stock, and 175,000 shares as Class B Common
Stock. All issued shares of Common Stock are entitled to vote on a one share/one
vote basis.
As of
December 31, 2009, 14,132 shares of Class A Common Stock were issued and
outstanding and 126,660 shares of the Class B Common Stock were issued
and outstanding. Shares of Class B Common Stock are subject to vesting as
described below. Other than provisions related to vesting and a $57,000
per share liquidation preference for the Class A Common Stock, holders of the
shares of Class A Common Stock and Class B Common Stock have identical
rights and privileges. The Company’s Credit Agreement restricts the ability to
pay dividends to holders of the Company’s capital stock.
Warrants
The
holders of the Senior Subordinated Notes hold warrants to purchase an aggregate
of 51.01 shares of Class A Common Stock. The warrant exercise price is $10 per
share, is immediately exercisable upon issuance, and expires on
September 9, 2014. As a result, the Company discounted the face value of
the Senior Subordinated Notes by $2.9 million representing the estimated
fair value of the stock warrants at the time of issuance. The
warrants had a de minimis fair value as of December 31, 2008 and
2009.
62
Restricted
Stock Purchase Plan
The
Company has a 2004 Restricted Stock Purchase Plan under which certain of its
employees may purchase shares of Class B Common Stock. The maximum number
of authorized shares that may be delivered pursuant to awards granted under the
2004 Restricted Stock Purchase Plan is 175,000, which equals 10.4% of the total
authorized shares of common stock.
The
Company’s board of directors administers the 2004 Restricted Stock Purchase
Plan. The plan is designed to serve as an incentive to attract and retain
qualified and competent employees. The per share purchase price for each share
of Class B Common Stock is determined by the Company’s board of directors.
Class B Common stock will vest based on performance criteria or ratably
over a period or periods, as provided in the related restricted stock purchase
agreement.
As of
December 31, 2009, 126,660 shares of Class B Common Stock were issued under
the 2004 Restricted Stock Purchase Plan. Of this amount, (a) 57,072 of these
shares were issued to our Chief Executive Officer; (b) 11,414 shares were issued
to our Chief Financial Officer; and (c) 58,174 shares were issued to eleven of
the Company’s executives and to current or previous members of the Company’s
board of directors.
These
shares are subject to forfeiture pursuant to the terms of the 2004 Restricted
Stock Purchase Plan and the restrictions described hereafter. The restriction
period of 33.33% of the shares issued to the majority of the Company’s
executives, ends upon the sale of the Company’s stock by certain of its other
stockholders. The restriction period for 33.34% of the stock ends upon the lapse
of time, ratably over three to four years from the date of issue. With respect
to the remaining shares, the restriction period ends upon the Company attaining
certain performance measures determined by its board of directors. Upon a
change of control, the restriction period could end for all of the restricted
shares that have not previously vested. The restricted shares are entitled to
dividends, if declared, which will be distributed upon termination of the
restriction period with respect to any such restricted shares.
The
Company measures compensation expense on these restricted shares commensurate
with their vesting schedules. For the portion of the restricted shares that vest
contingently with the occurrence of certain events, the Company records
compensation expense when such events become probable. The incremental
compensation expense on the restricted shares issued was determined based on the
estimated fair value of the Class B Common Stock, which resulted in less
than $0.1 million in compensation expense charged to “Selling General and
Administrative Expense” in the consolidated statement of operations for each of
the years ended December 31, 2007, 2008 and 2009.
As of
December 31, 2009, there was approximately $0.1 million total unrecognized
compensation cost related to the 2004 Restricted Stock Purchase Plan, of which
approximately half is expected to be recognized over a weighted average period
of 2 years and the remaining half will be recognized upon the sale of the
Company's stock by certain of the Company's other shareholders.
(9)RELATED-PARTY
TRANSACTIONS
The
Company has a consulting services agreement with H.I.G. pursuant to which H.I.G.
receives an annual consulting services fee of $750,000 for management,
consulting and financial advisory services. Required minimum annual
consulting fee payments for the remaining term are as follows (in
thousands):
Year
Ended December 31:
|
||||
2010
|
$
|
750
|
||
2011
|
750
|
|||
2012
|
750
|
|||
2013
|
750
|
|||
2014
|
750
|
|||
Thereafter
|
3,563
|
|||
Total
|
$
|
7,313
|
The
consulting services agreement, as amended, has an eleven-year commitment
period. In connection with this agreement, the Company paid
$0.8 million for each of the three years ended December 31, 2007,
2008, and 2009.
The
Company has a professional services agreement, as amended, with H.I.G., pursuant
to which H.I.G. is paid investment banking fees equal to 2% of the value of any
transaction in which the Company (i) sells all or substantially all of its
assets or a majority of its stock, (ii) acquires any other companies or
(iii) secures any debt or equity financing. In 2007, in connection with its
acquisition of Syscon and the issuance of the Series A Redeemable Convertible
Preferred Stock, H.I.G. received a professional services fee equal to 2% of each
transaction value, or approximately $1.0 million and $0.2 million,
respectively. In 2008, H.I.G. received a professional service fee of $0.8
million for their services related to the refinancing of the Company’s revolving
credit arrangement. No transactions took place during 2009, requiring payment
under the professional services agreement.
63
In 2008,
the Company entered into an amended agreement with the previous stockholder of
Syscon to amend the Syscon Purchase Agreement. Pursuant to the new
agreement, the former stockholder’s Employment Agreement with Syscon was
terminated and Syscon entered into a Consulting Agreement with a company
controlled by the former owner. The Consulting Agreement covers
certain management and advisory and other services to be provided over a period
of three years, for which Syscon will pay a total of approximately $1,090,000 in
fees. In 2008, the Company paid $0.5 million to an affiliate of the
former stockholder for professional software development consulting services. In
2009, the Company paid $0.2 million to the former stockholder related to the
provisions of the Consulting Agreement.
(10)COMMITMENTS AND
CONTINGENCIES
(a)Operating
Leases
The
Company leases office space and certain office equipment under operating lease
agreements. Most of our lease terms have escalation clauses and renewal options,
typically equal to the lease term. The Company accounts for escalating rents on
a straight-line basis over the life of the lease. Rent expense under operating
lease agreements for the year ended December 31, 2007, 2008, and 2009 was
approximately $2.5 million, $3.4 million and $3.8 million, respectively.
Future minimum lease payments under these lease agreements for each of the next
five years and thereafter are summarized as follows (in thousands):
Year
Ended December 31:
|
||||
2010
|
$ | 3,518 | ||
2011
|
2,144 | |||
2012
|
2,016 | |||
2013
|
1,779 | |||
2014
|
1,794 | |||
Thereafter
|
450 | |||
Total
minimum lease payments
|
$ | 11,701 |
(b)Minimum
Guaranteed Payments
The
Company records a liability for
guarantees, including indirect guarantees of indebtedness of others, at the
estimated fair value of the guarantee obligations and discloses the maximum
amount that could be paid under the guarantee obligation.
The
Company is required to make the following minimum commission payments to certain
of its correctional facility customers regardless of the level of revenues
generated by the Company on those contracts as follows (in
thousands):
Year
Ended December 31:
|
||||
2010
|
$ | 3,367 | ||
2011
|
720 | |||
2012
|
488 | |||
2013
|
98 | |||
2014
|
- | |||
Total
minimum commission payments
|
$ | 4,673 |
As of
December 31, 2009, the Company did not meet the minimum requirements for
certain correctional facilities customers and therefore, the Company recorded
$0.1 million in accrued liabilities. The Company cannot
guarantee that it will generate sufficient revenues from these contracts in
future periods to offset these guaranteed minimum payments.
64
Accudata
Technologies, a former affiliated company, provides validation services to the
Company. In August 2007, Accudata purchased the Company’s 50% interest in its
preferred stock for $1.0 million. In connection with the sale of our interest in
Accudata, the Company agreed to continue to conduct business at market rates
with Accudata for at least thirty-six months. Minimum monthly payments for
validation services are $85,000 for the first twelve months, $56,667 for the
second twelve months, and $28,333 for the third twelve months. The Company paid
Accudata $1.0 million and $0.7 million for the twelve months ended December 31,
2008 and 2009, respectively. The maximum amount of the commitment is $2.0
million, of which $1.8 million has been paid as of December 31,
2009.
In
2008, the Company entered into an agreement with a telecommunications vendor,
primarily for local and long distance services, whereby the Company guaranteed a
minimum annual purchase commitment over a three year period. As of December 31,
2009, the minimum purchase commitment is $1.9 million
annually. Additionally, the Company entered into an agreement with
another telecommunications provider for the purchase of custom carrier services,
whereby the Company guaranteed a minimum purchase commitment over a one year
period. The Company satisfied the minimum purchase commitment of $3.8
million during 2009.
(c)Employment
Agreements
As of
December 31, 2009, the Company had employment agreements with certain key
management personnel, which provided for minimum compensation levels and
incentive bonuses along with provisions for termination of benefits in certain
circumstances and for certain severance payments in the event of a change in
control (as defined).
(d)Litigation
We have
been, and expect to continue to be, subject to various legal and administrative
proceedings or various claims in the normal course of business. We believe the
ultimate disposition of these matters will not have a material effect on our
financial condition, liquidity, or results of operations.
From time
to time, inmate telecommunications providers, including the Company, are parties
to judicial and regulatory complaints and proceedings initiated by inmates,
consumer protection advocates or individual called parties alleging, among other
things, that excessive rates are being charged with respect to inmate collect
calls, that commissions paid by inmate telephone service providers to the
correctional facilities are too high, that a call was wrongfully disconnected,
that security notices played during the call disrupt the call, that the billed
party did not accept the collect calls for which they were billed or that rate
disclosure was not provided or was inadequate. On occasion, we are also the
subject of regulatory complaints regarding our compliance with various matters
including tariffing, access charges, payphone compensation requirements and rate
disclosure issues. In March 2007, the FCC asked for public comment on a proposal
from an inmate advocacy group to impose a federal rate cap on interstate inmate
calls. This proceeding could have a significant impact on the rates that we and
other companies in the inmate telecommunications industry may
charge. Similar proposals have been pending before the FCC for more
than four years without action by the agency. This newest proceeding remains
under review by the FCC and has received strong opposition from the inmate
telecommunications industry. In August 2008, a group of inmate telephone service
providers provided the FCC with an "industry wide" cost of service study for
their consideration. That proceeding remains ongoing and we have no
information as to when, if ever, it will be resolved. We cannot
predict the outcome at this time.
In June
2000, T-Netix was named, along with AT&T, in a lawsuit in the Superior
Court of King County, Washington, in which two private citizens allege
violations of state rules requiring pre-connect audible disclosure of rates as
required by Washington statutes and regulations. T-Netix and other
defendants successfully obtained dismissal and a "primary jurisdiction" referral
in 2002. In 2005, after several years of inactivity before the Washington
Utilities and Transportation Commission (“WUTC”), the state telecommunications
regulatory agency, T-Netix prevailed at the trial court in securing an
order entering summary judgment on grounds of lack of standing, but that
decision was reversed by an intermediate Washington state appellate court in
December 2006. T-Netix’s subsequent
petition for review by the Washington Supreme Court was denied in January 2008,
entitling plaintiffs to continue to pursue their claims against T-Netix and
AT&T. This matter was referred to the WUTC on the grounds of primary
jurisdiction, in order for the WUTC to determine various regulatory issues. On
May 22, 2008, AT&T filed with the trial court a cross-claim against T-Netix
seeking indemnification. T-Netix moved to dismiss AT&T’s cross-claim, but
the court denied that motion and deferred resolution of whether
AT&T's belated indemnification claim is within the statute of
limitations for summary judgment. Motions by both T-Netix and
AT&T for summary determination were briefed to the WUTC in September 2009
and remain pending before an administrative law judge. As merits and
damages discovery are not completed, however, we cannot estimate the
Company's potential exposure or predict the outcome of this
dispute.
In July
2009, Evercom filed a complaint against Combined Public Communications,
Inc. ("CPC"), alleging tortious interference with Evercom’s
contracts for the provision of telecommunications services with correctional
facilities in the Commonwealth of Kentucky and the State of
Indiana. Evercom claims CPC has misrepresented that the correctional
facility has a statutory right to terminate its contract with Evercom upon the
election of a new Sheriff. Accordingly, Evercom
seeks a declaration that under Kentucky law its contracts with
its customers are not personal services contracts and that under both Indiana
and Kentucky law, its contracts with correctional facilities are not void
for not being terminable within thirty days, as well as an award
of compensatory and punitive damages. On July 29,
2009, CPC filed a motion to dismiss for failure to state a
claim. On August 14, 2009, Evercom filed its response in
opposition to dismiss, and on September 9, 2009, the court denied CPC's
motion to dismiss. On January 8, 2009, the court entered a scheduling
order setting forth the pre-trial deadlines. This matter is in its
early stages and we cannot predict the outcome at this time.
65
In July
2009, the Company filed a petition with the FCC seeking affirmation of the
Company’s right to block attempts by inmates to use services, which the Company
calls “call diversion schemes,” designed to circumvent its secure calling
platforms. These illicit services are not permitted to carry calls from
any correctional facility, and the Company has received strong support from its
correctional authority clients to stop this activity. The FCC has
long-standing precedent that permits inmate telecommunications service providers
to block such attempts. The FCC had asked that interested parties file
comments to the Company’s petition by August 31, 2009; and thereafter, the
Company filed reply comments. This matter is in its early stages and we
cannot predict the outcome at this time.
In
September 2009, T-Netix filed suit against CPC in the United States Federal
District Court for the Western District of Kentucky, for patent infringement of
various T-Netix patents. The court has scheduled a Rule 26(f)
scheduling conference for February 10, 2010 and the parties are negotiating an
agreed discovery plan to present at the hearing. This matter is in
its early stages and we cannot predict the outcome at this time.
In
October 2009, T-Netix filed suit in the United States Federal District Court for
the Eastern District of Texas against Pinnacle Public Services, LLC for patent
infringement of various T-Netix patents. Pinnacle has served its
answer and filed a motion to transfer venue to the Northern District of
Texas. This matter is in its early stages and we cannot predict the
outcome at this time.
In
October 2009, the Company, along with Evercom and T-Netix, and one of the
Company’s competitors were sued in the Federal District Court for the Southern
District of Florida by Millicorp d/b/a ConsCallHome. Millicorp, a
proprietor of what the Company has described to the FCC as a call diverter, has
sued these companies under the Communications Act of 1934, alleging that the
companies have no right to block attempts by inmates to use the call diversion
scheme. The FCC has permitted inmate telecommunications service
providers to block such attempts since 1991, and the Company had sought
re-affirmance of that permission in the petition for declaratory ruling
described above. All defendants have filed motions to dismiss all
claims with prejudice. Discovery has not yet commenced. This
matter is in its early stages and we cannot predict the outcome at this
time.
In
October 2009, the Company filed suit in the District Court of Dallas County,
Texas, against Lattice Incorporated (“Lattice”, formerly known as Science
Dynamics Corporation) alleging breach of contract, tortious interference, unfair
competition, damage to goodwill and injunctive relief as a result of Lattice’s
breach of certain provisions of a December 2003 asset purchase agreement between
Evercom and Science Dynamics Corporation. On October 2, 2009, the court issued a
temporary restraining order against Lattice, and ordered Lattice to immediately
cease and desist from, among other things, (i) renewing any customer contracts
in the law enforcement industry; (ii) marketing, selling or soliciting, directly
or indirectly, any of its products and/or services to any customers in the law
enforcement industry; and (iii) interfering with any of the Company’s business
relationships in the law enforcement industry in the United
States. On January 4, 2010, the parties entered into a settlement
agreement and mutual release, and a patent license agreement wherein Lattice was
granted a license to use one (1) of the Company’s patents.
In
January 2010, T-Netix and Evercom filed suit in the United States
Federal District Court for the Eastern District of Texas against Legacy Long
Distance International, Inc. dba Legacy International, Inc. and Legacy Inmate
Communications for patent infringement of various T-Netix’s
and Evercom’s patents. This matter is in its early stages
and we cannot predict the outcome at this time.
During
fiscal year 2009, the Company dismissed KPMG LLP (“KPMG”) as its principal
accountant to audit its financial statements. The Audit Committee of the board
of directors of the Company approved the change in principal
accountants. In April 2009, the Company engaged McGladrey &
Pullen, LLP (“McGladrey”) as its principal accountant to audit the Company’s
financial statements. During the two most recent fiscal years ended December 31,
2008 and the subsequent interim period in 2009, the Company had not consulted
with McGladrey regarding any of the following: (1) the application of accounting
principles to a specified transaction, either completed or proposed; or the type
of audit opinion that might be rendered on the Company’s financial statements,
and neither a written report nor oral advice was provided to the Company that
McGladrey concluded was an important factor considered by the Company in
reaching a decision as to the accounting, auditing or financial reporting issue,
or (2) any matter that was either the subject of a disagreement (as defined in
paragraph 304(a)(1)(iv) and the related instructions to Item 304 of Regulation
S-K) or a reportable event (as defined in Item 304(a)(1)(v) of Regulation
S-K).
During
the two most recent fiscal years ended December 31, 2008 and the subsequent
interim period in 2009, there were no disagreements between KPMG and the Company
on any matter of accounting principles or practices, financial statement
disclosure, or auditing scope or procedure which, if not resolved to the
satisfaction of KPMG, would have caused it to make a reference to the subject
matter of any such disagreement with its report. No reportable events, as
defined in Item 304(a)(1)(v) of Regulation S-K, occurred within the Company’s
two most recent fiscal years ended December 31, 2008 and the subsequent interim
period in 2009.
66
1.
Disclosure Controls and Procedures
We
maintain disclosure controls and procedures that are designed to ensure that
information required to be disclosed in the reports that we file or submit under
the Securities Exchange Act of 1934 is recorded, processed, summarized and
reported within the time periods specified in the Securities and Exchange
Commission’s rules and forms, and that such information is accumulated and
communicated to our management, including our Chief Executive Officer and Chief
Financial Officer, as appropriate to allow timely decisions regarding required
disclosure.
As of the
end of the period covered by this report, we carried out an evaluation, under
the supervision and with the participation of our Disclosure Committee and
management, including the Chief Executive Officer and the Chief Financial
Officer, of the effectiveness of the design and operation of our disclosure
controls and procedures pursuant to Exchange Act Rule 13a-15(b). Based upon
this evaluation, the Chief Executive Officer and the Chief Financial Officer
concluded that our disclosure controls and procedures were effective as of the
end of the period covered by this report.
2.
Management’s Report on Internal Control over Financial Reporting
Our
management is responsible for establishing and maintaining adequate internal
control over financial reporting as defined in Rules 13a-15(f) and
15d-15(f) under the Securities Exchange Act of 1934. Our internal control over
financial reporting is a process designed under the supervision of our Chief
Executive Officer and Chief Financial Officer to provide reasonable assurance
regarding the reliability of financial reporting and the preparation of
financial statements for external purposes in accordance with U.S. generally
accepted accounting principles.
Because
of its inherent limitations, internal control over financial reporting may not
prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with policies and procedures may deteriorate.
Management
assessed the effectiveness of our internal control over financial reporting as
of December 31, 2009. In making this assessment, management used the
criteria described in Internal
Control — Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO). Based on this assessment,
management concluded that we maintained effective internal control over
financial reporting as of December 31, 2009.
The effectiveness
of the Company’s internal control over financial reporting as of
December 31, 2009 has been audited by an independent registered public
accounting firm, as stated in their report which appears
herein.
3. Changes in Internal Control over
Financial Reporting
There
were no changes in the Company’s internal control over financial reporting
during the period ended December 31, 2009, that have materially affected,
or are reasonably likely to materially affect, the Company’s internal control
over financial reporting.
67
Report
of Independent Registered Public Accounting Firm
To the
Board of Directors and Stockholders
Securus
Technologies, Inc.
We have
audited Securus Technologies, Inc. and Subsidiaries’ internal control over
financial reporting as of December 31, 2009, based on criteria established in
Internal Control — Integrated
Framework issued by the Committee of Sponsoring Organizations of the
Treadway Commission. Securus Technologies, Inc. and Subsidiaries’
management is responsible for maintaining effective internal control over
financial reporting and for its assessment of the effectiveness of internal
control over financial reporting included in the accompanying Management's
Report on Internal Control over Financial Reporting. Our
responsibility is to express an opinion on the company's internal control over
financial reporting based on our audit.
We
conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require
that we plan and perform the audit to obtain reasonable assurance about whether
effective internal control over financial reporting was maintained in all
material respects. Our audit included obtaining an understanding of
internal control over financial reporting, assessing the risk that a material
weakness exists, and testing and evaluating the design and operating
effectiveness of internal control based on the assessed risk. Our
audit also included performing such other procedures as we considered necessary
in the circumstances. We believe that our audit provides a reasonable
basis for our opinion.
A
company's internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with United States generally accepted accounting principles. A
company's internal control over financial reporting includes those policies and
procedures that (a)
pertain to the maintenance of records that, in reasonable detail, accurately and
fairly reflect the transactions and dispositions of the assets of the company;
(b) provide reasonable
assurance that transactions are recorded as necessary to permit preparation of
financial statements in accordance with United States generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (c)
provide reasonable assurance regarding prevention or timely detection of
unauthorized acquisition, use, or disposition of the company's assets that could
have a material effect on the financial statements.
Because
of its inherent limitations, internal control over financial reporting may not
prevent or detect misstatements. Also, projections of any evaluation
of effectiveness to future periods are subject to the risk that controls may
become inadequate because of changes in conditions, or that the degree of
compliance with the policies or procedures may deteriorate.
In our
opinion, Securus Technologies, Inc. and Subsidiaries maintained, in all material
respects, effective internal control over financial reporting as of December 31,
2009, based on criteria established in Internal Control — Integrated
Framework issued by the Committee of Sponsoring Organizations of the
Treadway Commission.
We have
also audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), the December 31, 2009 consolidated balance
sheet and the related consolidated statements of operations, stockholders’
deficit and comprehensive loss, and cash flows for the year then ended of
Securus Technologies, Inc. and Subsidiaries and our report dated March 15, 2010
expressed an unqualified opinion.
McGladrey & Pullen,
LLP
Dallas,
Texas
March 15,
2010
68
None.
The
following is a list of our executive officers, other senior executives and
directors as of March 1, 2010. All of our directors serve until a
successor is duly elected and qualified or until the earlier of his death,
resignation or removal. Our executive officers are appointed by and serve at the
discretion of our board of directors. There are no family relationships between
any of our directors or executive officers.
Name
|
Age
|
Position
|
||
Richard
A. Smith
|
58
|
Chairman,
Chief Executive Officer and President
|
||
William
D. Markert
|
45
|
Chief
Financial Officer
|
||
Dennis
J. Reinhold
|
49
|
Vice
President, General Counsel and Secretary
|
||
Arlin
B. Goldberg
|
53
|
Chief Information
Officer
|
||
Robert
E. Pickens
|
49
|
Chief
Marketing Officer
|
||
Daniel
A. Crawford
|
63
|
President,
Syscon Justice Systems
|
||
Joshua
E. Conklin
|
35
|
Vice
President, Sales
|
||
Danny
de Hoyos
|
34
|
Vice
President Service and Technical Operations
|
||
Kathryn
S. Lengyel
|
41
|
Vice
President, Human Resources
|
||
Larry
V. Ehlers
|
55
|
Vice
President, Applications
|
||
Patrick
W. Brolsma
|
47
|
Director
of Enterprise Program Management Office & Corporate
Development
|
||
Anthony
A. Tamer
|
49
|
Director
|
||
Brian
D. Schwartz
|
41
|
Director
|
||
Douglas
F. Berman
|
43
|
Director
|
||
Lewis
J. Schoenwetter
|
39
|
Director
|
||
Sami
W. Mnaymneh
|
50
|
Director
|
||
James
Neal Thomas (1)
|
64
|
Director
|
||
Rob
Wolfson
|
37
|
Director
|
(1)
|
Audit
Oversight Director.
|
The
following information summarizes the principal occupations and business
experience, during the past five years, of each of our directors and executive
officers.
Richard A. Smith has served
as our President and Chief Executive Officer since June 2008, and as Chairman of
the Board since January 2009. Mr. Smith served as the Chief
Executive Officer of Eschelon Telecom Inc., a publicly traded local exchange
carrier, from August 2003 through August 2007. Mr. Smith also served as
Eschelon’s President, Chief Financial Officer and Chief Operating Officer during
his tenure. Prior to joining Eschelon, Mr. Smith worked for Frontier
Corporation where he held many roles, including Controller, Chief Information
Officer, President of Frontier Information Technologies, Vice President of
Midwest Telephone Operations, Network Plant Operations Director, Director of
Business Development and Vice President of Financial Management. Mr. Smith
holds an Associate Degree of Applied Science in Electrical Engineering from the
Rochester Institute of Technology, a Bachelor of Science degree in Electrical
Engineering from the State University of New York at Buffalo, a Masters in
Mathematics degree from the State University of New York at Brockport, and a
Masters in Business Administration from the University of Rochester’s Simon
School. Mr. Smith presently serves as a director of Integra Telecom, a
privately held local exchange carrier based in Portland, Oregon.
William D. Markert has served
as our Chief Financial Officer since June 2008. From December 1999 to
November 2007, Mr. Markert held executive level finance positions at Eschelon
Telecom, Inc., with his most recent position being Executive Vice President of
Network Finance. During Mr. Markert’s employment with Eschelon, he was
responsible for revenue and cost accounting and reporting, network cost
management, carrier access billing and revenue and margin assurance. He also
directed various merger and acquisition related projects. Prior to joining
Eschelon, Mr. Markert worked for Global Crossing Limited, a publicly traded
communications solutions company, in various financial, regulatory and
operational management roles. Mr. Markert holds a Baccalaureate in Business
Administration from the University of Wisconsin-Whitewater and a Masters in
Business Administration from the University of St. Thomas in St. Paul,
Minnesota.
69
Dennis J. Reinhold has served
as our Vice President, General Counsel and Secretary since he joined us in
August 2005. Prior to joining us in August 2005, Mr. Reinhold served as the
Associate General Counsel of SOURCECORP, Inc. (NASDAQ: SRCP), at the time a
public company with approximately 7,000 employees worldwide that specialized in
business process outsourcing of critical data and documents. In that role, he
was responsible for the worldwide legal function of the Business Process
Solutions Division, the Statement Solutions Division, the Legal Claims Division
and the Direct Mail Division. While at SOURCECORP, he was the company’s Chairman
of the Juvenile Diabetes Research Foundation, and helped propel SOURCECORP to
one of the largest corporate fundraisers for Juvenile Diabetes in the DFW area.
Prior to his position at SOURCECORP, Mr. Reinhold served as Division General
Counsel/ Director of International Legal Affairs and Assistant Secretary for
AAF-McQuay, Inc. Mr. Reinhold has over 20 years of legal experience, both in law
firms and in-house positions, with an emphasis in practicing in the areas of
corporate and international law. Mr. Reinhold has a J.D. from St. Louis
University, a B.S. in Marketing and Business Administration from the University
of Illinois and has completed the Advanced Management Program at The Wharton
School, University of Pennsylvania. Mr. Reinhold was one of 20 finalists in the
2006 Dallas Business Journal’s Best Corporate Counsel Awards, and in 2006, he
was awarded a National Leadership Award by the National Republican Congressional
Committee. Mr. Reinhold has served on numerous civic organizations, including
the Board of Directors for the Louisville Ballet.
Arlin B. Goldberg has served
as our Chief Information Officer since September 2008. Mr. Goldberg
has over 30 years of telecommunication industry experience. Previously, Mr.
Goldberg served as the Executive Vice President of Information Technology for
Eschelon Telecom from October 1996 until July 2007. Prior to that, Mr. Goldberg
served as Director of Information Services at Frontier Corporation, and also as
Director of Information Services for Enhanced TeleManagement, Inc. Early in his
career, Mr. Goldberg served in a variety of roles at Norstan Communications
Systems, Inc. Mr. Goldberg received his Bachelor of Science in Business degree
in Accounting from the University of Minnesota Carlson School of
Management.
Robert E. Pickens has served
as our Chief Marketing Officer since September 2008. Mr. Pickens has over 18
years of senior level telecommunications experience. Before joining Securus
Technologies, Mr. Pickens was Chief Operating Officer of Eschelon Telecom.
During his eleven year tenure with that organization, he held leadership
positions in marketing, operations, and mergers & acquisitions integration
management. Mr. Pickens has a Bachelor of Science in Business degree in
Marketing and Management from the University of Minnesota Carlson School Of
Management.
Daniel A. Crawford has served
as President of Syscon Justice Systems since July 2007. Prior to this position
Mr. Crawford held the role of Senior Vice President of Corporate Development for
us from December 2006 to June 2007. In 2005, Mr. Crawford held the role of
Chairman, CEO and President of Tiburon, Inc. and has held such roles with a
number of leading companies in the public safety and criminal justice
industries. In 1992, Mr. Crawford founded EPIC Solutions, Inc., which was named
an INC 500 fastest growing company. Mr. Crawford has been named Business Leader
of the Month by the National Foundation for Enterprise Development, and One of
the Most Influential Technology Leaders by the San Diego Business Journal. Mr.
Crawford began his professional career in the military as a Naval Aviator. After
leaving active duty, Mr. Crawford remained in the Naval Reserves and retired in
1996 with the rank of captain. Mr. Crawford received a Bachelors of Science
degree in Business Administration from California State University, Northridge
in 1970 and a Masters in Business Administration from Chapman University in
1975. Mr. Crawford also holds a law degree from National University
School of Law, and has served on multiple boards of directors.
Joshua E. Conklin has served
as our Vice President of Sales since December of 2009. Mr. Conklin has the
responsibility for all new and existing facility sales for Securus Technologies,
Inc. prior to joining Securus, Mr. Conklin was Senior Vice President and General
Manager of California and Nevada for Integra Telecom Inc. In this role, Mr.
Conklin had full operational responsibility for Integra Telecom of California
and Nevada including sales, customer service, network operations, new customer
provisioning, and long haul network operations for the bulk of Integra’s network
in the western United States. Prior to joining Integra, Mr. Conklin served with
Eschelon Telecom Inc. as Senior Director of Network Sales for Colorado,
Minnesota, and Utah. In this capacity, Mr. Conklin was responsible for new
acquisition sales in over 40% of Eschelon Telecom’s network footprint. Mr.
Conklin also held several other sales roles within Eschelon including Sales
Director, Sales Manager, and Sales Training Manager over his 10-year career with
Eschelon. Mr. Conklin holds a Bachelor of Business Administration degree from
West Texas A&M University.
Danny de
Hoyos has served as Vice President of Customer Service since September
2008. Prior to joining Securus Technologies, Mr. De Hoyos served as Director of
Customer Operations for Medica located in Minneapolis, Minnesota. From 2001
through the end of 2007 Mr. de Hoyos was employed by Eschelon Telecom and served
as Vice President of Customer Service and Service Delivery. Prior to joining
Eschelon, Mr. de Hoyos was Director of Support Services for One World Online in
Provo, Utah. Mr. de Hoyos has also held Customer Operations and Call Center
Management leadership roles for other technology companies such as Big Planet
and Marketing Ally. Mr. de Hoyos has a Bachelor of Science degree from Brigham
Young University.
70
Kathryn S. Lengyel has served
as Vice President of Human Resources since June 2007. Prior to joining Securus
in July, 2007, Ms. Lengyel held the position of Vice President of Human
Resources at Excel Telecommunications from October 2005, where she was an
integral part of the company’s acquisition of Vartec Telecom. Ms. Lengyel acted
in a leadership capacity at Stone Holdings, Inc. where she was the Director of
Human Resources from November 1991 until 2005. She has created a successful
track record of employee initiatives, leadership and organizational change
management. Ms. Lengyel has diverse Human Resources experience in start-ups,
growth and M&A situations. Ms. Lengyel holds both a Bachelor of Science
degree in Human Development and a Masters of Education degree in Human Resource
Development from Vanderbilt University in Nashville, Tennessee.
Larry V. Ehlers has served as
the Vice President of Applications since January of 2009. Prior to
joining Securus Technologies he was Vice President of OSS & Applications at
Eschelon Telecom in Minneapolis, Minnesota from 2005 through 2008 and served as
Vice President of Corporate Systems at Advanced Telcom in Salem, Oregon from
2000 through 2005 prior to its acquisition by Eschelon. He was the
Director of Information Technology and Operations at Quintessent Communications
and a consultant with Network Designs Corporation in Seattle,
Washington. Prior to Network Designs Mr. Ehlers served in a variety
of Information Technology roles within the manufacturing
industry. Mr. Ehlers received his Bachelor of Science degree from
Iowa State University and holds several technical certifications.
Patrick W. Brolsma has served
as our Director of Enterprise Program Management Office and Corporate
Development since November of 2008. Mr. Brolsma has over 15 years of senior
level telecommunications experience. Prior to joining Securus, Mr. Brolsma spent
eight years with Eschelon Telecom where he held leadership positions in
Operations, Marketing, and Mergers & Acquisitions. Before Eschelon Mr.
Brolsma held various management positions at US West (Qwest), Sprint
Communications and Unisys. Mr. Brolsma has a B.S. degree in Computer Science and
Marketing from Minnesota State University in Mankato, Minnesota.
Anthony A. Tamer has served
as a member of the board of directors since February 2004. Mr. Tamer is a
co-founding Partner of H.I.G. Capital, LLC and serves as a Managing Partner of
the firm. Mr. Tamer has been an active investor in a number of industries
throughout H.I.G.’s life. Prior to founding H.I.G. in 1993, Mr. Tamer was a
partner at Bain & Company, one of the world’s leading management consulting
firms, and, through Bain Capital, one of the most successful private equity
funds in the United States. Mr. Tamer has extensive operating experience
particularly in the communications and semiconductor industries, having held
marketing, engineering and manufacturing positions at Hewlett-Packard and Embarq
(formerly Sprint) Corporation. Mr. Tamer holds an M.B.A. degree from Harvard
Business School, and a Masters degree in Electrical Engineering from Stanford
University. His undergraduate degree is from Rutgers University. He currently
serves on the board of directors of several H.I.G. portfolio companies, none of
which are registered filers.
Brian D. Schwartz has served
as a member of the board of directors since February 2004 and served as
President from February until September 2004. Mr. Schwartz is a
Managing Director of H.I.G. Capital Management and HIG Ventures. Since 1994, Mr.
Schwartz has led numerous transactions in a diverse set of industries including
business services (healthcare and IT), building products, and manufacturing.
Prior to joining H.I.G., Mr. Schwartz was a Business Manager in PepsiCo, Inc.’s
strategic planning group. Mr. Schwartz began his career with the investment
banking firm of Dillon, Read and Co. where he advised clients on transactions
encompassing initial public offerings, debt offerings and mergers and
acquisitions. Mr. Schwartz earned his M.B.A. from Harvard Business School and
his B.S. with honors from the University of Pennsylvania. He
currently serves on the board of directors of several H.I.G. portfolio
companies, none of which are registered filers.
Douglas F. Berman has served
as a member of the Company’s board of directors since February 2004. Mr. Berman
is a Managing Director at H.I.G. Capital. He has made investments in the
manufacturing, telecommunications, and business services industries. Since
joining H.I.G. in 1996, Mr. Berman has led a number of industry consolidations,
purchasing more than 30 businesses creating several industry-leading companies.
Prior to joining H.I.G., Mr. Berman was with Bain & Company, where he
managed a variety of projects for Fortune 100 clients, developing expertise in
telecommunications, financial services, and manufacturing. Mr. Berman earned a
Bachelor of Arts degree, with Honors in Economics, from University of Virginia
and his M.B.A. from the Wharton School.
Lewis J. Schoenwetter has
served as a member of the board of directors since February 2004 and served as
Vice President, until January 1, 2005. Mr. Schoenwetter is a Managing Director
at H.I.G. Capital. With more than 10 years of experience in private equity
investing, Mr. Schoenwetter has played a significant role in more than 30
acquisitions with an aggregate value in excess of $2 billion. Prior to joining
H.I.G. in April 2003, Mr. Schoenwetter was a director with Levine Leichtman
Capital Partners. He currently serves on the board of directors of several
H.I.G. portfolio companies, none of which are registered
filers.
71
Sami W. Mnaymneh previously
served as a member of the Company’s board of directors from February 2004 to
August 2007 and was re-appointed to the board of directors in July
2008. Mr. Mnaymneh is a co-founding partner and serves as a Managing
Partner of H.I.G. Mr. Mnaymneh has been an active investor in a number of
industries throughout H.I.G.’s life. Prior to founding H.I.G. in 1993, Mr.
Mnaymneh was a Managing Director at The Blackstone Group, where he specialized
in providing financial advisory services to Fortune 100 companies. Mr. Mnaymneh
has led over 75 transactions with an aggregate value in excess of $10 billion.
Mr. Mnaymneh earned a B.A. degree from Columbia University and subsequently
received a J.D. degree and an MBA degree, with honors, from Harvard Law School
and Harvard Business School, respectively. He currently serves on the
board of directors of several H.I.G. portfolio companies, none of which are
registered filers.
James Neal Thomas has served
as a member of the board of directors since May 9, 2005. Mr. Thomas served on
the board of directors of Haggar Corp. and chaired its audit committee until
November 2005. Until 2000, Mr. Thomas was a senior audit partner of Ernst &
Young, LLP, where he began his career in 1968. While at Ernst & Young, Mr.
Thomas served mostly Fortune 500 companies including Wal-Mart Stores, Inc., The
Williams Companies, Inc. and Tyson Foods, Inc. Mr. Thomas is a retired certified
public accountant and holds a degree in accounting from the University of
Arkansas.
Rob Wolfson has served as a
member of the board of directors since April 2008. Mr. Wolfson has served as
Managing Director at H.I.G. Capital, a private equity investment firm that is an
affiliate of the Company's majority stockholder, H.I.G. T-Netix, Inc., since
October 2008. Mr. Wolfson has more than 10 years of investment, financial
services, and senior deal leadership experience across many industries, most
notably telecommunications, healthcare and business services. Prior to joining
H.I.G. Capital, he was Vice President of Business Development for IPWireless, a
wireless infrastructure start-up purchased by Nextwave Wireless. Mr. Wolfson
began his career in mergers and acquisitions as a consultant with LEK
Consulting, a leading worldwide strategy consulting firm where he worked with
Fortune 500 companies, private equity firms and private equity portfolio
companies. Mr. Wolfson earned his M.B.A. from Harvard Business School and his
B.S. Cum Laude with honors from Northwestern University.
Board
Committees
Our board
of directors directs the management of our business and affairs as provided by
Delaware law and conducts its business through meetings of the full board of
directors and a standing meeting with our newly-appointed Audit Oversight
Director, who replaced the Audit Committee and operates in the same
capacity. During 2009, the board of directors approved the Audit
Oversight Charter.
James
Neal Thomas serves as the Company’s Audit Oversight Director. Mr.
Thomas qualifies as a financial expert, as defined by SEC regulations, and is
independent, as defined by the National Association of Securities Dealers
Rule 4200. The duties and responsibilities of the Audit Oversight Director
include the appointment and termination of the engagement of our independent
public accountants, otherwise overseeing the independent auditor relationship,
reviewing our significant accounting policies and internal controls and
reporting his findings to the full board of directors.
In
addition, from time to time committees may be established under the direction of
the board of directors when necessary to address specific issues.
Compensation
Committee Interlocks and Insider Participation
Our board
of directors has not established a compensation committee. Consequently, the
entire board of directors participates in the determination of our executive
officers’ compensation. No compensation meetings were held in
2009.
Indemnification
Agreements
We have
entered into indemnification agreements with certain of our officers and
directors which provide for their indemnification and the reimbursement and
advancement to them of expenses, as applicable, in connection with actual or
threatened proceedings and claims arising out of their status as a director or
officer.
Code
of Ethics
We have
adopted a written code of ethics that applies to our principal executive
officer, principal financial officer, and principal accounting officer or
controller, or persons performing similar functions. Our code of ethics, which
also applies to our directors and all of our officers and employees, is filed as
exhibit 14.1 to this report.
72
Compensation
Committee Report
We, the
members of the Board of Directors of Securus Technologies, Inc., have reviewed
and discussed the Compensation Discussion and Analysis with our Company’s
management. Based upon this review and discussion, the Board recommends that the
Compensation Discussion and Analysis be included in this Annual Report on Form
10-K.
BOARD
OF DIRECTORS
|
|
Richard
A. Smith
|
|
Anthony
A. Tamer
|
|
Brian
D. Schwartz
|
|
Douglas
F. Berman
|
|
Lewis
J. Schoenwetter
|
|
Sami
W. Mnaymneh
|
|
James
Neal Thomas
|
|
Rob
Wolfson
|
Compensation Discussion and
Analysis
Introduction
We have a
simple executive compensation program which is intended to provide appropriate
compensation that is strongly tied to our results. The program has only three
major components: salary, annual bonus and a restricted stock purchase plan. The
program provides executives with a significant amount of variable compensation
dependent on our performance. For example, for our chief executive officer, more
than half of his potential cash compensation is variable and a significant part
of his total potential compensation is via our restricted stock purchase
plan.
The
compensation program’s overall objective is to enable us to obtain and retain
the services of highly-skilled executives. The principles of our executive
compensation program are reflected in its two variable compensation components:
annual bonus and the restricted stock purchase plan. The program seeks to
enhance our profitability and value by aligning closely the financial interests
of our executives with those of our stockholders. This alignment is created by
strongly linking compensation to the achievement of important financial goals.
Our ability to reach the financial goals is dependent on strategic activities.
However, at the executive level, we measure success in these strategic
activities principally by the effect on our financial performance. The
compensation program considers the cash flow, accounting and tax aspects to
support the financial efficiency of the programs.
The
compensation program reflects that we operate with a small team of executives.
The executives are each given significant and extensive responsibilities that
encompass both our strategic policy and direct day-to-day activities in sales
and marketing, finance, legal and regulatory, customer service, product
development and other similar activities. The compensation program conditions
significant portions of management pay on the achievement of annual (for
bonuses) and long term (for restricted stock) financial performance
goals.
The
compensation packages for executives are designed to promote teamwork by
generally using the same performance goal for the annual bonus for all
executives. The individual initiative and achievement of an executive is
reflected in the level of salary and bonus, which is determined annually by our
board of directors. Of course, the primary evaluation of individual performance
is made in the decision to retain the services of the executive. If an
individual executive is not performing to expectations, the executive is not
retained.
Elements
of Compensation
Our
compensation program has only three principal elements: salary, annual bonus and
a restricted stock purchase plan. The remaining compensation paid through
employee benefits and perquisites are not significant in amount or as a
percentage of any executive’s compensation.
73
Salary. We
recognize that paying a reasonable cash salary is necessary to enable us to
obtain and retain the services of highly-skilled executives. We believe that a
reasonable salary is a component of a well-rounded compensation
program.
Annual
Bonus. We believe that an annual cash bonus provides a means to measure
and, if appropriate, reward elements of corporate performance that are closely
related to the efforts of executives. Under the Summary Compensation Table
following this section, the annual bonus is reported in the column labeled
“Non-Equity Incentive Plan Compensation” rather than in the “Bonus” column. This
reporting reflects that the annual cash bonus has pre-established and generally
non-discretionary goals that determine whether any amount will be paid. Under
the Summary Compensation Table, the “Bonus” column is used for discretionary
payments without pre-established goals. We refer to our annual cash incentive
program as a bonus program.
Because
salaries alone would not be sufficient to reach a reasonable level of potential
cash compensation to properly compensate key executives, we believe it is
appropriate and necessary to make bonus payments in cash on an annual basis when
earned. We choose to pay bonuses in cash rather than stock because we anticipate
that executives would use this payment to supplement their salaries. Also, if
the annual bonus were paid in stock, the total compensation package might be
overweighted in stock. Consequently, executives might discount the future value
of the benefit from the stock, which could put us at a competitive disadvantage.
The annual bonus as a percentage of an executive’s total potential cash
compensation generally increases with the level and responsibilities of the
executive.
Long-term
Incentive – Restricted
Stock Purchase Plan. We provide a long-term incentive compensation
program that is based on our stock through the use of a restricted stock
purchase plan. For stockholders, the long-term value of our stock is the most
important aspect of our performance. The price of our stock is the principal
factor in stockholder value over time. The value of a restricted share is tied
directly and primarily to the ultimate fair value of our stock. Restricted stock
is a means of aligning financial interests of executives and
stockholders.
We
believe that stock-based incentives through the restricted stock purchase plan
ensure that our top officers have a continuing stake in our long term success.
We maintain the 2004 Restricted Stock Purchase Plan to provide executives with
opportunities to acquire our Class B Common Stock, and our policy is to allow
only executive officers and key employees to participate.
Employee
Benefits. Our executives participate in all of the same employee benefit
programs as other employees and on the same basis. These programs are a
tax-qualified retirement plan, health and dental insurance, life insurance and
disability insurance. Our only active retirement plan for U.S. employees is a
401(k) plan in which executives participate on the same basis as other
employees. Additionally, we make a matching contribution to the 401(k) plan. The
amount of the matching contribution depends on the percentage of their own
compensation, up to IRS limits, that each executive chooses to defer in the
401(k) plan. In 2009, the amount of our matching contributions for the named
executive officers ranged from $7,769 to $8,250 as shown in the “All Other
Compensation” column on the Summary Compensation Table following this
section.
Perquisites.
We provide perquisites only for our chief executive officer, Mr. Smith, which
consists of a bi-annual reimburse of up to $10,000 related to direct medical
costs and up to $150 per month for home and wireless internet
charges.
Key
Factors in Determining Compensation
Performance
Measures. The annual bonus has been measured principally on our earnings
before interest, income taxes, depreciation and amortization (“EBITDA”). All of
our executives have the same EBITDA target for their annual bonus. EBITDA is
used because we believe that it represents the best measurement of our operating
earnings. The annual bonus is intended to be paid primarily based on actions
taken and decisions made during that fiscal year. Interest, income taxes,
depreciation and amortization are excluded because those items can significantly
reflect our long-term decisions on capital structure and investments rather than
annual decisions. We believe it is appropriate to determine bonuses based on our
EBITDA, which measures our performance as an entity, particularly considering
there is no public market for our stock. Because EBITDA for performance purposes
is intended to reflect operating earnings, our board of directors may make
adjustments in the calculation of EBITDA to reflect extraordinary
events.
74
The bonus
based on EBITDA is measured on an annual basis. The use of annual targets fits
with our annual business plan and allows us to measure the executive group’s
performance against targets which we believe can be set in a reasonable
manner.
The
estimated fair value of our stock is used for all long-term incentive purposes
through the restricted stock purchase plan. We often estimate the value of our
restricted stock by obtaining a valuation by an accredited firm.
We have
not had the need to establish a policy for the adjustment or recovery of awards
or payments when the relevant performance measures are restated or adjusted in a
way that would reduce the size of the award or
payment. The board of directors has the discretion to waive or reduce a
performance goal but this authority has been used infrequently.
Individual
Executive Officers. For compensation setting purposes, each named
executive officer is considered individually, however, the same considerations
apply to all executives. In setting salary, the primary factors are the scope of
the officer’s duties and responsibilities, the officer’s performance of those
duties and responsibilities, the officer’s tenure with us, and a general
evaluation of the competitive market conditions for executives with the
officer’s experience.
For the
named executive officers and other executives, annual bonus potential is set as
a percentage of salary. The percentage of salary amounts used for this purpose
reflects the officer’s duties and responsibilities. The same measurement,
EBITDA, is used for all officers and executives to encourage them to focus on
the same company goals. In setting the salary and bonus potential, we look at
total potential cash compensation for reasonableness and for internal pay
equity.
We have
not looked specifically at amounts realizable from prior year’s compensation in
setting compensation for the current year. We believe that the amount of
compensation for each year should be reasonable for that year.
Determining
the Amount of Each Type of Compensation
Roles in Setting
Compensation. Mr. Smith, as Chairman, President and Chief Executive
Officer, makes recommendations to the Board of Directors with respect to
compensation of executives (including the named executive officers) other than
himself for each of the Company’s compensation elements. The Board of Directors
reviews, and in some cases revises, the salary and bonus potential
recommendations for these executives. The Board of Directors makes the
determination about all restricted stock issuances.
The Board
of Directors makes an independent determination with respect to the compensation
for Mr. Smith as Chairman, President and Chief Executive Officer. This
determination involves all elements of his compensation. Mr. Smith’s employment
agreement establishes the minimum salary and bonus potential.
Timing of
Compensation Decisions. Compensation decisions, including decisions on
restricted stock issuances, are generally made periodically by the Board of
Directors, typically in March of each year.
Salary. We
intend for the salary levels of our executives to be in the competitive market
range but do not engage in a formal market analysis. Executives are generally
considered for salary adjustments annually.
Bonus.
Cash bonus opportunities are established annually in accordance with our
incentive plan. The amount of annual bonuses earned or unearned is not a major
factor in base salary decisions.
Restricted
Stock. The restricted stock purchase plan is designed primarily to
provide incentives to those executives who have the most potential to impact
stockholder value. The restricted stock purchase plan gives consideration to
reasonable compensation levels. Generally, the restricted stock is set initially
and then periodically reviewed by the Board of Directors.
Other
Compensation. Other types of compensation, including employee benefits
and perquisites, do not impact other compensation decisions in any material way.
The employee benefits are changed for executives at the same time and in the
same manner as for all other employees.
Balancing Types
of Compensation. As noted above, we do not maintain any supplemental
retirement plans for executives or other programs that reward tenure with us
more than our actual performance. Our restricted stock grants are our method of
providing a substantial part of an executive’s retirement and wealth
creation. In contrast, we expect that most executives will use their
salary and annual cash bonus primarily for current or short-term expenses. Since
the restricted stock plan is our primary contribution to an executive’s
long-term wealth creation, we determine the size of the restricted stock
purchase plan with that consideration in mind. We intend that our
executives will share in the creation of value in the Company but will not have
substantial guaranteed benefits upon their termination if value has not been
created for our stockholders.
75
Other
Matters Related to Compensation
Tax and
Accounting Considerations. We are covered by Internal Revenue Code
section 162(m) that may limit the income tax deductibility to us of certain
forms of compensation paid to our named executive officers in excess of
$1,000,000 per year. If these limits should become of broader applicability to
us, we will consider modifications to our compensation practices, to the extent
practicable, to provide appropriate deductibility for compensation
payments.
We record
the grant date fair value of all stock issued to employees as an expense over
the related vesting period. We apply the standards required for share based
payments in the accounting for issuances of stock under our 2004 Restricted
Stock Purchase Plan.
Change of Control
Triggers. We provide a change in control benefit under the 2004
Restricted Stock Purchase Plan, which provides for immediate vesting upon a
change in control. Additionally, our employment agreements with Mr. Smith and
Mr. Markert and severance agreements with the other named executives, which were
effective in January 2010, provide that they will receive certain compensation
if they are terminated without cause. (See “Employment Agreements”
for a description of compensation and benefits provided to named executives upon
termination without cause, including a change in control.) We believe
this benefit will help protect stockholders’ interests during any negotiations
relating to a possible business combination transaction by encouraging our top
executives to remain with us through a business combination
transaction.
No Stock
Ownership Guidelines. We have not adopted any stock ownership
requirements or guidelines, but each holder of our restricted stock is subject
to the terms of his or her respective stock purchase agreements, the 2004
Restricted Stock Purchase Plan and a stockholders’ agreement. We have not
adopted any policies about hedging the economic risk of our stock. We believe
that no executives have engaged in hedging or similar activities with our
stock.
Compensation
Information. We have engaged a consultant to conduct a
benchmarking study of compensation pricing for all employees, including the
named executives. Salary market data was assimilated from various sources for
the telecommunication and software industries to ensure compensation ranges were
in line with external market pricing. The study was completed in June
2009.
Management of
Compensation Risk. Our board of directors has discussed the
impact our compensation policies and practices for all of our employees may have
on our management of risk and has concluded that our programs do not encourage
excessive risk taking. The board considered that the policies have been designed
and consistently and effectively applied over a substantial period of time.
There is a balance of fixed and variable compensation with both cash and equity
components, and employees are required to adhere to the Code of Business Conduct
and Ethics.
Fiscal
2009 Compensation
For the
2009 fiscal year, the compensation of executives was set and administered
consistent with the philosophy and polices described above. Because we met our
performance objectives for 2009, we awarded annual bonuses to our named
executive officers. The salaries and bonuses for the named executive officers
are shown on the Summary Compensation Table following this section.
For the
named executive officers during the 2009 fiscal year, the potential bonus as a
percentage of base salary ranged from 50% to 111%. The 2009 annual
expense for restricted stock is shown in the “Stock Awards” column on the
Summary Compensation Table following this section. There were no
restricted stock sales to named executives in 2009.
76
The
following table sets forth the summary compensation for each of our named
executive officers for the years ended December 31, 2007, 2008 and
2009:
Summary
Compensation Table
Name
and
|
Non-Equity
|
|||||||||||||||
Principal
|
Stock
|
Incentive
Plan
|
All
Other
|
|||||||||||||
Position
|
Year
|
Salary
|
Bonus
|
Awards
|
Compensation
|
Compensation
|
Total
|
|||||||||
(4)
|
(2)
|
(1)
|
||||||||||||||
Richard
A. Smith – Principal Executive Officer, Chairman, Chief Executive Officer
and President
|
2009
|
$
|
465,231
|
$
|
-
|
$
|
107
|
$
|
464,995
|
$
|
9,385
|
$
|
939,718
|
|||
2008
|
$
|
216,346
|
$
|
$
|
54
|
(3)
|
$
|
204,948
|
$
|
134,858
|
$
|
556,206
|
||||
William
D. Markert – Principal Financial Officer, Chief Financial
Officer
|
2009
|
$
|
223,269
|
$
|
-
|
$
|
19
|
$
|
99,975
|
$
|
76,437
|
$
|
399,700
|
|||
2008
|
$
|
99,231
|
$
|
$
|
10
|
(3)
|
$
|
44,064
|
$
|
39,437
|
$
|
182,742
|
||||
Dennis
J. Reinhold - Vice
President,
General Counsel and Secretary
|
2009
|
$
|
223,269
|
$
|
-
|
$
|
1,207
|
$
|
99,975
|
$
|
7,769
|
$
|
332,220
|
|||
2008
|
$
|
215,000
|
$
|
1,000
|
$
|
4,082
|
(3)
|
$
|
88,128
|
$
|
6,480
|
$
|
314,690
|
|||
2007
|
$
|
203,616
|
$
|
100,000
|
(5)
|
$
|
5,569
|
$
|
-
|
$
|
7,750
|
$
|
316,935
|
|||
Daniel
A. Crawford -
President,
Syscon Justice Systems
|
2009
|
$
|
269,462
|
$
|
-
|
$
|
18
|
$
|
128,661
|
$
|
8,250
|
$
|
406,391
|
|||
2008
|
$
|
224,923
|
$
|
-
|
$
|
12
|
(3)
|
$
|
96,940
|
$
|
6,748
|
$
|
328,623
|
|||
2007
|
$
|
108,327
|
-
|
$
|
3
|
$
|
-
|
$
|
3,388
|
$
|
111,718
|
|||||
Robert
E. Pickens – Chief Marketing Officer
|
2009
|
$
|
223,269
|
$
|
-
|
$
|
10
|
$
|
99,975
|
$
|
51,708
|
$
|
374,962
|
|||
2008
|
$
|
45,481
|
$
|
-
|
$
|
3
|
$
|
22,032
|
$
|
6,783
|
$
|
74,299
|
(1)
|
Includes
the discretionary matching contributions by the Company for our 401(k)
savings plan, reimbursed relocation expenses and relocation bonuses of
$55,719 to Mr. Markert and $40,000 to Mr. Pickens in 2009, and $100,000 to
Mr. Smith and $19,281 to Mr. Markert in
2008.
|
(2)
|
Includes
bonuses paid in 2010 for attainment of EBITDA objectives in
2009.
|
(3)
|
In
2008, Mr. Smith, Mr. Markert, Mr. Reinhold, Mr. Pickens and Mr. Crawford
were awarded 57,073 shares, 11,415 shares, 10,273 shares, 5,707 shares and
5,707 shares, respectively.
|
(4)
|
2009
salaries included 27 bi-weekly pay periods compared to 26 in
2008.
|
(5)
|
Bonus
paid in July 2007 related to the consummation of the Syscon acquisition in
June 2007.
|
The
following table represents outstanding equity awards, or restricted stock grants
that were unvested as of December 31, 2009:
Outstanding Equity Awards at December 31, 2009 | |||||||||
Equity
Incentive Plan
|
Market
or Payout
|
||||||||
Number
of
|
Market
Value
|
Awards:
Number of
|
Value
of
|
||||||
Shares
That
|
Of
Shares That
|
Unearned
Shares
|
Unearned
|
||||||
Have
Not
|
Have
Not
|
That
Have Not
|
Shares
That Have
|
||||||
Name
|
Vested
(1)(a)
|
Vested(2)
|
Vested(1)(b)
|
Not
Vested(2)
|
|||||
Richard
A. Smith
|
17,835
|
178
|
23,186
|
232
|
|||||
William
D. Markert
|
2,378
|
24
|
6,182
|
62
|
|||||
Dennis
J. Reinhold
|
2,226
|
22
|
5,652
|
57
|
|||||
Daniel
A. Crawford
|
1,237
|
12
|
3,141
|
31
|
|||||
Robert
E. Pickens
|
1,287
|
13
|
3,189
|
32
|
|||||
Totals
|
24,963
|
$
|
249
|
41,350
|
$
|
414
|
(1)
|
All
shares were purchased by the executives for $.01 per share. Restricted
stock vests (a) ratably over a period or periods, or (b) based upon either
a change in control of the Company or performance criteria as provided in
the related restricted stock purchase agreement.
|
(2)
|
Assumes
a market value of $.01 per share, which we estimated to be the fair value
of the stock as of the last grant
date.
|
77
The
following table details the Class B restricted stock shares and the fair value
of stock-based compensation to our directors and named executive officers for
the year ended December 31, 2009:
Number
of
|
Value
Realized
|
|||||||
Name
|
Shares
Vested
|
On
Vesting(1)
|
||||||
Richard
A. Smith
|
16,052 | $ | 161 | |||||
William
D. Markert
|
2,854 | 29 | ||||||
Dennis
J. Reinhold
|
2,401 | 24 | ||||||
Daniel
A. Crawford
|
1,334 | 13 | ||||||
Robert
E. Pickens
|
1,231 | 12 | ||||||
James
Neal Thomas
|
4,183 | 42 | ||||||
Totals
|
28,055 | $ | 281 |
|
|
(1)
|
The
fair value is representative of the most recent fair value of $.01 per
share times the number of shares vested during 2009. None of the directors
or named executive officers received cash or other property as their
restricted shares vested. Because of the transfer restrictions on our
Class B Common Stock, the holders of such shares cannot freely transfer
them.
|
|
|
Employment
Agreements
On June
11, 2008, we entered into an employment agreement with Richard A. Smith to
appoint him as our President and Chief Executive Officer. The
employment contract extends through July 1, 2012 and provides that Mr. Smith
will receive (i) a minimum base salary of $450,000 per year; (ii) the potential
to earn an annual bonus of $500,000, which is earned upon achievement of
objectives mutually agreed upon by Mr. Smith and our board of directors each
year; (iii) eligibility to receive restricted stock shares of the Company’s
Class B common stock; and (iv) other benefits, such as life and health
insurance, paid vacation, and reimbursement of business
expenses. Additionally, in 2008 Mr. Smith received a one-time bonus
of $100,000 in conjunction with the sale of his primary residence and
reimbursement of his moving expenses. Mr. Smith will also receive a $200,000
bonus payable at the end of the contract term.
Mr. Smith
reports directly to the board of directors and must secure the board’s written
consent before consulting with any other entity or gaining more than a 5%
ownership interest in any enterprise other than ours, unless such ownership
interest will not have a material adverse effect upon his ability to perform his
duties under this agreement. We may terminate Mr. Smith’s employment for cause,
in which case we will pay him any base salary accrued or owing to him through
the date of termination, less any amounts he owes to us. We may also terminate
Mr. Smith’s employment without cause or Mr. Smith may terminate his own
employment due to the occurrence of events constituting constructive discharge.
If Mr. Smith is terminated without cause or is constructively discharged,
including upon a change of control, we will pay Mr. Smith an amount equal to (i)
the lesser of (1) two times his annual base salary or (2) the amount of
remaining base salary that would have been payable to him from the date of such
termination of employment through the agreement expiry date provided that amount
is not less than Mr. Smith’s base annual salary, plus (ii) the benefits which
were paid to him in the year prior to the year in which his employment was
terminated, plus (iii) a pro-rated bonus for the year in which Mr. Smith’s
employment was terminated.
During
Mr. Smith’s employment and for the two-year period immediately following the
expiration or earlier termination of the employment period, Mr. Smith is
prohibited from competing with us anywhere in the United States, including
locations in which we currently operate and plan to expand, and must abide by
customary covenants to safeguard our confidential information.
78
In 2008,
we entered into an employment agreement with William D. Markert to appoint him
as our Chief Financial Officer. The employment contract extends
through July 1, 2012 and provides that Mr. Markert will receive (i) a minimum
base salary of $215,000 per year; (ii) the potential to earn
an incentive bonus of $107,000, which is earned upon achievement of
objectives determined by our board of directors each year; (iii) eligibility to
receive restricted stock shares of the Company’s Class B common stock; and (iv)
other benefits, such as life and health insurance, paid vacation, and
reimbursement of business expenses. Additionally, Mr. Markert
received a one-time bonus of $75,000 in conjunction with the sale of his primary
residence and reimbursement of his moving expenses. If Mr. Markert is terminated
without cause, including upon a change in control, he will be entitled to
receive up to twelve months of compensation and benefits from the effective date
of his termination.
In
January of 2010 we entered into severance agreements with other named
executives, which provide for continued payment of their base salaries and heath
care benefits for a period of one year from their termination date should they
be terminated without cause, including a change in control.
2004
Restricted Stock Purchase Plan
We have a
2004 Restricted Stock Purchase Plan under which our employees may purchase
shares of our Class B common stock. In August 2008, we authorized an
additional 65,000 shares of Class B Common Stock. In September, 2008,
we filed a Third Amended and Restated Certificate of Incorporation which
authorized 165,000 shares of Class B common stock for issuance. Our
board of directors administers the restricted stock purchase plan.
On March
25, 2009, we filed a Fourth Amended and Restated Certificate of Incorporation,
which authorized 175,000 shares of Class B Common Stock for issuance. All issued
shares of Common Stock are entitled to vote on a one share/one vote
basis. The Restricted Stock Purchase Plan is designed to serve as an
incentive to attract and retain qualified and competent employees. The per share
purchase price for each share of restricted stock is determined by our board of
directors. Generally, restricted stock will vest based on performance criteria,
ratably over a period or periods, or upon a change of control of the Company, as
provided in the related restricted stock purchase agreements and the
plan.
Director
Compensation
Except
for Messrs. McCarthy and Thomas, our directors receive no compensation for
serving on the board; however, they receive reimbursement of reasonable expenses
incurred in attending meetings. In June 2009, Mr. McCarthy resigned from the
Audit Committee and board of directors of the Company. Mr. McCarthy received
$48,750 for serving on the board and Audit Committee in 2009. Mr. Thomas
receives $74,000 annually for serving on the board and as the Audit Oversight
Director. Additionally, Mr. Thomas and Mr. McCarthy each purchased
1.335 shares of restricted stock for $10.00 per share and 4,561 shares of
restricted stock for $.01 per share in 2006 and 2008. No shares were purchased
during 2007 and 2009. Our outside director compensation for the year ended
December 31, 2009 is as follows:
Director
Compensation Table(1)
|
||||||||||||
Fees
Earned
|
||||||||||||
or
Paid
|
Stock
|
Total
|
||||||||||
Name
|
In
Cash
|
Awards
|
Compensation
|
|||||||||
James
Neal Thomas
|
$ | 74,000 | $ | 8 | $ | 74,008 | ||||||
Jack
McCarthy
|
$ | 48,750 | $ | 8 | $ | 48,758 |
(1)
|
Our
only equity compensation plan is our 2004 restricted stock plan which has
been approved by shareholders. As of December 31, 2009, there were 175,000
shares authorized under the plan.
|
79
The
following sets forth certain information, as of March 1, 2010, with respect
to the beneficial ownership of shares of our common stock by:
•
|
each
person who is known to us to beneficially own more than 5% of the
outstanding shares of common stock;
|
•
|
each
of our directors;
|
•
|
each
of the principal executive officer, principal financial officer and the
three other most highly compensated executive officers who were serving as
executive officers on December 31, 2009; and
|
•
|
all
current directors and executive officers as a
group.
|
There is
no established public trading market for our common stock. The number of shares
of Common Stock beneficially owned by each person is determined under rules
promulgated by the SEC. Under these rules, a person is deemed to have
“beneficial ownership” of any shares over which that person has voting or
investment power, or shares such power, plus any shares that the person may
acquire within 60 days, including through the exercise of stock options.
Unless otherwise indicated, each person in the table has sole voting and
investment power over the shares listed. The inclusion in the table of any
shares does not constitute an admission of beneficial ownership of those shares
by the named stockholder. For each person, the “Number of Shares Beneficially
Owned” column may include shares of common stock attributable to the person due
to that person’s voting or investment power or other relationship.
Number
of Shares
|
|||||||||
Beneficially
Owned (1)
|
|||||||||
Class
B
|
Percentage
|
||||||||
Preferred
|
Common
|
Common
|
of
Common
|
||||||
Name
and Address of Beneficial Owner (1)
|
Stock
(2)
|
Stock
|
Stock
|
Stock
(3)
|
|||||
5%
Stockholders
|
|||||||||
H.I.G.-TNetix,
Inc.(4)
|
5,081
|
495
|
86.93
|
%
|
|||||
1001
Brickell Bay Drive, 27th Floor
Miami,
Florida 33131
|
|||||||||
AIF
Investment Company(4)
|
1,558
|
152
|
26.66
|
%
|
|||||
1001
Brickell Bay Drive, 27th
Floor
Miami,
Florida 33131
|
|||||||||
Directors
|
|||||||||
Richard
A. Smith(5)
|
57,073
|
4.88
|
%
|
||||||
Anthony A.
Tamer(6)
|
5,081
|
495
|
86.93
|
%
|
|||||
Brian
D. Schwartz(6)
|
5,081
|
495
|
86.93
|
%
|
|||||
Douglas
F. Berman(6)
|
5,081
|
495
|
86.93
|
%
|
|||||
Lewis
J. Schoenwetter(6)
|
5,081
|
495
|
86.93
|
%
|
|||||
Sami
W. Mnaymneh(6)
|
5,081
|
495
|
86.93
|
%
|
|||||
James
Neal Thomas(5)
|
4,563
|
*
|
|||||||
Rob
Wolfson (6)
|
5,081
|
495
|
86.93
|
%
|
|||||
Other
Named Executive Officers
|
|||||||||
William
B. Markert(5)
|
11,415
|
*
|
|||||||
Dennis
J. Reinhold(5)
|
10,279
|
*
|
|||||||
Robert
E. Pickens(5)
|
5,707
|
*
|
|||||||
Daniel
A. Crawford(5)
|
5,712
|
*
|
|||||||
Directors
and executive officers as a group –(15 persons) (7)
|
5,081
|
495
|
125,290
|
97.65
|
%
|
*
|
Denotes
less than 1%
|
(1)
|
Unless
otherwise indicated, the address of each beneficial owner listed above is
c/o Securus Technologies, Inc., 14651 Dallas Parkway, Suite 600,
Dallas, Texas 75254-8815
|
(2)
|
The
Series A Redeemable Convertible Preferred Stock converts into 200 shares
of Common Stock , as adjusted for certain events.
|
(3)
|
Represents
the aggregate ownership of our Common Stock and Class B Common Stock
on a fully diluted basis. Calculated based on 149,353 shares of Common
Stock and Class B Common Stock outstanding as of March 1, 2010,
giving effect to immediately exercisable options and warrants to purchase
an aggregate of 51.011 shares of Common Stock granted in connection with
our senior subordinated debt financing and conversion of preferred
stock.
|
(4)
|
Includes
an aggregate of 152 shares of Common Stock and 1,558 shares of preferred
stock beneficially owned by AIF Investment Company. AIF Investment Company
is wholly-owned by H.I.G.-TNetix. Mr. Tamer currently serves as a director
and officer of H.I.G.-TNetix, Inc.
|
(5)
|
Represents
shares of Class B Common Stock issued in connection with our 2004
Restricted Stock Purchase Plan.
|
(6)
|
Represents
shares beneficially owned by H.I.G.-TNetix, Inc. and AIF Investment
Company. H.I.G. Capital Partners III, L.P. is the controlling stockholder
of H.I.G.-TNetix, Inc. and H.I.G. — TNetix is the controlling stockholder
of AIF Investment Company. Mr. Tamer is a member of H.I.G. Advisors III,
L.L.C., the general partner of H.I.G. Capital Partners III, L.P., the
ultimate parent entity of H.I.G.-TNetix, Inc. and AIF Investment Company.
Messrs. Tamer, Schwartz, Wolfson, Mnaymneh, Berman and Schoenwetter
may, by virtue of their respective relationships with either H.I.G.-
TNetix, Inc., AIF Investment Company or H.I.G. Capital, L.L.C., be deemed
to beneficially own the securities held by H.I.G.-TNetix, Inc. and AIF
Investment Company, and to share voting and investment power with respect
to such securities. Each of Messrs. Tamer, Schwartz, Wolfson,
Mnaymneh, Berman and Schoenwetter disclaim beneficial ownership of the
securities beneficially owned by H.I.G.-TNetix and AIF Investment Co. The
address of each of Messrs. Tamer, Schwartz, Wolfson,Mnaymneh, Berman
and Schoenwetter is c/o H.I.G. Capital, LLC, 1001 Brickell Bay Drive, 27th
Floor, Miami, Florida 33131.
|
(7)
|
Represents
(a) 125,290 shares beneficially owned by Richard A. Smith, William B.
Markert, Dennis J. Reinhold, Dan A. Crawford, Steve Viefaus,
James Neil Thomas, Kathryn S. Lengyel, Danny de Hoyos, Arlin B.
Goldberg, Robert E. Pickens, Larry Ehlers, Patrick W. Brolsma, Joshua E.
Conklin and Byron Cantrall and (b) 495 Common Stock and 5,081 Preferred
Stock beneficially owned by H.I.G.-TNetix, Inc. and AIF Investment Company
and attributable to each of the Messrs. Tamer, Schwartz, Wolfson,
Mnaymneh, Berman and Schoenwetter.
|
80
Related Party Transaction
Policy
We expect our
directors, officers and employees to act and make decisions that are in our best
interests and encourage them to avoid situations which present a conflict
between our interests and their own personal interests. Under our code of
ethics, our directors, officers and employees are prohibited from taking any
action that may make it difficult for them to perform their duties,
responsibilities and services to us in an objective and fair manner.
The
entire board of directors is responsible for reviewing and approving or
ratifying all material transactions between us and our subsidiaries with any
related party. To identify related party transactions, each year we require our
directors and officers to complete Director and Officer Questionnaires
identifying any transactions with us in which the officer or director or their
immediate family members have an interest. Related parties include any of our
directors or executive officers, and their immediate family members. The types
of transactions that must be reviewed and approved include extensions of credit
and other business relationships.
We
reviewed related party transactions for a conflict of interest. A conflict of
interest occurs when an individual’s private interest interferes, or appears to
interfere, in any way with our interests. Our Code of Ethics requires all
directors, officers and employees who may have a potential or apparent conflict
of interest to immediately notify the Audit Oversight Director. Other than
our Code of Ethics, our related party transaction policy is not in
writing.
Restricted
Stock Purchase Agreements
We have a
restricted stock purchase agreement with Mr. Smith and other members of our
management pursuant to our 2004 Restricted Stock Plan. The maximum number of
shares of Class B Common Stock available under the 2004 Restricted Stock
Purchase Plan was 175,000 as of December 31, 2009, subject to
adjustment. As of December 31, 2009, an aggregate of 140,792 shares
were issued under the plan to executives, employees and members of our board of
directors. Pursuant to the terms of the plan and the applicable restricted stock
purchase agreements, shares of Class B Common Stock are subject to time and
performance vesting based upon the length of service such executive has with us
and other vesting criteria including obtaining a specified sales price in
connection with our sale to an independent third party. Shares of Common Stock
issuable pursuant to restricted stock purchase agreements are subject to certain
rights of repurchase and certain restrictions on transfer. Generally, if an
executive’s employment is terminated, shares of restricted stock that have not
vested prior to or in connection with a sale of us to an independent third party
are forfeited to us without consideration.
Equity
Investment by Richard A. Smith
In June
of 2008 Mr. Richard A. Smith, Chairman, Chief Executive Officer and President,
was issued 57,072.61 shares of the Company’s Class B Common Stock pursuant to a
restricted stock purchase agreement. These restricted shares are subject to
forfeiture pursuant to the terms of our 2004 Restricted Stock Purchase Plan and
the restrictions described hereafter. With respect to 25.0% of the restricted
stock, the restriction period ends upon the sale of our stock by certain of our
other stockholders. The restriction period for 50.0% of the restricted stock
ends upon the lapse of time each December 31 and June 30. With respect
to the remaining shares, the restriction period ends upon our attainment of
certain performance measures determined by our board of directors and
Mr. Smith. Further, upon a change of control, the restriction period will
end for all of Mr. Smith’s restricted shares that have not previously
vested. The restricted shares are entitled to dividends, if declared, which will
be distributed upon termination of the restriction period with respect to any
such restricted shares.
Stockholders’
Agreement
We and
our stockholders have entered into a stockholders’ agreement to assure
continuity in our management and ownership, to limit the manner in which our
outstanding shares of capital stock may be transferred, and to provide certain
registration rights. The stockholders’ agreement provides for customary transfer
restrictions, rights of first refusal for us and our stockholders, preemptive
rights, drag-along and tag-along rights, and registration rights. The
stockholders’ agreement also provides that as long as H.I.G.-TNetix, Inc., or
its affiliates owns more than 50% of our Common Stock, H.I.G.-TNetix or its
affiliate may designate the majority of our board of directors. We have also
agreed to pay an aggregate of $0.1 million annually on a pro rata basis to those
previous Evercom stockholders who invested in our Company contemporaneously with
the closing of the Evercom acquisition.
Additionally,
we have agreed to indemnify our stockholders (as sellers of securities, not as
officers or directors), their officers and directors, and each person who
controls such stockholder for losses which the indemnified person may sustain,
incur or assume as a result of our violation of the Securities Act, the Exchange
Act or any state securities law, or any untrue or alleged untrue statement of
material fact contained in any document we file with the SEC.
81
H.I.G.
Capital, LLC Consulting Agreements
Consulting
Services Agreement
We have a
consulting services agreement with H.I.G. pursuant to which H.I.G. is paid an
annual fee of $750,000 for management, consulting and financial advisory
services.
Professional
Services Agreement
We also
have a professional services agreement with H.I.G., pursuant to which H.I.G. is
paid investment banking fees equal to 2% of the value of any transaction in
which we (i) sell all or substantially all of
our assets or a majority of our stock, (ii) acquire any other companies, or
(iii) secure any debt or equity financing. In connection with the
refinancing of our revolving credit facility (See Note 5), H.I.G. received a
professional service fee equal to 2% of the transaction value, or
$0.8 million, in 2008. No professional service fee was paid in
2009.
Management
Certain
of our directors are affiliated with H.I.G. Mr. Tamer and Mr. Mnaymneh are
managing partners of H.I.G. and Mr. Berman, Mr. Schwartz, Mr. Wolfson and
Mr. Schoenwetter are managing directors of H.I.G.
Audit Fees
The
following table represents the aggregate fees paid or accrued for services
rendered by McGladrey & Pullen LLP, our independent registered public
accounting firm, for the year ended December 31, 2009 and by
KPMG, our previous independent registered public accounting firm, for the year
ended December 31, 2008 (in thousands).
2008
|
2009
|
|||||||
Audit
fees
|
$ | 725 | $ | 477 | ||||
Audit-related
fees
|
- | 49 | ||||||
Tax
fees
|
29 | - | ||||||
Total
fees
|
$ | 754 | $ | 526 |
Audit
fees consist of fees for the audit of our financial statements, the review of
the interim financial statements included in our quarterly reports on Form 10-Q,
and other professional services provided in connection with statutory and
regulatory filings or engagements. Fees were paid to KPMG LLP related
to the audit of our 2008 financial statements and to McGladrey & Pullen LLP
related to the audit of our 2009 financial statements.
Audit-Related
Fees
These are
fees for assurance and related services and consisted primarily of audits of
employee benefit plans, specific internal control process reviews and
consultations regarding accounting and financial reporting. There
were no audit-related services provided by our principal accountants in
2008.
Tax
Fees
Tax fees
consist of fees for tax compliance and tax advice services associated with the
preparation of original tax returns and requests for technical advice from
taxing authorities. Tax services are provided by an outside firm for our tax
related matters within the United States and by KPMG LLP Canada for tax
services related to our foreign jurisdisctions.
Audit
Oversight Director's Pre-approval Policy and Procedures
The Audit
Oversight Director (formerly the Audit Committee) has adopted policies and
procedures relating to the approval of all audit and non-audit services that are
to be performed by our independent auditor. This policy generally provides that
we will not engage our independent auditor to render audit or non-audit services
unless the service is specifically approved in advance by the Audit Oversight
Director or the engagement is entered into pursuant to one of the pre-approval
procedures described below.
82
From time
to time, the Audit Oversight Director may pre-approve specified types of
services that are expected to be provided to us by our independent auditor
during the next 12 months. Any such pre-approval would be detailed as to
the particular service or type of services to be provided and would be generally
subject to a maximum dollar amount.
All
of our 2009 audit and audit-related services were approved by the Audit
Oversight Director pursuant to our Audit Oversight Charter. No other
services were provided by our independent auditor that were not approved by the
Audit Oversight Director pursuant to the de minimis exception to the
pre-approval requirement set forth in paragraph (c)(7)(i)(C) of Rule 2-01 of
Regulation S-X.
During
fiscal year 2009, the Audit Committee of the board of directors of the Company
approved the change in principal accountants. In April of 2009, the
Company engaged McGladrey & Pullen, LLP (“McGladrey”) as its principal
accountant to audit the Company’s financial statements. During the two most
recent fiscal years ended December 31, 2008 and the subsequent interim period in
2009, the Company had not consulted with McGladrey regarding any of the
following: (1) the application of accounting principles to a specified
transaction, either completed or proposed; or the type of audit opinion that
might be rendered on the Company’s financial statements, and neither a written
report nor oral advice was provided to the Company that McGladrey concluded was
an important factor considered by the Company in reaching a decision as to the
accounting, auditing or financial reporting issue, or (2) any matter that was
either the subject of a disagreement (as defined in paragraph 304(a)(1)(iv) and
the related instructions to Item 304 of Regulation S-K) or a reportable event
(as defined in Item 304(a)(1)(v) of Regulation S-K).
During
the two most recent fiscal years ended December 31, 2008 and the subsequent
interim period in 2009, there were no disagreements between KPMG and the Company
on any matter of accounting principles or practices, financial statement
disclosure, or auditing scope or procedure which, if not resolved to the
satisfaction of KPMG, would have caused it to make a reference to the subject
matter of any such disagreement with its report. No reportable events, as
defined in Item 304(a)(1)(v) of Regulation S-K, occurred within the Company’s
two most recent fiscal years ended December 31, 2008 and the subsequent interim
period in 2009.
83
(a)
|
Index
to Consolidated Financial Statements
|
|
1.
|
Financial
Statements: The following financial statements and
schedules of Securus Technologies, Inc. are included in this
report:
|
|
•
|
Consolidated
Balance Sheets — As of December 31, 2008 and December 31,
2009.
|
|
•
|
Consolidated
Statements of Operations —For the Years Ended December 31, 2007, 2008
and 2009.
|
|
•
|
Consolidated
Statements of Stockholders’ Deficit —For the Years Ended December 31,
2007, 2008 and 2009.
|
|
•
|
Consolidated
Statements of Cash Flows — For the Years Ended December 31, 2007,
2008 and 2009.
|
|
•
|
Notes
to Consolidated Financial Statements
|
|
2.
|
Financial Statement
Schedules: None.
|
|
3.
|
Exhibits: The
exhibits which are filed with this report or which are incorporated herein
by reference are set forth in the Exhibit Index on page 86 which is
incorporated herein by reference.
|
84
Signatures
Pursuant
to the requirements of Section 13 or 15(d) of the Securities Exchange Act
of 1934, the registrant has duly caused this report to be signed on its behalf
by the undersigned, thereunto duly authorized, on March 15, 2010.
SECURUS
TECHNOLOGIES, INC.
|
||
By:
|
/s/ RICHARD A. SMITH | |
Richard
A. Smith,
|
||
Chairman
of the Board, Chief Executive Officer and President
|
||
(Principal
Executive Officer)
|
||
Pursuant
to the Securities Exchange Act of 1934, this report has been signed below by the
following persons on behalf of the registrant and in the capacities below on the
dates indicated.
Signature
|
Capacity
|
Date
|
||
/s/ RICHARD A. SMITH |
Chairman,
Chief Executive Officer, President, and Director (Principal
Executive Officer)
|
March
15, 2010
|
||
Richard
A. Smith
|
||||
/s/ ANTHONY A. TAMER |
Director
|
March
15, 2010
|
||
Anthony
A. Tamer
|
||||
/s/ BRIAN D. SCHWARTZ |
Director
|
March
15, 2010
|
||
Brian
D. Schwartz
|
||||
/s/ DOUGLAS F. BERMAN |
Director
|
March
15, 2010
|
||
Douglas
F. Berman
|
||||
/s/ LEWIS J. SCHOENWETTER |
Director
|
March
15, 2010
|
||
Lewis
J. Schoenwetter
|
||||
/s/ SAMI W. MNAYMNEH |
Director
|
March
15, 2010
|
||
Sami
W. Mnaymneh
|
||||
/s/ ROB WOLFSON |
Director
|
March
15, 2010
|
||
Rob
Wolfson
|
||||
/s/ JAMES NEAL THOMAS |
Director
|
March
15, 2010
|
||
James
Neal Thomas
|
||||
/s/ WILLIAM D. MARKERT |
Chief
Financial Officer
|
March
15, 2010
|
||
William
D. Markert
|
(Principal
Financial Officer)
|
|||
/s/ MARY F. CLEAR |
Vice
President, Corporate Controller
|
March
15, 2010
|
||
Mary
F. Clear
|
(Principal
Accounting Officer)
|
85
Exhibit Index
2.1
|
Stock
Purchase Agreement, dated April 11, 2007, by and among Securus
Technologies, Inc., Appaloosa Acquisition Company, 0787223 B.C. Ltd, and
0787223 B.C. Ltd’s sole stockholder, incorporated by reference from Form
8-K filed April 16, 2007.
|
2.1.1
|
Settlement
Agreement, dated November 12, 2008, by and among Securus Technologies,
Inc., Syscon Justice Systems Canada, Ltd., 0787223 B.C. Ltd., and 0787223
B.C. Ltd’s sole stockholder incorporated by reference from Form 10-Q filed
November 14, 2008.
|
|
|
2.1.2
|
Consulting
Agreement, dated November 12, 2008, by and among Securus Technologies,
Inc., Syscon Justice Systems Canada, Ltd., 0787223 B.C. Ltd., and 0787223
B.C. Ltd’s sole stockholder incorporated by reference from Form 10-Q filed
November 14, 2008.
|
3.1
|
Fourth
Amended and Restated Certificate of Incorporation of Securus Technologies,
Inc., incorporated by reference from Form 10-K filed March 31,
2009.
|
3.2
|
Amended
and Restated Bylaws of Securus Technologies, Inc., incorporated by
reference from Form S-4 filed May 16, 2005.
|
3.3
|
Certificate
of Incorporation of T-Netix, Inc., filed on September 7, 2001, as amended,
incorporated by reference from Form S-4 filed May 16,
2005.
|
3.4
|
Bylaws
of T-Netix, Inc, incorporated by reference from Form S-4 filed May 16,
2005.
|
3.5
|
Articles
of Incorporation of Telequip Labs, Inc., filed on November 9, 1987, as
amended, incorporated by reference from Form S-4 filed May 16,
2005.
|
3.6
|
Amended
and Restated Bylaws of Telequip Labs, Inc., incorporated by reference from
Form S-4 filed May 16, 2005.
|
3.7
|
Articles
of Incorporation of T-NETIX Telecommunications Services, Inc., filed on
February 11, 1988, as amended, incorporated by reference from Form S-4
filed May 16, 2005.
|
3.8
|
Bylaws
of T-NETIX Telecommunications Services, Inc., incorporated by reference
from Form S-4 filed May 16, 2005.
|
3.9
|
Certificate
of Incorporation of Evercom Holdings, Inc., filed on November 25, 2002, as
amended, incorporated by reference from Form S-4 filed May 16,
2005.
|
3.10
|
Bylaws
of Evercom Holdings, Inc., incorporated by reference from Form S-4 filed
May 16, 2005.
|
3.11
|
Amended
and Restated Certificate of Incorporation of Evercom, Inc., filed on
February 19, 2003, incorporated by reference from Form S-4 filed May 16,
2005.
|
3.12
|
Bylaws
of Evercom, Inc., incorporated by reference from Form S-4 filed May 16,
2005.
|
3.13
|
Certificate
of Incorporation of Evercom Systems, Inc., filed on August 22, 1997, as
amended, incorporated by reference from Form S-4 filed May 16,
2005.
|
3.14
|
Bylaws
of Evercom Systems, Inc., incorporated by reference from Form S-4 filed
May 16, 2005.
|
3.15
|
Certificate
of Incorporation of Syscon Justice Systems Canada Ltd., incorporated by
reference from Form S-4 filed August 1, 2007.
|
3.16
|
Articles
of Syscon Justice Systems Canada Ltd., incorporated by reference from Form
S-4 filed August 1, 2007.
|
3.17
|
Articles
of Incorporation of Syscon Justice Systems, Inc., incorporated by
reference from Form S-4 filed August 1, 2007.
|
3.18
|
Bylaws
of Syscon Justice Systems, Inc., incorporated by reference from Form S-4
filed August 1, 2007.
|
3.19
|
Articles
of Organization of Modeling Solutions LLC incorporated by reference from
Form S-4 filed August 1, 2007.
|
3.20
|
Operating
Agreement of Modeling Solutions LLC incorporated by reference from Form
S-4 filed August 1, 2007.
|
3.21
|
Articles
of Organization of Modeling Solutions, LLC incorporated by reference from
Form S-4 filed August 1, 2007
|
3.22
|
Operating
Agreement of Modeling Solutions, LLC incorporated by reference from Form
S-4 filed August 1, 2007.
|
4.1
|
Form
of 11% Second-priority Senior Secured Notes due 2011, incorporated by
reference from Form S-4 filed May 16, 2005.
|
4.2
|
Indenture,
dated as of September 9, 2004, by and among Securus Technologies, Inc.,
T-Netix, Inc., T-NETIX Telecommunications Services, Inc., T-Netix
Monitoring Corporation, SpeakEZ, Inc., Telequip Labs, Inc., Evercom
Holdings, Inc., Evercom, Inc., EverConnect, Inc., Evercom Systems, Inc.,
and The Bank of New York Trust Company, N.A., incorporated by reference
from Form S-4 filed May 16, 2005.
|
4.2.1
|
Supplemental
Indenture, dated June 27, 2007, by and among Appaloosa Acquisition Company
Ltd., T-NETIX, Inc., T-NETIX Telecommunications Services, Inc., Telequip
Labs, Inc., Evercom Holdings, Inc., Evercom, Inc., and Evercom Systems,
Inc., as guarantors, and The Bank of New York, as trustee, incorporated by
reference from Form 8-K filed July 2, 2007.
|
4.2.2
|
Supplemental
Indenture, dated June 29, 2007, by and among Appaloosa Acquisition Company
Ltd., Syscon Justice Systems Canada Ltd., Syscon Holdings Ltd., Syscon
Justice Systems, Inc., Modeling Solutions, LLC, Modeling Solutions LLC,
and The Bank of New York, as trustee, incorporated by reference from
Form S-4 filed August 1, 2007.
|
4.3
|
Amended
and Restated Security Agreement, dated June 29, 2007, by and among
Appaloosa Acquisition Company Ltd., Modeling Solutions, LLC, Modeling
Solutions LLC, Syscon Justice Systems International Pty Limited, Syscon
Justice Systems International Limited, Syscon Justice Systems Canada Ltd.,
and Syscon Justice Systems, Inc., as guarantors, and The Bank of New York
Trust Company, N.A., incorporated by reference from Form S-4 filed
August 1, 2007.
|
4.3.1
|
Supplement
to Amended and Restated Security Agreement, dated June 29, 2007,
incorporated by reference from Form S-4 filed August 1,
2007.
|
4.4
|
Amended
and Restated Patent Security Agreement, dated June 29, 2007, by and among
Securus Technologies, Inc., T-Netix, Inc., T-NETIX Telecommunications
Services, Inc., Telequip Labs, Inc., Evercom Holdings, Inc., Evercom,
Inc., Evercom Systems, Inc., Modeling Solutions, LLC, Modeling Solutions
LLC, Syscon Justice Systems, Inc., and The Bank of New York Trust Company,
N.A., incorporated by reference from Form S-4 filed August 1,
2007.
|
4.5
|
Amended
and Restated Copyright Security Agreement, dated June 29, 2007, by and
among Securus Technologies, Inc., T-Netix, Inc., T-NETIX
Telecommunications Services, Inc., Telequip Labs, Inc., Evercom Holdings,
Inc., Evercom, Inc., Evercom Systems, Inc., Modeling Solutions, LLC,
Modeling Solutions LLC, Syscon Justice Systems, Inc., and The Bank of New
York Trust Company, N.A., incorporated by reference from Form S-4 filed
August 1, 2007.
|
4.6
|
Amended
and Restated Trademark Security Agreement, dated June 29, 2007, by and
among Securus Technologies, Inc., T-Netix, Inc., T-NETIX
Telecommunications Services, Inc., Telequip Labs, Inc., Evercom Holdings,
Inc., Evercom, Inc., Evercom Systems, Inc., Modeling Solutions, LLC,
Modeling Solutions LLC, Syscon Justice Systems, Inc., and The Bank of New
York Trust Company, N.A., incorporated by reference from Form S-4 filed
August 1, 2007.
|
4.7
|
Amended
and Restated Pledge Agreement, dated June 29, 2007, by and among Appaloosa
Acquisition Company Ltd., Syscon Justice Systems, Inc., and T-Netix, Inc.,
Evercom Holdings, Inc., Evercom, Inc., incorporated by reference from Form
S-4 filed August 1, 2007.
|
4.7.1
|
Supplement
No. 1 to Amended and Restated Pledge Agreement, dated June 29, 2007,
incorporated by reference from Form S-4 filed August 1,
2007.
|
4.8
|
Credit
Agreement, dated September 30, 2008, among Securus Technologies, Inc., as
Parent and as a Borrower, certain subsidiaries of Parent party thereto, as
Borrowers, the lenders from time to time parties thereto, and Wells Fargo
Foothill, LLC, as the Arranger, Administrative Agent and lender,
incorporated by reference from Form 8-K filed October 7,
2008.
|
4.9
|
General
Continuing Guaranty, dated September 30, 2008, by and between Wells Fargo
Foothill, LLC and Syscon Justice Systems Canada Ltd., incorporated by
reference from Form 8-K filed October 7, 2008.
|
4.10
|
Security
Agreement, dated September 30, 2008, among Wells Fargo Foothill, LLC,
Securus Technologies, Inc., T-Netix, Inc., Telequip Labs, Inc., T-Netix
Telecommunications Services, Inc., Evercom Holding, Inc., Evercom, Inc.,
Evercom Systems, Inc., Modeling Solutions LLC, Modeling Solutions, LLC,
and Syscon Justice Systems, Inc., incorporated by reference from Form 8-K
filed October 7, 2008.
|
4.11
|
Security
Agreement, dated as of September 30, 2008, between Wells Fargo Foothill,
LLC and Syscon Justice Systems Canada Ltd., incorporated by reference from
Form 8-K filed October 7, 2008.
|
4.12
|
Trademark
Security Agreement, dated September 30, 2008, among Wells Fargo Foothill,
LLC, Securus Technologies, Inc., T-Netix, Inc., Telequip Labs, Inc.,
T-Netix Telecommunications Services, Inc., Evercom Holding, Inc., Evercom,
Inc., Evercom Systems, Inc., Modeling Solutions LLC, Modeling Solutions,
LLC and Syscon Justice Systems, Inc., incorporated by reference from Form
8-K filed October 7, 2008.
|
4.13
|
Copyright
Security Agreement, dated September 30, 2008, among Wells Fargo Foothill,
LLC, Securus Technologies, Inc., T-Netix, Inc., Telequip Labs, Inc.,
T-Netix Telecommunications Services, Inc., Evercom Holding, Inc., Evercom,
Inc., Evercom Systems, Inc., Modeling Solutions LLC, Modeling Solutions,
LLC and Syscon Justice Systems, Inc., incorporated by reference from Form
8-K filed October 7, 2008.
|
4.14
|
Patent
Security Agreement, dated September 30, 2008, among Wells Fargo Foothill,
LLC, Securus Technologies, Inc., T-Netix, Inc., Telequip Labs, Inc.,
T-Netix Telecommunications Services, Inc., Evercom Holding, Inc., Evercom,
Inc., Evercom Systems, Inc., Modeling Solutions LLC, Modeling Solutions,
LLC and Syscon Justice Systems, Inc., incorporated by reference from Form
8-K filed October 7, 2008.
|
4.15
|
Trademark
Security Agreement, dated as of September 30, 2008, between Wells Fargo
Foothill, LLC and Syscon Justice Systems Canada Ltd., incorporated by
reference from Form 8-K filed October 7, 2008.
|
4.16
|
Copyright
Security Agreement, dated as of September 30, 2008, between Wells Fargo
Foothill, LLC and Syscon Justice Systems Canada Ltd., incorporated by
reference from Form 8-K filed October 7, 2008.
|
4.17
|
Patent
Agreement, dated as of September 30, 2008, between Wells Fargo Foothill,
LLC and Syscon Justice Systems Canada Ltd., incorporated by reference from
Form 8-K filed October 7, 2008.
|
4.18
|
Subordination
and Intercreditor Agreement, dated as of September 9, 2004, by and among
Laminar Direct Capital, L.P., Securus Technologies, Inc., T-Netix, Inc.,
T-NETIX Telecommunications Services, Inc., T-Netix Monitoring Corporation,
SpeakEZ, Inc., Telequip Labs, Inc., Evercom Holdings, Inc., Evercom, Inc.,
EverConnect, Inc., Evercom Systems, Inc., and The Bank of New York Trust
Company, N.A., incorporated by reference from Form S-4 filed May 16,
2005.
|
4.18.1
|
First
Amendment to Subordination and Intercreditor Agreement, dated as of June
29, 2007, by and among Laminar Direct Capital, L.P., Securus Technologies,
Inc., T-Netix, Inc., T-NETIX Telecommunications Services, Inc., Telequip
Labs, Inc., Evercom Holdings, Inc., Evercom, Inc., Evercom Systems, Inc.,
Syscon Justice Systems, Inc., Modeling Solutions, LLC, Modeling Solutions
LLC, and The Bank of New York Trust Company, N.A., incorporated by
reference from Form S-4 filed August 1, 2007.
|
4.19
|
Amended
and Restated Intercreditor Agreement, dated as of September 30, 2008, by
and among Wells Fargo Foothill, LLC, as Intercreditor Agent, The Bank of
New York Mellon Trust Company, N.A., as Trustee, Securus Technologies,
Inc., and certain subsidiaries of Securus Technologies, Inc. incorporated
by reference from Form 10-Q filed November 14, 2008.
|
4.20
|
Note
Purchase Agreement, dated as of September 9, 2004, by and among Securus
Technologies, Inc., T-Netix, Inc., Telequip Labs, Inc., T-Netix
Telecommunications Services, Inc., SpeakEZ, Inc., T-Netix Monitoring
Corporation, Evercom Holding, Inc., Evercom, Inc., Evercom Systems, Inc.,
FortuneLinX, Inc., and Everconnect, Inc. and Laminar Direct Capital L.P.,
incorporated by reference from Form 10-K/A filed September 13,
2006.
|
4.20.1
|
June
2007 Amendment to Note Purchase Agreement, dated June 29, 2007, by and
among Securus Technologies, Inc., T-Netix, Inc., Telequip Labs, Inc.,
T-Netix Telecommunications Services, Inc., Evercom Holding, Inc., Evercom,
Inc., Evercom Systems, Inc., Appaloosa Acquisition Company Ltd., Modeling
Solutions, LLC, Modeling Solutions LLC, Syscon Justice Systems
International Pty Limited, Syscon Justice Systems International Limited,
Syscon Justice Systems Canada Ltd., Syscon Justice Systems, Inc., and
Laminar Direct Capital L.P., incorporated by reference from Form 8-K filed
July 2, 2007.
|
4.21
|
Form
of 11% Second-priority Senior Secured Notes due 2011, incorporated by
reference from Form S-4 filed August 1, 2007.
|
4.22
|
Security
Agreement, dated June 29, 2007, by and among Appaloosa Acquisition Company
Ltd., Syscon Justice Systems Canada Ltd., Syscon Holdings Ltd., and The
Bank of New York, as trustee, incorporated by reference from Form S-4
filed August 1, 2007.
|
4.23
|
Pledge
Agreement, dated June 29, 2007, by and among Appaloosa Acquisition Company
Ltd., Syscon Justice Systems Canada Ltd., and Syscon Holdings Ltd., and
The Bank of New York, as trustee, incorporated by reference from Form S-4
filed August 1, 2007.
|
4.24
|
Trademark
Security Agreement, dated June 29, 2007, by and among Appaloosa
Acquisition Company Ltd., Syscon Justice Systems Canada Ltd., Syscon
Holdings Ltd., a British Columbia corporation and The Bank of New York, as
trustee, incorporated by reference from Form S-4 filed August 1,
2007.
|
4.25
|
Copyright
Security Agreement, dated June 29, 2007, by and among Appaloosa
Acquisition Company Ltd., Syscon Justice Systems Canada Ltd., Syscon
Holdings Ltd., and The Bank of New York, as trustee, incorporated by
reference from Form S-4 filed August 1, 2007.
|
10.1
|
Stockholders
Agreement, dated September 9, 2004, by and among Securus Technologies,
Inc., H.I.G.-TNetix, Inc., T-Netix, Inc., American Capital Strategies,
Ltd., Laminar Direct Capital, L.P., and each of the other investors then
or thereafter set forth on the signature pages thereto, incorporated by
reference from Form S-4 filed May 16, 2005.
|
10.2
|
Amended
and Restated Consulting Services Agreement, dated as of September 9, 2004,
among T-Netix, Inc., Evercom Systems, Inc. and H.I.G. Capital, LLC,
incorporated by reference from Form S-4 filed May 16,
2005.
|
10.2.1
|
First
Amendment to Amended and Restated Consulting Services Agreement, dated as
of September 30, 2008, among T-Netix, Inc., Evercom Systems, Inc. and
H.I.G. Capital, LLC, incorporated by reference from Form 8-K filed October
7, 2008.
|
10.3
|
Amended
and Restated Professional Services Agreement, dated as of September 9,
2004, by and between T-Netix, Inc., Evercom Systems, Inc., and H.I.G.
Capital, LLC, incorporated by reference from Form S-4 filed May 16,
2005.
|
10.3.1
|
First
Amendment to Amended and Restated Professional Services Agreement, dated
as of September 30, 2008, among T-Netix, Inc., Evercom Systems, Inc. and
H.I.G. Capital, LLC, incorporated by reference from Form 8-K filed October
7, 2008.
|
10.4
|
Office
Lease Agreement, dated as of November 8, 2004, by and between T-Netix,
Inc. and the Prudential Insurance Company of America, incorporated by
reference from Form 10-Q filed August 15, 2005.
|
10.4.1
|
First
Amendment to the Office Lease Agreement, dated as of November 19, 2004, by
and between T-Netix, Inc. and the Prudential Insurance Company of America,
incorporated by reference from Form 10-Q filed August 15,
2005.
|
10.5
|
2004
Restricted Stock Purchase Plan, incorporated by reference from Form 10-Q
filed November 14, 2006.
|
10.6
|
Fourth
Amendment to 2004 Restricted Stock Purchase Plan and Stockholder Consent,
increasing authorized shares under the plan, incorporated by reference
from Form 10-K filed March 31, 2009.
|
10.7
|
Employment
Agreement, dated June 11, 2008, by and between Securus Technologies, Inc.
and Richard A. Smith, incorporated by reference from Form 8-K filed June
13, 2008.
|
10.8
|
Restricted
Stock Purchase Agreement, dated June 23, 2008, by and between Securus
Technologies, Inc and Richard A. Smith, incorporated by reference from
Form 8-K filed June 13, 2008.
|
10.9
|
Employment
Agreement, dated June 20, 2008, by and between Securus Technologies, Inc.
and William D. Markert, incorporated by reference from Form 8-K filed June
24, 2008.
|
10.10
|
Restricted
Stock Purchase Agreement, dated June 30, 2008, by and between Securus
Technologies, Inc and William D. Markert, incorporated by reference from
Form 8-K filed June 24, 2008.
|
14.1*
|
Securus
Code of Ethics
|
21.1*
|
Schedule
of Subsidiaries of Securus Technologies, Inc.
|
23.1*
|
Consent
of KPMG LLP
|
23.2*
|
Consent of McGladrey & Pullen LLP |
31.1*
|
Certification
of Chief Executive Officer pursuant to Section 302 of the
Sarbanes-Oxley of 2002.
|
31.2*
|
Certification
of Chief Financial Officer pursuant to Section 302 of the
Sarbanes-Oxley of 2002.
|
32.1*
|
Certification
of Chief Executive Officer pursuant to Section 906 of the
Sarbanes-Oxley of 2002.
|
32.2*
|
Certification
of Chief Financial Officer pursuant to Section 906 of the
Sarbanes-Oxley of 2002.
|
*
|
Filed
herewith.
|