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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
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FOR THE YEAR ENDED JULY 31, 1997 COMMISSION FILE NUMBER 0-25016
T-NETIX, INC.
(Exact Name of registrant as Specified in Its Charter)
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COLORADO 84-1037352
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(State of Other Jurisdiction of Incorporation) (I.R.S. Employer Identification No.)
67 INVERNESS DRIVE EAST
ENGLEWOOD,COLORADO 80112
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(Address of principal executive offices) (Zip Code)
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REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (303) 790-9111
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Securities registered pursuant to Section 12(b) of the Act: NONE.
Securities registered pursuant to Section 12(g) of the Act: COMMON STOCK
(Title of Class)
Indicate by check mark whether the Registrant: (1) has filed all reports 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
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Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein and will not be contained, to the best
of 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
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The aggregate market value of the voting stock held by non-affiliates of the
Registrant as of October 15, 1997, was approximately $ 68,546,287.
The number of shares outstanding of the Registrant's common stock as of October
15, 1997, was 8,472,315.
The following document is incorporated herein by reference into the part of the
Form 10-K indicated: the Proxy Statement for the 1997 Annual Meeting of
Shareholders to be filed prior to November 30, 1997, pursuant to regulation 14A
of the General Rules and Regulations of the Commission is incorporated by
reference into Part III of this Form 10-K.
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FORM 10-K CROSS REFERENCE INDEX
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PART I
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Item 1 Business........................................................................................ 3
Item 2 Properties...................................................................................... 22
Item 3 Legal Proceedings............................................................................... 22
Item 4 Submission of Matters to a Vote of Security-Holders............................................. 23
PART II
Item 5 Market for Registrant's Common Equity and Related Stockholder Matters........................... 23
Item 6 Selected Financial Data......................................................................... 24
Item 7 Management's Discussion and Analysis of Financial Condition and
Results of Operations........................................................................... 25
Item 8 Financial Statements and Supplementary Data..................................................... 35
Item 9 Changes in and Disagreements with Accountants on Accounting and
Financial Disclosures........................................................................... 35
PART III
Item 10 Directors and Executive Officers of the Registrant.............................................. 35
Item 11 Executive Compensation.......................................................................... 35
Item 12 Security Ownership of Certain Beneficial Owners and Management.................................. 35
Item 13 Certain Relationships and Related Transactions.................................................. 35
PART IV
Item 14 Exhibits, Financial Statement Schedules and Reports on Form 8-K................................. 35
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PART I
ITEM 1. BUSINESS
THE COMPANY
T-NETIX, Inc. (the "Company" or the "Registrant") provides specialized call
processing and fraud control services to the telecommunications and other
service industries. The Company's primary customers include AT&T, Bell Atlantic,
GTE, NYNEX, SBC Communications, Inc., BellSouth and U S WEST. These customers
use the Company's products and services to provide annually over 90,000,000
billable inmate collect calls in over 1,000 correctional institutions. The
Company's products and services include comprehensive transaction processing,
call management and identification systems for the corrections industry and
special-purpose speech processing software and systems. Most of the Company's
current products are based on proprietary software, the most critical of which
are patented or patent pending, and a combination of proprietary and
"off-the-shelf" electronic hardware. These systems are designed to be flexible
delivery platforms which are easily integrated with its customer's networks and
information systems. The Company's revenue stream is mostly recurring, as a
result of the Company historically generally charging for its services on a fee
per transaction processed basis over long term contracts.
In October 1995, the Company acquired SpeakEZ, Inc. (SpeakEZ). SpeakEZ is a
wholly-owned subsidiary. The Company is engaged in the sale, marketing, and
development of new fraud prevention products and services based on its SpeakEZ
Voice Print(sm) speaker verification biometric technology. Developed by SpeakEZ,
this technology uses "voice prints" or speech patterns as a means to verify or
determine an individual's identity. The Company believes SpeakEZ Voice Print(sm)
products to have a particular applicability to the fraud problems experienced by
the financial services, telecommunications and network security industries.
The Company's objective is to be a leading provider of innovative fraud
prevention and identification products and services to the global
telecommunications, financial services and network security industries. The
Company believes that its expansion into these new markets will be assisted by
its strategic relationships with its customers, its network integration
expertise and its national service infrastructure. To date, substantially all
the Company's revenue has been derived from its corrections industry call
processing services.
TELECOMMUNICATIONS INDUSTRY BACKGROUND
In recent years, the telecommunications industry has become increasingly
competitive. In the U.S., established service providers such as AT&T and the
RBOCs are experiencing intense competition in long distance and local services
from other providers such as MCI and Sprint, numerous re-sellers and specialized
service providers. Competition in the local and long distance markets is
expected to increase as a result of the Telecommunications Act of 1996 which
will permit AT&T and the RBOCs to compete with each other in their respective
markets. Additionally, Competitive Access Providers or "CAPS" have begun to
offer access alternatives, while traditional cable television providers can
offer dial-tone services over their cable distribution networks. Wireless
operators, including Personal Communications Services ("PCS") operators, offer
services which will compete with both local dial-tone and long distance
services. The international telecommunications services industry is also facing
significant changes. Many countries are privatizing their state-owned
telecommunications monopolies, while others have begun to open their markets to
competition through deregulation.
Telecommunications service providers compete on the basis of price, service
differentiation and the introduction of new services and controlling fraud in
their networks. Technologies which enable these providers to lower the costs of
delivering their services and to introduce new
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services are increasingly important. In addition, many local and long-distance
providers "outsource" certain support operations to third parties which offer
more cost-effective and flexible alternatives to internal solutions. By doing
so, service providers are able to develop services for customers with special
needs and to reduce the time required to introduce such services into the
market. As a result, the Company believes that new business opportunities are
being created for third-party organizations that can provide these technologies.
The Company is addressing this market opportunity by offering services which
lower costs through automated call processing, lower bad debt charges and fraud
through fraud prevention, increase the level of customer service and integrate
the end-user's information management requirements through full-service support.
MARKETS
TELECOMMUNICATIONS - WIRELINE
Public Communications services, broadly defined as calls not billed to the
originating telephone, includes local and long-distance credit and pre-paid card
calls, third-party calls and collect calls. These calls typically require
specialized network-based functionality to facilitate billing, call handling and
account validation. As a result, Public Communications calls generate higher
per-call revenues than standard residential and commercial calls.
While the industry has almost universally automated calling card calling to
reduce processing costs, the automation of collect and third-party calling has
presented greater challenges due to the customized handling required for these
calls. Such requirements include the need to identify the caller to the billed
party, to obtain billing acceptance, and in some cases, verify the callers'
billing authority. Moreover, automation of these services by the major call
providers faces significant technological hurdles, since their networks were
historically built upon a framework of large network switches designed to
reliably process a high volume of calls with few customized features. The need
to meet these challenges has created an opportunity for vendors such as the
Company to (1) provide custom call processing services through premises-based
equipment, adjunct call processing platforms or other proprietary technology
that is integrated within the telecommunications network and (2) to offer
validation of information associated with the call or calling party.
Specialized call processing within the Public Communications market requires the
development of advanced capabilities such as control of outgoing calls, flexible
billing procedures and easy-to-use speaker identification and verification
procedures. The Company believes such services are also applicable to calling
card, bill-to-third number, and debit or pre-paid calling.
In addition to the call processing challenges facing the Public Communications
providers, the entire telecommunications industry is focused on finding
effective solutions for fraud prevention. Loss figures for network toll fraud
continue to be significant. Industry estimates show that the total annual fraud
is approximately $2.9 billion. Of this amount $1.4 billion comes from customer
premise equipment. Without such means crooks bill long distance calls to
fraudulently obtained, valid calling card accounts, bill international and long
distance calls to unsuspecting homes and businesses, and "hack" into office
telephone or voice mail systems to defraud long distance networks. The costs of
this fraud to the carriers is reflected in their cost of services to their
customers.
Early attempts by carriers to combat fraud resulted in the use of Personal
Identification Numbers along with special calling card numbers. These methods,
however, are cumbersome for the customer and easily compromised by the crook. In
some cases, the carrier control measures cause legitimate customers' use of its
services to decline or, in the worst case, to switch carriers. What is needed is
a method of verifying a caller's billing authority which is natural and
intuitive
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to the caller, yet reliable and effective at preventing fraud for the carrier.
The solution must also be able to use standard telephony and be easily
integrated with the carrier's network.
SECURITY SERVICES - INMATE CALLING MARKET
Calls from inmates of federal, state and local correctional facilities comprise
a significant segment of the Public Communications market. Inmates typically may
only place calls for a limited duration, generating a high volume of calls per
phone, and generally may only place collect calls, which tend to generate higher
revenue per call than other types of calling. Consequently, the inmate calling
market is an attractive segment to call providers.
According to the U.S. Bureau of Justice Statistics, the number of inmates in
state and federal and local prisons as of June 1996 reached approximately 1.5
million. Currently, the number of inmates in federal, state and local prisons
increased to an estimated 1.6 million.
The inmate calling market presents unique and substantial challenges to the call
provider. Correctional facilities generally favor call providers who can manage
the inmate phone systems themselves, maintain consistent service and easily
process new inmates into the systems. Corrections officials generally require
control features that limit the length of calls, limit the time of day calls are
made, and restrict the ability of inmates to make harassing or unapproved
telephone calls. The call provider must be able to customize the call control
features by facility, cell block, telephone and, in some cases, each inmate. One
of the unique challenges is to prevent the fraudulent bypassing of these
controls through three-way calling. Inmates bypass traditional control features
by calling an accomplice at an approved number and having the accomplice use
three-way calling to conference a non-allowed party. Through this method,
inmates have been known to harass and intimidate people, such as witnesses,
whose numbers would otherwise be blocked, or to call merchants to conduct
fraudulent activities.
Correctional facilities generally select telephone/telecommunications service
providers on the basis of services and features provided and on the level of
commissions paid to the facilities. To date, intense competition among the
service providers has led to commission payments to correctional facilities at
levels that the Company believes only the major service providers can afford. In
addition, to win new contracts and renew existing contracts, call providers must
differentiate their services from the competition. They do so by offering
advanced call control services as well as additional complementary services such
as booking and identification processes, trust fund and commissary automation
and management, investigation support and jail management support systems.
TELECOMMUNICATIONS - WIRELESS
Industry estimates indicate that the number of subscribers for cellular phones
is approximately 50 million in the U.S., 53 million in Asia/Pacific, and 44
million in Europe. The Cellular Telecommunications Industry Association ("CTIA")
estimates an annual cost of wireless fraud of approximately $1 billion annually.
Roaming fraud is estimated to be approximately 30% of that number or $300
million. The root of this problem is the ease with which analog cellular phones'
electronic serial and identification numbers can be copied off the air waves and
reprogrammed into another illegal or "cloned" cell phone. While digital
technology is expected to somewhat solve this problem, over 80% of the existing
50 million cell phones in the U.S. use analog technology and the U.S. carriers
are several years and many millions if not billions of dollars away from
converting their networks and users to digital technology.
To address this compelling issue, cellular carriers are implementing interim
fraud prevention technologies such as PIN, RF Fingerprinting and A-Key
Authentication for use in their home markets. Because of the high costs of
acquiring and implementing these technologies, they are not universally adopted
by all carriers. They are for the most part deployed in the highest fraud
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markets such as New York and Los Angeles by the largest carriers. Other small
carriers in other markets either use less technologically sophisticated methods
such as PIN or post-call analysis to combat fraud or simply have no protection.
In the cellular fraud business, as with other types of crime, crooks seek the
path of least resistance. As some carriers implement home market fraud
protection, crooks either re-locate the criminal enterprise to less-protected
markets or, as is most often the case, stay at "home" and clone the cell phones
of unsuspecting callers who "roam" into their territories. This phenomenon is
borne out by the latest industry statistics which put roaming fraud at an
estimated 30%, or over $300 million, of the total industry fraud. This would
suggest that about 14% of the total industry roaming revenue of approximately
$2.1 billion is lost to fraud. The fact that roaming revenues constitute much of
a carriers revenue growth and profit potential make this problem even more
compelling.
Cellular carriers are looking for a solution to this problem. Some have
implemented "brown-out" policies which simply deny roaming service to their
subscribers in the high fraud markets. Of course not only do these practices
sacrifice "good" revenue, but risk the "churn" of the customer to a competing
carrier because of the perceived poor service. Other carriers are looking to
extend their home market fraud prevention technologies to the roaming
environment. But as different carriers deploy different technologies, the
barriers to interoperability and carrier cooperation become more challenging.
Another phenomenon experienced by carriers who have implemented digital cellular
networks, principally the European carriers, is the evolution of the type of
fraud they experience. Because cloning of digital phones is arguably
impracticable (at the moment, at least) crooks resort to cell phone theft and
subscription fraud to continue their fraud business. In the UK, the cost of this
wireless fraud is estimated at $150 million annually. This type of fraud differs
from "cloning" fraud because the cell phone or device is "authenticated" or
otherwise legitimate. The fraudulent element is the user. Digital cellular
technology, and the home market technologies such as RF Fingerprinting and A-key
Authentication only verify the device - not the user.
What is needed is a means by which home market and roaming calls can be easily
verified at the individual user level, rather than the device level.
Verification technology is preferred when it is easy to use, i.e., obviating the
dialing of digits or the memorization of PINs or other codes or passwords. The
use of the technology must be interoperable between carrier networks and cost
effective to implement.
FINANCIAL SERVICES MARKET
A Nilson Report recently estimated domestic credit card fraud losses to be in
excess of $1.5 billion last year alone. U.S. check fraud has been estimated at
$10 billion according to the Chairman of the Senate Financial Services and
Technology Subcommittee, Bob Bennett (R - Utah). Overall, fraud is estimated to
cost the industry in excess of many billion dollars per year and is on the rise.
Credit card fraud, check forgery and wire transfer fraud, are at all time highs.
Concurrently, the financial services industry is experiencing explosive growth
in "virtual" or remote banking transactions. Financial institutions, seeking the
cost efficiencies inherent in telephony and network-based transaction
processing, seek to implement automated, albeit "depersonalized" customer
interaction systems. These factors lead to increased anonymity, the breeding
ground of criminal enterprise.
To counter this burgeoning fraud dilemma, financial institutions are examining
and deploying technologies which not only automate many customer transactions or
interactions but also determine the identity of remote customers before the
transaction is permitted. Many institutions are using Interactive Voice Response
("IVR") technologies which when integrated with the
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institution's telephone systems, provide the means to automate common customer
transactions. Typical IVR systems employ recorded or synthetic voice prompts to
provide the following customer interaction: automated answering of the customer
call, solicitation of the customer ID or account number through the customer's
use of his telephone keypad; presentation of an action menu to the customer;
voice-prompted guidance through the chosen action; and integration of the
customer input into the institutions' Management Information System application.
The action items usually offered to the customer during the IVR session commonly
include account balance and available credit queries, billing balances and
payment status; order or trading status; account maintenance such as change of
billing address; and transfer of funds between same customer accounts. A more
recent trend by certain large financial institutions is to expand the customer's
automated account activities to include wire transfer; funds transfer to
creditor and other accounts; and trading of securities and mutual funds.
In addition to the use of IVR technologies, financial institutions are rushing
to deploy new automation technologies such as: "virtual branch banks"; enhanced
Automated Teller Machines ("ATM"); card-based technologies such as debit, cash
or "smart" cards; and PC-based Home and Internet Banking. These latest
technologies provide the customer with greater interaction, account control
capabilities and help the institution achieve its automation goals. These
expanded capabilities, however, significantly increase risk exposure of the
institution and its customers. Without adequate customer identification, these
automated, impersonal capabilities promote criminal opportunity.
The only security element currently used in most of these automated processes is
a Personal Identification Number or PIN. PINs have many disadvantages from both
the user and security perspectives. Users dislike PINs because they are not
intuitive, most often not chosen by the user, and intrusive and difficult to
remember among other reasons. PINs can be easily comprised through observance or
"shoulder-surfing", customer service manipulation, account maintenance abuse,
transaction recording and intercept and many other criminal methods.
To address the shortcomings of PIN utilization, financial institutions are
evaluating the use of newer, biometric identification technologies. These
technologies include electronic signature analysis, eye retinal or iris
comparison, electronic fingerprint identification and speaker verification.
Besides the performance characteristics of the approaches, financial
institutions are also concerned with the cost and implementation aspects of the
technology integration and customer perception or the human factors. Ideally,
the identification method should be natural and intuitive to the user,
physically non-intrusive and easy to implement without the requirement of
special hardware or devices.
E-COMMERCE MARKET
As commerce over the Internet becomes more popular, websites require better
methods of securing transactions and access to sensitive material. In survey
after survey, the general public state that the main reason they hesitate to
transact on-line is due to a perceived lack of security on the Internet. In
attempt to allay these fears, several companies currently offer Internet
security services (e.g. VeriSign, IBM, GTE, and Nortel). These companies, known
as "certificate authorities", offer "certificates of authenticity" that vouch
for an entity wishing to be certified that they are who they claim to be. It is
here that opportunities exist for biometric technologies to verify the identity
of people on the Internet.
NETWORK SECURITY MARKET
A chronic challenge facing management information systems executives is to
balance the security requirements of their systems with the human factor
requirements (the degree to which a system is "user-friendly"). Traditional
typed passwords consistently fail to meet both requirements. Although secure
when used correctly (difficult-to-remember, frequent changes),
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typed passwords are not user-friendly. When they are user-friendly (easy-to
remember, infrequent changes), they are insecure. Even when secured methods are
used to "log-on," a user to a data terminal, workstation or PC, networked
servers cannot be assured that the current user is the authorized user and not
someone who has gained access to the secured terminal or workstation. Networks
which are not secured from unauthorized user access are subject to fraudulent or
intercepted e-mail, exposure of proprietary or confidential file data,
industrial espionage or cyber-terrorism.
The solution to this problem lies with technologies which prove the identity of
the current user in addition to securing the device and the data transmission
between the voice and the network server. This technology must be both highly
accurate and user-friendly. Because biometric technologies measure something
that a person "is" rather than a piece of information or a piece of equipment a
person "has", they lend themselves well to solving the management information
system executive's dilemma. Specifically, speaker verification offers the
optimal combination of accuracy, user-friendliness, (it's non-intrusive;
natural), and value.
PRODUCTS AND SERVICES
The Company's primary focus in the design of its products and services is to
provide innovative, software-based solutions to very costly "niche" problems
with which major services providers are faced. The Company believes this
approach will result in a willingness of its customers to pay more value for
these solutions and thus an opportunity to generate higher margin revenue. Also
important is the ease with which its solutions are supported by available
hardware and operating systems and integrated with its customers' in-place
networks.
These products and services provide specific, caller-level customization and
advanced call processing capabilities to the Company's customers' service
offerings. Combined with the full service delivery option, the Company's
advanced call processing solutions provide its customers with services which can
be differentiated from that of the customer's competitors and which lower the
cost of providing such services.
INMATE CALLING PRODUCTS
Currently, substantially all of the Company's revenue is derived from the
services it provides to its customers for use in correctional facilities. The
Company's products and services for the inmate calling market include a
comprehensive set of technological and administrative features which provide
call control, fraud prevention and systems integration capabilities. The Company
offers the following advanced features for each phase of the calling process:
Pre-connection Restriction Features. Unlimited individual number blocking
capabilities; personal identification number ("PIN") operation with allowed or
denied number lists; SpeakEZ Voice Print(sm) speaker verification technology;
restrictions based on calls per time period per inmate; restrictions on the
number of call attempts versus completions; restrictions on calls to a single
number; and real-time billed number validation by external database query.
Call Connection Automation. Automated operator; debit or collect calling
operation; custom call announcement and identification of facility and call
provider; customized introductory messages such as the possibility that the call
may be recorded; PIN-based automated inmate caller identification by which the
inmate is identified to the called party through a pre-recorded statement of the
inmate's name in his own voice; active billing acceptance which requires the
called party to respond with a key-press to accept the inmate call; and
multi-lingual and international call processing.
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Post-connection Services. Three-way call detection/prevention technology based
on the Company's patented Strike Three!(TM) technology that prevents inmates
from bypassing control features through three-way calling; "Hot Number"
operation, a real-time alert feature based on inmate PINs, destination number or
originating telephone number; automated attorney-client confidentiality which
precludes recording or monitoring of calls between the inmate and his attorney;
and comprehensive system reports for billing, administrative, law enforcement
and investigative support purposes.
PIN-LOCK(sm). The Company recently announced another technological
innovation-PIN-LOCK(sm), Inmate Caller Verification Service, expected to
increase the competitive advantage provided by its patented Strike Three!(TM)
technology. Before this innovation, inmates would use another inmate's PIN to
subvert call restriction controls. PIN-LOCK(sm) prevents this practice by
denying the call if there is not a match with the proper inmate's "voice print".
The Company believes this technology will greatly enhance the security of its
call processing systems.
Corrections Systems Integration Applications. The Company's customers offer
additional services as an off-set to higher commission payments to win new and
retain existing inmate calling contracts. The Company offers to its customers an
expanded set of integrated automation, identification and management
applications. The Company's integration design focuses on inmate identification.
Identification attributes such as voice print, PIN, Video Digital Image,
recorded conversations and bar codes are common to the various corrections
applications. The individual applications offered by the Company include the
following:
Trust Fund and Commissary. The Company's Trust Fund/Automated Commissary
system ("TFC") provides for a fully-integrated, point-of-sale commissary or
canteen operation including inventory management, using the inmate bar
coded-ID card for transaction processing. The commissary purchases are
electronically processed on a cashless, electronic funds transfer basis,
through the trust fund accounting system provided by the Company.
Tel-Base Investigative Services and Recording Access Management. Tel-Base
provides tools to monitor inmate telephone usage for abuse and criminal
conduct. The user-friendly interface permits corrections officers to sort
and identify calls using a variety of search criteria including by PIN,
destination number, originating telephone, etc. Through the Recording
Access Management (RAM) application, officers can designate certain calls
to be recorded onto magnetic digital or analog tape. Calls can be selected
for playback off the recorded conversations and the officer can record
notes of the conversation and append these notes as text files to the
investigative file. Call detail information is provided by the inmate
calling application. The integration of the call management system with the
recording system is very beneficial to the corrections officer who
previously had no efficient means of relating telephone calls to specific
recorded conversations.
By facilitating the concentration and selection of calls for recording, RAM
requires much less recording capacity than the typical
one-recording-channel per phone arrangement. The savings in recording
capacity provides cost savings benefits to the Company's customers.
Video Imaging/Inmate Management. Video imaging is used primarily for
admission and release identification purposes. Corrections officers use a
Company-provided work station to take a digital image or snapshot of an
inmate, input pertinent information, such as allowed/denied calling
numbers, medical requirements, currency on hand, etc., and print an
identification card or wrist band which contains the bar-coded
representation of the inmate identification number or other code. This data
is saved in data bases, with the inmate calling application, the TFC
system, and Tel-Base investigative and Recording Access Management
applications. The Company's Video Imaging/ Inmate Management System
eliminates the costly and cumbersome manual photography process typically
used today.
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SPEAKER VERIFICATION PRODUCTS
TELECOMMUNICATIONS - WIRELINE
SpeakEZ Voice Print(sm) technology could have a major impact on types of
criminal activity which contribute to the industry's $2.9 billion fraud problem.
By requiring a match between the speech pattern of the caller and the authorized
customer, illegally obtained PINs and calling card numbers are useless to the
crook. The Company's Securi-Voice(sm) application provides these capabilities
through its enrollment and verification processes. Through the service support
organizations of carriers subscribing in the future to the Company's services,
authorized callers are "enrolled" into the Securi-Voice(sm) system. This process
is fully automated and requires the authorized caller to state their password,
usually their name, 3 or 4 times in response to the Company's IVR prompts. In
less than a minute, the technology prepares a "voice print", or digital code
which represents the speech pattern of this caller. The voice print data is then
uploaded into the verification system data base. When the caller attempts to
make a call of the type for which Securi-Voice(sm) is applicable - typically a
call which will be billed to another number or account and which originate from
a pay telephone or hotel phone - the carrier's network will route the caller to
the Securi-Voice(sm) platform for verification. Verification consists of a
request to the caller to state her name or password and a nearly instantaneous
analysis of the match between the current caller's voice print with that of the
stored voice print of the authorized caller. In the verification process, the
Securi-Voice(sm) system produces a confidence coefficient of voice print match.
This coefficient enables the carrier to set variable thresholds in the
verification or rejection of call attempts. If the caller's voice print meets
the established pass threshold, the call is completed through the carrier's
network. In the event the caller's voice print does not meet the carrier's
threshold, the caller is transferred to customer care representatives for
further validation information.
Through the use of SpeakEZ Voice Print(sm) Securi-Voice(sm), the carrier's level
of network billing security will be greatly enhanced. Because caller voice
prints are unique to the individual, they cannot be copied and if "stolen";
i.e., learned, overheard or recorded, are nonetheless useless to the criminal.
Also, because the caller uses her name or some other short, intuitive phrase for
verification purposes, the caller inconveniences of PIN utilization are avoided.
Securi-Voice(sm) runs as a software application program on various operating
systems such as Windows NT or UNIX on the Company's or the customers Adjunct
Processors so it is easily integrated with the carrier's network.
In 1997, in conjunction with a license to Ottawa Telephony Group ("OTG"), the
Company's SpeakEZ Voice Print(sm) Securi-Voice(sm) will be used in an
application for securing internal PBX systems. Securi-Voice(sm) continues to be
marketed to the Company's current telecommunication customers as well as to
other major domestic and international telecommunications companies.
TELECOMMUNICATIONS -WIRELESS
The Company's wireless solution, Voice Verifi-Air(sm), uses SpeakEZ Voice
Print(sm) technology to verify the identity of the roaming cellular caller.
Similar in function to the Securi-Voice(sm) application, Voice Verifi-Air(sm) ,
compares a cellular caller's password utterance or voice print, with the stored
voice print of the authorized caller. With Voice Verifi-Air(sm) ("VVA"), the
Company provides the carrier with subscriber enrollment support, through
IVR-driven interfaces with the carrier's customer care center. The subscriber
enrolls their voice print with VVA in the standard manner for SpeakEZ Voice
Print(sm) applications - by stating their password 3-4 times. The subscriber's
voice print is then linked to the subscriber's Mobile Identification Number or
MIN.
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To verify cellular roaming calls it is necessary to intercept the call and route
it to the network system on which VVA is available. The Company entered into a
strategic relationship and services provisioning agreement with GTE
Telecommunications Services, Inc. (GTE-TSI"), which has the wireless network
infrastructure to accomplish the call interception and routing tasks. GTE-TSI,
the cellular service subsidiary of GTE MobileNet, has commercialized the
Company's Voice Verifi-Air(sm) application as part of their FraudForce(sm)
service offering. GTE-TSI's technology for intercepting and routing wireless
roaming calls, a service generally referred to as Roamer Verification
Reinstatement or "RVR", was recently endorsed by CTIA.
When a subscriber travels to a market or city in which the subscriber's home
carrier uses GTE-TSI's FraudForce(sm) or similar services, GTE-TSI's RVR service
intercepts the call and routes it to the Company's Voice Verifi-Air(sm) platform
for voice print verification. If the confidence coefficient resulting from VVA's
voice print match exceeds the pass threshold established by the carrier, the
caller's roaming session will be enabled. If the threshold is not attained, the
caller will be routed to the carrier's customer care center for additional
verification information.
Unlike technology for home market verification, Voice Verifi-Air(sm) validates
the identity of the caller - not the cell phone or device. Because of this fact,
the Company believes its SpeakEZ Voice Print(sm) technology will be effective at
controlling other kinds of wireless fraud, such as subscription fraud and cell
phone theft. This factor along with the avoidance of major capital investments
by the carrier and RVR infrastructure, is expected to make VVA an attractive
solution to the cellular carriers' roaming fraud problems. To this end, the
Company entered into an agreement with Lucent Technologies ("Lucent") to deploy
Voice Verifi-Air(sm) as a part of Lucent's RVR products to the wireless and PCS
industries.
FINANCIAL SERVICES MARKET
The SpeakEZ Voice Print(sm) technology application designed for the financial
services industry is Customer Verification Service(sm) (CVS). CVS is designed
for use by banks, brokerage houses, insurance companies, and other financial
institutions to authenticate customer transactions. CVS is designed to work in
conjunction with an overall Interactive Voice Response ("IVR") System to provide
the very best in customer service while at the same time protecting the
financial institution from fraudulent transactions from unauthorized persons.
Access to services would only be permitted when requested by individuals whose
voice print is on file and whose real-time password utterance matches the stored
voice print.
A customer simply dials the access number to the financial institution's IVR
system or call center. The customer is then instructed to enter their account
number, the financial institution's IVR system prompts the caller to speak the
password which was previously established by the caller in the enrollment
process. At this stage, CVS analyzes the characteristics of the caller's
statement of the password (Feature Extraction) and characterizes its tonal
aspects (Modulation Model). The process also results in characterization and
isolation of the channel environment (i.e., line type, hand-set type), and
results in the determination of a confidence coefficient as to the likelihood of
the match between the caller and the claimed identity.
The Company believes CVS will be cost effective and easy to implement for the
financial institution. The caller uses an ordinary office, home or public
telephone - unlike other biometric identification technologies such as
fingerprint, signature or retinal scans, no special hardware or devices are
required at the "point of sale". CVS is client server and network-based. It can
run in Window-NT, OS/2 and several versions of UNIX and supports the prevalent
IVR and Computer Telephony Integration ("CTI") environments. Currently, the
Company has developed versions
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of CVS which are compatible with IBM's DirectTalk/Call Path, Dialogic's Antares
and Windows NT. In 1997, the Company deployed a client-based CVS system at
INTRUST Bank for use in the bank's internal and external security applications.
In addition several major financial institutions have entered into trial
agreements with the Company for the evaluations of the performance, integration,
and customer acceptance aspects of CVS.
E-COMMERCE MARKET
The Company is currently developing a web-based CVS. Webmasters will use it to
verify the identity of Internet users before being permitted a sensitive web
transaction or to access sensitive information on a secured web page(s). The
web-based CVS will work in a client-server fashion, whereby the user's Internet
browser will prompt, record and preprocess the user's voice and send an
encrypted, proprietary file across the Internet to the website server. The
website server will perform the remaining verification processing, and grant or
deny access to the user.
NETWORK SECURITY MARKET
The Company has introduced its first fully functional application of SpeakEZ
Voice Print(sm) Speaker Verification technology for network security in the form
of a Windows 95 screen saver. The Company has received preliminary feedback on
its yet-to-be-named screen-saver product and from this it will continue to
refine the product. This process will help the Company develop more complex
computer/network security applications ranging from a secure log-in for a single
desktop PC, to securing access to varying levels of network servers.
SECURITY SERVICES
The Company believes one of the key applications of SpeakEZ Voice Print(sm)
technology is the use of speaker verification for secured-area access. Most
current security technologies use some form of card-identification or pass-key-
as the basic identification medium for access to secured areas. Since cards can
be lost, stolen or replicated and used by non-authorized personnel, security is
significantly enhanced through the addition of biometric identification
technology. The Company plans to address these market demands by developing
products to address such security needs. Currently, a major software company is
using the Company's SpeakEZ Voice Print(sm) technology in a prototype
voice-secured access application in its research and development building.
SYSTEM ARCHITECTURES AND TECHNOLOGY
Call Processing Technology
The Company's proprietary technology is designed for the specialized call
processing environment and includes the Company's system architectures
consisting of microprocessor-based line cards connected to multiple host
processors by fiber-optic local area networks. The host processors consist of
dual 386, 486 or Pentium microprocessors. System features are implemented
through a combination of proprietary software and database management
applications. The Company uses and supports a variety of network interfaces
including 2-wire and 4-wire, T-1, ISDN and Feature Group D to interface with its
customers' networks. Remote system management and real-time system diagnostics
across the Company's wide area frame relay network is provided through the
Company's Network Operations Center which operates 24 hours a day, seven days a
week.
The Company's system architectures are fault tolerant, with redundancies
provided for critical operations. The multiple host processor design provides
backup in the event one host fails. If a local area network link or multiple
host processors were to fail, the line cards can operate as
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stand-alone call processing systems. Moreover, call record data is stored in
several media at the line card and host processor level to ensure against call
data loss. This distributed and redundant design is highly reliable and reduces
the probability of complete system downtime.
The proprietary technology referred to above can be deployed to service
providers in varying methods. In both the premises and network architectures,
the telephones and the interconnecting network lines are usually provided and
maintained by the Company's customers at their cost. Typically, the Company
owns, installs and operates at its cost the systems which interface with the
customers' telephones and their networks.
Correctional Industry Systems Architecture
The Company has developed both premises-based and network-based systems to
provide flexibility in the provision of inmate calling services by its
customers. The Company's premises-based systems are located in secure areas of
the jail or prison and are controlled by the Company's service administrators.
In a typical installation, microprocessor-based controllers, or "line cards,"
are positioned between the customer-provided inmate telephones and their network
access lines.
Unlike the premises-based systems, the network-based systems are not directly
connected to the inmate telephone. Instead, calls originating from the inmate
telephones are switched to the Company's equipment, located in leased commercial
office space referred to as a "point of presence" ("POP"), through a software
routing instruction programmed into the local carrier's central office switch.
The Company's network-based systems offer higher utilization per line card and
are deployed without requiring the installation of any of the Company's
equipment within the correctional facility.
The Company's latest network-based system (T-NET(TM)) is the adjunct
architecture. T-NET(TM) is designed in stand-alone and network-based
configurations. The stand-alone T-NET(TM) systems are located in POPs, usually
in close proximity to the customer's network switch. The T-NET(TM) adjunct is
designed to work with the #5ESS switch, offering advanced call processing
services in a manner transparent to the larger AT&T network.
Currently, the Company has deployed 15 stand-alone T-NET(TM) systems and 32
T-NET(TM) adjunct systems for AT&T. Also, the Company has installed a large
stand-alone system for an RBOC customer located in the customer's central
office. In 1997, the Company migrated a large number of stand-alone T-NET(TM)
systems to adjunct systems and expects to continue such conversion and
deployment in 1998. Both systems have been designed with this migration process
in mind, so most of the system components are compatible.
The first version of the T-NET(TM) adjunct system was jointly developed with
AT&T Bell Labs to interface with the #5ESS network switching system. The first
of 32 such adjuncts were deployed in various AT&T switching offices across the
country. The adjunct version of T-NET(TM) has several economic advantages over
its stand-alone version. For example, the Company can obtain 100% coverage of
the U.S. by deploying in 35 geographic locations compared to 200 potential sites
for the stand alone version. This greatly reduces the Company's system
administration, office leasing and operating costs. Additionally, the new
version has enhanced interfaces with AT&T's billing and fraud databases which
eliminates several back office support functions currently being provided by the
Company's Denver Data Center.
To remain on the forefront of innovative technology and a market leader in the
Corrections Industry, the Company plans to deliver a new Computer Telephony
Interface Platform in early 1998. This new Inmate Call Control System, will
include all of the current voice response technology, fraud control features,
and network interfaces along with new data link interfaces, switching functions,
a new Graphical User Interface (GUI) and many new call control features.
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The hardware construction will be primarily from third party manufacturers and
will utilize high density digital/analog network interfaces and shared hardware
resources to allow many channels of call control within a single enclosure. This
architecture dramatically reduces the physical space, power and operational
maintenance requirements of the Company's current inmate calling system while
also dramatically increasing system features, functionality and efficiencies.
Speaker Verification Technology
SpeakEZ Voice Print(sm) technology is proprietary software which compares the
speech pattern of a current speaker with a stored digital voice print of the
authorized person to confirm or reject claimed identity. The technology can be
used in a text independent or text dependent mode and is being adapted to
perform identification (no pre-claimed ID such as a PIN). The technology is both
language and vocabulary independent. The system uses a combination of neural
network technology and decision trees called a "neural tree network." Each node
of the system's decision tree consists of a single neuron. Training of neurons
requires four or five repetitions of a user-defined password (text dependent) or
a small sample of speech (text independent) and applies "discriminant training"
to the input. This discriminant training contrasts acoustic features of the
speaker being enrolled with features for all the speakers already enrolled in
the system. During verification, each neuron must decide whether acoustic
features of the spoken input are more like those of the person whose identity is
claimed or more like those of all other speakers in the system. Speakers are
enrolled using a personal abbreviated password, typically the person's name,
which they must say before being allowed to place a telephone call or perform a
transaction. The password utterance is then compared to the stored print for
that allowed user or users. The user population can be large and varied. The
system can reside on the public network as an intelligent peripheral or can be
placed as an adjunct servicing a customer phone system or PBX. In a cellular
environment, the system can be an adjunct to the Mobile Service Center (MSC).
The system also operates on the Company's Adjunct Processor ("AP") platform.
The first point of integration with a customer is accomplished through trunking
between the AP and a customer's Call Center PBX/ACD. This interface permits the
transmission of the account number or other relevant data from the caller in the
event that the Account Number Data or other relevant data is not provided via
the integration of the AP with the CTI Server. The voice path interface also
permits the AP VRU to prompt the caller to speak their password and allows the
speaker verification process to be performed. At the conclusion of the SpeakEZ
Voice Print(sm) speaker verification process and based on the customer-selected
post-processing instructions, the call is released back to the PBX/ACD for
either normal processing or to be transferred to an operator center for further
handling.
The second point of integration is the customer's data base usually associated
with the fraud management system. This data integration provides the capability
to keep current the T-NETIX VIDB(sm) and for the transmission of management and
fraud alert reports from the T-NETIX AP to the customer's fraud management
system. This communication can be accomplished via the CTI link to the PBX/ACD
or directly to the appropriate server.
The final point of integration that would be required is between the customer's
Account Activation/ Maintenance operations and the T-NETIX VIDB(sm) enrollment
process. This integration provides for the conversion enrollment of existing
subscribers to the system and for the activation enrollment of new subscribers.
The enrollment process itself is VRU-based with the subscriber being asked to
state his/her password 4-5 times to allow the system software to construct the
authorized voice print. Within minutes the system prepares the voice print, and
on a regularly scheduled basis updates T-NETIX VIDB(sm) with the new subscriber
identification information.
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The account number data is indexed to the authorized caller's voice print as a
result of the enrollment process. The stored voice print is then accessed from
the T-NETIX Voice Identification Data Base(sm) (VIDB). The voice print of the
authorized caller, which is stored in the form of a pattern classifier, is used
to process the utterance. Through the use of the Neural Tree Network, a nearly
instantaneous (300-500 milliseconds) response is obtained that consists of a
coefficient which indicates the confidence level of the match. The financial
institution determines the confidence or "matching" level at which the call is
to be denied, allowed or referred (transferred) to a live operator for
assistance or further screening. The entire process, including the VRU prompts,
is accomplished in less than five seconds.
As an option, the T-NETIX AP can be located as a network Point-of-Presence
(POP). Calls would be routed to the AP via the carrier for the customer. The
process for the customer would be similar to the Premise Delivery architecture.
At the conclusion of the SpeakEZ Voice Print(sm) speaker verification process
and based on the customer-selected post-processing instructions, the call is
released back to the PBX/ACD for either normal processing or to be transferred
to an operator center for further handling.
The benefit of this option would be the ability to handle calls potentially from
multiple Call Centers and route the call appropriately once the speaker
verification is completed. The interface requirements with the customer fraud
management system and the Account Maintenance and Activation operations would be
the same. These interfaces would also benefit from the ability to handle
multiple Call Centers from a single location.
SUPPORT INFRASTRUCTURE
Call Processing
The call applications enabled by the Company's technology provide customized
programming and call handling services on a per call or per person basis and
require optimized systems management. The Company's service administration
employees typically assume all operational responsibilities for the Company's
systems and manage the day-to-day configuration of the systems. These employees
perform such functions as changing all blocking profiles for inmates and
monitoring and cataloging calls and are critical to the smooth operation of the
Company's systems. Its systems are supported by a national services organization
consisting of over 212 employees covering 36 states. The Company's systems can
be administered on-site or from a remote location through network management
software. The Company deploys its service administrators depending on several
criteria, including the size of the facility, the feature set of the facility
(PIN versus non-PIN), the geographic proximity of the Company's current service
administrator force and the correctional facility requirements.
A wide area network connects all of the Company's installed systems and provides
for centralized collection of call and reporting data and real-time diagnostic
information on the status of each major system component. The Company also uses
the network to process the on-line called number validation, tele-process its
call records and transmit administrative data between each location and
headquarters. This call data is reformatted and provided to the customer to be
incorporated in the billing process. To process calls, the Company performs
real-time billed number validation by external database query over the network
to an on-line database service provided by its customers. Its Denver-based
network operations center provides 24-hour per day, seven days a week system
support.
Speaker Verification
The Company's SpeakEZ Voice Print(sm) technology is designed for full service
delivery or for "plug-and-play" applications. The Company has installed both
types of applications to its current customer base.
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PRICING
Transaction-based Pricing
The Company's transaction-based pricing provides a recurring, usage-driven
revenue stream. In a typical arrangement, the Company operates under long-term
(three to five years) site-specific contracts with both a long-distance carrier
and a local call provider. The customer pays transaction fees for each call
processed by the Company, regardless of whether the customer collects the
revenue for the call. The transaction fee is determined by the type of service
performed by the Company and the total volume of calls processed for the
customer during the monthly billing period. The Company bills these customers
for transaction fees associated with calls processed during the previous month
on net 30-day terms.
The Company offers its customers a volume-adjusted schedule of transaction fees
which provides discounts for higher volumes of calls processed per month. Since
the discounted fees apply to all of the Company's call processing services, the
customers have the incentive to increase the amount and scope of services
performed by the Company.
The Company separately bills the customer for other network services required by
the customer, such as on-line database queries performed as part of the collect
call validation process, and for certain types of network access lines. These
services are billed to the customer with minimal margins on net 30-day terms.
The Company's transaction-based pricing structure was developed in response to
customers' demand for lower deployment costs and to reward customers for
increased utilization of the Company's services. The Company believes that its
transaction-based pricing policy differentiates it substantially from its
competitors, enables its customers to rapidly deploy advanced call processing
services to new sites and reinforces the relationships between the Company and
its customers.
Speaker Verification Pricing
Pricing for the SpeakEZ Voice Print(sm) technology includes directly purchasing
client-server systems, the licensing of software on a per voice print basis, as
well as transaction based pricing based on enrollments and verifications. In
addition, the SpeakEZ Voice Print(sm) technology is available for development
applications by purchasing a software development kit ("SDK"). The Company will
also provide custom engineering services at a standard hourly rate or
contractual project rate.
CUSTOMERS
Inmate Calling
The Company provides its call processing services to AT&T, MCI, Bell Atlantic,
GTE, NYNEX, SBC Communications, Inc., U S West, BellSouth, and other call
providers. For the year ended July 31, 1997, AT&T, Bell Atlantic, SBC
Communications, Inc. and U S West accounted for approximately 36%, 11%, 15% and
14%, respectively, of the Company's total revenue. No other customer accounted
for more than 10% of the Company's total revenue in the same period. The Company
believes that its customers have selected it on the basis of the quality and
breadth of its turn-key services, the capability of its technology and its
ability to price its services at competitive rates. The Company generally
establishes non-exclusive master agreements with its customers which set forth
the general terms and conditions, including price, under which the Company will
provide its call processing services. The Company then enters into three to five
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year site-specific contracts under these master agreements which govern the
provision of services in specific correctional facilities. Each master agreement
provides that its term is automatically extended through the term of any
site-specific contract under the master agreement. Certain site-specific
contracts contain early termination provisions, including penalties. The
Company's services are generally evaluated by its customers against both
internal and external competition. During an extensive trial or testing phase,
typically lasting nine to eighteen months, the Company's delivery of services is
evaluated to ensure interoperability with the customer's infrastructure.
In a typical installation at a correctional facility, the Company provides its
services to an IXC, for inter-LATA calls, and one of its other customers for
local and intra-LATA calls. Under this arrangement, the Company's services are
provided to both customers, who, in turn, can offer a consistent service
offering to the correctional facility.
The Company's strategic relationships with its customers have resulted in
several important benefits to the Company:
- - A significant portion of the Company's revenue has come from the
conversion of its customers' existing contracts with correctional
facilities.
- - The Company and its customers jointly submit proposals to state
departments of corrections and large correctional facilities for new
business opportunities. The Company is providing its services to 25
such state departments (including the District of Columbia) as of July
31, 1997.
- - The Company benefits from the scope of its customers' sales and
marketing staffs and greater market presence.
Speaker Verification
The Company markets its SpeakEZ Voice Print(sm) technology through various
marketing channels. This includes service provider delivery and leveraging off
current customer relationships (e.g. GTE-TSI). In addition, the Company has
entered into various sales and distributor agreements to deploy SpeakEZ Voice
Print(sm) technology in various industries (e.g. Lucent, IBM, and OTG).
COMPETITION
Inmate Calling
The telecommunications services industry, especially the Public Communications
sector and the inmate calling market, is and can be expected to remain highly
competitive. The Company competes directly with other suppliers of inmate call
processing systems that sell their products to the Company's customers, such as
manufacturers of call processing equipment. These include Lucent Technologies
(formerly AT&T Network Systems), Nortel (formerly Northern Telecom, Inc.),
Gateway Technologies, Inc., Talton Communications, Harris Corporation, and
Science Dynamics Corporation. The Company also competes with some of these same
companies that are teamed with various call providers, including the Company's
current customers. Finally, the Company's systems may also compete with
technologies developed internally by its customers, such as those developed by
AT&T Bell Labs. The Company believes that its ability to compete in the inmate
calling industry depends upon the quality of the features and services it
provides, its proprietary technology such as three-way call prevention, lower
cost of deployment through transaction-based pricing, the availability of
service administrators, the flexibility it offers through both premises-based
and network-based systems and the strength of its relationships
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with customers. However, the Company often relies on its customers to market its
services to correctional facilities, which has the effect of limiting the
Company's control over the outcome of competitive bidding processes.
Speaker Verification
The market for speaker verification technology is relatively new. The Company
will primarily compete with speaker verification companies along with
established speech recognition, IVR and telephone system companies. These
include AT&T, InterVoice, Inc., ITT Aerospace/ Communication, Nortel, Phillips,
IBM, Lernout and Hauspie, Texas Instruments, Veritel Corporation and Voice
Control Systems, Inc., and Voice Processing Corporation. The Company also faces
competition from biometric technology providers such as Identix and from network
security technology providers such as Security Dynamics. The Company believes
that its ability to compete for the markets outlined previously, depends on the
performance of its technology, its feature-rich nature, and the cost and ease
with which it is integrated with customers networks. In addition, the Company
believes existing relationships and experience strengthen its competitive
position.
MANUFACTURING AND PRODUCT DESIGN
Inmate Calling
The Company designs and develops its proprietary technology for its inmate
calling systems. The Company has designed eleven proprietary printed circuit
boards for its products.
The manufacturing process consists of line card assembly (performed by ISO 9002
compliant subcontractors) and system integration and testing (performed by the
Company). The Company's primary subcontractor purchases virtually all of the
peripheral devices and components of its systems from other manufacturers. Most
of the components and peripheral devices are available from a number of
different suppliers, although the Company purchases one component from a single
source. Although the Company has not experienced any significant problems in
obtaining required supplies and believes that alternative sources for most items
could be obtained, future shortages of components could result in installation
delays which might have a material adverse effect on its business. The Company
has adopted inventory policies which are designed to mitigate this risk.
The final assembly and systems installation consists of rack-mounting multiple
line cards, configuring the local area network, calibrating and conditioning the
system and customizing software as required by the correctional facility. These
procedures are performed by the Company's installers and service administrators
on site, or at the point-of-presence in the case of a network-based
installation. The Company strongly emphasizes quality control in the design,
manufacture, installation and test phases of the product development and service
delivery process.
To remain on the forefront of innovative technology and a market leader in the
Corrections Industry, the Company plans to deliver a new Computer Telephony
Interface Platform in early 1998. This new Inmate Call Control System, will
include all of the current voice response technology, fraud control features,
and network interfaces along with new data link interfaces, switching functions,
a new Graphical User Interface (GUI) and many new call control features. The
hardware construction will be primarily from third party manufacturers and will
utilize high density digital/analog network interfaces and shared hardware
resources to allow many channels of call control within a single enclosure. This
architecture dramatically reduces the physical space, power and operational
maintenance requirements of the Company's current inmate calling system while
also dramatically increasing system features, functionality and efficiencies.
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Speaker Verification
SpeakEZ Voice Print(sm) technology is primarily software applications. The
hardware necessary for implementation is primarily provided by third party
manufacturers and is available from a variety of suppliers.
RESEARCH AND PRODUCT DEVELOPMENT
The Company believes that the timely development of new products and
enhancements to existing products is essential to maintain its competitive
position. The Company conducts research and development to enhance its existing
products (including inmate calling products and SpeakEZ Voice Print(sm)
products) and to build new products , both complementary to the existing
product line and in new functional areas. Delays or difficulties associated
with new products or product enhancements could have a material adverse affect
on the Company's business, operating results and financial condition.
During fiscal 1997, 1996 and 1995, the Company's research and product
development expenditures were approximately $2.8 million, $2.4 million and $0.7
million. Such amounts in 1997 are net of capitalized software development costs
of $469,000. There were no such costs capitalized in 1996 and 1995. In fiscal
1997 approximately $1.5 million of research and product development
expenditures were for the SpeakEZ Voice Print(sm) technology. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations".
DIRECT INMATE CALL PROVISIONING
Prior to the establishment of its transaction-based fee structure, the Company
conducted business as a private provider of inmate calling services directly to
certain correctional facilities. The Company is contractually bound to continue
this business operation; however, it has been converting this business to the
transaction-based fee structure as contracts come up for renewal.
Additionally, the Company from time to time acquires new contracts to provide
inmate calling services directly as an accommodation to certain customers in
situations where the customer has a contract to provide long-distance services
to the correctional facility but where the local exchange carrier is not a
customer and not a member of the bidding team. In these cases, the Company then
acts as the local call provider delivering a consistent level of service for all
inmate calls, local or long distance.
As a direct inmate call provider, the Company buys "wholesale" call services
from the call providers to be re-sold as collect calls to the inmates' called
parties. The Company uses the services of third parties to bill its calls to the
billed parties. The Company enters into direct contracts with the correctional
facilities and generally pays commissions on the gross billed revenue to the
correctional facilities. Because of these and other operating costs, including
bad debt write-offs, the margins from this line of business are significantly
lower than the Company's transaction-based arrangements and the risk is
considerably higher. As a result, the Company's strategy is to continue to
manage this line of business as an accommodation and expects to convert the
business to the transaction basis as soon as it is practicable to do so.
In 1997, the Company installed its first significant location where the Company
is the long distance carrier. Due to the changing competitive environment, the
Company anticipates that it will increase its role as a long distance carrier
and experience the associated revenue in the future.
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REGULATION
The Company's customers, and a minor portion of its current operations, are
subject to regulation by the FCC and public utility commissions of certain
states in which the Company and its customers operate. Regulatory actions have
impacted, and are likely to continue to impact, both the Company's customers and
its operations. For example, the adoption of regulations which would encourage
additional competition in the business of the Company's customers could have a
material adverse effect on the amount of business done by such customers and the
manner in which such business is done. A reduction in the amount of business
done by the Company's customers would have a material adverse impact on the
Company's revenue since such revenues are directly related to volumes of calls
processed under the Company's transaction fee pricing. Changes in the manner in
which the Company's customers conduct their business could have a material
adverse impact on the Company if, as a result of such changes, the Company's
services and features were no longer needed or desired or if the Company were
not able to modify, or add to, its services in a way that meets the new market
demands of its customers.
The FCC has adopted a petition filed by an industry group comprised of
independent inmate call providers asking the FCC to adopt regulations modifying
the treatment of the provision of inmate calling services by all LECs including
the RBOCs. This petition requires the LECs to provide separate accounting
records for their public communication segments which includes inmate calling.
These regulations may be to require LECs to allocate more of their costs to
inmate calling services, thereby making the RBOC customers of the Company less
competitive in this market, which in turn could have a material adverse effect
on the Company.
In 1996, Congress passed the Telecommunications Act of 1996. This legislation
opens up the network of local exchange carriers to further competition, and to
eliminate certain prohibitions upon LECs entering into other lines of business.
The legislation (i) opens local exchange service to competition and preempts
states from imposing barriers preventing such competition, (ii) imposes new
unbundling and interconnection requirements on local exchange carrier networks,
(iii) removes prohibitions on inter-LATA services and manufacturing if certain
competitive conditions are met, (iv) transfers any remaining requirements of the
Consent Decree (including its nondiscrimination provisions) to the FCC's
jurisdiction, (v) imposes requirements to conduct certain competitive activities
only through structurally separate affiliates and (vi) eliminates many of the
remaining cable and telephone company cross-ownership restrictions.
Additionally, the legislation requires the special accounting provisions for the
LECs as requested in the petition described above.
This legislation will significantly change the competitive landscape of the
telecommunications industry as a whole. For example, permitting the RBOCs to
provide long-distance service cause the Company's RBOC customers to become
direct competitors of AT&T, which in turn could adversely affect the Company's
relationships with all such customers. For example, the Company's current
relationship with AT&T may foreclose opportunities to provide long distance
services to its current RBOC customers, if and when they enter the long-distance
market. As a result, a loss of long-distance market share by AT&T could result
in a corresponding loss of market share by the Company.
In April 1992, the FCC proposed a new access plan for operator-assisted
interstate calls. Currently, the site owner selects the call provider for
interstate collect calls or other operator-assisted interstate calls originating
from the site owner's premises. Under the proposed access plan, referred to as
"billed party preference," interstate collect calls or other operator-assisted
interstate calls would instead be provided by the interstate call provider
chosen by the party paying for the call. The billed party preference proposal,
if adopted, could immediately reduce the Company's revenue derived from existing
contracts to the extent that billed parties for interstate calls currently
processed by the Company select call providers with whom the
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<PAGE> 21
Company has no relevant contractual relationship. Moreover, if implementation of
this proposal leads to technological or structural changes in the Public
Communications industry, it could render the Company's technology obsolete,
diminish the value of the Company's customer relationships, or reduce the volume
or profitability of calls originating from correctional facilities.
The foregoing discussion does not purport to describe all present and proposed
federal, state and local regulations, legislation, and related judicial or
administrative proceedings relating to the telecommunications industry and
thereby affecting the businesses of the Company. The impact of increased
competition on the operations of the Company will be influenced by the future
actions of regulators and legislators who are increasingly advocating
competition. While the Company would attempt to modify its customer
relationships and its service offerings to meet the challenges resulting from
changes in the telecommunications competitive environment, there is no assurance
it will be able to do so.
PATENTS AND OTHER PROPRIETARY RIGHTS
The Company relies on a combination of patents, copyrights, and trade-secrets to
establish and protect its proprietary rights in its systems. The Company
vigorously pursues protection of its proprietary technology and other
intellectual property. On June 7, 1994, the U.S. Patent & Trademark Office
issued to the Company Patent No. 5,319,702 related to three-way call detection.
The Company has filed a corresponding patent application with the patent office
in Canada, but this application has not yet been acted upon. On July 23, 1997,
the U.S. Patent Trademark Office issued to the Company Patent No. 5,539,812
which is a continuation-in-part of Patent No. 5,319,702. While the Company
considers any patents issued to be a significant factor in enabling it to
compete in the inmate calling industry, the Company believes its success is
primarily dependent on the knowledge, ability and experience of its personnel,
its customer service and its ongoing ability to develop services to meet its
customers' needs. The Company has sought federal and state trademark protection
for certain of its trademarks, including Strike Three!(TM) and T-NET(TM).
Additionally, the Company is seeking patent protection for significant
enhancements to its three-way detection technology.
In conjunction with its acquisition of SpeakEZ, the Company has obtained certain
exclusive and/or non-exclusive rights U.S. and foreign patent applications
relating to the speaker verification and/or identification technology that are
pending in the name of Rutgers University including one already issued U.S.
Patent, i.e., No. 5,522,012 for "Speaker Identification and Verification
System," which was issued on May 28, 1997. The Company has also filed patent
applications in its own name for further developments in that field.
Despite the precautions taken by the Company, it may be possible for
unauthorized third parties to copy aspects of the Company's products or to
obtain and use information that the Company regards as proprietary. The Company
has and intends to continue to enforce patents issued to it and protect its
trade secrets.
On October 21, 1996, the Company reached a settlement with Gateway Technologies,
Inc. of Carrollton, Texas ("Gateway") regarding the patent infringement
litigation between them. Included in the settlement, the Company was granted a
royalty-bearing, nonexclusive, non-assignable license, without right to grant
sublicenses, under certain Gateway Licensed Patents dealing primarily with
automated operator operations.
In December 1995, the Company was awarded a Consent Order from the U.S. District
Court in Colorado as a result of a patent infringement lawsuit it brought
against Communications Equipment and Engineering Corp. (CEECO). By terms of the
Consent Order, CEECO admitted infringement of the Company's technology and
agreed to cease the manufacturing of the infringing product. Included in the
CEECO settlement, the Company was granted an exclusive
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<PAGE> 22
license for U.S. Patent No. 4,993,062 for "Telephone Control System Including
Stored Blocked and Allowed Telephone Numbers: (the "DULA Patent").
EMPLOYEES
As of July 31, 1997, the Company had 337 full-time equivalent employees. For
the Inmate calling line of business, the departmental classification of such
employees is as follows: 15 engineering and product development personnel; 12
marketing and sales personnel; 32 finance, information systems and
administrative personnel; 21 production and installation personnel; and 212
field operations personnel. For the SpeakEZ Voice Print(sm) line of business,
the departmental classification of such employees is as follows: 30 research
and product development personnel; 9 marketing and sales personnel; 6
administrative personnel. None of the Company's employees are subject to a
collective bargaining agreement.
ITEM 2. PROPERTIES
The Company's corporate headquarters and assembly operations are located in
approximately 38,000 square feet of leased office space in Englewood, Colorado.
The lease for such space terminates effective November 1, 2001. These facilities
are suitable and adequate for the Company's operations currently and through the
end of the lease. The Company also leases approximately 13,000 square feet in
Piscataway, New Jersey, where the company's SpeakEZ Voice Print(sm) research and
development operations are located. In addition, as of July 31, 1997, the
Company leased 15 point of presence locations throughout the country, with a
maximum size of approximately 750 square feet. These point of presence
facilities are suitable and adequate for the Company's operations in these
locations currently and for the foreseeable future.
ITEM 3. LEGAL PROCEEDINGS
Except as set forth below, the Company is not a part to any pending material
legal proceedings before any court, administrative agency or other tribunal.
Further, the Company is not aware of any litigation which is threatened against
it in any court, administrative agency or other tribunal.
Effective as of February 11, 1997, the Company entered into a Settlement
Agreement with BellSouth Telecommunications, Inc. ("BellSouth") in settlement of
the suits pending between the parties in federal courts in Colorado and Georgia.
Under the terms of the Agreement, the parties agreed to enter Stipulated Orders
of Dismissal in both suits, ending the litigation between them.
Under the Agreement, the Company has agreed to a limited license of certain of
its technology, including U.S. Patent No. 5,319,702 relating to three-way call
detection technology, to BellSouth in exchange for an up-front payment of
$750,000 and additional payments, based on additional lines which may be
deployed by BellSouth in the future, of up to $350,000. The terms of the license
permit BellSouth to use, or have made for its use, three-way call detection
products utilizing the Company's technology, but not to sublicense or to
manufacture or sell products utilizing such technology for use by others. The
use license extends to those customers of BellSouth with respect to products
supplied by BellSouth.
On October 21, 1996, the Company reached a settlement with Gateway Technologies,
Inc. of Carrollton, Texas ("Gateway") regarding the patent infringement
litigation between them.
As previously reported in 1996, the Company filed a civil action against Gateway
Technologies, Inc. ("Gateway") alleging infringement of the Company's U.S.
Patent 5,319,702 on three-way call detection (the "702 Patent"), in Tele-Matic
Corporation v. Gateway Technologies, Inc., Civil Action No. 95-S-880, pending in
the United States District Court for the District of Colorado. On May 5, 1996,
Gateway and Intellicall, Inc. ("Intellicall") filed an action against
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<PAGE> 23
the Company alleging infringement of U.S. Patents No. 4,935,956, 4,908,852,
4,920,558, 5,920,562, 4,933,966 and 5,093,858 (collectively, the "Gateway
Patents") in Gateway Technologies, Inc. et. al. v. Tele-Matic Corporation, Civil
Action No. 395-CV-0855R, pending in the U.S. District Court for the Northern
District of Texas, Dallas Division. On October 21, 1997, the parties resolved
the matters involved in both lawsuits.
Pursuant to the settlement agreement, the parties have filed and the courts have
entered stipulated final judgments and orders dismissing the claims in
litigation. As part of the settlement, the Company and Gateway have agreed to
cross-license certain patents involved in the litigation. Each party will pay
royalties to the other for the use of such patents.
In August 1995, Independent Telecommunications Network, Inc. ("ITN") filed a
demand for arbitration with the American Arbitration Association, claiming the
Company had breached certain query transport services contracts with ITN by, ITN
alleges, terminating those contracts. In August 1997, the Company and ITN
entered into a settlement agreement whereby the Company agreed to a new
agreement for provisioning of telecommunication services. There was no material
effect on the Company as a result of the settlement.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of shareholders during the fourth
quarter of the fiscal year on which this report is being made.
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS
The Common Stock of the Company is quoted on the NASDAQ National Market System
under the symbol "TNTX." The following table sets forth the range of quarterly
high and low closing sale prices of the Common Stock of the Company, all as
reported on the NASDAQ National Market System for the two most recent fiscal
years.
<TABLE>
<CAPTION>
High Low
<S> <C> <C>
Year Ended July 31, 1997
First quarter.............................................................. $14.75 $8.50
Second quarter............................................................. 14.13 9.25
Third quarter.............................................................. 12.25 7.00
Fourth quarter............................................................. 10.25 6.75
Year Ended July 31, 1996
First quarter.............................................................. $15.00 $11.50
Second quarter............................................................. 13.75 8.19
Third quarter.............................................................. 12.75 8.75
Fourth quarter............................................................. 16.50 7.25
</TABLE>
As of October 15, 1997, the number of record holders of the Company's common
stock was approximately 183, and the Company estimates that as of that date
there were 2,275 beneficial owners of its stock.
The Company has never declared or paid any cash dividends on its capital stock.
The Company currently intends to retain its earnings, if any, to finance future
growth and therefore does not anticipate paying any cash dividends in the
foreseeable future.
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<PAGE> 24
ITEM 6. SELECTED FINANCIAL DATA
The selected financial data presented below under the captions "Statement of
Operations Data" and "Balance Sheet Data" for, and as of the end of, each of the
years in the five-year period ended July 31, 1997, are derived from the audited
consolidated financial statements of the Company and subsidiaries. The
consolidated financial statements as of July 31, 1997 and 1996, and for each of
the years in the three-year period ended July 31, 1997, are included elsewhere
in this Form 10-K.
<TABLE>
<CAPTION>
YEAR ENDED JULY 31,
------------------------------------------------------
1997 1996 1995 1994 1993
---- ---- ---- ---- ----
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenue:
Telecommunications services....................... $ 33,471 $ 30,249 $ 24,262 $ 7,529 $ 2,000
Telecommunications licensing...................... 750 - - - -
Direct call provisioning.......................... 1,395 3,072 3,492 3,416 3,342
Voice print....................................... 676 57 - - -
Equipment sales................................... - - - 345 225
-------- -------- -------- ------- --------
Total revenue................................. 36,292 33,378 27,754 11,290 5,567
Expenses:
Operating costs and expenses:
Telecommunications services..................... 14,478 13,489 10,658 3,128 1,172
Direct call provisioning........................ 1,297 2,940 3,370 2,840 2,695
Voice print..................................... 170 - - - -
Cost of equipment sold.......................... - - - 304 182
-------- -------- -------- ------- --------
Total operating costs and expenses............ 15,945 16,429 14,028 6,272 4,049
Selling, general and administrative............... 7,488 6,434 5,413 2,703 1,965
Research and development.......................... 2,769 2,374 732 494 317
Depreciation and amortization..................... 8,135 5,920 3,607 1,099 381
-------- -------- -------- ------- --------
Total expenses................................ 34,337 31,157 23,780 10,568 6,712
-------- -------- -------- ------- --------
Operating income (loss)........................... 1,955 2,221 3,974 722 (1,145)
Interest expense.................................. (932) (548) (636) (1,044) (441)
-------- -------- -------- ------- --------
Earnings (loss) before income taxes........... 1,023 1,673 3,338 (322) (1,586)
Income taxes...................................... (432) (46) (150) - -
-------- -------- -------- ------- --------
Net earnings (loss)........................... $ 591 $ 1,627 $ 3,188 $ (322) $ (1,586)
======== ======== ======== ======== ========
Net earnings (loss) per common share.............. $ 0.07 $ 0.18 $ 0.38 $ (0.06) $ (0.32)
======== ======== ======== ======== ========
Weighted average common shares
outstanding..................................... 8,950 9,151 8,360 5,280 4,907
NUMBER OF CALLS PROCESSED............................ 90,953 79,760 61,650 19,846 5,974
</TABLE>
<TABLE>
<CAPTION>
JULY 31,
------------------------------------------------------
1997 1996 1995 1994 1993
---- ---- ---- ---- ----
(AMOUNT IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Total assets......................................... $ 46,910 $ 42,527 $ 34,904 $ 16,968 $ 5,838
Loans from customer.................................. - - 449 3,728 3,550
Debt and capital lease obligations................... 13,378 6,809 5,613 5,883 2,185
Total liabilities.................................... 20,058 16,968 14,449 15,401 7,535
Shareholders' equity (deficit)....................... 26,852 25,559 20,455 1,567 (1,697)
</TABLE>
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<PAGE> 25
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
For a comprehensive understanding of the Company's financial condition and
performance, this discussion should be considered within the context of the
consolidated financial statements and accompanying notes and other information
contained herein.
The Private Securities Litigation Reform Act of 1995 provides a "safe harbor"
for forward-looking statements. Certain information contained in management's
discussion and analysis of financial condition and results of operations and
elsewhere in this Form 10-K include forward-looking statements that involve
risks and uncertainties not limited to, the demand for the Company's products
and services and market acceptance risks, the renewal of existing site specific
customer contracts, the ability to retain the base of current site specific
customer contracts, the continued relationship with existing customers, the
effect of economic conditions, the effect of regulation, including the
Telecommunications Act of 1996, the impact of competitive products and pricing,
the Company's continuing ability to develop hardware and software products,
commercialization and technological difficulties, manufacturing capacity and
product supply constraints or difficulties, actual purchases by current and
prospective customers under existing and expected agreements, the progress of
contract implementation efforts that allow the Company to recognize revenue
under its accounting policies, and the results of financing efforts, along with
the other risks detailed herein.
OVERVIEW
INMATE CALLING SERVICES
The Company derives revenue under contracts with its customers, including AT&T,
MCI, Bell Atlantic, GTE, NYNEX, SBC Communications, Inc., BellSouth and U S
WEST, and other telecommunications service providers, primarily from the
provisioning of specialized call processing services for correctional
facilities. This revenue is generated under long-term contracts which provide
for transaction fees paid on a per-call basis. The Company is paid a prescribed
fee for each call completed and additional fees for validating phone numbers
dialed by inmates. The Company also derives revenue as a direct provider of
inmate calls, although this service is provided primarily as an accommodation to
certain customers. The Company expects to derive a declining percentage of total
revenue from its direct call provisioning business. However, in the event the
Company is awarded contracts as a long distance provider, revenue will increase
accordingly. The following table sets forth certain information concerning the
accepted calls processed by the Company for its customers in the inmate calling
market and excludes direct call provisioning.
<TABLE>
<CAPTION>
THREE MONTHS ENDED
-----------------------------------------------------------------------------------------------------
JUL. 31, APR. 30, JAN. 31, OCT. 31, JUL. 31, APR. 30, JAN. 31, OCT. 31,
1997 1997 1997 1996 1996 1996 1996 1995
-----------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Call volumes processed ......23,468,000 22,695,000 23,059,000 21,731,000 21,064,000 20,344,000 19,715,000 18,637,000
Average daily transactions .. 255,000 255,000 250,000 236,000 229,000 226,000 214,000 203,000
</TABLE>
The Company's call volume and revenue growth have resulted primarily from adding
call processing systems for both existing and new customers. The Company
believes it has also benefited, to a lesser extent, from the overall growth in
the inmate calling market. The Company will continue to market its services to
additional call providers; however, it expects growth in call processing volumes
will come predominantly from adding new systems for existing customers. The
Company expects the rate of growth in calls processed will decrease relative to
the historical rates.
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<PAGE> 26
SPEAKEZ SUBSIDIARY
The Company's acquisition of SpeakEZ in October 1995 has led to an increased
focus on new technology, specifically speaker verification and identification
technologies. The Company believes that its on going product development
activities for the SpeakEZ Voice Print(sm) technology will provide current and
future opportunities for revenue. SpeakEZ Voice Print(sm) products are available
and ready for sale in the telecommunications, financial services, computer
network and computer telephony integration ("CTI") markets and the Company has
recorded initial revenue on these products in the year ended July 31, 1997.
However, there can be no assurance that these products will achieve market
acceptance and become widely adopted. The market for speaker verification
software has only recently begun to develop. As is typical in the case of a new
and rapidly evolving market, demand and market acceptance for recently
introduced products and services are subject to a high level of uncertainty.
The SpeakEZ Voice Print(sm) products are also often times subject to a long
sales cycle. This is especially true in the Company's target markets, where
customers generally commit significant resources to an evaluation of new
software and require the vendor to expend substantial time, effort, and money
educating them about the value of the vendor's solution. As a result, sales to
these types of customers generally require an extensive sales effort throughout
the organization, and often require final approval by an executive officer or
senior level employee. Further, in most cases the Company's SpeakEZ Voice
Print(sm) software applications must be integrated and made compatible with the
customers' embedded information systems. Typically, the system integration
effort requires the cooperation of other technology vendors which also
contribute to the extension of the sales cycle. The Company will likely
experience delays following initial contact with prospective customers and
expend substantial funds and management effort in connections with these sales.
There can be no assurance that the Company will be able to successfully execute
such sales. The Company uses other technology suppliers in addition to its own
direct sales force to distribute its technology and therefore at time lacks
control over such partners. Due to this and reason discussed above, revenue
from the Company's SpeakEZ Voice Print(sm) products and services will be
difficult to predict. While the Company attempts to pursue multiple market
revenue opportunities at any given time, there can be no assurance that the
Company will not experience fluctuations in revenue from its SpeakEZ Voice
Print(sm) products and services. The Company has and will continue to invest
significant time and effort and resources in bringing these products to market
and anticipates the continued offering of new SpeakEZ Voice Print(sm) products
and services.
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<PAGE> 27
RESULTS OF OPERATIONS
Fiscal 1997 Compared to Fiscal 1996
The following table sets forth certain statement of operations data as a
percentage of total revenue for the years ended July 31, 1997 and 1996.
<TABLE>
<CAPTION>
YEAR ENDED JULY 31,
-------------------
1997 1996
---- ----
<S> <C> <C>
Revenue:
Telecommunications services ................................................. 92% 91%
Telecommunications licensing ................................................ 2 --
Direct call provisioning .................................................... 4 9
Voice print ................................................................. 2 --
---- ----
Total revenue ........................................................... 100 100
Expenses:
Operating costs and expenses ................................................ 44 49
Selling, general and administrative ......................................... 21 19
Research and development .................................................... 8 7
Depreciation and amortization ............................................... 22 18
---- ----
Operating income .......................................................... 5 7
Interest expense ............................................................ (2) (2)
---- ----
Earnings before income taxes .............................................. 3 5
Income taxes ................................................................ (1) --
---- ----
Net earnings .............................................................. 2% 5%
==== ====
</TABLE>
Total Revenue. Total revenue increased 9% to $36,292,000 for the year ended
July 31, 1997, from $33,378,000 for the prior year. This increase resulted from
a 11% increase in telecommunications services revenue to $33,471,000 for the
year ended July 31, 1997, from $30,249,000 in the prior year, due to a 14%
increase in call volume to 90,953,000 calls resulting primarily from an
increase in the number of installed systems and the conversion of direct call
provisioning to transaction based fee contracts with other call providers. Due
to the Company's significant market share, the Company expects that the rate of
growth in calls processed will decrease relative to the historical rate. The
Company recorded $750,000 of telecommunications licensing revenue during the
year ended July 31, 1997. This revenue was associated with the licensing of the
Company's Strike ThreeTM product to a single customer. There was no such
revenue in the corresponding prior period. The Company does not expect
significant contribution from telecommunications licensing revenue in the near
future. Direct call provisioning revenue decreased as a percentage of total
revenue in part due to the increase in telecommunications services revenue and
other forms of revenue and due to the conversion of direct sites to
telecommunications services revenue sites. There was also a dollar decrease in
direct call provisioning revenue of $1,677,000 due to conversion of certain
sites serviced to transaction based fees. The Company anticipates it will
continue to convert some of its direct call provisioning accounts to
telecommunications services customers for which it receives transaction fee
revenue versus direct call provisioning revenue. The Company does anticipate an
increase in direct revenue in the event that it continues to be successful in
provisioning the long distance service on certain site contracts. The Company
also recognized SpeakEZ Voice Print(sm) revenue in the amount of $676,000 for
custom engineering and for the sale of software licenses and hardware systems.
Future amounts of voice print revenue are unpredictable and depend upon market
acceptance, risk of technological success, and impact of new competition.
-27-
<PAGE> 28
Operating Costs and Expenses. Total operating costs and expenses decreased to
$15,945,000 for the year ended July 31, 1997, from $16,429,000 for the year
ended July 31, 1996, and also decreased as a percentage of total revenue to 44%
from 49% in the prior year. Operating costs and expenses of telecommunications
services primarily consist of service administration costs for correctional
facilities, including salaries and related personnel expenses, communication
costs and inmate calling systems repair and maintenance expense. Operating costs
and expenses of telecommunications services also include costs associated with
call verification procedures, primarily network expenses and database access
charges. The Company invoices these verification procedure costs to its
customers with minimal margins. There were minimal costs directly associated
with telecommunications licensing revenue. Operating costs and expenses
associated with direct call provisioning include the costs associated with
telephone line access, commissions paid to correctional facilities, costs
associated with uncollectible accounts and billing charges. Voice print
operating costs for the year ended July 31, 1997 include the cost of hardware
systems sold, installation costs, and royalty charges.
The following table sets forth the operating costs and expenses for each type of
revenue as a percentage of corresponding revenue for the years ended July 31,
1997 and 1996.
<TABLE>
<CAPTION>
YEAR ENDED JULY 31,
-------------------
1997 1996
---- ----
<S> <C> <C>
Operating costs and expenses:
Telecommunications services ......................................... 43% 45%
Direct call provisioning ............................................ 93 96
Voice print ......................................................... 25 --
</TABLE>
Operating costs and expenses associated with providing telecommunications
services decreased as a percentage of corresponding revenue to 43% for the year
ended July 31, 1997, from 45% in the prior year. The decrease is primarily due
to cost containment measures implemented by the Company in the delivery of its
services. Direct call provisioning costs decreased as a percentage of
corresponding revenue to 93% for the year ended July 31, 1997, from 96% in the
corresponding prior year. This percentage decrease is primarily attributable to
the conversion of sites that had an overall higher cost structure due to a
higher commission expense than the remaining direct sites. Voice print operating
costs for the year ended July 31, 1997 include the cost of hardware systems
sold, installation costs, and royalty charges.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased to $7,488,000 for the year ended July 31,
1997, from $6,434,000 in the prior year, and increased as a percentage of total
revenue to 21% from 19% in the corresponding prior year. The dollar increase was
$1,054,000. This increase consists primarily of approximately $938,000 for
marketing personnel and other marketing costs to support the SpeakEZ Voice
Print(sm) products. The Company expects selling, general, and administrative
expenses for the fiscal year ended July 31, 1998 to be consistent with the
percentages incurred during fiscal 1997. There can be no assurance, however,
that due to the potential lack of market acceptance, risk of technological
success, or impact of new competition that revenue will grow at the same rate as
the anticipated selling, general and administrative expenses.
Research and Development Expenses. Research and development expenses increased
to $2,769,000 for the year ended July 31, 1997, from $2,374,000 in the
corresponding prior year, primarily due to the addition of personnel to develop
and commercialize the Company's SpeakEZ Voice Print(sm) technology. The
research and development expense associated with the SpeakEZ Voice Print(sm)
technology was $1,527,000 for the year ended July 31, 1997 as compared to
$1,060,000 for the corresponding prior year. For the year ended July 31, 1997,
the Company capitalized $411,000 of computer software development costs
associated with the
-28-
<PAGE> 29
SpeakEZ Voice Print(sm) technology. There were no such costs capitalized in the
corresponding prior year. In addition, under a government contract the Company
is partially reimbursed for expenses on this project. This reimbursement totaled
approximately $350,000 for the year ended July 31, 1997 and was recognized as a
reduction to SpeakEZ Voice Print(sm) technology related research and development
expenses. Such reimbursements were not significant for the corresponding prior
year. The Company capitalized $58,000 of computer software development costs
associated with the development of a new inmate calling platform during the year
ended July 31, 1997. The Company expects the dollar amount of research and
development expense to remain at current levels over the next fiscal year. There
can be no assurance, however, that due to potential lack of market acceptance,
risk of technological success, or impact of new competition that revenue will
grow at the same rate as the anticipated research and development expenses.
Depreciation and Amortization Expenses. Depreciation and amortization expenses
increased to $8,135,000 for the year ended July 31, 1997, from $5,920,000 in
the corresponding prior year. The increase is due to an increased fixed asset
base resulting from increased inmate call processing systems installed by the
Company. In addition, infrastructure additions in research and development and
selling, general and administrative functions also added to the increase in
depreciation for office and testing equipment. The depreciation and
amortization associated with the SpeakEZ Voice Print(sm) technology and the
related business acquisition was $705,000 for the year ended July 31, 1997 as
compared to $344,000 for the corresponding prior year. The Company expects
depreciation and amortization to continue to increase as the number of inmate
call processing systems and potential installations for SpeakEZ Voice Print(sm)
systems increase. The increases, however, may be offset as certain capitalized
costs from previous periods become fully depreciated.
Interest Expense. Interest expense increased to $932,000 for the year ended July
31, 1997, from $548,000 in the corresponding prior period. The increase was
primarily attributable to a increase in the balance of indebtedness. The
increase in indebtedness was necessary to support capital expenditures for
inmate call processing systems and operating expenses. In addition, the Company
had a significant increase in accounts receivable due to a change in a major
customer's purchase order system. Approximately $4,800,000 of accounts
receivable is attributable to this customer at July 31, 1997 and approximately
$3,200,000 has been collected by September 1997. Management believes that the
processing issues will be resolved and the amount outstanding will be paid by
the customer.
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<PAGE> 30
Fiscal 1996 Compared to Fiscal 1995
The following table sets forth certain statement of operations data as a
percentage of total revenue for the years ended July 31, 1996 and 1995.
<TABLE>
<CAPTION>
YEAR ENDED JULY 31,
1996 1995
---- ----
<S> <C> <C>
Revenue:
Telecommunications services ................... 91% 87%
Direct call provisioning ...................... 9 13
---- ----
Total revenue ............................. 100 100
Expenses:
Operating costs and expenses .................. 49 51
Selling, general and administrative ........... 19 19
Research and development ...................... 7 3
Depreciation and amortization ................. 18 13
---- ----
Operating income ............................ 7 14
Interest expense .............................. (2) (2)
---- ----
Earnings before income taxes ................ 5 12
Income taxes .................................. -- (1)
---- ----
Net earnings ................................ 5% 11%
==== ====
</TABLE>
Total Revenue. Total revenue increased 20% to $33,378,000 for the year ended
July 31, 1996, from $27,754,000 for the prior year. This increase resulted from
a 25% increase in telecommunications services revenue to $30,249,000 for the
year ended July 31, 1996, from $24,262,000 in the prior year, due to a 29%
increase in call volume to 79,760,000 calls resulting primarily from an increase
in the number of installed systems and the conversion of direct call
provisioning to transaction based fee contracts with other call providers. Due
to the Company's significant market share, the Company expects that the rate of
growth in calls processed will decrease relative to the historical rate. An
offsetting factor to the increase in telecommunications services revenue dollars
is a reduction in charges per call as the Company's customers meet contractually
agreed upon call volume discounts. Specifically, these discounts accounted for a
reduction in revenue of approximately $1,180,000 during the year ended July 31,
1996. Direct call provisioning revenue decreased as a percentage of total
revenue in part due to the increase in telecommunications services revenue and
due to the conversion of direct sites to telecommunications services revenue.
There was also a dollar decrease in direct call provisioning revenue due to
conversion of sites serviced to transaction based fees.
Operating Costs and Expenses. Total operating costs and expenses increased to
$16,429,000 for the year ended July 31, 1996, from $14,028,000 for the year
ended July 31, 1995, but decreased as a percentage of total revenue to 49% from
51% in the prior year. Total operating costs and expenses as a percentage of
total revenue decreased due to an increase in telecommunications services
revenue which has a higher margin than direct call provisioning. This was
partially offset by a decline in margins for telecommunications services due to
volume discounts. Operating costs and expenses of telecommunications services
primarily consist of service administration costs for correctional facilities,
including salaries and related personnel expenses and inmate calling systems
repair and maintenance expense. Operating costs and expenses of
telecommunications services also include costs associated with call verification
procedures, primarily network expenses and database access charges. The Company
invoices these verification procedure costs to its customers with minimal
margins. Operating costs and expenses associated with direct call provisioning
include the costs associated with telephone line access, commissions paid to
correctional facilities, costs associated with uncollectible accounts and
billing charges.
-30-
<PAGE> 31
The following table sets forth the operating costs and expenses for each type of
revenue as a percentage of corresponding revenue for the years ended July 31,
1996 and 1995.
<TABLE>
<CAPTION>
YEAR ENDED JULY 31,
---------------------
1996 1995
---- ----
<S> <C> <C>
Operating costs and expenses:
Telecommunications services..................................................... 45% 44%
Direct call provisioning........................................................ 96 97
</TABLE>
Operating costs and expenses associated with providing telecommunications
services increased as a percentage of corresponding revenue to 45% for the year
ended July 31, 1996, from 44% in the prior year. During fiscal 1996 there was a
decline in margin for telecommunications services because of volume discounts.
This caused a two percentage point increase in telecommunications services
operating costs and expenses. This was offset by a one percentage point decrease
due to a change in the mix of revenue and costs within telecommunications
services between site services and validation services. Validation services are
billed to customers with minimal margins. Direct call provisioning costs
decreased as a percentage of corresponding revenue to 96% for the year ended
July 31, 1996, from 97% in the prior year. This percentage decrease is primarily
attributable to a decrease in local and long distance expenses and commission
expenses for sites converted to transaction fee sites or sites not in operation
subsequent to July 31, 1996. Bad debt expense remained constant as a percentage
of direct call provisioning revenue at 16% for the year ended July 31, 1996 and
1995, and is based upon the estimates provided by the Company's billing agent.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased to $6,434,000 for the year ended July 31,
1996, from $5,413,000 in the prior year, and remained constant as a percentage
of total revenue at 19%. The dollar increase was $1,021,000. This increase
consists primarily of approximately $695,000 for salaries for administrative
personnel and related expenses (including contract personnel) and $238,000 in
insurance costs. The increase in salaries and contract personnel is due
primarily to growth in the infrastructure to support current inmate call
processing operations and the development of SpeakEZ Voice Print(sm) technology.
The increase in insurance cost relates to the amount of time directors and
officers and prospectus insurance coverage was in effect for comparative periods
and due to premium increases.
Research and Development Expenses. Research and development expenses increased
to $2,374,000 for the year ended July 31, 1996, from $732,000 in the
corresponding prior period due to the addition of personnel to develop and
commercialize the Company's SpeakEZ Voice Print(sm) technology. The research and
development expense associated with the SpeakEZ Voice Print(sm) technology was
$1,060,000 for the year ended July 31, 1996.
Depreciation and Amortization Expenses. Depreciation and amortization expenses
increased to $5,920,000 for the year ended July 31, 1996, from $3,607,000 in the
corresponding prior period. The increase is due to an increased fixed asset base
resulting from increased inmate call processing systems installed by the
Company, and due to the Company's continued investment in its data network for
verification procedures. In addition, infrastructure additions in research and
development and selling, general and administrative functions also add to an
increase in depreciation for office and testing equipment. The depreciation and
amortization associated with the SpeakEZ Voice Print(sm) technology and the
related business acquisition was $344,000 for the year ended July 31, 1996.
-31-
<PAGE> 32
Interest Expense. Interest expense decreased to $548,000 for the year ended July
31, 1996, from $636,000 in the corresponding prior period. The decrease was
primarily attributable to a change in the type of indebtedness and the related
reduction in borrowing rates.
QUARTERLY RESULTS
The following tables present unaudited quarterly operating results for the
Company and in the opinion of management contain all adjustments necessary for a
fair presentation of the results of operations for these periods. Management
believes that quarter-to-quarter comparisons of the Company's financial results
should not be relied upon as an indication of annual or future performance.
<TABLE>
<CAPTION>
THREE MONTHS ENDED
-----------------------------------------
JUL. 31, APR. 30, JAN. 31, OCT. 31,
1997 1997 1997 1996
---- ---- ---- ----
(AMOUNTS IN THOUSANDS)
<S> <C> <C> <C> <C>
Revenue:
Telecommunications services ................... $ 8,698 $ 8,209 $ 8,505 $ 8,059
Telecommunications licensing .................. -- 750 -- --
Direct call provisioning ...................... 347 268 351 429
Voice print ................................... 267 243 148 18
------- ------- ------- -------
Total revenue ............................. 9,312 9,470 9,004 8,506
Expenses:
Operating costs and expenses .................. 3,777 3,752 4,069 4,347
Selling, general and administrative ........... 1,637 1,924 2,063 1,864
Research and development ...................... 679 692 687 711
Depreciation and amortization ................. 2,378 2,022 1,909 1,826
------- ------- ------- -------
Total expenses ............................ 8,471 8,390 8,728 8,748
------- ------- ------- -------
Operating income .............................. 841 1,080 276 (242)
Interest expense .............................. (342) (245) (190) (155)
------- ------- ------- -------
Earnings before income taxes .............. 499 835 86 (397)
Income taxes ................................ (240) (192) -- --
------- ------- ------- -------
Net earnings .............................. $ 259 $ 643 $ 86 $ (397)
======= ======= ======= =======
</TABLE>
-32-
<PAGE> 33
The following table sets forth for the periods indicated the percentage of total
revenue represented by certain items in the Company's unaudited quarterly
statement of operations.
<TABLE>
<CAPTION>
THREE MONTHS ENDED
-----------------------------------------------------
JUL. 31, APR. 30, JAN. 31, OCT. 31,
1997 1997 1997 1996
---- ---- ---- ----
<S> <C> <C> <C> <C>
Revenue:
Telecommunications services ........................... 93% 87% 94% 95%
Telecommunications licensing .......................... -- 8 -- --
Direct call provisioning .............................. 4 3 4 5
Voice print ........................................... 3 2 2 --
---- ---- ---- ----
Total revenue ..................................... 100 100 100 100
Expenses:
Operating costs and expenses .......................... 41 40 45 51
Selling, general and administrative ................... 18 20 23 22
Research and development .............................. 7 7 8 9
Depreciation and amortization ......................... 25 21 21 21
---- ---- ---- ----
Operating income .................................... 9 12 3 (3)
Interest expense ...................................... (4) (3) (2) (2)
---- ---- ---- ----
Earnings before income taxes ........................ 5 9 1 (5)
Income taxes .......................................... (2) (2) -- --
---- ---- ---- ----
Net earnings ........................................ 3% 7% 1% (5)%
==== ==== ==== ====
</TABLE>
The following table sets forth the operating costs and expenses for each type of
revenue as a percentage of corresponding revenue for each unaudited quarter:
<TABLE>
<CAPTION>
THREE MONTHS ENDED
-----------------------------------------------------
JUL. 31, APR. 30, JAN. 31, OCT. 31,
1997 1997 1997 1996
---- ---- ---- ----
<S> <C> <C> <C> <C>
Operating costs and expenses:
Telecommunications services......................... 39% 42% 44% 49%
Direct call provisioning............................ 90 88 89 102
Voice print......................................... 36 24 9 -
</TABLE>
Total revenue decreased in the quarter ended July 31, 1997 to $9,312,000 from
$9,470,000 in the quarter ended April 30, 1997. However, telecommunications
services revenue increased by $489,000 quarter to quarter. The offsetting
difference was that $750,000 of telecommunications licensing revenue was
recognized in the quarter ended April 30, 1997 and it was not expected to recur
in the future. Direct call provisioning revenue showed an increase of $79,000
quarter to quarter reflecting the Company's first major direct call provisioning
long distance site.
Total operating costs and expenses increased to $3,777,000 for the quarter ended
July 31, 1997. This is primarily telecommunications services expense of
$3,368,000. Telecommunications services expense for the quarter ended April 30,
1997 was $3,457,000. As a percentage of related revenue, telecommunications
services expense decreased to 39% for the quarter ended July 31, 1997 from 42%
for the quarter ended April 30, 1997 due to the Company's continued cost
containment measures.
-33-
<PAGE> 34
Selling, general and administrative expenses decreased by $287,000 in the
quarter ended July 31, 1997 as compared to the previous quarter primarily due to
reductions in professional services expense and revised estimates of property
tax expense. Research and development expense decreased in the quarter ended
July 31, 1997 as compared to the previous quarter primarily due to an increase
in capitalized computer software costs associated with the new inmate calling
platform.
LIQUIDITY AND CAPITAL RESOURCES
The Company has historically relied upon commercial borrowings, the sale of
equity securities and operating cash flow to fund its operations and capital
needs. Borrowings from a line of credit with a bank supplied the Company with a
majority of its cash provided by financing activities during the year ended July
31, 1997. The net cash provided by financing activities in the year ended July
31, 1997 was $6,613,000 . Cash provided by operations was $1,986,000 for the
year July 31, 1997 as compared to $9,474,000 for the prior period. The change in
cash provided by operations was primarily attributable to decreases in net
earnings, adjusted for noncash expense items such as depreciation and
amortization, provision for losses on accounts receivable, and deferred tax
expense and noncash reductions of loans from customer. Comparably, these net
amounts totaled $9,389,000 for the year ended July 31, 1997 and $7,591,000 for
the same period in the prior year. The net change in operating assets and
liabilities was the other offsetting difference in the change in cash provided
by operations. The total change for the year ended July 31, 1997 was made up
primarily of increases in accounts receivable of $3,742,000 and decreases in
accounts payable of $4,976,000, offset by increases in accrued liabilities of
$1,560,000. The total change for the year ended July 31, 1996 was made up
primarily of decreases in accounts receivable of $508,000 offset by increases in
accounts payable of $1,828,000.
Cash used in investing activities was $8,554,000. This included capital
expenditures of $7,346,000 for the year ended July 31, 1997 as compared to
$10,440,000 in the prior period. The capital expenditures for the year ended
July 31, 1997 were mainly for telecommunications equipment and office equipment.
Additional investing activities of $1,208,000 for the year ended July 31, 1997
and $668,000 for the year ended July 31, 1996 included expenditures for patent
defense costs and capitalized software development costs. The Company
anticipates that capital expenditures for telecommunications equipment will
primarily follow the installation of new systems.
The Company has been funding its operations by using cash provided by
operations and available borrowings under a $20,000,000 line of credit
arrangement. Management believes that the credit facility should be sufficient
to fund the Company's operations and anticipated new inmate call processing
systems and potential installations for SpeakEZ Voice Print(sm) for the
foreseeable future. If the borrowing facilities and cash from operations are
insufficient to satisfy the Company's requirements, the Company may be required
to sell additional equity securities or extend its borrowing facilities. There
can be no assurance that such financing will be available or, if available,
will be obtainable on satisfactory terms.
-34-
<PAGE> 35
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The information required by Item 8 is hereby incorporated by reference to pages
F-1 through F-17 of the Company's 1997 Consolidated Financial Statements,
attached hereto.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not Applicable.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information regarding the Registrant's directors and executive officers will be
set forth in the Registrant's Proxy Statement for use in connection with the
Annual Meeting of Shareholders to be held on or about December 11, 1997. Such
information is incorporated herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
Information regarding executive compensation will be set forth in the
Registrant's Proxy Statement for use in connection with the Annual Meeting of
Shareholders to be held on or about December 11, 1997. Such information is
incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information regarding security ownership of certain beneficial owners, directors
and executive officers of Registrant will be set forth in the Registrant's Proxy
Statement for use in connection with the Annual Meeting of Shareholders to be
held on or about December 11, 1997. Such information is incorporated herein by
reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information regarding certain relationships and related transactions will be set
forth in the Registrant's Proxy Statement for use in connection with the Annual
Meeting of Shareholders to be held on or about December 11, 1997. Such
information is incorporated herein by reference.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) 1. Index to Financial Statements: A list of the consolidated
financial statements of the Registrant is incorporated
herein at Item 8 and is attached hereto.
2. Financial Statement Schedules: Following is the Index to the
Financial Statement Schedules which are attached hereto.
Independent Auditors' Report on Financial Statement
Schedule - S-1
Schedule II - Valuation and Qualifying Accounts for the Years
Ended July 31, 1997, 1996 and 1995 - S-2
-35-
<PAGE> 36
All other schedules have been omitted because they are not
required, do not apply, or the information is set forth in the
financial statements or notes thereto.
3. Exhibits:
<TABLE>
<CAPTION>
Exhibit
Number Description of Exhibit
------- ----------------------
<S> <C>
(2.1) Acquisition Agreement and Plan of Merger between Registrant and
SpeakEZ, Inc. dated October 11, 1995.****
(3.1) Articles of Amendment to the Articles of Incorporation of
Registrant****
(3.2) Amended and Restated Articles of Incorporation of Registrant**
(3.3) Amended and Restated Bylaws of Registrant*
(10.1) 1991 Non-Qualified Stock Option Plan***
(10.2) Form of 1991 Non-Qualified Stock Option Agreement***
(10.3) 1991 Incentive Stock Option Plan***
(10.4) Form of 1991 Incentive Stock Option Agreement***
(10.5) 1993 Incentive Stock Option Plan***
(10.6) Form of 1993 Incentive Stock Option Agreement***
(10.7) Agreement between American Telephone and Telegraph Company and
Registrant dated November 1, 1991*
(10.8) Loan Agreement between Registrant and INTRUST BANK, N.A., dated
as of June 2, 1997. (10.9) Standard Industrial Lease between
Pacifica Development Properties, II LLC and Registrant dated April
15, 1996 and Amendment Number One thereto, dated May 20, 1996.****
(21) Subsidiaries of Registrant*
(23.1) Consent of KPMG Peat Marwick LLP
(24) Power of Attorney
(27) Financial Data Schedule
</TABLE>
------------------------
* Incorporated herein by this reference from the Exhibits
to the Registrant's Registration Statement on Form S-1
filed with the Commission on September 8, 1994, SEC
Registration No. 33-83844.
** Incorporated herein by this reference from the Exhibits
to the Registrant's Amendment No. 1 to Registration
Statement on Form S-1 filed with the Commission on
October 11, 1994, SEC Registration No. 33-83844.
*** Incorporated herein by this reference from the Exhibits
to the Registrant's Registration Statement on Form S-8
filed with the Commission on May 23, 1995, SEC
Registration No. 33-92642 and amended on May 3, 1996.
**** Previously filed with the Commission as an exhibit to
the Company's Annual Report on Form 10-K for fiscal
year ended 1996.
(b) Reports on Form 8-K: There were no reports on Form 8-K filed
during the fourth quarter of the year ended July 31, 1997.
-36-
<PAGE> 37
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this report to be signed on its
behalf by the undersigned on October 28,1997.
T-NETIX, INC.
By: /s/ Thomas J. Huzjak
-----------------------------------------
Thomas J. Huzjak, Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the Registrant and
in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
Signature Title Date
- --------- ----- ----
<S> <C> <C>
/s/ Thomas J. Huzjak October 28, 1997
- ---------------------------------- Chairman/Chief
Thomas J. Huzjak Executive Officer
/s/ Alvyn A. Schopp October 28, 1997
- ------------------------------- Director/Exec. Vice President/
Alvyn A. Schopp Chief Accounting Officer
/s/ Daniel M. Carney Director October 28, 1997
- --------------------------------
Daniel M. Carney
/s/ Robert A. Geist Director October 28, 1997
- --------------------------------
Robert A. Geist
/s/ James L. Mann Director October 28, 1997
- ------------------------------
James L. Mann
</TABLE>
-37-
<PAGE> 38
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<S> <C>
Independent Auditors' Report .................................................................. F-1
Consolidated Balance Sheets as of July 31, 1997 and 1996....................................... F-2
Consolidated Statements of Operations for the Years Ended
July 31, 1997, 1996 and 1995 .................................................................. F-3
Consolidated Statements of Shareholders' Equity for the Years Ended
July 31, 1997, 1996 and 1995 .................................................................. F-4
Consolidated Statements of Cash Flows for the Years Ended
July 31, 1997, 1996 and 1995 .................................................................. F-5
Notes to Consolidated Financial Statements..................................................... F-6
</TABLE>
<PAGE> 39
INDEPENDENT AUDITORS' REPORT
THE BOARD OF DIRECTORS AND SHAREHOLDERS
T-NETIX, INC.:
We have audited the accompanying consolidated balance sheets of T-NETIX, Inc.
and subsidiaries as of July 31, 1997 and 1996, and the related consolidated
statements of operations, shareholders' equity, and cash flows for each of the
years in the three-year period ended July 31, 1997. 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 generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of T-NETIX, Inc. and
subsidiaries as of July 31, 1997 and 1996, and the results of their operations
and their cash flows for each of the years in the three-year period ended July
31, 1997, in conformity with generally accepted accounting principles.
KPMG PEAT MARWICK LLP
Denver, Colorado
October 10, 1997
F-1
<PAGE> 40
T-NETIX, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
JULY 31
----------------------
1997 1996
----------------------
ASSETS (AMOUNTS IN THOUSANDS)
<S> <C> <C>
Cash and cash equivalents ........................................... $ 190 $ 145
Trade accounts receivable, net of allowance for doubtful accounts
of $120,000 and $129,000 at July 31, 1997 and 1996,
respectively (note 5) ............................................ 11,703 8,222
Other receivables ................................................... 76 73
Prepaid expenses .................................................... 236 296
Property and equipment, at cost (notes 5 and 9):
Telecommunications equipment ..................................... 39,065 31,463
Construction in progress ......................................... 3,626 5,012
Office equipment ................................................. 3,901 2,771
-------- --------
Property and equipment ......................................... 46,592 39,246
Less accumulated depreciation and amortization ................... (17,798) (10,516)
-------- --------
Property and equipment, net .................................... 28,794 28,730
Patent license rights, net (note 4) ................................. 2,586 2,788
Other assets, net ................................................... 3,325 2,273
-------- --------
Total assets ................................................... $ 46,910 $ 42,527
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Accounts payable ................................................. $ 2,992 $ 7,968
Accrued liabilities .............................................. 3,688 2,191
Debt (note 5) .................................................... 13,227 6,324
Capital lease obligations (note 9) ............................... 151 485
-------- --------
Total liabilities .............................................. 20,058 16,968
Shareholders' equity (note 6):
Preferred stock, $.01 stated value. 10,000,000 shares authorized;
no shares issued ............................................... -- --
Common stock, $.01 stated value. 70,000,000 shares authorized;
8,314,583 and 8,150,493 shares issued and outstanding at
July 31, 1997 and 1996, respectively ........................... 83 81
Additional paid-in capital ....................................... 26,908 26,208
Accumulated deficit .............................................. (139) (730)
-------- --------
Total shareholders' equity ..................................... 26,852 25,559
Commitments and contingencies (notes 9 and 10)
Total liabilities and shareholders' equity ..................... $ 46,910 $ 42,527
======== ========
</TABLE>
See accompanying notes to consolidated financial statements.
F-2
<PAGE> 41
T-NETIX, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
YEARS ENDED
JULY 31,
----------------------------
1997 1996 1995
---- ---- ----
(AMOUNTS IN THOUSANDS
EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C>
Revenue (note 7):
Telecommunications services............................................ $ 33,471 $ 30,249 $ 24,262
Telecommunications licensing........................................... 750 - -
Direct call provisioning............................................... 1,395 3,072 3,492
Voice print............................................................ 676 57 -
-------- -------- --------
Total revenue.................................................... 36,292 33,378 27,754
Expenses:
Operating costs and expenses:
Telecommunications services.......................................... 14,478 13,489 10,658
Direct call provisioning (including bad debt expense of
$261,000, $493,000 and $559,000 for 1997, 1996 and 1995,
respectively)...................................................... 1,297 2,940 3,370
Voice print.......................................................... 170 - -
-------- -------- --------
Total operating costs and expenses................................. 15,945 16,429 14,028
Selling, general and administrative.................................... 7,488 6,434 5,413
Research and development............................................... 2,769 2,374 732
Depreciation and amortization.......................................... 8,135 5,920 3,607
-------- -------- --------
Total expenses..................................................... 34,337 31,157 23,780
-------- -------- --------
Operating income................................................. 1,955 2,221 3,974
Interest expense....................................................... (932) (548) (636)
-------- -------- --------
Earnings before income taxes....................................... 1,023 1,673 3,338
Income taxes (note 8).................................................. (432) (46) (150)
-------- -------- --------
Net earnings.............................................................. $ 591 $ 1,627 $ 3,188
======== ======== ========
Net earnings per common share............................................ $ 0.07 $ 0.18 $ 0.38
======== ======== ========
Weighted average common shares............................................ 8,950 9,151 8,360
======== ======== ========
</TABLE>
See accompanying notes to consolidated financial statements.
F-3
<PAGE> 42
T-NETIX, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
<TABLE>
<CAPTION>
TOTAL
COMMON STOCK ADDITIONAL ACCUM- SHARE-
---------------- PAID-IN ULATED HOLDERS'
SHARES AMOUNTS CAPITAL DEFICIT EQUITY
------ ------- ------- ------- ------
(AMOUNTS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
BALANCES AT AUGUST 1, 1994 ...................... 5,405 $ 54 $ 7,058 $(5,545) $ 1,567
Common stock issued upon exercise of
stock options ................................. 414 4 205 -- 209
Common stock issued for assets acquired ......... 4 -- 22 -- 22
Common stock issued for cash, net of
offering costs and underwriting discounts
of $1,631,000 (note 6) ........................ 1,800 18 15,451 -- 15,469
Net earnings .................................... -- -- -- 3,188 3,188
------- ------- ------- ------- -------
BALANCES AT JULY 31, 1995 ....................... 7,623 76 22,736 (2,357) 20,455
Common stock issued upon exercise of
stock options ................................. 303 3 195 -- 198
Common stock issued for assets acquired
(note 3) ........................................ 30 -- -- -- --
Common stock issued in business acquisition
(note 4) ........................................ 195 2 2,269 -- 2,271
Stock option tax benefit (note 8) ............... -- -- 1,008 -- 1,008
Net earnings .................................... -- -- -- 1,627 1,627
------- ------- ------- ------- -------
BALANCES AT JULY 31, 1996 ....................... 8,151 81 26,208 (730) 25,559
Common stock issued upon exercise of
stock options ................................. 155 2 204 -- 206
Common stock issued in business acquisition
(note 4) ........................................ 8 -- 94 -- 94
Stock option tax benefit (note 8) ............... -- -- 402 -- 402
Net earnings .................................... -- -- -- 591 591
------- ------- ------- ------- -------
BALANCES AT JULY 31, 1997 ....................... 8,314 $ 83 $26,908 $ (139) $26,852
======= ======= ======= ======= =======
</TABLE>
See accompanying notes to consolidated financial statements.
F-4
<PAGE> 43
T-NETIX, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEARS ENDED
JULY 31
-----------------------------
1997 1996 1995
---- ---- ----
(AMOUNTS IN THOUSANDS)
<S> <C> <C> <C>
Cash flows from operating activities:
Net earnings ........................................................ $ 591 $ 1,627 $ 3,188
Adjustments to reconcile net earnings to net cash
provided by operating activities:
Depreciation and amortization ..................................... 8,135 5,920 3,607
Provision for losses on accounts receivable ....................... 261 493 559
Deferred tax expense .............................................. 402 -- --
Noncash interest accruals added to principal (related party) ...... -- -- 34
Noncash reductions of loans from customer ......................... -- (449) (2,608)
Changes in operating assets and liabilities:
Change in trade accounts receivable ............................ (3,742) 508 (6,098)
Change in other receivables .................................... (3) 25 (50)
Change in prepaid expenses ..................................... 60 (28) (241)
Change in other assets ......................................... (302) (163) (448)
Change in accounts payable ..................................... (4,976) 1,828 1,312
Change in accrued liabilities .................................. 1,560 (287) 1,303
-------- -------- --------
Cash provided by operating activities ........................ 1,986 9,474 558
-------- -------- --------
Cash used in investing activities:
Capital expenditures .............................................. (7,346) (10,440) (14,606)
Acquisition of business ........................................... -- (450) --
Other investing activities ........................................ (1,208) (668) --
-------- -------- --------
Cash used in investing activities ............................ (8,554) (11,558) (14,606)
-------- -------- --------
Cash flows from financing activities:
Proceeds from borrowings .......................................... 6,802 1,299 9,506
Proceeds from borrowings-related party ............................ -- -- 270
Payments of debt .................................................. (24) (25) (8,042)
Payments of debt-related party .................................... -- -- (1,784)
Payments of loans from customer ................................... -- -- (671)
Payments of capital lease obligations ............................. (334) (474) (330)
Common stock issued for cash ...................................... 206 198 16,111
Payment for loan fees and offering costs .......................... -- (37) (434)
Increase (decrease) in bank overdraft ............................. (37) 396 (213)
-------- -------- --------
Cash provided by financing activities ........................ 6,613 1,357 14,413
-------- -------- --------
Net increase (decrease) in cash and cash equivalents ................ 45 (727) 365
Cash and cash equivalents at beginning of year ...................... 145 872 507
-------- -------- --------
Cash and cash equivalents at end of year ............................ $ 190 $ 145 $ 872
======== ======== ========
</TABLE>
See accompanying notes to consolidated financial statements.
F-5
<PAGE> 44
T-NETIX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JULY 31, 1997 AND 1996
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
GENERAL
T-NETIX, Inc. and subsidiaries ("T-NETIX" or the "Company") was
incorporated in Colorado in 1986. The Company is primarily engaged in the
design, assembly, and management of specialized telecommunications
hardware and software systems.
The Company manages its specialized telecommunications hardware and
software systems for long distance and local exchange carriers on a
contractual basis. The long distance and local exchange carriers in turn
pay a fee per call to the Company for each billable call made from a phone
subject to a contract with the Company. The Company also receives revenue
from billing collect calls made from correctional facilities in which the
Company's specialized telecommunications hardware and software systems are
located.
Through its wholly owned subsidiary, SpeakEZ, Inc. ("SpeakEZ'), the
Company engages in the sales and marketing and the research and
development of speaker verification technology. This technology is
incorporated into the Company's proprietary telecommunication systems and
is also designed for stand alone verification systems.
BASIS OF PRESENTATION AND PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of the Company
and those of its wholly-owned subsidiaries. All significant intercompany
accounts and transactions have been eliminated in consolidation.
CASH EQUIVALENTS
Cash equivalents consist of highly liquid investments, such as
certificates of deposit and money market funds, with original maturities
of 90 days or less.
ACCOUNTS RECEIVABLE
Accounts receivable related to direct call provisioning were $758,000 and
$581,000 as of July 31, 1997 and 1996, respectively. The allowance for
doubtful accounts relates to these receivables.
PROPERTY AND EQUIPMENT
Property and equipment is stated at cost, including costs necessary to
place such property and equipment in service. Major renewals and
improvements are capitalized, while repairs and maintenance are charged to
operations as incurred.
Construction in progress represents the cost of material purchases and
construction costs, including interest capitalized during construction,
for telecommunications hardware systems in various stages of completion.
During 1997, 1996 and 1995, interest capitalized was insignificant.
F-6
<PAGE> 45
T-NETIX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Depreciation is computed on a straight-line basis using estimated useful
lives of 3 to 7 years for telecommunications equipment and 5 to 10 years
for office equipment. No depreciation is recorded on construction in
progress until the asset is placed in service.
OTHER ASSETS
Other assets include deposits, purchased computer software, internally
developed software, patent defense costs, patents, and other intangible
assets. Patents and intangible assets are stated at cost. Amortization is
computed on the straight-line basis over 17 years for patent costs and
periods ranging from 3 to 7 years for other intangibles.
IMPAIRMENT OF LONG-LIVED ASSETS
The Company reviews its property and equipment and unamortized intangible
assets whenever events or changes in circumstances indicate that the
carrying amount may not be recoverable. The Company estimates the future
cash flows expected to result from operations and if the sum of the
expected undiscounted future cash flows is less than the carrying amount
of the long-lived asset, the Company recognizes an impairment loss by
reducing the unamortized cost of the long-lived asset to its estimated
fair value. To date the Company has not recognized impairment on any
long-lived assets.
REVENUE RECOGNITION
Revenue and expenses from telecommunications services and direct call
provisioning are recognized at the time the telephone call is completed.
Revenue under research and development contracts is recognized as it is
earned.
License revenue is recognized when a license agreement is in effect, the
product has been delivered, the license fee is fixed or determinable, no
significant vendor obligations remain and collectibility is reasonably
assured. Maintenance revenue is recognized ratably over the maintenance
period. Revenue from training, consulting and custom engineering services
are recognized as the services are performed.
RESEARCH AND DEVELOPMENT
Costs associated with the research and development of new technology or
significantly altering existing technology are charged to operations as
incurred.
Software development costs have been accounted for in accordance with
Statement of Financial Accounting Standards No. 86, Accounting for the
Costs of Computer Software to be Sold, Leased or Otherwise Marketed. Under
the standard, capitalization of software development costs begins upon the
establishment of technological feasibility, subject to net realizable
value considerations. Capitalized software costs are amortized over the
economic useful life of the software product, which is generally estimated
to be three years. Unamortized capitalized software cost was $449,000 at
July 31, 1997.
F-7
<PAGE> 46
T-NETIX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
401(K) PLAN
The Company established a 401(k) plan for all of its full time employees
effective January 1, 1994. To date, no contributions have been made to
this plan by the Company.
INCOME TAXES
The Company utilizes the asset and liability method of accounting for
income taxes. Accordingly, deferred tax assets and liabilities are
recognized for the future tax consequences attributable to differences
between the financial statement carrying amounts of existing assets and
liabilities and their respective tax bases and operating loss and tax
credit carryforwards. Deferred tax assets and liabilities are measured
using enacted income tax rates expected to apply to taxable income in the
years in which those differences are expected to be recovered or settled.
The effect on deferred tax assets and liabilities of a change in income
tax rates is recognized in the results of operations in the period that
includes the enactment date.
EARNINGS PER COMMON SHARE
Earnings per common share for the years ended July 31, 1997 and 1996, are
computed based upon the weighted average number of common and dilutive
common equivalent shares outstanding during the period. For purposes of
the calculation of earnings per common share, common stock equivalents
consist of stock options to acquire common stock (using the treasury stock
method).
STOCK COMPENSATION
The Company accounts for employee stock options under the provisions APB
Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB 25"). In
October 1996, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 123, "Accounting for the
Stock-Based Compensation" ("SFAS 123"), which requires proforma disclosure
of compensation expense using a fair value based method of accounting for
stock-based compensation plans. SFAS 123 is effective for fiscal years
beginning after December 15, 1996.
ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities at
the date of the financial statements and the reported amounts of revenue
and expenses during the reporting period. Actual results could differ from
those estimates.
F-8
<PAGE> 47
T-NETIX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In February 1997, the FASB issued Statement of Financial Accounting
Standards Statement No. 128, "Earnings Per Share" ("SFAS 128") which
revises the calculation and presentation provisions of Accounting
Principles Board Opinion 15 and related interpretations. SFAS 128 is
effective for the Company's fiscal year ended July 31, 1998. Retroactive
application will be required. The Company believes the adoption of SFAS
128 will not have a significant effect on its reported earnings per share.
SFAS 130, "Reporting Comprehensive Income," was issued in June 1997. It
establishes standards for reporting and display of comprehensive income
and its components in a full set of general-purpose financial statements.
The Company does not believe the adoption of this standard will have a
significant effect on its consolidated financial statements.
SFAS 131, "Disclosures about Segments of an Enterprise and Related
Information," was issued in June 1997. It establishes standards for the
way public business enterprises report information about operating
segments in annual financial statements and requires that those
enterprises report selected information about operating segments in
interim financial reports to shareholders. It also establishes standards
for related disclosures about products and services, geographical areas,
and major customers. The Company anticipates adoption of SFAS 131 in its
fiscal 1998 interim financial reporting to the extent that such
disclosures would be significant and applicable to its corrections
business and its SpeakEZ subsidiary.
RECLASSIFICATION
Certain amounts in the 1996 financial statements have been reclassified to
conform with the 1997 presentation.
(2) SUPPLEMENTAL DISCLOSURES TO STATEMENTS OF CASH FLOWS
Cash paid for interest was approximately $894,000, $563,000 and $591,000
for the years ended July 31, 1997, 1996 and 1995, respectively. Cash
payments for income taxes during 1997, 1996 and 1995 were not significant.
In 1995, the Company acquired $331,000 in property and equipment subject
to capital lease obligations.
(3) JOINT VENTURE
In November 1991, the Company entered into a joint venture created to
market the Company's specialized telecommunications hardware and software
systems in certain international markets, whereby the Company owned 49% or
the joint venture. Effective October 30, 1995, the Company acquired the
remaining 51% interest in the joint venture, which was previously owned by
a related party, for 30,000 shares of restricted common stock. As such,
the Company recorded its basis in the assets of the joint venture at the
predecessor cost of the related party, which was not material. There has
been no activity in the now wholly owned subsidiary since acquisition.
F-9
<PAGE> 48
T-NETIX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(4) BUSINESS ACQUISITION
On October 12, 1995, the Company completed its acquisition of all of the
outstanding stock of SpeakEZ, a development stage company. SpeakEZ is
developing products using biometric identification technologies including
voice print and speaker identification software. Total consideration for
the acquisition was approximately $3,000,000. The initial consideration
included $450,000 in cash (including payment of previously issued notes
payable), restricted common stock of the Company valued at approximately
$2,271,000 and approximately $279,000 payable pursuant to the final
distribution agreement, in restricted stock and cash. In fiscal 1997, the
Company paid additional, final consideration in the form of common stock
of $94,000. The Company accounted for the acquisition using the purchase
method of accounting; accordingly, the purchased assets and liabilities
have been recorded at their estimated fair value at the date of the
acquisition. Amounts in excess of the fair value of tangible assets
acquired were attributed to patent license rights to existing and pending
patents and other intangibles along with the related deferred income tax
effects. The total capitalized cost of the patent license rights and other
intangibles is being amortized on a straight line basis over seven years.
The results of operations of SpeakEZ have been included in the
consolidated financial statements since the date of the acquisition.
Results of operations of SpeakEZ prior to the acquisition were not
significant.
(5) DEBT
Debt at July 31, 1997 and 1996 is summarized as follows:
<TABLE>
<CAPTION>
JULY 31,
-----------------
1997 1996
------- -------
(AMOUNTS IN THOUSANDS)
<S> <C> <C>
Debt:
Line of credit agreement $12,706 $ 5,905
Bank overdraft and other 521 419
------- -------
$13,227 $ 6,324
======= =======
</TABLE>
In June 1997, the Company entered into a new Loan Agreement with its
current commercial bank. The Loan Agreement is for a total of $20,000,000
in committed credit. Borrowings are at the prime rate (8.5% at July 31,
1997) and are secured by substantially all of the assets of the Company.
The agreement provides for various financial covenants, including
maintaining certain financial ratios and minimum net worth requirements.
As of July 31, 1997, the Company has an unused amount on the committed
credit of $7,294,000. All of the debt at July 31, 1997, matures within one
year. The Bank has also issued a standby letter of credit for $225,000 on
behalf of the Company in favor of the lessor on its new office space (note
9). The letter of credit is for the term of the lease.
F-10
<PAGE> 49
T-NETIX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(6) SHAREHOLDERS' EQUITY
On November 8, 1994, the Company completed a public offering of 2,100,000
shares of common stock. Of the 2,100,000 shares, 1,800,000 shares were
sold by the Company to the public at $9.50 per share. The proceeds to the
Company, net of offering costs and underwriting discount were $15,469,000.
STOCK OPTION PLANS
The Company has reserved 3,250,000 shares of common stock for employees
and non-employee directors under various stock option plans (collectively
the "Plans"): the 1991 Incentive Stock Option Plan ("the 1991 ISO Plan");
the 1991 Non-Qualified Stock Option Plan ("the 1991 NSO Plan"); and the
1993 Incentive Stock Option Plan ("the 1993 ISO Plan"). The Plans provide
for issuing both incentive stock options, and non-qualified stock options,
which must be granted at not less than 100% of the fair market value of
the stock on the date of grant. All options to date have been granted at
the fair market value of the stock as determined by the Board of
Directors. Options issued prior to 1994 had vesting terms of one to three
years from the date of grant. Substantially all of the Incentive Stock
Options issued after 1993 vest over four years from the date of grant. The
Options expire ten years from the date of grant.
<TABLE>
<CAPTION>
WEIGHTED
AVERAGE
SHARES RESERVED OPTIONS EXERCISE
FOR OPTIONS OUTSTANDING PRICE
----------- ----------- -----
<S> <C> <C> <C>
Outstanding at August 1, 1994 . 35,050 1,607,378 $ 1.12
Increase in authorized shares 1,000,000 --
Granted ..................... (691,500) 691,500 5.60
Exercised ................... -- (413,563) 0.50
Canceled .................... 101,751 (101,751) 4.03
---------- ----------
Outstanding at July 31, 1995 .. 445,301 1,783,564 2.84
Increase in authorized shares 500,000 --
Granted ..................... (650,000) 650,000 9.74
Exercised ................... -- (302,746) 0.65
Canceled .................... 74,817 (74,817) 4.80
---------- ----------
Outstanding at July 31, 1996 .. 370,118 2,056,001 5.27
Granted ..................... (239,500) 239,500 10.92
Exercised ................... -- (155,968) 1.32
Canceled .................... 82,000 (82,000) 9.33
---------- ----------
Outstanding at July 31, 1997 .. 212,618 2,057,533 6.07
========== ==========
</TABLE>
F-11
<PAGE> 50
T-NETIX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(6) SHAREHOLDERS' EQUITY (CONTINUED)
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
--------------------------------------------------------- -------------------------
WEIGHTED
NUMBER OF AVERAGE WEIGHTED WEIGHTED
OUTSTANDING REMAINING AVERAGE NUMBER AVERAGE
RANGE OF JULY 31, CONTRACTUAL EXERCISE EXERCISABLE AT EXERCISE
EXERCISE PRICES 1997 LIFE PRICE JULY 31, 1997 PRICE
<S> <C> <C> <C> <C> <C>
$ 0.20 379,632 3.7 $ 0.20 379,632 $ 0.20
3.00-4.00 270,827 6.0 3.25 270,827 3.25
5.50 552,824 7.1 5.50 335,908 5.50
7.50-10.50 536,750 8.9 9.34 138,625 8.72
11.00-15.00 317,500 8.7 12.30 61,125 13.58
--------- ---------
$ 0.20-15.00 2,057,533 1,186,117
========= =========
</TABLE>
The Company has not recorded compensation expense pursuant to the grants
of its stock options under APB 25. Had the Company determined compensation
cost based on the fair value at the grant date for its stock options under
SFAS 123, the Company's net earnings (loss) and net earnings (loss) per
common share would have been:
<TABLE>
<CAPTION>
JULY 31, 1997 JULY 31, 1996
----------------------------------- -------------------------------
AS REPORTED PROFORMA AS REPORTED PROFORMA
(AMOUNTS IN THOUSANDS) (AMOUNTS IN THOUSANDS)
<S> <C> <C> <C> <C>
Net earnings (loss) $ 591 $(421) $ 1,627 $ 1,095
=== === ===== =====
Net earnings (loss)
per common
share $ 0.07 $(0.05) $ 0.18 $ 0.12
==== ==== ==== ====
</TABLE>
Under SFAS 123, the per-share minimum value of stock options granted in
1997 and 1996 was $5.98 and $5.49, respectively. The minimum value was
calculated using an expected volatility of the underlying stock of 40% for
both 1997 and 1996, a risk free interest rate of 6.02% and 6.80%, no
expected dividend yields, and an estimated option life of 7.56 years.
In July, 1997, the Board of Directors amended the 1993 ISO Plan and the
1991 NSO Plan to provide that the Compensation Committee may amend certain
outstanding options with an exercise price in excess of the current market
price in order to modify the exercise price to the current market price or
greater. On August 11, 1997, the Compensation Committee re-priced the
exercise price to $7.25 per share for certain outstanding options under
the 1993 ISO Plan and the 1991 NSO Plan having an exercise price equal to
or greater than $7.50 prior to such re-pricing. This re-pricing affected
773,500 options under these Plans.
F-12
<PAGE> 51
T-NETIX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(7) MAJOR CUSTOMERS
Revenue, as a percentage of total revenue, attributable to significant
customers was as follows: 1997 1996 1995 ---- ---- ----
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Customer A ......... 11% 10% 14%
Customer B ......... 36% 40% 37%
Customer C ......... 14% 13% 12%
Customer D ......... 15% 14% 11%
</TABLE>
(8) INCOME TAXES
Income tax expense for the years ended July 31, 1997, 1996 and 1995 is as
follows:
<TABLE>
<CAPTION>
1997 1996 1995
----- ----- -----
(AMOUNTS IN THOUSANDS)
<S> <C> <C> <C>
Current:
Federal ............... $ (--) $ (--) $ (--)
State ................. (30) (46) (150)
----- ----- -----
Total ................. (30) (46) (150)
Deferred:
Federal ............... (348) (--) (--)
State ................. (54) -- --
----- ----- -----
Total ................. (402) (--) (--)
-----
Total income taxes ...... $(432) $ (46) $(150)
===== ===== =====
</TABLE>
Income taxes differ from the expected statutory income tax benefit, by
applying the U.S. federal income tax rate of 34% to pretax earnings, for
the years ended July 31, 1997, 1996 and 1995 due to the following:
<TABLE>
<CAPTION>
1997 1996 1995
------- ------- -------
(AMOUNTS IN THOUSANDS)
<S> <C> <C> <C>
Expected statutory income tax expense ............ $ (348) $ (569) $(1,135)
Amounts not deductible for income tax purposes ... (86) (61) (35)
State taxes, net of federal benefit .............. (55) (30) (110)
Other, including change in valuation allowance
relating to provision .......................... 57 614 1,130
------- ------- -------
Total income taxes ............................... $ (432) $ (46) $ (150)
======= ======= =======
</TABLE>
F-13
<PAGE> 52
T-NETIX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(8) INCOME TAXES (CONTINUED)
The tax effects of temporary differences that give rise to significant
portions of the deferred income tax assets and deferred income tax
liabilities are presented below:
<TABLE>
<CAPTION>
JULY 31
---------------------
1997 1996
------- -------
(AMOUNTS IN THOUSANDS)
<S> <C> <C>
Deferred income tax assets:
Net operating loss carryforwards ..................... $ 4,255 $ 3,939
Allowance for doubtful accounts ...................... 46 49
Other ................................................ 137 68
------- -------
Total gross deferred income tax assets ............... 4,438 4,056
Less valuation allowance ............................. (1,484) (1,546)
------- -------
2,954 2,510
Deferred income tax liabilities:
Intangible assets, due to difference in book/tax basis (832) (1,008)
Property and equipment, principally due to differences
in depreciation ...................................... (1,349) (1,230)
Other assets, due to differences in book/tax basis ... (773) (272)
------- -------
Total gross deferred tax liabilities ................. (2,954) (2,510)
------- -------
$ -- $ --
======= =======
</TABLE>
At July 31, 1997, the Company had net operating loss carryforwards for tax
purposes aggregating approximately $11,200,000 which, if not utilized to
reduce taxable income in future periods, expire at various dates through
the year 2009. Approximately $1,300,000 of these net operating loss
carryforwards are subject to certain rules limiting their annual usage.
The Company believes these annual limitations will not ultimately affect
the Company's ability to use substantially all of its net operating loss
carryforwards for income tax purposes.
A valuation allowance is provided when it is more likely than not that
some portion or all of the net deferred tax asset will not be realized.
The Company has historically established valuation allowances primarily
for net operating loss carryforwards and portions of other deferred tax
assets as a result of its history of net losses. The Company has pre-tax
net earnings for 1997, 1996 and 1995 and has reversed the valuation
allowance in each of these years to the extent that net operating losses
and other items were used to offset taxable income. The net reduction in
the valuation allowance in these years resulted from decreases associated
with tax benefits related to utilization of net operating losses offset by
increases attributable to certain originating stock option deductions
discussed below. The decrease in the valuation allowance in 1997 was
offset by an increase in paid-in capital, and the decreases in the
valuation allowance in 1996 and 1995 were offset by reductions in the
provision for income taxes.
The exercise of stock options which have been granted under the Company's
1991 NSO stock option plan gives rise to compensation which is includable
in the taxable income of the applicable option holder and deductible by
the Company for federal and state income tax purposes. Compensation
resulting from increases in the fair
F-14
<PAGE> 53
T-NETIX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(8) INCOME TAXES (CONTINUED)
market value of the Company's Common Stock subsequent to the date of grant
of the applicable exercised stock options is not recognized, in accordance
with Accounting Principles Board Opinion No. 25, as an expense for
financial accounting purposes and the related tax benefits are taken
directly to additional paid-in capital.
(9) COMMITMENTS
The Company leases certain telecommunications and office equipment under
capital leases and leases office space under operating lease agreements.
Capitalized costs of the property and equipment under capital leases was
$1,150,000 at July 31, 1997, and accumulated amortization was $678,000.
Rent expense under operating lease agreements for the years ended July 31,
1997, 1996 and 1995 was approximately $789,000, $450,000, and $320,000,
respectively. Future minimum lease payments under these lease agreements
for each of the next five years are summarized as follows (amounts in
thousands):
<TABLE>
<CAPTION>
CAPITAL OPERATING
LEASES LEASES
------ ------
(AMOUNTS IN THOUSANDS)
<S> <C> <C>
Year ending July 31:
1998 ............................ $ 107 $ 634
1999 ............................ 54 623
2000 ............................ 1 620
2001 ............................ -- 586
2002 ............................ -- 140
------ ------
Total minimum lease payments . 162 $2,603
======
Less amount representing interest (11)
------
$ 151
======
</TABLE>
In April 1996, the Company entered into a lease agreement for
approximately 38,000 square feet of office space. The term of the lease is
for five years and commenced on November 1, 1996. The Bank has also issued
a standby letter of credit on behalf of the Company for $225,000 in favor
of the lessor on the new lease (note 5). The Company leases an additional
13,000 square feet of office space for its SpeakEZ operations under a five
year lease, and various point of presence locations throughout the United
States.
(10) CONTINGENCIES
Effective as of February 11, 1997, the Company entered into a Settlement
Agreement with BellSouth Telecommunications, Inc. ("BellSouth") in
settlement of the suits pending between the parties in federal courts in
Colorado and Georgia. Under the terms of the Agreement, the parties agreed
to enter Stipulated Orders of Dismissal in both suits, ending the
litigation between them.
F-15
<PAGE> 54
T-NETIX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(10) CONTINGENCIES (CONTINUED)
Under the Agreement, the Company has agreed to a limited license of
certain of its technology, including U.S. Patent No. 5,319,702 relating to
three-way call detection technology, to BellSouth in exchange for an
up-front payment of $750,000 and additional payments, based on additional
lines which may be deployed by BellSouth in the future, of up to $350,000.
The terms of the license permit BellSouth to use, or have made for its
use, three-way call detection products utilizing the Company's technology,
but not to sublicense or to manufacture or sell products utilizing such
technology for use by others. The use license extends to those customers
of BellSouth with respect to products supplied by BellSouth. Payments by
BellSouth represent telecommunications licensing revenue and have been
recognized in the Company's financial statements for the year ended July
31, 1997.
On October 21, 1996, the Company reached a settlement with Gateway
Technologies, Inc. of Carrollton, Texas ("Gateway") regarding the patent
infringement litigation between them.
As previously reported in April 1996, the Company filed a civil action
against Gateway Technologies, Inc. ("Gateway") alleging infringement of
the Company's U.S. Patent 5,319,702 on three-way call detection technology
(the "`702 Patent"), in Tele-Matic Corporation v. Gateway Technologies,
Inc., Civil Action No. 95-S-880, pending in the United States District
Court for the District of Colorado. Gateway has filed an answer denying
the Company's allegations and requesting that the court declare that the
`702 Patent is invalid and is not infringed by Gateway. On May 5, 1996,
Gateway and Intellicall, Inc. ("Intellicall") filed an action against the
Company alleging infringement of U.S. Patents No. 4,935,956, 4,908,852,
4,920,558, 5,920,562, 4,933,966 and 5,093,858 (collectively, the "Gateway
Patents") in Gateway Technologies, Inc. et. al. v. Tele-Matic Corporation,
Civil Action No. 395-CV-0855R, pending in the U.S. District Court for the
Northern District of Texas, Dallas Division. On October 21, 1996, the
parties resolved the matters involved in both lawsuits.
Pursuant to the settlement agreement, the parties have filed and the
courts have entered stipulated final judgments and orders dismissing the
claims in litigation. As part of the settlement, the Company and Gateway
have agreed to cross-license certain patents involved in the litigation.
Each party will pay royalties to the other for the use of such patents.
In August 1995, Independent Telecommunications Network, Inc. ("ITN") filed
a demand for arbitration with the American Arbitration Association,
claiming the Company had breached certain query transport services
contracts with ITN by, ITN alleges, terminating those contracts. In August
1997, the Company and ITN entered into a settlement agreement whereby the
Company agreed to a new agreement for provisioning of telecommunication
services. There was no material effect on the Company as a result of the
settlement.
F-16
<PAGE> 55
T-NETIX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(10) CONTINGENCIES (CONTINUED)
Certain other claims and suits have been filed or are pending against the
Company. In the opinion of management, all matters are adequately accrued
for, and are not anticipated to have a material effect on the financial
position, results of operations and cash flows of the Company if disposed
of unfavorably.
(11) QUARTERLY RESULTS - (UNAUDITED)
The following tables present unaudited quarterly operating results for the
Company and in the opinion of management contain all adjustments,
necessary for a fair presentation of the results of operations for these
periods. Management believes that quarter-to-quarter comparisons of the
Company's financial results should not be relied upon as an indication of
annual or future performance.
<TABLE>
<CAPTION>
YEAR ENDED THREE MONTHS ENDED
---------- --------------------------------------
JULY 31, JUL. 31, APR. 30, JAN. 31, OCT. 31,
1997 1997 1997 1997 1996
-------- -------- -------- -------- --------
(AMOUNTS IN THOUSANDS EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C> <C>
Revenue:
Telecommunication services ........ $ 33,471 $ 8,698 $ 8,209 $ 8,505 $ 8,059
Telecommunication licensing ....... 750 -- 750 -- --
Direct call provisioning .......... 1,395 347 268 351 429
Voice print ....................... 676 267 243 148 18
-------- -------- -------- -------- --------
Total revenue ................. 36,292 9,312 9,470 9,004 8,506
Expenses:
Operating costs and expenses ...... 15,945 3,777 3,752 4,069 4,347
Selling, general and administrative 7,488 1,637 1,924 2,063 1,864
Research and development .......... 2,769 679 692 687 711
Depreciation and amortization ..... 8,135 2,378 2,022 1,909 1,826
-------- -------- -------- -------- --------
Total expenses ................ 34,337 8,471 8,390 8,728 8,748
-------- -------- -------- -------- --------
Operating income .................. 1,955 841 1,080 276 (242)
Interest and other expenses, net .. (932) (342) (245) (190) (155)
-------- -------- -------- -------- --------
Earnings before income taxes ...... 1,023 499 835 86 (397)
Income taxes ...................... (432) (240) (192) -- --
-------- -------- -------- -------- --------
Net earnings .................. $ 591 $ 259 $ 643 $ 86 $ (397)
======== ======== ======== ======== ========
Net earnings per common
share ......................... $ 0.07 $ 0.03 $ 0.07 $ 0.01 $ (0.04)
======== ======== ======== ======== ========
</TABLE>
F-17
<PAGE> 56
INDEPENDENT AUDITORS' REPORT
THE BOARD OF DIRECTORS AND SHAREHOLDERS
T-NETIX, INC.:
Under the date of October 10, 1997, we reported on the consolidated balance
sheets of T-NETIX, Inc. and subsidiaries as of July 31, 1997 and 1996, and the
related consolidated statements of operations, shareholders' equity, and cash
flows for each of the years in the three-year period ended July 31, 1997. In
connection with our audits of the aforementioned consolidated financial
statements, we also audited the related consolidated financial statement
Schedule II. This financial statement schedule is the responsibility of the
Company's management. Our responsibility is to express an opinion on this
financial statement schedule based on our audits.
In our opinion, such consolidated financial statement schedule, when considered
in relation to the basic consolidated financial statements taken as whole,
presents fairly, in all material respects, the information set forth therein.
/s/ KPMG PEAT MARWICK LLP
KPMG PEAT MARWICK LLP
Denver, Colorado
October 10, 1997
S-1
<PAGE> 57
T-NETIX, INC. AND SUBSIDIARIES
SCHEDULE II
VALUATION AND QUALIFYING ACCOUNTS
YEARS ENDED JULY 31, 1997, 1996 AND 1995
(AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
Balance at Charged to Balance
Beginning Costs and Deductions/ at End
of Period Expenses Write-offs of Period
--------- -------- ---------- ---------
<S> <C> <C> <C> <C>
Year ended July 31, 1995:
Allowance for doubtful accounts $ 169 $ 559 $(591) $ 137
===== ===== ===== =====
Year ended July 31, 1996:
Allowance for doubtful accounts 137 493 (501) 129
===== ===== ===== =====
Year ended July 31, 1997:
Allowance for doubtful accounts $ 129 $ 261 $(270) $ 120
===== ===== ===== =====
</TABLE>
S-2
<PAGE> 58
EXHIBIT INDEX
<TABLE>
<CAPTION>
Exhibit
Number Description of Exhibit
------- ----------------------
<S> <C>
(2.1) Acquisition Agreement and Plan of Merger between Registrant and
SpeakEZ, Inc. dated October 11, 1995.****
(3.1) Articles of Amendment to the Articles of Incorporation of
Registrant****
(3.2) Amended and Restated Articles of Incorporation of Registrant**
(3.3) Amended and Restated Bylaws of Registrant*
(10.1) 1991 Non-Qualified Stock Option Plan***
(10.2) Form of 1991 Non-Qualified Stock Option Agreement***
(10.3) 1991 Incentive Stock Option Plan***
(10.4) Form of 1991 Incentive Stock Option Agreement***
(10.5) 1993 Incentive Stock Option Plan***
(10.6) Form of 1993 Incentive Stock Option Agreement***
(10.7) Agreement between American Telephone and Telegraph Company and
Registrant dated November 1, 1991*
(10.8) Loan Agreement between Registrant and INTRUST BANK, N.A., dated
as of June 2, 1997. (10.9) Standard Industrial Lease between
Pacifica Development Properties, II LLC and Registrant dated April
15, 1996 and Amendment Number One thereto, dated May 20, 1996.****
(21) Subsidiaries of Registrant*
(23.1) Consent of KPMG Peat Marwick LLP
(27) Financial Data Schedule
</TABLE>
- ------------------------
* Incorporated herein by this reference from the Exhibits
to the Registrant's Registration Statement on Form S-1
filed with the Commission on September 8, 1994, SEC
Registration No. 33-83844.
** Incorporated herein by this reference from the Exhibits
to the Registrant's Amendment No. 1 to Registration
Statement on Form S-1 filed with the Commission on
October 11, 1994, SEC Registration No. 33-83844.
*** Incorporated herein by this reference from the Exhibits
to the Registrant's Registration Statement on Form S-8
filed with the Commission on May 23, 1995, SEC
Registration No. 33-92642 and amended on May 3, 1996.
**** Previously filed with the Commission as an exhibit to
the Company's Annual Report on Form 10-K for fiscal
year ended 1996.
<PAGE> 1
LOAN AGREEMENT
THIS AGREEMENT, made and entered into this 2nd day of June, 1997, by
and between the INTRUST BANK, N.A. and NATIONAL BANK OF CANADA (herein
collectively referred to as "Banks"), and T-NETIX, INC. (herein referred to as
"Borrower").
WITNESSETH:
WHEREAS, Borrower has requested an increase in its line of credit and
an additional multi-advance term note; and
WHEREAS, Banks have agreed to provide such additional credit under
certain terms and conditions.
NOW, THEREFORE, in consideration of the terms and conditions contained
herein, the parties agree as follows:
ARTICLE I - NOTES AND SECURITY
Section 1.1. REVOLVING CREDIT FACILITY. Banks agree to establish a
revolving credit facility of $15,000,000 (the "Facility") in favor of Borrower
evidenced by a promissory note (the "Facility Note"), a copy of which is
attached hereto, which shall mature on June 1, 1998. The Facility is a
continuation of a facility dated April 1, 1996 and amended December 12, 1996
with INTRUST Bank, N.A. and the Facility Note is a continuation of note number
29163 dated May 1, 1997, and note number 30976 dated May 1, 1997, and evidences
the same indebtedness evidenced by such two notes.
Section 1.2. TERMS OF PAYMENT ON CREDIT FACILITY. Interest on the
Facility Note, or any advance thereunder, shall be adjusted daily to the prime
rate as published in the Money Rates section of the Southwest Edition of the
Wall Street Journal as of such date. In the event that such index is no longer
available or published, interest on the Facility Note shall bear interest at
the prime rate as established pursuant to another index selected by the Banks
in their reasonable discretion. Accrued interest shall be due on the first day
of each month.
Section 1.3. LIMITATIONS ON CREDIT FACILITY. Borrower may borrow,
partially or wholly repay its borrowings, and reborrow, by requesting advances
from the Facility, so long as:
(a) The Facility balance, including all principal and accrued
interest, does not exceed the amount of the Facility at any one time;
(b) There shall have occurred no Event of Default hereunder or event
that with notice or the passage of time shall constitute an Event of Default
hereunder and the Banks shall not have determined that there has been a
material adverse change in the financial condition of Borrower or the value or
condition of any Collateral;
1
<PAGE> 2
(c) Borrower is not in default under any loan or any other financial
obligation, or any other agreement.
(d) The conditions precedent in Article III shall have been satisfied
in a manner acceptable to the Banks.
Section 1.4. USE OF PROCEEDS. The proceeds from the Facility shall be
used to provide general working capital.
Section 1.5. TERM NOTE. Banks agree to loan Borrower the sum of
$5,000,000 evidenced by a promissory note (the "Term Note"), a copy of which is
attached hereto, which shall mature on June 1, 1998. Banks will advance on
the Term Note based on receipt of purchase orders/invoices and installation
cost sheets for SpeakEZ products and new installations for inmate call
processing equipment acceptable to the Banks. Accrued interest shall be due on
the first day of each month with the entire balance due on the maturity date.
Interest shall be adjusted daily to the prime rate as published in the Money
Rates section of the Southwest Edition of the Wall Street Journal. In the
event that such index is no longer available or published, interest on the Term
Note shall bear interest at the prime rate as established pursuant to another
index selected by the Banks in their reasonable discretion.
Section 1.6. SECURITY. As security for the entire indebtedness to
Banks, Borrower hereby pledges, assigns, and grants a first security interest
in favor of Banks in all accounts, contract rights, inventory (including all
"construction in progress" as set forth in Borrower's financial statements),
fixtures, machinery, equipment, general intangibles, trademark and patent
rights of Borrower and all SpeakEZ, Inc. stock owned by Borrower, now owned or
hereafter acquired including all proceeds from the disposition or collection
thereof (the "Collateral"). "Accounts" include all receivables, third-party
claims, instruments, documents, chattel paper and executory contract rights.
Section 1.7. RENEWALS AND EXTENSIONS. Any renewal or extension of the
Facility Note or the Term Note, or any advance made pursuant to the terms of
such Notes, or any other indebtedness which Borrower may have with Banks in
the future, shall be subject to the terms of this Agreement. Banks are under
no obligation to renew any indebtedness when it matures.
Section 1.8. INDEBTEDNESS. Where the term "indebtedness" is used in
this Agreement, it shall include all debt of Borrower to Banks of every kind
and description, direct or indirect, primary or secondary, secured or unsecured
(including overdrafts), joint and several, absolute or contingent, due or to
become due, now existing or hereafter arising, regarding of how it may be
evidenced, arising out of or in any way related to the Facility, the Facility
Note, the Term Note, the loan evidenced by the Term Note or any of the other
transactions contemplated by this Agreement or any other agreement executed in
connection herewith.
Section 1.9. LETTER OF CREDIT. As of the date of this Agreement,
INTRUST Bank, N.A. has issued a Letter of Credit in Borrower's favor in the
amount of $225,000 (the "Letter of Credit"). In the event there is a draw or
draws on the Letter of Credit, the amount of such draw or draws shall be
considered an advance on the Facility. Notwithstanding any other provision of
this Agreement, the amount of the Letter of Credit shall be included in the
Facility total and the amount available for advances on the Facility Note shall
be reduced by the amount of the Letter of Credit.
2
<PAGE> 3
ARTICLE II - REPRESENTATIONS AND WARRANTIES
Borrower hereby represents and warrants, and so long as any
indebtedness from Borrower to the Banks remains outstanding, continuously
represents and warrants as follows:
Section 2.1. LEGAL STATUS. Borrower is a corporation duly organized
and existing under the laws of the State of Colorado, and is qualified to do
business, and is in good standing, in all jurisdictions in which it conducts
its business.
Section 2.2 NO VIOLATION. The making and performance by Borrower of
this Agreement does not violate any provision of law, or result in a breach of,
or constitute a default under, Borrower's articles of incorporation and bylaws,
or any Loan Documents, agreement, indenture or other instrument to which
Borrower may be a party or by which it may be bound.
Section 2.3. LITIGATION. There are no material pending or threatened
actions or proceedings before any court or administrative agency against
Borrower which may adversely affect the financial condition or operation of
Borrower other than those heretofore disclosed to Bank in writing and there are
no material pending or threatened actions or proceedings before any court or
administrative agency affecting the Collateral. "Material" is defined as a
claim or proceeding wherein the amount claimed against Borrower is in excess
$250,000.
Section 2.4. CORRECTNESS OF FINANCIAL STATEMENTS. The financial
statements heretofore and hereafter delivered by Borrower to Banks present
fairly the financial condition of Borrower, and have been prepared in
accordance with generally accepted accounting principles consistently applied.
As of the date of each such financial statement, and since such date, there has
been no material adverse change in the condition of operation of Borrower, nor
has Borrower mortgaged, pledged or granted a security interest in, or
encumbered, any assets or properties since such date.
Section 2.5. AUTHORIZATION. The Loan Documents have been duly
authorized, executed and delivered by Borrower and are the legal, valid and
binding obligations of Borrower, enforceable in accordance with their
respective terms. As used in this Loan Agreement, "Loan Documents" shall mean
and refer to this Loan Agreement, all Notes, all Security Agreements and
Assignments, all Guaranty Agreements, and all other documents and agreements
required to be executed herein, and as any of them may be extended, renewed,
amended or supplemented from time to time.
Section 2.6. NO SUBORDINATION. The obligations of Borrower under this
Agreement, are not subordinated in right of payment or in lien priority to any
obligation of Borrower.
Section 2.7. PERMITS, FRANCHISES. The Borrower now possesses, and
will hereafter possess, all permits, memberships, franchises, contracts, and
licenses required and all trademark rights, trade names, trade name rights,
patents, patent rights, and fictitious name rights necessary to enable it to
conduct its business without conflict with the rights of others.
3
<PAGE> 4
ARTICLE III - CONDITIONS PRECEDENT
The obligation of Banks to make any advance under either Note, is
subject to the fulfillment of the following conditions:
Section 3.1. APPROVAL OF BANK COUNSEL. All legal matters incidental
to all such advances hereunder shall be satisfactory to legal counsel of Banks.
Section 3.2. COMPLIANCE. The representations and warranties contained
herein shall be true as of the date of the signing of this Agreement and on the
date of any advance, no Event of Default, as defined in Article VI herein, and
no condition, event or act which, with the giving of notice or the lapse of
time or both, would constitute an Event of Default, shall have occurred.
Section 3.3. DOCUMENTATION. Borrower shall have delivered to Banks in
form and substance satisfactory to Banks the following described documents:
(a) This Agreement, Facility Note and Term Note duly executed.
(b) All Security Agreements and other loan documents requested by Banks
duly executed by Borrower granting to Banks a first and prior perfected
security interest in the Collateral.
(c) Certified copy of Corporate Resolution of Borrower ratifying this
Agreement and authorizing the execution of the Loan Documents.
(d) Such other documentation as Banks may reasonably require.
ARTICLE IV - AFFIRMATIVE COVENANTS
Borrower covenants that so long as Borrower is indebted to Banks under
this Agreement, Borrower will:
Section 4.1. PUNCTUAL PAYMENT. Punctually pay to Banks all payments
required to be made under this Loan Agreement and any Note.
Section 4.2. ACCOUNTING RECORDS. Maintain adequate books and accounts
in accordance with generally accepted accounting principles consistently
applied, so that anytime and from time to time the true and complete financial
condition of Borrower is fairly presented and can be readily determined, and
permit any representative of Banks at any reasonable time, to inspect, audit
and examine such books and accounts of Borrower and permit Banks to make and
obtain copies of any such books and accounts, and to permit any representative
of Banks to inspect the properties of Borrower.
4
<PAGE> 5
Section 4.3. FINANCIAL STATEMENTS: Furnish Banks:
(a) Not later than 90 days after, and as of the end of each fiscal
year, an audited financial statement of Borrower to include balance sheet,
income statement, statement of retained earnings and statement of cash flows;
(b) Not later than 45 days after the end of each quarter, a balance
sheet and statement of income of Borrower in a form satisfactory to Banks,
certified correct by an officer of Borrower and copies of Form 10-Q;
(c) Not later than 45 days after the end of each quarter, an aged
listing of all accounts payable and receivable of Borrower certified correct by
an officer of Borrower;
(d) Not later than 45 days after the end of each quarter, a lending
base certificate from an officer of Borrower in the form of the attached
Exhibit certifying that Borrower is in compliance with all the terms of this
Agreement;
(e) Semi-annually, a one-year cash flow estimate from telecommunication
contracts by state; and
(f) From time to time such other information as Banks may reasonably
request.
Section 4.4. NOTICE TO ACCOUNTANTS. Notify Borrower's accountants in
writing that Bank intends to rely upon financial information prepared by such
accountants in behalf of Borrower in determining whether to make any extension
of credit covered by this Loan Agreement, including any advance, renewal or
extension thereto.
Section 4.5. EXISTENCE. Preserve and maintain the existence and all
of the rights, privileges and franchises of Borrower; conduct all business in an
orderly, efficient, and regular manner; and comply with the requirements of all
applicable laws, rules, regulations and orders of a governmental authority.
Section 4.6. INSURANCE. Maintain and keep in force insurance of the
types and in amounts customarily carried in the line of business similar to
that of Borrower, including, but not limited to, fire, public liability,
property damage, workers' compensation, and carried with companies and in
amounts satisfactory to Banks; and Borrower shall deliver to Banks from time to
time, at Banks' request, schedules setting forth all insurance then in effect.
The Borrower shall cause the Banks to be listed as the loss payee on all
property damages and other insurance requested by the Banks and as additional
insured on all liability and similar insurance and shall cause Certificates of
Insurance or copies of policies to be delivered to the Banks and shall cause
the insurer to provide the Banks at least ten (10) days prior written notice
prior to the cancellation of any insurance policies. Borrower shall maintain
and keep in force product liability insurance in such amounts deemed adequate
and economically feasible by the Banks.
Section 4.7. FACILITIES. Keep all Borrower's properties in good
repair and condition, and from time to time make necessary repairs, renewals
and replacements thereto so that such properties shall be
5
<PAGE> 6
fully and efficiently preserved and maintained. Borrower shall promptly
satisfy any and all mechanic's or materialmen's liens filed on any of its
facilities.
Section 4.8. TAXES AND OTHER LIABILITIES. Pay and discharge when due
any and all indebtedness, obligations, assessments, and taxes of Borrower,
except such as it may in good faith contest or as to which a bona fide dispute
may arise.
Section 4.9. LITIGATION. Promptly give notice in writing to Banks of
any litigation pending or threatened against Borrower.
Section 4.10. NOTICE TO BANKS. Promptly give notice in writing to
Banks of (a) the occurrence of any Event of Default, as defined in Article VI;
(b) any change in the name, identity or corporate structure of Borrower at
least 30 days prior to such change; or (c) any uninsured or partially uninsured
loss through fire, theft, liability, or property damage in excess of an
aggregate of $500,000 to Borrower.
Section 4.11. SECURITY DOCUMENTATION AND POWER OF ATTORNEY. Upon
request of Banks, assist Banks in obtaining and filing all security agreements,
financing statements, and other documentation required to retain Banks'
perfected security interest in the assets of Borrower. Borrower irrevocably
appoints Banks as its attorney in fact to execute all financing statements and
amendments thereto in behalf of Borrower.
Section 4.12. FINANCIAL CONDITIONS. Maintain Borrower's financial
condition at all times as follows:
(a) Borrower shall maintain a minimum tangible net worth of
$19,000,000. Tangible net worth shall be defined as net worth less intangibles.
(b) Borrower shall maintain a current assets to current liabilities
ratio of not less than 0.75:1. Current assets include only cash and cash
equivalents, trade accounts receivable (net of allowance), other receivables
and prepaid expenses. Current liabilities include only accounts payable,
accrued liabilities, loans from customers, and debt, excluding the balances of
the Facility Note and the Term Note.
(c) Borrower shall maintain a total liabilities (as determined in
accordance with GAAP) to net worth (as determined in accordance with GAAP)
ratio of not greater than 1.2:1.
(d) Adjusted EBITDA (quarterly net earnings before interest expense,
income tax expense depreciation expense and amortization expense) defined as
the summation of EBITDA for the previous four quarters, must not be less than
1.0 debt service coverage of the outstanding balances of the Facility Note and
the Term Note amortized over a 36 month period at the then current Note
interest rate.
Section 4.13. PAYMENT OF COSTS AND EXPENSES. Borrower agrees to pay
to Banks, on demand, all reasonable and necessary costs and expenses as
provided in this Agreement and the other Loan Documents, and all costs and
expenses reasonably and necessarily incurred by Banks from time to time in
connection with this Agreement and the other Loan Documents, including, without
limitation, those reasonably and necessarily incurred in: (i) preparing,
negotiating, amending, waiving or granting consent with respect to the
6
<PAGE> 7
terms of any or all of the Loan Documents; (ii) enforcing the Loan Documents;
(iii) performing any of Borrower's duties under the Loan Documents upon
Borrower's failure to perform them; (iv) filing financing statements,
assignments or other documents relating to the Collateral (e.g., filing fees,
registration taxes); (v) compromising, pursuing, or defending any controversy,
action or proceeding resulting, directly or indirectly, from Banks'
relationship with Borrower, regardless of whether Borrower is a party to such
controversy, action or proceeding and of whether the controversy, action or
proceeding occurs before or after the all indebtedness owing to Banks by
Borrower has been paid in full; provided, however, that Borrower shall not be
liable to Banks for costs and expenses resulting from the gross negligence or
the willful misconduct of Banks in connection therewith; (vi) enforcing or
collecting any part of the indebtedness owing to Banks by Borrower or any
guaranty contemplated under the Loan Documents; (vii) actual out of pocket
expenses of Banks incurred to employ collection agencies or other agents to
collect any or all of the accounts and accounts receivables; and (viii)
obtaining independent appraisals of the Collateral from time to time as deemed
reasonably necessary by Banks. Any amount due to Banks pursuant to this
Section shall, if not paid upon demand, accrue interest at the Facility Note
rate.
ARTICLE V - NEGATIVE COVENANTS
Borrower covenants that so long as Borrower is indebted to Banks,
Borrower will not, without prior written consent of Banks:
Section 5.1. OTHER INDEBTEDNESS. Except as to indebtedness owed Banks
and unrelated obligations to INTRUST Bank, N.A., create, incur, or permit to
exist any liabilities resulting from borrowings, leases, loans or advances,
whether secured or unsecured, or any liens, mortgages or other encumbrances,
other than indebtedness outstanding as of the date of this Agreement. Banks
will not unreasonably withhold approval for capital leases for equipment which
is subsequently leased to AT&T or to Regional Bell Operating Companies.
Nothing in this Section shall prevent Borrower from incurring trade payables
in the ordinary course of business.
Section 5.2. MERGER, CONSOLIDATION, SALE OF ASSETS. Merge into or
consolidate with any corporation or other entity or acquire all or
substantially all of the assets of any other corporation or entity; or sell,
lease, assign, transfer or otherwise dispose of all or substantially all of its
assets.
Section 5.3. GUARANTIES. Guarantee or become liable in any way as
surety, endorser (other than as endorser of negotiable instruments in the
ordinary course of business) or accommodation for the debt or obligations of any
person or entity.
ARTICLE VI - EVENTS OF DEFAULT
Section 6.1. EVENTS OF DEFAULT. Any of the following shall constitute
an Event of Default.
(a) Default by Borrower in any payment when due of principal or
interest under the Facility Note or Term Note or any sum due in this Agreement;
or
7
<PAGE> 8
(b) Any representation or warranty made by Borrower hereunder which
shall prove to be at any time incorrect in any material respect; or
(c) Default by Borrower in the performance of any other term,
covenant or agreement contained herein, which default is not cured within 20
days from its occurrence; or
(d) Default by Borrower under the terms of any agreement, note or
other instrument with any other creditor of Borrower and such default having
not been cured within 30 days; provided,however, that if Borrower defaults in
its performance under any other such agreement, note, or instrument and such
default causes Borrower's obligations to such other creditor to be immediately
due and payable, then Banks, in their sole discretion, may immediately exercise
their rights under Section 6.2 herein; or
(e) The failure of Borrower to promptly pay and discharge any
judgment, levy of attachment, execution or other process against the assets of
Borrower and such judgment be not satisfied, or such levy or other process be
not removed, within 10 days after the entry of levy thereof; or
(f) Borrower shall be adjudicated a bankrupt or insolvent, or
shall consent to or apply for the appointment of a receiver, trustee or
liquidator of itself or any of its property, or shall admit in writing its
inability to pay its debts generally as they become due, or shall make a
general assignment for the benefit of creditors, or shall file a voluntary
petition in bankruptcy or voluntary petition or an answer seeking reorganization
or arrangement in a proceeding under any bankruptcy law, or shall any
involuntary petition be filed against Borrower under any bankruptcy law; or
(g) There shall have occurred a material adverse change, as
reasonably determined by Banks, in the financial condition or results in
operations of the Borrower or the value or condition of the Collateral provided
in connection therewith since the date of this Agreement; or
(h) An Event of Default (as defined in the other Loan Documents)
occurs in any of the other Loan Documents.
Section 6.2. ACCELERATION. If an Event of Default shall occur, any
indebtedness of Borrower under this Agreement or any Note, any term of such
Note to the contrary notwithstanding, shall, at Bank's option and without
notice become immediately due and payable or if an Event of Default shall occur
under Section 6.1(f) above, any indebtedness of Borrower under this Agreement
or any note, any term of such note to the contrary notwithstanding shall,
automatically become due and payable, in each case without presentment, notice
or demand, all of which are herby expressly waived by Borrower; and the
obligation, if any, of the Banks to permit further borrowings hereunder shall
immediately cease and terminate.
Upon an Event of Default and the request of Banks, Borrower shall
immediately assemble the Collateral and deliver it to Banks and shall, upon
request of Banks, execute all assignments and other documentation in favor of
Banks for the purpose of delivering possession of all Collateral to Banks
subject only to any restriction contained within any Collateral document.
8
<PAGE> 9
ARTICLE VII - MISCELLANEOUS
Section 7.1. WAIVER. No delay or failure of Banks, in exercising any
right, power or privilege hereunder, shall affect such right, power or
privilege; nor shall any single or partial exercise thereof or any abandonment
or discontinuance of steps to enforce such a right, power or privilege
hereunder, shall affect such right, power or privilege. The rights and remedies
of Banks hereunder are cumulative and not exclusive. Any waiver, permit,
consent or approval of any kind to Banks, of any breach or default hereunder,
or any such waiver of any provisions or conditions hereof, must be in writing
and shall be effective only to the extent set forth in such writing.
Section 7.2. JURY WAIVER. BORROWER EXPRESSLY WAIVES ANY RIGHT TO A
TRIAL BY JURY IN ANY ACTION OR PROCEEDINGS TO ENFORCE OR DEFEND ANY RIGHTS
HEREUNDER OR UNDER ANY AMENDMENT, INSTRUMENT, DOCUMENT OR AGREEMENT DELIVERED,
OR WHICH MAY HEREAFTER BE DELIVERED, TO BORROWER.
Section 7.3. NOTICES. All notices, requests and demands given to or
made upon the respective parties shall be deemed to have been given or made
when deposited in the mail, postage prepaid, and addressed as follows:
Borrower: T-NETIX, INC.
67 Inverness Drive East
Englewood, Colorado 80112
Banks: INTRUST Bank, N.A.
P.O. Box One
Wichita, KS 67201
Attn: Commercial Loan Department
NATIONAL BANK OF CANADA
One Tabor Center
1200 17th Street
Suite 2760
Denver, CO 80202
Section 7.4. WRITTEN AGREEMENTS. THIS LOAN AGREEMENT, TOGETHER WITH
OTHER WRITTEN AGREEMENTS OF THE PARTIES, IS THE FINAL EXPRESSION OF THE
AGREEMENT BETWEEN THE BANKS AND THE BORROWER, AND MAY NOT BE CONTRADICTED BY
EVIDENCE OF ANY PRIOR OR CONTEMPORANEOUS ORAL AGREEMENT BETWEEN THE PARTIES.
ANY NON-STANDARD TERM MUST BE WRITTEN BELOW TO BE ENFORCEABLE.
9
<PAGE> 10
BY SIGNING BELOW THE PARTIES AFFIRM THERE ARE NO UNWRITTEN AGREEMENTS
BETWEEN THEM.
"BANKS" "BORROWER"
INTRUST Bank, N.A. T-NETIX, INC.
By /s/ ROBERT P. HARMON By /s/ JOHN GIANNAULA
------------------------------ ------------------------------
Robert P. Harmon John Giannaula
Vice President Vice President
NATIONAL BANK OF CANADA
By /s/ WILLIAM N. TSIOUVARAS
------------------------------
William N. Tsiouvaras
Vice President
Section 7.5. KANSAS LAW APPLICABLE. This Agreement shall be construed
in accordance with the laws of the State of Kansas, without regard to the
principles of conflicts of laws, and applicable federal law. Borrower expressly
agrees that jurisdiction and venue for all legal proceedings filed in
connection herewith shall lie exclusively in Sedgwick County, Kansas.
Section 7.6. PREVIOUS SECURITY AGREEMENTS. Any security interest
previously granted to INTRUST Bank, N.A. by Borrower shall survive and continue
to exist in priority.
Section 7.7. OTHER LOAN DOCUMENTS. Borrower understands and agrees that
it is additionally bound by the terms and conditions of the other Loan
Documents, which such terms and conditions are incorporated herein and made a
part of this Agreement. To the extent that any term or provision contained in
other Loan Documents conflicts with a term or provision of this Agreement, the
term or provision providing the Banks the most security or the greatest right
shall control.
Section 7.8. BINDING EFFECT. The rights and obligations of the parties
under this Agreement shall inure to the benefit of, and shall be binding upon
their heirs, personal representatives, successors and assigns.
Section 7.9. SECURITY AGREEMENTS. INTRUST Bank, N.A. is acting as agent
for itself and National Bank of Canada pursuant to a Co-Lender Agreement, dated
of even date herewith. All security interests granted INTRUST Bank, N.A. herein
and all other rights of INTRUST Bank, N.A. herein are in its capacity as agent
pursuant to the Co-Lender Agreement.
10
<PAGE> 11
Section 7.10 CO-LENDER AGREEMENT. Borrower acknowledges that Banks are
acting as co-lenders pursuant to a Co-Lender Agreement of even date herewith.
The Banks' rights as co-lender are set forth more fully in the Co-Lender
Agreement. In addition, INTRUST Bank, N.A. is acting as agent for National Bank
of Canada in connection with the Collateral as set forth more fully in the
Co-Lender Agreement.
Borrower agrees notwithstanding anything to the contrary
herein, no Bank shall be liable for the failure of the other Bank to perform
its obligations hereunder. Without limiting the generality of the foregoing, if
one Bank fails to fund the amount due hereunder the remaining Bank shall have
no further liability or obligation to fund amounts required to be funded
hereunder and Borrower shall have no claim against such Bank for failure to
fund. Each Bank has a 50% interest in the Facility and the Term Note.
IN WITNESS WHEREOF, the parties have executed this Agreement the day
first above written.
"BANKS" "BORROWER"
INTRUST Bank, N.A. T-NETIX, INC.
By /s/ ROBERT P. HARMON By /s/ JOHN GIANNAULA
------------------------------ ------------------------------
Robert P. Harmon John Giannaula
Vice President Vice President
NATIONAL BANK OF CANADA
By /s/ WILLIAM N. TSIOUVARAS
------------------------------
William N. Tsiouvaras
Vice President
11
<PAGE> 12
NATIONAL BANK OF CANADA
By: /s/ ANDREW M. CONNEEN
------------------------------
Andrew M. Conneen, Jr.
Title: Vice President, Manager
<PAGE> 1
INDEPENDENT AUDITORS' CONSENT
THE BOARD OF DIRECTORS
T-NETIX, INC.:
We consent to incorporation by reference in the registration statement
(No. 33-92642) on Form S-8 of T-NETIX, Inc. of our report dated October 10,
1997, relating to the consolidated balance sheets of T-NETIX, Inc. and
subsidiaries as of July 31, 1997, and 1996, and the related consolidated
statements of operations, shareholders' equity, and cash flows for each of the
years in the three-year period ended July 31, 1997, and our report dated
October 10, 1997 relating to the consolidated financial statement Schedule II,
which reports appear in the July 31, 1997, annual report on Form 10-K of
T-NETIX, Inc.
/s/ KPMG PEAT MARWICK LLP
KPMG PEAT MARWICK LLP
Denver, Colorado
October 28, 1997
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM FINANCIAL
STATEMENTS INCLUDED IN T-NETIX, INC.'S ANNUAL REPORT ON FORM 10-K FOR THE YEAR
ENDED JULY 31, 1997 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> JUL-31-1997
<PERIOD-START> AUG-01-1996
<PERIOD-END> JUL-31-1997
<CASH> 190
<SECURITIES> 0
<RECEIVABLES> 11,823
<ALLOWANCES> 120
<INVENTORY> 0
<CURRENT-ASSETS> 0
<PP&E> 46,592
<DEPRECIATION> 17,798
<TOTAL-ASSETS> 46,910
<CURRENT-LIABILITIES> 0
<BONDS> 151
0
0
<COMMON> 83
<OTHER-SE> 26,769
<TOTAL-LIABILITY-AND-EQUITY> 46,910
<SALES> 0
<TOTAL-REVENUES> 36,292
<CGS> 0
<TOTAL-COSTS> 15,945
<OTHER-EXPENSES> 18,392
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 932
<INCOME-PRETAX> 1,023
<INCOME-TAX> 432
<INCOME-CONTINUING> 591
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 591
<EPS-PRIMARY> .07
<EPS-DILUTED> .07
</TABLE>
