<PAGE> 1
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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
---------------------
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
---------------------
FOR THE QUARTER ENDED SEPTEMBER 30, 2000
COMMISSION FILE NUMBER 0-25016
T-NETIX, INC.
(Exact Name of Registrant as Specified in Its Charter)
<TABLE>
<S> <C>
COLORADO 84-1037352
(State of Other Jurisdiction (I.R.S. Employer
of Incorporation) Identification No.)
67 INVERNESS DRIVE EAST
ENGLEWOOD, COLORADO 80112
(Address of principal executive offices) (Zip Code)
</TABLE>
Registrant's Telephone Number, Including Area Code: (303) 790-9111
---------------------
Indicate by check [X] whether the registrant (1) has filed all reports
required to filed by Section 13 or 15(d) of the Securities and Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practical date.
<TABLE>
<CAPTION>
CLASS OUTSTANDING AT NOVEMBER 9, 2000
----- -------------------------------
<S> <C>
Common Stock, $.01 stated value 12,978,242
</TABLE>
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<PAGE> 2
FORM 10-Q CROSS REFERENCE INDEX
<TABLE>
<CAPTION>
PAGE
----
<S> <C> <C>
PART I FINANCIAL INFORMATION
Item 1 Condensed Financial Statements (Unaudited).................. 2
Item 2 Management's Discussion and Analysis of Financial Condition 13
and Results of
Operations................................................
Item 3 Quantitative and Qualitative Disclosure About Market Risk... 21
PART II OTHER INFORMATION
Item 1 Legal Proceedings........................................... 22
Item 2 Changes in Securities and Use of Proceeds................... 22
Item 3 Defaults Upon Senior Securities............................. 23
Item 4 Submission of Matters to a Vote of Security Holders......... 23
Item 5 Other Information........................................... 23
Item 6 Exhibits and Reports on Form 8-K............................ 23
</TABLE>
1
<PAGE> 3
PART I
ITEM 1. FINANCIAL STATEMENTS
INDEX TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<S> <C>
Condensed Consolidated Balance Sheets as of September 30,
2000 and December 31, 1999 (Unaudited).................... 3
Condensed Consolidated Statements of Operations for the
Three Months Ended September 30, 2000 and 1999, and the
Nine Months Ended September 30, 2000 and 1999
(Unaudited)............................................... 4
Condensed Consolidated Statements of Cash Flows for the Nine
Months Ended September 30, 2000 and 1999 (Unaudited)...... 5
Notes to Condensed Consolidated Financial Statements
(Unaudited)............................................... 6
</TABLE>
2
<PAGE> 4
T-NETIX, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
2000 1999
------------- ------------
(AMOUNTS IN THOUSANDS)
<S> <C> <C>
ASSETS
Cash and cash equivalents................................... $ 14 $ 118
Accounts receivable, net.................................... 18,583 16,459
Prepaid expenses............................................ 1,936 1,038
Inventories................................................. 192 710
-------- --------
Total current assets.............................. 20,725 18,325
Property and equipment, net................................. 36,552 33,858
Goodwill, net............................................... 5,860 6,401
Deferred tax asset.......................................... 2,247 2,297
Intangible and other assets, net............................ 8,460 9,252
-------- --------
Total assets...................................... $ 73,844 $ 70,133
======== ========
LIABILITIES, REDEEMABLE CONVERTIBLE PREFERRED STOCK
AND STOCKHOLDERS' EQUITY
Liabilities:
Accounts payable.......................................... $ 10,597 $ 13,187
Accrued liabilities....................................... 6,072 5,924
Current portion of long term debt......................... 32,209 7,366
-------- --------
Total current liabilities......................... 48,878 26,477
Long-term debt............................................ 43 21,555
-------- --------
Total liabilities................................. 48,921 48,032
Series A redeemable convertible preferred stock, $1,000 per
share, stated value, 3,750 shares authorized; issued and
outstanding at September 30, 2000; liquidation preference
of $3,875,000 at September 30, 2000....................... 2,357 --
Stockholders' equity:
Common stock, $.01 stated value, 70,000,000 shares
authorized; 12,733,084 and 12,699,400 shares issued and
outstanding at September 30, 2000 and December 31,
1999, respectively..................................... 127 127
Additional paid-in capital................................ 37,052 35,791
Accumulated deficit....................................... (14,613) (13,817)
-------- --------
Total stockholders' equity........................ 22,566 22,101
-------- --------
Commitments and contingencies
Total liabilities, redeemable convertible preferred stock
and stockholders' equity............................... $ 73,844 $ 70,133
======== ========
</TABLE>
See accompanying notes to condensed consolidated financial statements.
3
<PAGE> 5
T-NETIX, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------- ------------------
2000 1999 2000 1999
-------- -------- ------- --------
(AMOUNTS IN THOUSANDS, EXCEPT
PER SHARE AMOUNTS)
<S> <C> <C> <C> <C>
Revenue:
Telecommunications services......................... $14,615 $ 9,761 $36,693 $ 29,631
Direct call provisioning............................ 6,811 6,811 21,303 20,334
Internet services................................... 7,367 -- 19,928 --
Equipment sales and other........................... 494 190 1,701 2,318
------- ------- ------- --------
Total revenue............................... 29,287 16,762 79,625 52,283
------- ------- ------- --------
Expenses:
Operating costs:
Telecommunications services...................... 5,405 4,509 15,265 13,177
Direct call provisioning......................... 6,050 6,281 19,318 18,820
Internet services................................ 5,953 -- 16,602 --
Cost of equipment sold and other................. 105 56 655 934
------- ------- ------- --------
Total operating costs....................... 17,513 10,846 51,840 32,931
Selling, general and administrative................. 5,144 3,440 13,464 9,907
Research and development............................ 1,236 1,100 3,980 3,716
Impairment of telecommunication assets.............. -- 4,632 -- 4,632
Depreciation and amortization....................... 3,106 2,947 9,273 8,618
------- ------- ------- --------
Total expenses.............................. 26,999 22,965 78,557 59,804
------- ------- ------- --------
Operating income (loss)................... 2,288 (6,203) 1,068 (7,521)
Merger transaction expenses........................... -- -- -- (1,017)
Interest and other expense, net....................... (734) (479) (1,760) (1,595)
------- ------- ------- --------
Income (loss) before income taxes..................... 1,554 (6,682) (692) (10,133)
Income tax (expense) benefit.......................... -- -- (103) 1,117
------- ------- ------- --------
Net income (loss)..................................... 1,554 (6,682) (795) (9,016)
Accretion of discount on redeemable convertible
preferred stock..................................... (515) -- (945) --
------- ------- ------- --------
Net income (loss) applicable to common stockholders... $ 1,039 $(6,682) $(1,740) $ (9,016)
------- ------- ------- --------
Basic net income (loss) per common share.............. $ 0.08 $ (0.53) $ (0.14) $ (0.72)
======= ======= ======= ========
Diluted net income (loss) per common share............ $ 0.08 $ (0.53) $ (0.14) $ (0.72)
======= ======= ======= ========
Shares used in computing basic net income (loss)
per common share.................................... 12,733 12,699 12,761 12,448
======= ======= ======= ========
Shares used in computing diluted net income (loss)
per common share.................................... 13,025 12,699 12,761 12,448
======= ======= ======= ========
</TABLE>
See accompanying notes to condensed consolidated financial statements.
4
<PAGE> 6
T-NETIX, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
-----------------------
2000 1999
---------- ----------
(AMOUNTS IN THOUSANDS)
<S> <C> <C>
Cash flows from operating activities:
Net loss.................................................. $ (795) $ (9,016)
Adjustments to reconcile net loss to net cash provided by
operating activities:
Depreciation and amortization.......................... 9,273 8,618
Impairment loss........................................ -- 4,632
Deferred income tax expense (benefit).................. 50 (1,338)
Gain on sale of property and equipment................. (324) (108)
Accretion of discount on subordinated note payable..... 40 --
Changes in operating assets and liabilities:
Accounts receivable, net............................. (2,124) 1,253
Prepaid expenses..................................... (898) (512)
Inventories.......................................... 518 --
Intangibles and other assets......................... (410) (186)
Accounts payable..................................... (2,590) 4,349
Accrued liabilities.................................. 142 68
-------- --------
Cash provided by operating activities............. 2,882 7,760
-------- --------
Cash used in investing activities:
Purchase of property and equipment........................ (10,178) (10,080)
Proceeds from disposal of property and equipment.......... 350 --
Other investing activities................................ (23) (803)
-------- --------
Cash used in investing activities................. (9,851) (10,883)
-------- --------
Cash flows from financing activities:
Net proceeds from (payments on) line of credit............ (69) 5,877
Proceeds from debt........................................ 3,750 25,000
Payments of debt.......................................... (350) (27,790)
Proceeds from issuance of redeemable convertible preferred
stock, net............................................. 3,459 --
Common stock issued for cash under stock option plans..... 75 257
-------- --------
Cash provided by financing activities............. 6,865 3,344
-------- --------
Net increase (decrease) in cash and cash equivalents........ (104) 221
Cash and cash equivalents at beginning of period............ 118 678
-------- --------
Cash and cash equivalents at end of period.................. $ 14 $ 899
======== ========
Cash paid for interest...................................... $ 1,535 $ 1,639
======== ========
Cash paid for income taxes.................................. $ 103 $ 113
======== ========
</TABLE>
See accompanying notes to condensed consolidated financial statements.
5
<PAGE> 7
T-NETIX, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Unaudited Financial Statements
The accompanying unaudited consolidated financial statements reflect all
adjustments which, in the opinion of management, are necessary to reflect a fair
presentation of the financial position and results of operations of T-NETIX,
Inc. and subsidiaries (the Company) for the interim periods presented. All
adjustments, in the opinion of management, are of a normal and recurring nature.
Some adjustments involve estimates, which may require revision in subsequent
interim periods or at year-end. The financial statements have been presented in
accordance with generally accepted accounting principles. Refer to notes to
consolidated financial statements, which appear in the 1999 Annual Report on
Form 10-K for the Company's accounting policies, which are pertinent to these
statements.
Basis of Presentation
On June 14, 1999, the Company completed a merger with Gateway Technologies,
Inc. ("Gateway"), a privately held provider of inmate calling services. As a
result of the merger, Gateway became a wholly owned subsidiary of the Company.
Prior to the merger, the Company changed its year-end from July 31 to December
31. Gateway's year-end was December 31.
The merger was accounted for as a pooling of interests. As a result, the
Company's financial statements have been restated to combine Gateway's financial
statements as if the merger had occurred at the beginning of the earliest period
presented. Information concerning common stock and per share data has been
restated on an equivalent share basis.
Liquidity
The Company recorded net income from operations of $1.6 million in the
three months and a net loss of $795,000 for the nine months ended September 30,
2000. The working capital deficit as of September 30, 2000 was $28.1 million. In
July 2000, the Company and its lenders amended the Company's credit agreement to
revise certain financial covenants and extended the maturity date until April
30, 2001, and as a result the debt with the bank has been classified as a
current liability.
The Company has taken steps to increase cash flow from operations,
including renegotiating contract pricing and cost control measures, in order to
carry out the remainder of its fiscal 2000 business plan. These changes have
allowed the company to generate net income for the three months ended September
30, 2000. A decrease in cash flows from operations for the nine months ended
September 30, 2000 was primarily the result of higher levels of trade
receivables and a reduction in trade payables. The Company will require
additional financing to fund operations and to repay or refinance existing debt
as it becomes due. If the Company is not able to obtain financing on terms
acceptable to the Company it may have to curtail its operations.
Earnings (Loss) Per Common Share
Earnings (loss) per common share is presented in accordance with the
provisions of Statement of Financial Accounting Standards No. 128, Earnings Per
Share (SFAS 128). Basic earnings per share excludes the impact of potentially
dilutive securities and is computed by dividing income or loss available to
common shareholders by the weighted average number of common shares outstanding
during the period. Diluted earnings per share reflect the potential dilution
that could occur if securities or other contracts to issue common stock were
exercised or converted into common stock. For the three months ended September
30, 2000 diluted common and common equivalent shares outstanding includes
292,000 of common share equivalents, consisting of stock options and warrants
and redeemable convertible preferred stock, determined under the treasury stock
method. There is no difference between basic and diluted net loss per share
since
6
<PAGE> 8
T-NETIX, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- (CONTINUED)
potentially dilutive securities from the conversion of redeemable convertible
preferred stock and the exercises of options and warrants are anti-dilutive for
the nine months ended September 30, 2000 and the three and nine months ended
September 30, 1999. The calculations of diluted net loss per common share for
the nine months ended September 30, 2000 and the three and nine months ended
September 30, 1999, do not include 359,000, 355,000 and 400,000, respectively,
of potentially dilutive securities, including common stock options and warrants
and redeemable convertible preferred stock.
Recent Accounting Pronouncements
In March 2000, the Financial Accounting Standards Board ("FASB") issued
interpretation No. 44 "Accounting for Certain Transactions involving Stock
Compensation -- an interpretation of APB Opinion No. 25 ("FIN 44"). This
interpretation provides guidance on the accounting for certain stock option
transactions and subsequent amendments to stock option transactions. FIN 44 is
effective July 1, 2000, but certain provisions cover specific events that occur
after either December 15, 1998 or January 12, 2000. The adoption of FIN 44 did
not have a material effect on the financial position or results of operations of
the company.
In December 1999, the SEC released Staff Accounting Bulletin ("SAB") No.
101, "Revenue Recognition in Financial Statements," which provides guidance on
the recognition, presentation, and disclosure of revenue in financial statements
filed with the SEC. Subsequently, the SEC delayed the implementation date of SAB
101 for the Company until the quarter ended December 31, 2000. The Company does
not expect the adoption of SAB 101 to have a material impact on its financial
position or results of operations.
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, (SFAS 133), "Accounting for Derivative
Instruments and Hedging Activities," as amended by SFAS No. 137. SFAS 137 defers
the effective date of SFAS 133 to all fiscal quarters of all fiscal years
beginning after June 15, 2000. SFAS 133 establishes accounting and reporting
standards for derivative instruments, including certain derivative instruments
embedded in other contracts (collectively referred to as derivatives), and for
hedging activities. SFAS 133 requires companies to recognize all derivatives as
either assets or liabilities, with the instruments measured at fair value. The
accounting for changes in fair value, gains or losses, depends on the intended
use of the derivative and its resulting designation. The Company does not expect
the adoption of SFAS 133 to have a material impact on its financial position or
results of operations.
Reclassification
Certain amounts in the 1999 financial statements have been reclassified to
conform to the 2000 presentation.
7
<PAGE> 9
T-NETIX, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(2) BALANCE SHEET COMPONENTS
Accounts receivable consist of the following:
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
2000 1999
------------- ------------
(AMOUNTS IN THOUSANDS)
<S> <C> <C>
Accounts receivable, net:
Trade accounts receivable................................. $14,353 $12,549
Direct call provisioning receivable....................... 5,168 7,268
Other receivables......................................... 445 231
------- -------
19,966 20,048
Less: Allowance for doubtful accounts............. (1,383) (3,589)
------- -------
$18,583 $16,459
======= =======
</TABLE>
Bad debt expense was $1.3 million and $1.4 million for the three months
ended September 30, 2000 and 1999, respectively, and $3.9 million and $4.3
million for the nine months ended September 30, 2000 and 1999, respectively.
Property and equipment consists of the following:
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
2000 1999
------------- ------------
(AMOUNTS IN THOUSANDS)
<S> <C> <C>
Property and equipment, net:
Telecommunications equipment.............................. $ 61,754 $ 55,487
Construction in progress.................................. 6,702 7,341
Office equipment.......................................... 11,733 9,169
-------- --------
80,189 71,997
Less: Accumulated depreciation and amortization... (43,637) (38,139)
-------- --------
$ 36,552 $ 33,858
======== ========
</TABLE>
Intangible and other assets consist of the following:
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
2000 1999
------------- ------------
(AMOUNTS IN THOUSANDS)
<S> <C> <C>
Intangible and other assets, net:
Patent license rights..................................... $ 3,325 $ 3,325
Purchased technology assets............................... 2,487 2,487
Capitalized software development costs.................... 663 651
Acquired software technologies............................ 1,961 1,783
Patent defense and application costs...................... 2,590 2,583
Deposits and long-term prepayments........................ 1,724 1,183
Other..................................................... 1,270 1,649
------- -------
14,020 13,661
Less: Accumulated amortization............................ (5,560) (4,409)
------- -------
$ 8,460 $ 9,252
======= =======
</TABLE>
8
<PAGE> 10
T-NETIX, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(2) BALANCE SHEET COMPONENTS -- (CONTINUED)
Accrued liabilities consist of the following:
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
2000 1999
------------- ------------
(AMOUNTS IN THOUSANDS)
<S> <C> <C>
Accrued liabilities:
Deferred revenue and customer advances.................... $1,653 $2,114
Compensation related...................................... 1,402 1,175
Other..................................................... 3,017 2,635
------ ------
$6,072 $5,924
====== ======
</TABLE>
(3) DEBT
Debt consists of the following:
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
2000 1999
------------- ------------
(AMOUNTS IN THOUSANDS)
<S> <C> <C>
Debt:
Bank lines of credit...................................... $28,392 $28,461
Subordinated note payable................................. 3,750 --
Other..................................................... 110 460
------- -------
32,252 28,921
Less current portion...................................... 32,209 7,366
------- -------
Non current portion............................... $ 43 $21,555
======= =======
</TABLE>
Bank Line of Credit
In September 1999, the Company entered into a Senior Secured Revolving
Credit Facility (the "Credit Facility") with its commercial bank. The Credit
Facility provides for maximum credit of $40 million subject to limitations based
on financial covenant calculations. The Credit Facility is comprised of a one
month LIBOR component of $23.5 million at an interest rate of LIBOR plus 2.75%
at September 30, 2000; and $4.9 million at the Bank's prime rate, 9.5% at
September 30, plus 0.5%. As of September 30, 2000, the interest rates on
borrowings under the bank Credit Facility ranged from 9.4% to 10.0%. The Company
also pays a fee of 0.3% per annum on the unused portion of the line of credit.
The Credit Facility is collateralized by substantially all of the assets of
the Company. Under the terms of the Credit Facility, the Company is required to
maintain certain financial ratios and other financial covenants. These ratios
include a debt to a four quarter rolling earnings before interest, taxes and
depreciation and amortization (EBITDA) ratio, a ratio of fixed charges (interest
and debt payments) to EBITDA, and minimum quarterly EBITDA. The agreement also
prohibits the Company from incurring additional indebtedness.
In July 2000, the Company and its lenders amended its credit agreement to
provide for revised financial covenants and extended the maturity date until
April 30, 2001 and as a result the debt with the bank has been classified as a
current liability. The Company raised $7.5 million of additional financing in
April 2000. The net proceeds were used to reduce the outstanding balance on the
credit facility. As of September 30, 2000, the Company is in compliance with all
terms of the amended agreement with the lenders. The maximum amount of credit
under the credit facility available to the Company is dependent upon the
Company's financial performance. Based on the financial covenants, the Company's
maximum available borrowings at September 30, 2000 were $34.3 million.
9
<PAGE> 11
T-NETIX, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(3) DEBT -- (CONTINUED)
Subordinated Note Payable
The Company issued a subordinated note payable of $3.75 million, due April
30, 2001, to a director and significant shareholder of the Company. The note
bears interest at prime rate plus one percent per annum (10.5% at September 30,
2000) which is payable every six months beginning in October 2000. The lender
also received warrants to purchase 25,000 shares of common stock at an exercise
price of $6.05 per share for a period of five years. The estimated fair value of
the stock purchase warrants, calculated using the Black-Scholes model, has been
recorded as deferred financing fees and is being amortized over the term of the
debt.
(4) STOCKHOLDERS EQUITY
In April 2000, the company issued 3,750 shares of series A non-voting
redeemable convertible preferred stock and five-year stock purchase warrants to
acquire 340,909 common shares for net proceeds of $3.5 million. The company
accounted for the transaction in accordance with ETIF 98-5, "Accounting for
Convertible Securities with Beneficial Conversion Features or Contingently
Adjustable Conversion Ratios." The Company recognized an increase in additional
paid in capital in the amount of $771,000 for the value of the beneficial
conversion. The Company is accreting the resulting discount on the preferred
stock to income (loss) applicable to common stockholders over the six-month
period beginning April 17, 2000. The series A preferred stock does not bear any
dividends.
In the event of any liquidation, dissolution or winding up of the Company,
merger with a change in voting control or a sale of substantially all of the
Company's assets, the holders of the redeemable convertible preferred stock are
entitled to receive a liquidation preference of 8% per annum. If the funds
available for distribution are insufficient to cover the liquidation preference,
then the entire assets and funds of the Company legally available for
distribution are to be distributed ratably among the holders of the redeemable
convertible preferred stock.
The preferred stock is convertible by the holder beginning on October 17,
2000. The redeemable convertible preferred stock is convertible into a number of
common shares calculated by dividing (1) the sum of (a) the stated value of the
preferred stock plus (b) a premium amount which is the product of the stated
value multiplied by 8% annualized for the period outstanding, by the Conversion
Price. The number of shares issuable upon any conversion plus any other shares
held by the holders cannot exceed 4.9% of the outstanding shares of the
Company's common stock.
The Conversion Price is the lesser of the Variable Conversion Price and the
Fixed Conversion Price. The Variable Conversion Price is defined as the average
closing bid prices for any five consecutive trading days during the twenty-two
consecutive trading day period ending one trading day prior to a notice of
conversion. The Fixed Conversion Price was initially set at $6.05. In accordance
with the original agreement, the Fixed Conversion Price was re-set to $4.1388 as
of August 17, 2000.
The preferred stock is redeemable at the option of the Company if the
closing market price of the Company's common stock is less than or equal to
$4.00 for 10 consecutive days. The optional redemption is available to the
Company as long as (i) all of the shares of common stock issuable upon
conversion of the Series A preferred stock are then authorized and reserved for
issuance, registered for sale under the 1933 Act by the Company and such shares
are eligible to trade on Nasdaq and (ii) no Mandatory Redemption Event or
Trading Market Redemption event has occurred and is continuing. The amount of
cash payable upon the optional redemption is the greater of (i) 120% of the
liquidation preference or (ii) a parity value. The parity value is the product
of (a) the number of shares of common stock issuable upon conversion of the
redeemable preferred stock, as calculated using the conversion price noted
above, multiplied by (b) the highest closing price of the common stock during
the period from the date the notice of redemption was delivered and ending one
day prior to the redemption date.
10
<PAGE> 12
T-NETIX, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(4) STOCKHOLDERS EQUITY -- (CONTINUED)
If the Company provides notice at the beginning of a month in which
conversion is requested, it will have the option to redeem any preferred shares
submitted for conversion by the holders in cash rather than by issuing shares of
common stock. The price used in the redemption shall be the closing price of the
common stock on the date of conversion. The conversion date is set by the holder
upon the notice of conversion. Any amounts due in cash to the holders must be
paid within two trading days of the conversion.
In the event the Company publicly announces its intention to consummate a
major transaction, such as the sale, conveyance or disposition of all or
substantially all of the assets of the Company, the effectuation by the Company
of a transaction or series of transactions in which more than 50% of the voting
power of the Company is disposed of, or the consolidation, merger or other
business combination of the Corporation when the Company is not the survivor, at
the option of the holders of preferred shares, (A) the company shall be required
to distribute 120% of the calculated liquidation preference to holders of the
preferred shares; or (B) if the transaction results in the common stock of the
Company being changed into securities or assets of another corporation, the
holders of the preferred shares can elect to receive such securities or assets
that such holder of the preferred shares would have been entitled to receive had
the holder converted the preferred shares in full immediately prior to the
transaction. Alternatively, upon the happening of one of these major transaction
events, the Company can elect to redeem the preferred shares from the holders
rather than distributing the liquidation preference. The major transaction
redemption amount will be equal to the greater of (x) the major transaction
percentage, which is (A) 165% in the case of a major transaction consummated in
the prior to April 17, 2001, (B) 200% in the case of a major transaction
consummated on or after April 17, 2001, multiplied by the sum of (a) the stated
value of the shares to be redeemed, plus (b) an amount equal to 8% per annum of
the stated value for the period outstanding, plus (c) any conversion default
payments, and the equivalent value of the shares to be redeemed. The equivalent
value means the product of (a) the number of shares of common stock issuable
upon conversion of the preferred stock utilizing the dates of the major
transaction as the trading days, and the conversion price calculations noted
above, multiplied by (b) the price per share of common stock paid to the
stockholders in connection with the major transaction.
In connection with the issuance of the redeemable convertible preferred
stock, the Company issued a five-year stock purchase warrant exercisable for
340,909 shares at $6.60 per share of the Company's common stock. The Company
allocated the fair value of the warrants ($1.1 million) to additional paid in
capital and recognized a discount on the preferred shares issued. The Company
also issued warrants to purchase 50,000 shares of common stock to the broker on
the sale of preferred stock at an exercise price of $6.60 per share. The stock
purchase warrants were valued at fair value ($163,000) using the Black-Scholes
model and are being amortized as accretion of discount on preferred stock over
the term of the preferred stock.
(5) COMMITMENTS AND CONTINGENCIES
Future minimum lease payments under operating leases for the next five
years total approximately $1.5 million.
(6) SEGMENT INFORMATION
The Company has three reportable segments; the Corrections Divisions, the
SpeakEZ Division, and the Internet Services Division. The Company evaluates
performance based on earnings (loss) before income taxes. Additional measures
include operating income, depreciation and amortization, and interest expense.
There are no intersegment sales. The Company's reportable segments are specific
business units that offer different products and services. They are managed
separately because each business requires different technology and marketing
strategies. The accounting policies of the reportable segments are the same as
those
11
<PAGE> 13
T-NETIX, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(6) SEGMENT INFORMATION -- (CONTINUED)
described in the summary of significant accounting policies. Segment information
for the three and nine months ended September 30, 2000 and 1999 is as follows:
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------- ------------------
2000 1999 2000 1999
-------- -------- ------- --------
(AMOUNTS IN THOUSANDS)
<S> <C> <C> <C> <C>
REVENUE FROM EXTERNAL CUSTOMERS:
Corrections Division........................ $21,910 $16,733 $59,587 $ 52,195
SpeakEZ Division............................ 10 29 110 88
Internet Services Division.................. 7,367 -- 19,928 --
------- ------- ------- --------
$29,287 $16,762 $79,625 $ 52,283
======= ======= ======= ========
OPERATING INCOME (LOSS):
Corrections Division........................ $ 1,314 $(5,628) $ (889) $ (5,576)
SpeakEZ Division............................ (440) (575) (1,369) (1,945)
Internet Services Division.................. 1,414 -- 3,326 --
------- ------- ------- --------
$ 2,288 $(6,203) $ 1,068 $ (7,521)
======= ======= ======= ========
DEPRECIATION AND AMORTIZATION:
Corrections Division........................ $ 2,901 $ 2,713 $ 8,602 $ 7,886
SpeakEZ Division............................ 205 234 671 732
Internet Services Division.................. -- -- -- --
------- ------- ------- --------
$ 3,106 $ 2,947 $ 9,273 $ 8,618
======= ======= ======= ========
INTEREST AND OTHER EXPENSE, NET:
Corrections Division........................ $ (417) $ (252) $ (859) $ (914)
SpeakEZ Division............................ (317) (227) (901) (681)
Internet Services Division.................. -- -- -- --
------- ------- ------- --------
$ (734) $ (479) $(1,760) $ (1,595)
======= ======= ======= ========
SEGMENT EARNINGS (LOSS) BEFORE INCOME TAXES:
Corrections Division........................ $ 899 $(5,880) $(1,745) $ (7,507)
SpeakEZ Division............................ (759) (802) (2,272) (2,626)
Internet Services Division.................. 1,414 -- 3,325 --
------- ------- ------- --------
$ 1,554 $(6,682) $ (692) $(10,133)
======= ======= ======= ========
</TABLE>
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
2000 1999
------------- ------------
(AMOUNTS IN THOUSANDS)
<S> <C> <C>
SEGMENT ASSETS:
Corrections Division...................................... $71,300 $66,534
SpeakEZ Division.......................................... 2,375 3,599
Internet Services Division................................ 209 --
------- -------
$73,884 $70,133
======= =======
</TABLE>
There was no intersegment revenue for the three months ended September 30,
2000 and 1999. Consolidated total assets included eliminations of approximately
$12.9 million and $13.0 million as of September 30, 2000 and December 31, 1999,
respectively. Eliminations consist of intercompany receivables in the
Corrections Division and intercompany payables in the SpeakEZ Division related
solely to intercompany borrowing of the SpeakEZ Division.
12
<PAGE> 14
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
For a comprehensive understanding of our financial condition and
performance, this discussion should be considered in the context of the
condensed consolidated financial statements and accompanying notes and other
information contained herein.
The Private Securities Litigation Reform Act of 1995 provides a "safe
harbor" for forward-looking statements. Certain information contained in this
Management's Discussion and Analysis of Financial Condition and Results of
Operations and elsewhere in this Form 10-Q includes forward-looking statements.
Important factors that could cause actual results to differ materially from
those in the forward-looking statements include, but are not limited to, those
listed under the caption "Risk Factors" in the Company's Form 10-K for the year
ended December 31, 1999, which may affect the potential technological
obsolescence of existing systems, the renewal of existing site specific
Corrections and Internet Service Division customer contracts, the ability to
retain the base of current site specific customer contracts, the ability to
perform under contractual performance requirements, the continued relationship
with existing customers, the ability to win new contracts for our products and
services, including Lock & Track(TM), Contain(R) and our Internet Services
Division, the ability of our existing customers, including AT&T, to maintain
their market share of the inmate calling market, our ability to penetrate the
market for jail management systems and to successfully license voice
verification and fraud prevention technology, the effect of economic conditions,
the effect of regulation, including the Telecommunications Act of 1996 that
could affect our sales or pricing, the impact of competitive products and
pricing particularly in the our Corrections Division, our continuing ability to
develop hardware and software products, commercialization and technological
difficulties, manufacturing capacity and product supply constraints or
difficulties, actual purchases by current and prospective customers under
existing and expected agreements, and the results of financing efforts, along
with the other risks detailed therein.
OVERVIEW
Acquisition of Gateway Technologies, Inc.
On June 14, 1999, we completed our merger with Gateway Technologies, Inc.
or "Gateway" by exchanging 3,672,234 shares of our common stock for all of the
common stock of Gateway. Each share of Gateway was exchanged for 5.0375 shares
of our common stock. In addition, outstanding Gateway stock options were
converted at the same exchange rate into options to purchase approximately
379,000 shares of our common stock.
The merger constituted a tax-free reorganization and has been accounted for
as a pooling of interests under Accounting Principles Board Opinion No. 16.
Accordingly, all prior period information contained in this Management's
Discussion and Analysis of Financial Condition and Results of Operations has
been restated to include the combined results of operations, financial position
and cash flows of T-NETIX and Gateway as though Gateway had always been a part
of T-NETIX
In addition, in connection with the merger transaction, T-NETIX issued
375,341 shares of common stock to certain shareholders of Gateway in exchange
for their terminating a royalty agreement with Gateway. The royalty agreement
related to automated call processing technology and intellectual property rights
that were assigned to Gateway by the royalty owners in exchange for royalty
payments. The termination of the royalty owners' interests resulted in the
acquisition of an intangible asset. The asset has been recorded at its estimated
fair value, or $2,487,000. The fair value is based on the value of T-NETIX
common stock at February 10, 1999 (date of the Merger Agreement), or $6.625,
multiplied by the number of shares issued in exchange for termination of the
royalty owners' interests. The intangible asset has an estimated useful life of
10 years, the remaining term of the underlying patent.
13
<PAGE> 15
Corrections Division
In the Corrections Division we derive revenue from three main sources:
telecommunications services, direct call provisioning and equipment sales. Each
form of revenue has specific and varying operating costs associated with such
revenue. The Corrections Division accounted for approximately 75% of the
Company's total revenue for the three and nine months ended September 30, 2000.
Selling, general and administrative expenses, along with research and
development and depreciation and amortization are common expenses regardless of
the revenue generated.
Telecommunications services revenue is primarily generated under long-term
contracts from three to five years in length. Pricing historically provided for
transaction fees to be paid on a per-call basis where we are paid a prescribed
fee for each call completed and additional fees for validating phone numbers
dialed by inmates. The per-call charge is primarily for the provisioning of
specialized call processing services to telecommunications service providers for
their correctional facilities customers. However, recently we entered into a
contract amendment and a new price commitment with two significant customers to
record revenue as a percentage of gross revenue earned by the customer, subject
to certain adjustments. This new pricing was an effort by us to have our pricing
remain flexible and not be effected by factors that affected call volumes.
Pursuant to the actual and pending amendment, we also recognized certain
telecommunications expenses that were previously reimbursable charges to these
customers. In addition, during the current period we reached a new pricing
commitment with another of our customers that significantly increased the
per-call rate. Our telecommunications service provider customers include AT&T,
Verizon, Qwest, SBC Communications, BellSouth, and Sprint.
As a direct inmate call provider, we buy "wholesale" call services to be
re-sold as collect calls. We use the services of third parties to bill the
collect calls. We then enter into direct contracts with the correctional
facilities and generally pay to the correctional facilities commissions on the
gross billed revenue. The rates charged by us are consistent with the collect
call rates charged by the incumbent local exchange carrier or "ILEC" in the same
service area and the predominant interexchange carrier or "IXC." Since all calls
originating from the inmate phones are collect calls, each phone generates
higher-than-industry-average revenues. The uncertainty of the creditworthiness
of the billed parties results however in a higher-than-industry-average
uncollectible cost.
Equipment sales and other revenue includes the sales of our inmate calling
system and the DRS system. The sales of the inmate calling system are generally
made to only one customer. We then charge monthly maintenance fees to keep the
system operational. Sales to this customer can vary depending upon the success
of the customer in winning contracts with correctional facilities.
Internet Services Division
In December 1999, we entered into a master service agreement with US WEST
INTERPRISE America, Inc. to provide interLATA Internet services to Qwest
customers. The contract, which commenced December 1, 1999, calls for us to buy,
resell and process billings of Internet bandwidth to these customers. The
contract with Qwest is for a minimum of sixteen months.
The Internet Services Division accounted for approximately 25% of the
Company's total revenue for the three and nine months ended September 30, 2000.
Our gross margin on these services was 19% and 17% for the three and nine months
ended September 30, 2000, respectively. The gross margin is effected by the
negotiated base management fee and contract incentive payments. The costs
associated with this contract are primarily the costs for Internet bandwidth.
There were no capital outlays required to begin provisioning these services. The
Company anticipates adding personnel to expand the service offerings of the
Internet Services Division beyond the scope of the current contract.
Extension of the contract beyond the minimum sixteen-month period is
dependent upon the regulatory approval process in various states. In the event
that Qwest receives regulatory approval to provide interLATA telecommunications
services during or after the initial sixteen month period, our Internet Services
revenue could be reduced significantly or eliminated.
14
<PAGE> 16
Speaker Verification Division
In our SpeakEZ Division the marketing strategy has been directed a
technology licensing strategy versus a direct customer strategy. A direct
customer sales strategy markets a specifically developed software product to
specific end user customers. The strategy is then to find other specific
customers who have similar operating systems and market this product to these
customers. In contrast, a technology licensing strategy focuses on a larger
scale customer who can integrate the SpeakEZ software product into its existing
product line. This larger customer, such as a computer manufacturer, would then
be responsible for the product integration and ultimate delivery to the end user
customer. In keeping with this strategy, the SpeakEZ Division entered into an
OEM Agreement to license its SpeakEZ technology to a major speech recognition
company.
Even with the changes in marketing strategy, there can be no assurance that
the products based on the SpeakEZ technology will achieve the necessary market
acceptance or 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. Our
voice print revenue has been minimal to date.
Results of Operations for the Three Months Ended September 30, 2000
Compared to September 30, 1999
The following table sets forth certain statement of operations data as a
percentage of total revenue for the three months ended September 30, 2000 and
1999.
<TABLE>
<CAPTION>
2000 1999
---- ----
<S> <C> <C>
Revenue:
Telecommunications services............................... 50% 58%
Direct call provisioning.................................. 23 41
Internet services......................................... 25 --
Equipment sales and other................................. 2 1
--- ---
Total revenue..................................... 100 100
Expenses:
Operating costs........................................... 60 65
Selling, general and administrative....................... 17 21
Research and development.................................. 4 6
Impairment of telecommunication assets.................... -- 28
Depreciation and amortization............................. 11 17
--- ---
Operating income (loss)........................... 8 (37)
Interest and other expense................................ (3) (3)
--- ---
Income (loss) before income taxes................. 5 (40)
Income tax (expense) benefit.............................. -- --
--- ---
Net income (loss)................................. 5 (40)
Accretion of discount on redeemable convertible preferred
stock.................................................. (2) --
--- ---
Net income (loss) applicable to common stock...... 3% (40)%
=== ===
</TABLE>
Total Revenue. Total revenue for the three months ended September 30, 2000
was $29.3 million, an increase of 75% over $16.8 million for the corresponding
prior period. This increase was primarily attributable to the commencement of
Internet services, as well as increases in telecommunications services revenue.
The 50% increase in telecommunications services revenue to $14.6 million in
the three months ended September 30, 2000, from $9.8 million for the
corresponding prior period, was due primarily to an increase in contract prices.
We changed our pricing to two significant customers whereby revenue is
calculated as a percentage of our customer's gross revenue versus a transaction
fee per call and increased the per-call rate to another customer. In addition we
experienced an increase in revenue due to call volume increases, primarily due
to the addition of new sites.
15
<PAGE> 17
Direct call provisioning revenue was $6.8 million for the three months
ended September 30, 2000 and 1999 respectively. There was no change in direct
provisioning revenue as additions of new sites were offset by the loss of other
sites. The addition of sites is primarily a result of our being successful in
competitive bidding arrangements for contracts directly with correctional
institutions. Conversely as contracts with correctional institutions expire, due
to the competitive bidding process some sites, have been lost to competitors.
The Internet Services contract commenced in December 1999. Future revenue
is dependent upon the base of subscribers and contract incentive payments.
Internet gross margin for the three months ended September 30, 2000 was 19%.
This contract is scheduled to expire March 31, 2001.
Equipment sales and other revenue increased 160% to $494,000 for the three
months ended September 30, 2000 from $190,000 in the corresponding prior period.
Such sales are primarily associated with one telecommunications service provider
customer and are dependent upon the timing of installations for this customer
and the customer's success rate in its territory. In the three months ended
September 30, 2000 significantly all of our equipment sales were to this
telecommunications service provider customer. We do not expect significant
equipment sales in the near future.
Operating costs. Total operating costs were $17.5 million in the three
months ended September 30, 2000, an increase of 61% from $10.8 million in the
corresponding prior period. The increases were primarily due to the commencement
of Internet services as well as increases in telecommunication services.
Operating costs of telecommunications services primarily consist of service
administration costs for correctional facilities, including salaries and related
personnel expenses, communication costs and inmate calling systems repair and
maintenance expense. Operating costs of telecommunications services also include
costs associated with call verification procedures, primarily network expenses
and database access charges. Operating costs associated with direct call
provisioning include the costs associated with telephone line access, long
distance charges, commissions paid to correctional facilities, costs associated
with uncollectible accounts and billing charges. Internet Services expense
consists of Internet bandwidth costs. Cost of equipment sold and other includes
primarily the purchase price of equipment which is resold. Other equipment cost
components were minimal. Voice print operating costs include royalty charges,
the cost of hardware and the cost of services which amounts are reflected as
other operating costs.
The following table sets forth the operating costs and expenses for each
type of revenue as a percentage of corresponding revenue for the three months
ended September 30, 2000 and 1999.
<TABLE>
<CAPTION>
2000 1999
---- ----
<S> <C> <C>
Operating costs:
Telecommunications services............................... 37% 46%
Direct call provisioning.................................. 89 92
Internet services......................................... 81 --
Cost of equipment sold and other.......................... 21 29
</TABLE>
Operating costs associated with providing telecommunications services as a
percentage of corresponding revenue was 37% for the three months ended September
30, 2000, a decrease from 46% for the corresponding prior period. The decrease
was due primarily to revenue increases in excess of cost increases. Total
telecommunications services operating expenses were $5.4 million for the three
months ended September 30, 2000 and $4.5 million for the corresponding prior
period. The increase in 2000 is due to increases in personnel costs as a result
of increased personnel and to a lesser extent, increases in salaries and wages.
Also, the addition of contract labor personnel in the National Service Center
and other operational support functions contributed to cost increases. To a
lesser extent, increases in travel and communications expenses contributed to
the overall cost increase. With the addition of personnel at our National
Service Center we believe we can reduce field operations personnel costs in the
near future.
Direct call provisioning costs as a percentage of applicable revenue
decreased slightly to 89% of revenue for the three months ended September 30,
2000 from 92% for the corresponding prior period. These costs
16
<PAGE> 18
include increases due to site commissions and transmissions costs offset by a
reduction in bad debt expense because of improved collections efforts.
The contract for Internet services commenced in December 1999. Future
revenue increases are dependent upon the base of subscribers and additional
contract incentive payments. Cost of equipment sold and other increased in the
three months ended September 30, 2000 and also decreased as a percentage of
corresponding revenue from the corresponding prior primarily due to the change
in the revenue mix of equipment sales.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses were $5.1 million for the three months ended September
30, 2000 compared to $3.4 million for the corresponding prior period. Selling,
general and administrative expenses associated with the Corrections Division
were $5.0 million for the three months ended September 30, 2000 compared to $3.3
million in the corresponding prior period. The increase in the three months
ended September 30, 2000 was primarily due to increases in salary and benefits
for additional personnel and from raises for existing personnel. Other expenses,
including travel and professional fees, increased due to the integration of
Gateway's operations.
Research and Development Expenses. Research and development expenses were
$1.2 million in the three months ended September 30, 2000 compared to $1.1
million for the corresponding prior period. Research and development expenses
for the Corrections Division were $1.1 million in the three months ended
September 30, 2000 and $0.9 million in the corresponding prior period. The
increase was primarily due to increased personnel expenses. We anticipate
research and development expenses to remain consistent for the remainder of the
year.
Depreciation and Amortization Expenses. Depreciation and amortization
expense was $3.1 million in the three months ended September 30, 2000, an
increase from $2.9 million for the corresponding prior period. The increase was
due primarily to the depreciation associated with new site installations and
additional equipment purchased for internal operations.
Interest and Other Expense, Net. Interest and other expense, net was
$734,000 for the three months ended September 30, 2000, an increase from
$479,000 for the corresponding prior period. Included in other income in the
three months ended September 30, 2000 is a gain of approximately $79,000 on the
sale of used telecommunications equipment. Interest expense was $813,000 for the
three months ended September 30, 2000, and $479,000 for the corresponding prior
period. The increase in 2000 was attributable to an increase in the average
amount of indebtedness outstanding and an increase in interest rates. The
average debt balance increased primarily due to the increase in capital
expenditures.
17
<PAGE> 19
Results of Operations for the Nine Months Ended September 30, 2000 Compared
to September 30, 1999
The following table sets forth certain statement of operations data as a
percentage of total revenue for the nine months ended September 30, 2000 and
1999.
<TABLE>
<CAPTION>
2000 1999
---- ----
<S> <C> <C>
Revenue:
Telecommunications services............................... 46% 57%
Direct call provisioning.................................. 27 39
Internet services......................................... 25 --
Equipment sales and other................................. 2 4
--- ---
Total revenue..................................... 100 100
Expenses:
Operating costs........................................... 65 63
Selling, general and administrative....................... 17 19
Research and development.................................. 5 7
Impairment of telecommunication assets.................... -- 9
Depreciation and amortization............................. 12 16
--- ---
Operating income (loss)........................... 1 (14)
Merger transaction expenses............................... -- (2)
Interest and other expense................................ (2) (3)
--- ---
Loss before income taxes.......................... (1) (19)
Income tax benefit........................................ -- 2
--- ---
Net loss.......................................... (1) (17)
Accretion of discount on redeemable convertible preferred
stock.................................................. (1) --
--- ---
Net loss applicable to common stock............... (2)% (17)%
=== ===
</TABLE>
Total Revenue. Total revenue for the nine months ended September 30, 2000
was $79.6 million, an increase of 52% over $52.3 million for the corresponding
prior period. This increase was primarily attributable to the commencement of
Internet services, as well as increases in telecommunications services revenue
and direct call provisioning revenue, offset in part by decreases in equipment
sales and other.
The 24% increase in telecommunications services revenue to $36.7 million in
the nine months ended September 30, 2000, from $29.6 million for the
corresponding prior period, was due primarily to an increase in contract prices.
In addition we experienced an increase in revenue due to call volume increases,
primarily due to the addition of new sites.
Direct call provisioning revenue increased 5% to $21.3 million for the nine
months ended September 30, 2000, from $20.3 million in the corresponding prior
period. This increase was primarily due to the addition of new sites for which
we are provisioning the long distance service. The addition of sites is a result
of our being successful in competitive bidding arrangements for contracts
directly with correctional institutions.
The Internet Services contract commenced in December 1999. Future revenue
increases are dependent upon the base of subscribers and additional contract
incentive payments.
Equipment sales and other revenue decreased 26% to $1.7 million for the
nine months ended September 30, 2000 from $2.3 million in the corresponding
prior period. Such sales are primarily associated with one telecommunications
service provider customer and are dependent upon the timing of installations for
this customer and the customer's success rate in its territory. In the nine
months ended September 30, 2000 significantly all equipment sales were to this
telecommunications service provider customer. The reduction for the nine months
ended September 30, 2000 from the corresponding prior period is due primarily to
the timing of purchases by this customer.
18
<PAGE> 20
Operating costs. Total operating costs were $51.8 million in the nine
months ended September 30, 2000, an increase of 58% from $32.9 million in the
corresponding prior period. The increases were primarily due to the commencement
of Internet services as well as increases in telecommunication services and
direct call provisioning expenses offset by a reduction in the cost of equipment
sold and other expenses.
Operating costs of telecommunications services primarily consist of service
administration costs for correctional facilities, including salaries and related
personnel expenses, communication costs and inmate calling systems repair and
maintenance expense. Operating costs of telecommunications services also include
costs associated with call verification procedures, primarily network expenses
and database access charges. Operating costs associated with direct call
provisioning include the costs associated with telephone line access, long
distance charges, commissions paid to correctional facilities, costs associated
with uncollectible accounts and billing charges. Internet Services operating
expense consists of purchased internet bandwidth costs.
The following table sets forth the operating costs and expenses for each
type of revenue as a percentage of corresponding revenue for the nine months
ended September 30, 2000 and 1999.
<TABLE>
<CAPTION>
2000 1999
---- ----
<S> <C> <C>
Operating costs:
Telecommunications services............................... 42% 44%
Direct call provisioning.................................. 91 93
Internet services......................................... 83 --
Cost of equipment sold and other.......................... 39 40
</TABLE>
Operating costs associated with providing telecommunications services as a
percentage of corresponding revenue was 42% for the nine months ended September
30, 2000, a decrease from 44% for the corresponding prior period. The decrease
was due to revenue increases in excess of cost increases. Total
telecommunications services operating expenses were $15.3 million for the nine
months ended September 30, 2000 and $13.2 million for the corresponding prior
period. The increase in 2000 is due to new services being provisioned for a
significant customer as part of a contract amendment and due to increases in
personnel costs. The increase included bonus costs associated with our line
installation bonus program. The bonus program ended as of June 30, 2000. Also,
the addition of new personnel in the National Service Center and other
operational support functions contributed to cost increases. To a lesser extent,
increases in travel, consulting services, repairs and maintenance contributed to
the overall cost increase.
Direct call provisioning costs as a percentage of applicable revenue
decreased to 91% of revenue for the nine months ended September 30, 2000 from
93% in for the corresponding prior period. This decrease was primarily due to a
reduction in bad debt expense because of improved collections efforts.
The contract for Internet services commenced in December 1999. Cost of
equipment sold and other decreased in the nine months ended September 30, 2000
but increased as a percentage of corresponding revenue from the corresponding
prior primarily due to the change in the revenue mix for equipment sales and
voice print sales.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses were $13.4 million for the nine months ended September
30, 2000 compared to $9.9 million for the corresponding prior period. Selling,
general and administrative expenses associated with the Corrections Division
were $13.1 million for the nine months ended September 30, 2000 compared to $9.3
million in the corresponding prior period. The increase in the nine months ended
September 30, 2000 was primarily due to increases in salary and benefits for
additional personnel, from raises for existing personnel and a bonus program.
Other expenses increased due to travel, communications and professional fees due
to the integration of Gateway operations.
Research and Development Expenses. Research and development expenses were
$4.0 million in the nine months ended September 30, 2000 compared to $3.7
million for the corresponding prior period. Research and development expenses
for the Corrections Division were $3.6 million in the nine months ended
September 30, 2000 and $3.0 million in the corresponding prior period. The
increase was primarily due to higher travel and consulting costs.
19
<PAGE> 21
Depreciation and Amortization Expenses. Depreciation and amortization
expense was $9.3 million in the nine months ended September 30, 2000, an
increase from $8.6 million for the corresponding prior period. The increase was
due primarily to the depreciation associated with new site installations.
Merger Transaction Expenses. These expenses were directly related to the
merger with Gateway and amounted to approximately $1.0 million for the nine
months ended September 30, 1999. Merger transaction expenses consisted primarily
of fees for investment bankers, attorneys, accountants, financial printing and
other related charges.
Interest and Other Expense, Net. Interest and other expense, net was $1.8
million for the nine months ended September 30, 2000, an increase from $1.6
million for the corresponding prior period. Included in other income in the nine
months ended September 30, 2000 is a gain of approximately $283,000 on the sale
of used telecommunications equipment. There was $59,000 of miscellaneous other
income in the nine months ended September 30, 1999. Interest expense was $2.2
million for the nine months ended September 30, 2000, and $1.7 million for the
corresponding prior period. The increase in 2000 was attributable to an increase
in the average amount of indebtedness outstanding and an increase in interest
rates. The average debt balance increased primarily due to the increase in
capital expenditures and business acquisitions.
LIQUIDITY AND CAPITAL RESOURCES
Cash Flows
We incurred losses from operations for the nine months ended September 30,
2000 of $795,000 and had a working capital deficit of $28.1 million at September
30, 2000. In July 2000 our lenders amended our credit agreement to provide for
revised financial covenants. Additionally, we raised $7.5 million of debt and
equity financing in April 2000. The net proceeds were used to reduce the
outstanding balance on our credit facility. We have taken steps to improve our
cash flow from operations, including renegotiating contract pricing and cost
control measures in order to carry out the remainder of our fiscal 2000 business
plan. We have seen increases in our cash flow from operating income which will
allow for higher levels of borrowings under our current loan agreement. This
credit facility is expected to provide the borrowing capacity necessary to fund
continuing operational needs through April 30, 2001.
We have historically relied upon commercial borrowings, operating cash flow
and the sale of equity securities to fund our operations and capital needs.
Investing activities consist primarily of additions to property and equipment
for site telecommunications equipment and internal equipment requirements. Cash
provided by operations decreased 63% to $2.9 million for the nine months ended
September 30, 2000 from $7.8 million in the corresponding prior period primarily
due to reductions in accounts payable, and increases in accounts receivable. The
increase in the working capital deficit is primarily due to the reclassification
of the bank credit facility as a current liability. The current maturity date of
the facility is April 30, 2001.
Purchases of property and equipment were $10.2 million in the nine months
ended September 30, 2000 compared to $10.1 million for the corresponding prior
period. The increase in purchases of property and equipment was primarily due to
additional inmate calling system installations and upgrades to existing systems.
Debt and Equity
We have been funding our operations primarily from available borrowings
under a line of credit and by using cash provided by operations. Due to our
capital requirements for new installations and the merger with Gateway, in
September 1999, we entered into a Senior Secured Revolving Credit Facility
("Credit Facility") with a commercial bank. The maximum available amount of
credit under the credit facility available to the Company is dependent upon the
Company's financial performance. Based on the financial covenants, the Company's
maximum borrowings at September 30, 2000 were $34.3 million. In July 2000 our
lenders amended our credit agreement to revise certain financial covenants. In
addition, we raised $7.5 million of debt and equity financing in April 2000. The
net proceeds of approximately $7.2 million were used to reduce the outstanding
balance on the Credit Facility.
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We anticipate that our capital expenditures in 2000 will be consistent with
1999 based on our anticipated growth in installed systems at correctional
facilities. We believe our Credit Facility and cash flows from operations will
be sufficient in order for us to meet our anticipated cash needs for anticipated
new installations of inmate call processing systems and upgrades of existing
systems and to finance our operations for at least the next 6 months.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
We are exposed to interest rate risk as discussed below.
INTEREST RATE RISK
We have current debt outstanding under the credit facility of $29.4 million
at September 30, 2000. The credit facility bears interest at differing rates
including, $23.5 million at LIBOR plus 2.75 % and the remaining balance at the
prime rate, 9.5% at September 30, 2000, plus 0.5%. Interest on the LIBOR rate
loan and prime rate loans are payable monthly. Since the interest rates on the
loans outstanding are variable and are reset periodically, we are exposed to
interest rate risk. An increase in interest rates of 1% would increase estimated
annual interest expense by approximately $280,000 based on the amount of
borrowings outstanding under the line of credit at September 30, 2000.
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PART II OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
From time to time we have been, and expect to continue to be subject to
various legal and administrative proceedings or suits in the normal course of
our business.
Gateway recently won a dismissal of a case brought in the First Judicial
District Court of the State of New Mexico, styled Valdez v. State of New Mexico,
et al. That case named as defendants the State of New Mexico, several political
subdivisions of the State of New Mexico and several inmate telecommunications
service providers, including Gateway. The complaint includes a request for
certification by the court of a plaintiffs' class action consisting of all
persons who have been billed for and paid for telephone calls initiated by an
inmate confined in a jail, prison, detention center or other New Mexico
correctional facility. The complaint alleges violations of New Mexico Unfair
Practices Act, the New Mexico Antitrust Act and the New Mexico Constitution, and
also alleges unjust enrichment, constructive trust, economic compulsion,
constructive fraud and illegality of contracts, all in connection with the
provision of "collect only" inmate telecommunications services. The case was
never certified as a class action. The Plaintiffs have indicated a readiness to
appeal the dismissal of the case, although they have not done so to date.
Similarly, T-Netix is likely to win dismissal of another state case brought
in the Superior Court of Washington for King County, styled Sandy Judd, et al.
v. American Telephone and Telegraph Company, et al. In that case, the complaint
joined several inmate telecommunications service providers as defendants,
including T-NETIX. The complaint includes a request for certification by the
court of a plaintiffs' class action consisting of all persons who have been
billed for and paid for telephone calls initiated by an inmate confined in a
jail, prison, detention center or other Washington correctional facility. The
complaint alleges violations of the Washington Consumer Protection Act (WCPA)
and requests an injunction under the Washington Consumer Protection Act and
common law to enjoin further violations. The court has held that the complaint
fails to state a valid claim under the WCPA and has granted plaintiffs leave to
amend the complaint to address this infirmity. Regardless of the merits of the
amended claim, the judge has ruled that it has no jurisdiction to adjudicate the
matter and will refer the claim to the Washington Utilities and Transportation
Commission for disposition.
Gateway is presently litigating an appeal from a similar favorable ruling
in Kentucky federal court in the case Gus "Skip" Daleure, Jr., et al. vs.
Commonwealth of Kentucky, et al. The complaint in this case joined as defendants
several states, political subdivisions of states, and inmate service
telecommunications providers and was filed contemporaneously with a request for
certification by the court of a nationwide plaintiffs' class action consisting
of all persons who have received and paid for telephone calls initiated by an
inmate at a prison, jail or other correctional institution for the provision of
"collect only" inmate telecommunications services. The complaint sought
declaratory and injunctive relief and money damages in an unstated amount for
alleged violations of the Sherman Antitrust Act, the Robinson-Patman Act and the
U.S. Constitution. The district court held, on motions to dismiss; Kentucky did
not have personal jurisdiction over defendants not located in or doing business
in the state of Kentucky; that telephone calls are not goods or commodities and
thus are not subject to the antitrust provisions of the Robinson-Patman Act;
that Plaintiffs did not state a claim for relief under the Equal Protection
Clause of the Fourteenth Amendment; and that Plaintiffs had not shown any harm
in support of its antitrust claim under Section 1 of the Sherman Act. The trial
judge did not, however, dismiss the plaintiff's prayer for injunctive relief,
despite these findings. The case is currently subject to appeal and cross appeal
in the Second Circuit Court of Appeals. Although Gateway believes the District
Court holding will not be overturned it is possible that it may be, and there
can be no assurance that a judgment against a class of the providers will not
ultimately be entered.
We believe the ultimate disposition of the forgoing matters will not have a
material affect on our financial condition, liquidity, or results of operations.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
None
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ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
<TABLE>
<C> <S>
27 -- Financial Data Schedule
</TABLE>
(b) The Company filed a Form 8-K dated August 28, 2000 reporting the
following:
Item 5 on Form 8-K regarding resignation of chief executive officer
and director.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
T-NETIX, INC.
(Registrant)
By: /s/ THOMAS E. LARKIN
----------------------------------
Thomas E. Larkin
President
By: /s/ JOHN GIERSCHER
----------------------------------
John Gierscher
Principal Accounting Officer
Date November 13, 2000
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EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<C> <S>
27 -- Financial Data Schedule
</TABLE>
