**SECURITIES AND EXCHANGE COMMISSION**

Washington, DC 20549

|   |   |   |
|--------|--------|--------|

 

FORM 10-Q

 

[ X ] Quarterly report pursuant to sections 13 or 15(d) of the Securities Exchange Act of 1934

 

For the quarterly period ended September 30, 2007

 

Or

 

o Transition report pursuant to section 13 or 15(d) of the Securities Exchange Act of 1934 For The Transition Period From _____ to _____

 

Commission File Number 333-124962

 

**SECURUS TECHNOLOGIES, INC.**

(Exact name of registrant as specified in its charter)

 

| **Delaware**                    |   | **20-0673095**         |
|---------------------------------|--------|------------------------|
| (State of other jurisdiction of |   | (I.R.S. Employer       |
| incorporation or organization)  |   | Identification Number) |

 

14651 Dallas Parkway, Suite 600

Dallas, TX 75254-8815

(972) 277-0300

 

(Address, including zip code, and telephone number, including area code, of Registrant’s principal executive offices) 

 

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.   Yes  [ X ]          No   o

 

Indicate by check mark whether the Registrant is an accelerated filer, or a non-accelerated filer.  See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act  (Check one):

 

|   | Large Accelerated Filer  [ | ]   | Accelerated Filer  [ | ]   | Non-Accelerated Filer  [ X ] |
|--------|--------------------------------------|---------------|--------------------------------|---------------|----------------------------------------|

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

|   | Yes  [ | ]   | No   | [ X ] |
|--------|------------------|---------------|----------------|-------|

 

No established published trading market exists for either the common stock, par value $0.01 per share, of Securus Technologies, Inc. or the Class B common stock, par value $0.01 per share, of Securus Technologies, Inc.

 

Shares outstanding of each of the registrant’s classes of common stock:

 

| **Class**            |   | **Outstanding at September** **30, 2007** |
|----------------------|--------|------------------------------------------------|
| Class A common stock |   | 589,463.65 shares                              |
| Class B common stock |   | 72,084.32 shares                               |

 

 

 

 

 

Page 1

 

 

 

 

**TABLEOFCONTENTS**

 

 

|   | PART I – FINANCIAL INFORMATION | 3 |  
 

ITEM 1. FINANCIAL STATEMENTS

3

 
 

ITEM 2

. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

18

 

ITEM 3

. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

32

 
 

ITEM 4

. CONTROLS AND PROCEDURES

32

 
 

PART II

— OTHER INFORMATION

33

 
 

ITEM 1. LEGAL PROCEEDINGS

33

 
 

ITEM 1A

. RISK FACTORS

34

 
 

ITEM 2

. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

35

 
 

ITEM 3

. DEFAULTS UPON SENIOR SECURITIES

35

 
 

ITEM 4

. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

35

 
 

ITEM 5

. OTHER INFORMATION

35

 
 

ITEM 6

. EXHIBITS

36

 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Page 2

 

 

**PART I – FINANCIAL INFORMATION**

 

**ITEM 1. FINANCIAL STATEMENTS**

 

SECURUS TECHNOLOGIES, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(Dollars in thousands, except share and per share amounts)

 

 

 

**December 31,**

 

 

**September 30,**

 

 

 

**2006**

 

 

**2007**

 

 

 

 

 

 

 

**(Unaudited)**

 

***ASSETS***

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

558

 

 

$

2,088

 

Restricted cash

 

 

1,461

 

 

 

1,518

 

Accounts receivable, net

 

 

64,174

 

 

 

55,175

 

Prepaid expenses and other current assets

 

 

5,063

 

 

 

5,531

 

Deferred income taxes

 

 

5,155

 

 

 

5,428 

 

Total current assets

 

 

76,411

 

 

 

69,740

 

Property and equipment, net

 

 

46,429

 

 

 

42,121

 

Intangibles and other assets, net

 

 

98,873 

 

 

 

123,885

 

Goodwill

 

 

37,936

 

 

 

66,785

 

Total assets

 

$

259,649

 

 

$

302,531

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

***LIABILITIES AND STOCKHOLDERS’ DEFICIT***

 

 

 

 

 

 

 

 

Accounts payable

 

$

42,728

 

 

$

36,679

 

Due to related party, net

 

 

-

 

 

 

4,933

 

Accrued liabilities

 

 

39,395

 

 

 

36,259

 

Deferred revenue and customer advances

 

 

8,801

 

 

 

14,967

 

Deferred income taxes

 

 

-

 

 

 

509

 

Total current liabilities

 

 

90,924

 

 

 

93,347

 

Deferred income taxes

 

 

8,262

 

 

 

16,197

 

Long-term debt

 

 

210,642

 

 

 

269,321

 

Other long-term liabilities

 

 

1,694

 

 

 

1,622

 

Total liabilities

 

$

311,522

 

 

$

380,487

 

 

 

 

 

 

 

 

 

 

Commitments and contingencies

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Stockholders’ deficit:

 

 

 

 

 

 

 

 

Common stock, $0.01 stated value, 1,000,000 shares authorized; 

 

 

 

 

 

 

 

 

609,510 shares issued and outstanding at December 31, 2006 and

 

 

 

 

 

 

 

 

661,548 shares issued and outstanding at September 30, 2007 

 

 

6

 

 

 

7

 

Additional paid-in capital

 

 

34,140

 

 

 

35,604

 

Accumulated other comprehensive income

 

 

-

 

 

 

1,684

 

Accumulated deficit

 

 

(86,019

)

 

 

(115,251

)

Total stockholders’ deficit

 

 

(51,873

)

 

 

(77,956

)

Total liabilities and stockholders’ deficit

 

$

259,649

 

 

$

302,531

 

 

See accompanying notes to condensed consolidated financial statements.

 

 

 

 

 

Page 3

 

 

SECURUS TECHNOLOGIES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

For the Three Months and Nine Months ended September 30, 2006 and 2007

(Dollars in thousands)

 

 

**For the Three Months Ended**

 

 

**For The Nine Months Ended**

 

 

**September 30,**

 

 

**September 30,**

 

 

 

 

**September 30,**

 

 

**September 30,**

 

 

 

**2006**

 

 

**2007**

 

 

 

 

**2006**

 

 

**2007**

 

 

**(unaudited)**

 

**(unaudited)**

 

Revenue:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Direct call provisioning

$

84,094

 

$

79,462

 

 

 

$

251,721

 

$

257,633

 

Solution services

 

11,183

 

 

8,422

 

 

 

 

35,161

 

 

28,042

 

Telecommunications services

 

2,744

 

 

1,698

 

 

 

 

11,077

 

 

6,063

 

Offender management software

 

-  

 

 

4,798

 

 

 

 

-  

 

 

4,798

 

Equipment sales and other

 

64

 

 

222

 

 

 

 

494

 

 

462

 

Total revenue

 

98,085

 

 

94,602

 

 

 

 

298,453

 

 

296,998

 

Cost of service, exclusive of depreciation and amortization shown separately below

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Direct call provisioning, exclusive of bad debt expense

 

57,276

 

 

54,724

 

 

 

 

167,296

 

 

174,123

 

Direct call provisioning bad debt expense

 

9,595

 

 

8,203

 

 

 

 

29,634

 

 

29,648

 

Solutions services expense

 

8,619

 

 

5,518

 

 

 

 

26,314

 

 

18,831

 

Offender management software

 

-  

 

 

3,456

 

 

 

 

-  

 

 

3,456

 

Telecommunications services expenses

 

1,307

 

 

755

 

 

 

 

5,421

 

 

2,692

 

Cost of equipment sold and other

 

18

 

 

189

 

 

 

 

367

 

 

364

 

Total cost of service

 

76,815

 

 

72,845

 

 

 

 

229,032

 

 

229,114

 

Selling, general and administrative

 

12,364

 

 

17,342

 

 

 

 

38,779

 

 

45,628

 

Restructuring costs

 

-  

 

 

-  

 

 

 

 

-  

 

 

614

 

Depreciation and amortization

 

7,609

 

 

9,904

 

 

 

 

21,307

 

 

27,495

 

Total operating costs and expenses

 

96,788

 

 

100,091

 

 

 

 

289,118

 

 

302,851

 

Operating income (loss)

 

1,297

 

 

(5,489

)

 

 

 

9,335

 

 

(5,853

)

Interest and other expenses, net

 

6,892

 

 

7,744

 

 

 

 

20,742

 

 

22,531

 

Loss before income taxes

 

(5,595

)

 

(13,233

)

 

 

 

(11,407

)

 

(28,384

)

Income tax expense

 

392

 

 

(46

)

 

 

 

1,020

 

 

848

 

Net loss

$

(5,987

)

$

(13,187

)

 

 

$

(12,427

)

$

(29,232

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

See accompanying notes to condensed consolidated financial statements.

 

 

 

Page 4

 

 

SECURUS TECHNOLOGIES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

For the Nine Months ended September 30, 2006 and 2007

(Dollars in thousands)

 

 

 

**September 30,**

 

 

**September 30,**

 

 

**2006**

 

 

**2007**

 

 

**(Unaudited)**

 

CASH FLOWS FROM OPERATING ACTIVITIES:

 

 

 

 

 

 

 

Net loss

$

(12,427

)

 

$

(29,232

)

Adjustment to reconcile net loss to net cash provided by operating activities:

 

 

 

 

 

 

 

Depreciation and amortization

 

21,307

 

 

 

27,495

 

Amortization of fair value of contracts acquired

 

-  

 

 

 

861

 

Deferred income taxes

 

873

 

 

 

(1,052

)

Non-cash interest expense

 

6,616

 

 

 

8,214

 

Equity (income) loss from unconsolidated affiliate

 

(348

)

 

 

102

 

Stock-based compensation

 

83

 

 

 

51

 

Amortization of deferred financing costs and debt discounts

 

1,143

 

 

 

1,540

 

Changes in operating assets and liabilities:

 

 

 

 

 

 

 

Restricted cash

 

(47

)

 

 

(57

)

Accounts receivable

 

583

 

 

 

15,748

 

Prepaid expenses and other current assets

 

446

 

 

 

245

 

Intangible and other assets

 

(705

)

 

 

569

 

Accounts payable

 

(5,643

)

 

 

(7,291

)

Accrued liabilities and other liabilities

 

(4,572

)

 

 

(5,384

)

Net cash provided by operating activities

$

7,309

 

 

$

11,809

 

 

 

 

 

 

 

 

 

CASH FLOWS FROM INVESTING ACTIVITIES:

 

 

 

 

 

 

 

Purchase of property and equipment including costs of intangibles

$

(19,282

)

 

 

(16,948

)

Cash consideration paid for acquired business

 

-  

 

 

 

(43,689

)

Proceeds from sale of unconsolidated affiliate

 

-  

 

 

 

985

 

Property insurance proceeds

 

-  

 

 

 

88

 

Net cash used in investing activities

$

(19,282

)

 

$

(59,564

)

 

 

 

 

 

 

 

 

CASH FLOWS FROM FINANCING ACTIVITIES:

 

 

 

 

 

 

 

Proceeds from issuance of second-priority senior secured notes

$

-  

 

 

$

39,060

 

Advances on revolving credit facility, net

 

7,250

 

 

 

10,894

 

Cash overdraft

 

2,593

 

 

 

562

 

Debt issuance costs

 

-  

 

 

 

(5,009

)

Advance from related party

 

-  

 

 

 

5,000

 

Payments on other debt

 

(80

)

 

 

-  

 

Net cash provided by financing activities

$

9,763

 

 

$

50,507

 

 

 

 

 

 

 

 

 

Effect of exchange rates on cash and cash equivalents

$

-  

 

 

$

(1,222

)

 

 

 

 

 

 

 

 

Increase (decrease) in cash and cash equivalents

$

(2,210

)

 

$

1,530

 

Cash and cash equivalents at the beginning of the period

 

2,630

 

 

 

558

 

Cash and cash equivalents at the end of the period

$

420

 

 

$

2,088

 

 

 

 

 

 

 

 

 

SUPPLEMENTAL DISCLOSURES:

 

 

 

 

 

 

 

Cash paid during period for:

 

 

 

 

 

 

 

Interest

$

17,347

 

 

$

18,337

 

Income taxes

$

131 

 

 

$

236 

 

Non-cash consent fee

$

-  

 

 

$

400

 

 

See accompanying notes to condensed consolidated financial statements.

 

 

Page 5

 

 

SECURUS TECHNOLOGIES, INC. AND SUBSIDIARIES

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

**Note 1 –** **Description of Business and Significant Accounting Policies and Practices**

 

*Description of Business and Organization*

 

Securus Technologies, Inc. (“Securus”) and subsidiaries (“we” or the “Company”) provide inmate communications services to correctional facilities operated by city, county, state and federal authorities and other types of confinement facilities in 47 states, the District of Columbia, and two Canadian provinces. Securus was incorporated in Delaware on January 12, 2004. On March 3, 2004, Securus acquired all of the outstanding equity interests of T-Netix, Inc. (“T-Netix”) and on September 9, 2004, we acquired all of the outstanding equity interests of Evercom Holdings, Inc. (“Evercom”). On June 29, 2007, we acquired Syscon Holdings, Ltd, and certain of its affiliates (“Syscon”), which provides offender management software to more than 250 correctional facilities and probation offices in the United States, Canada, the UnitedKingdom and Australia. Syscon is included in the results of operations beginning on June 29, 2007.

 

*Basis of Presentation*

 

The accompanying unaudited condensed consolidated financial statements as of and for the three and nine months ended September 30, 2006 and 2007 have been prepared in accordance with U.S. Generally Accepted Accounting Principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X.  Accordingly, they do not include all of the information and notes required by U.S. Generally Accepted Accounting Principles for complete financial statements of Securus.  In the opinion of management, all adjustments necessary for a fair presentation have been included and are of a normal recurring nature.  Interim results are not necessarily indicative of the results that may be expected for the year.  The condensed consolidated financial statements should be read in conjunction with the audited consolidated financialstatements and accompanying notes for the year ended December 31, 2006 of the Company as filed in the Company’s Annual Report on Form 10-K and the consolidated financial statements and accompanying notes of Syscon for the periods ended March 31, 2007, filed on June 22, 2007 as an Exhibit to Form 8-K.

 

*Accounting Estimates*

 

The preparation of unaudited condensed consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenue and expenses during the reported period.  Significant items subject to such estimates include the valuation allowances for receivables, revenue recognition under the percentage of completion accounting method and prescribed methods unique to software contracts, the carrying amount for property and equipment, goodwill, intangible and other assets, and deferred income taxes.  Actual results could differ from those estimates.

 

On January 1, 2007, the Company reduced its estimate of the useful life of certain telecommunications equipment to reflect the installation, over the next several years, of our new packet-based architecture. This change in the depreciation period increased net loss by $1.4 million for the first nine months of 2007, and will increase net loss by approximately $1.9 million for the year ending December 31, 2007.

 

*Principles of Consolidation*

 

The accompanying condensed consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries, T-Netix, Inc., Evercom Holdings, Inc., and Syscon. All significant intercompany accounts and transactions have been eliminated in consolidation. 

 

 

 

 

 

Page 6

 

 

*Recent Accounting Pronouncements*

 

The Company adopted EITF Issue No. 06-3, “*How Taxes Collected from Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement (That is, Gross versus Net Presentation)”,* in the first quarter of 2007. The scope of this issue includes any tax assessed by a governmental authority that is both imposed on and concurrent with a specific revenue-producing transaction between a seller and a customer, and may include, but is not limited to, sales, use, value added, and some excise taxes. The presentation of revenues on either a gross or a net basis is an accounting policy decision that should be disclosed under Accounting Principals Board (APB) Opinion No. 22. The Company’s policy is to report revenues using a net presentation. 

 

In July 2006, the FASB issued Interpretation No. 48, “*Accounting for Uncertainty in Income Taxes*” (“FIN No. 48”), which clarifies the accounting for uncertainty in income taxes recognized in the financial statements in accordance with SFAS No. 109. FIN No. 48 provides guidance on the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN No. 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosures, and transition.  The Company adopted the provisions of FIN No. 48 on January 1, 2007.  The adoption of these provisions did not have any impact on the financial condition or results of operations of the Company.

 

The Company recognized no adjustment in the liability for unrecognized tax benefits upon the adoption of FIN 48. As of the date of adoption, the Company’s unrecognized tax benefits totaled $0.1 million, including interest and penalties of $0. The amount of unrecognized tax benefits that would impact the effective rate, if recognized, would be $0.1 million.  The amount of the unrecognized tax benefits that would impact goodwill, if recognized, would be $0.6 million.  The Company does not anticipate a significant change to the total amount of unrecognized tax benefits over the next twelve months.

 

The Company or one of its subsidiaries file income tax returns in the US federal jurisdiction, Canada, the United Kingdom, Australia and various states. The Company has open tax years for the U.S. federal return from 1996 forward with respect to its net operating loss (“NOL”) carryforwards, where the IRS may not raise tax for these years, but can reduce NOLs. Otherwise, with few exceptions, the Company is no longer subject to federal, foreign, state, or local income tax examinations for years prior to 2003.

 

The Company recognizes potential accrued interest and penalties related to unrecognized tax benefits in income tax expense. For the quarter ended and year to date September, 2007, the Company recognized $0.09 million in potential interest and penalties with respect to unrecognized tax benefits.

 

In September 2006, the FASB issued SFAS No. 157, *“Fair Value Measurement”*(“SFAS No. 157”), which defines fair value, establishes a framework for measuring fair value in GAAP and expands disclosure about fair value measurements. This statement does not require any new fair value measurements; rather, it applies whenever other accounting pronouncements require or permit fair value measurements. The provisions of this statement are to be applied prospectively as of the beginning of the fiscal year in which this statement is initially applied, with any transition adjustment recognized as a cumulative-effect adjustment to the opening balance of retained earnings. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007 and interim periods within those fiscal years. The Company will berequired to adopt SFAS No. 157 in the first quarter of fiscal year 2008. The Company has not completed its evaluation of the effect of SFAS No. 157. 

 

In February 2007, the FASB issued SFAS No. 159, *“The Fair Value Option for Financial Assets and Financial Liabilities — Including an amendment of FASB Statement No.* *115”*(“SFAS No. 159”), which permits entities to choose to measure many financial instruments and certain other items at fair value. The objective of SFAS No. 159 is to improve financial reporting by providing entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. SFAS No. 159 is effective for fiscal years beginning after November 15, 2007. The Company has the option of adopting SFAS No. 159 on January 1, 2008. The Company has notcompleted its evaluation of the effect SFAS No. 159 would have on the Company if adopted.

 

Page 7

 

 

 

*Comprehensive Income*

 

Statement of Financial Accounting Standards (“SFAS”) No. 130, *Reporting Comprehensive Income*, requires that certain items such as foreign currency translation adjustments and unrealized gains and losses on certain derivative instruments classified as a hedge be presented as separate components of shareholders’ equity.  Total comprehensive loss for the three months ended September 30, 2006 and 2007 was $6.0 million and $11.5 million, respectively.  Total comprehensive loss for the nine months ended September 30, 2006 and 2007 was $12.4 million and $27.5 million, respectively. For the three and nine months ending September 30, 2007, comprehensive loss includes foreign currency translation adjustment of $1.7 million.

 

**Note 2 –** **Acquisition & Disposition**

 

On June 29, 2007, we acquired all of the outstanding capital stock of Syscon pursuant to a Stock Purchase Agreement dated April 11, 2007 (“Purchase Agreement”). The initial consideration for Syscon’s capital stock was approximately $41 million in cash and 45,604 shares of our Class A common stock, subject to a working capital adjustment. In addition, we will pay up to an additional $7 million after each of the first three 12 month periods after the closing date if Syscon’s revenues exceed certain thresholds and the seller still remains an employee of the Company.  Any additional payments made will be reflected as compensation expense in the statement of operations.  Pursuant to the Purchase Agreement, Syscon’s previous stockholder also left $5.0 million of cash in Syscon’s bank accounts upon the closing of the Syscon acquisition. We will paySyscon’s previous stockholder up to $5.0 million as Syscon generates Net Cash Flow (as defined in the Purchase Agreement).

 

Syscon is an enterprise software development company for the correctional facility industry. Syscon’s core product is a sophisticated and comprehensive software system utilized by correctional facilities and law enforcement agencies for complete offender management. Syscon’s system provides correctional facilities with the ability to manage and monitor inmate parole and probation activity and development at a sophisticated level. Syscon’s customers operate more than 250 correctional facilities and probation offices maintaining records for over 300,000 offenders in the United States, Canada, the United Kingdom and Australia. Syscon is the largest offender management software provider to Electronic Data Systems, Inc. for the U.K.’s National Offender Management System for Her Majesty’s Prison Service.

 

The acquisition has been accounted for as a purchase in accordance with SFAS No. 141, *Business Combinations*. Under the purchase method of accounting, the total purchase price has been allocated to the assets acquired and liabilities assumed of Syscon based on their respective fair values. A preliminary allocation of the purchase costs has been made for major categories of assets and liabilities in the consolidated balance sheet based on estimates of fair values reflecting valuations prepared by third-party appraisers. The value of intangible assets was determined using a discounted net cash flow approach. The fair value of the Class A common stock we issued to Syscon’s previous shareholder was estimated using the option-pricing method, whereby the fair value of stock is modeled as a series of call options, representing the present value ofthe expected future returns to shareholders. Under this method, each class of stock is modeled with a distinct claim on the shareholders' equity value of the Company, creating three call options with various liquidation preference values that represent significant milestones for the Company's shareholders. The value of these three call options are then calculated utilizing the Black-Scholes option pricing model. Any final adjustments to the purchase price or the estimated fair values of the assets purchased will change the allocations of purchase price and could result in changes to the unaudited pro forma and actual consolidated financial statements, and the changes could be material.

 

 

Page 8

 

 

The total purchase price for Syscon was $45.1 million, as shown below, and has been preliminarily allocated as follows (in thousands):

 

 

**Purchase Price Calculation:**

 

 

 

 

 

Cash payment for tendered shares

$

41,000

 

 

 

Costs incurred related to the acquisition

 

2,689

 

 

 

Value of common stock

 

1,414

 

 

 

 

$

45,103

 

 

 

**Allocation of Purchase Price**:

 

 

 

 

 

Accounts receivable, net

$

5,981

 

 

 

Prepaid expenses and other assets

 

1,606

 

 

 

Property, plant and equipment

 

886

 

 

 

Goodwill

 

27,058

 

 

 

Intangibles

 

25,728

 

 

 

Accounts payable

 

(511

)

 

 

Accrued expenses

 

(2,398

)

 

 

Deferred revenue

 

(6,516

)

 

 

Net deferred tax liability

 

(6,731

)

 

 

Total Allocation

$

45,103

 

 

 

 

The following unaudited pro forma combined amounts give effect to the acquisition of Syscon as if the acquisition had occurred on January 1, 2006. The pro forma amounts do not purport to be indicative of what would have occurred had the acquisition been made as of the beginning of the period or of results which may occur in the future.

 

 

(**Unaudited)**

 

 

**For the Three Months Ended**

 

**For the Nine Months Ended**

 

 

**September 30,**

 

 

**September 30,**

 

 

 

**September 30,**

 

 

**September 30,**

 

 

 

**2006**

 

 

**2007**

 

 

 

**2006**

 

 

**2007**

 

Total revenue

$

104,439

 

$

94,602

 

 

$

316,073

 

$

308,688

 

Net loss

$

(6,862

)

$

(13,187

)

 

$

(18,297

)

$

(33,030

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

On August 9, 2007, Accudata, Inc. purchased our 50% interest in its preferred stock for $1.0 million. In connection with the sale of its stock, Securus agreed to continue to conduct business with Accudata, Inc. for at least thirty-six months. Minimum monthly payments for validation services will be $85,000 for the first twelve months, $56,667 for the second twelve months, and $28,333 for the third twelve months.

 

**Note 3 –** **Balance Sheet Components**

 

Accounts receivable, net, consist of the following (in thousands):

 

 

 

**December 31,**

 

 

**September 30,**

 

 

 

 

 

**2006**

 

 

 

**2007**

 

 

 

 

 

 

 

 

**(Unaudited)**

 

 

Accounts receivable, net:

 

 

 

 

 

 

 

 

 

Trade accounts receivable

$

75,045

 

 

$

65,181

 

 

 

Advance commissions receivable

 

3,306

 

 

 

2,594

 

 

 

Other receivables

 

868

 

 

 

1,954

 

 

 

 

 

79,219

 

 

 

69,729

 

 

 

Less: Allowance for doubtful accounts

 

(15,045

)

 

 

(14,554

)

 

 

 

$

64,174

 

 

$

55,175

 

 

 

At December 31, 2006 and September 30, 2007, the Company had advanced commissions to certain facilities totaling $3.3 million and $2.6 million, respectively, which are recoverable from such facilities as a reduction of earned commissions for specified monthly amounts. Amounts included in accounts receivable represent the estimated recoverable amounts during the next fiscal year.

 

Page 9

 

 

 

Direct call provisioning bad debt expense for the three and nine months ended September 30, 2006 was $9.6 million, or 11.4%, and $29.6 million, or 11.8%, respectively, of direct call provisioning revenue of $84.1 million and $251.7 million, respectively. Direct call provisioning bad debt expense for the three and nine months ended September 30, 2007 was $8.2 million, or 10.3%, and $29.6 million, or 11.5%, respectively, of direct call provisioning revenue of $79.5 million and $257.6 million, respectively.

 

Property and equipment, net, consists of the following (in thousands):

 

 

 

**December 31,**

 

 

**September 30,**

 

 

 

 

 

**2006**

 

 

 

**2007**

 

 

 

 

 

 

 

 

**(Unaudited)**

 

 

Property and equipment, net:

 

 

 

 

 

 

 

 

 

Telecommunications equipment

$

47,420

 

 

$

54,684

 

 

 

Leasehold improvements

 

3,400

 

 

 

3,585

 

 

 

Construction in progress

 

6,727

 

 

 

4,931

 

 

 

Office equipment

 

13,842

 

 

 

16,095

 

 

 

 

 

71,389

 

 

 

79,295

 

 

 

Less: Accumulated depreciation and amortization

 

(24,960

)

 

 

(37,174

)

 

 

 

$

46,429

 

 

$

42,121

 

 

 

Intangibles and other assets, net, consist of the following (in thousands):

 

 

 

**December 31, 2006**

 

**Gross**

 

 

 

 

 

 

 

**Weighted**

 

**Carrying**

 

**Accumulated**

 

 

 

 

**Average**

 

**Value**

 

**Amortization**

 

**Net**

 

**Life**

Patents and trademarks

$

19,115

 

$

(4,574

)

$

14,541

 

10.2

Deferred financing costs

 

9,022

 

 

(2,054

)

 

6,968

 

7.3

Capitalized software development costs

 

18,633

 

 

(6,975

)

 

11,658

 

4.3

Acquired contract rights

 

83,637

 

 

(20,773

)

 

62,864

 

10.5

Deposits and long-term prepayments

 

1,755

 

 

-  

 

 

1,755

 

 

Other

 

1,087

 

 

-  

 

 

1,087

 

 

 

$

133,249

 

$

(34,376

)

$

98,873

 

 

 

 

**September 30, 2007 (Unaudited)**

 

**Gross**

 

 

 

 

 

 

 

**Weighted**

 

**Carrying**

 

**Accumulated**

 

 

 

 

**Average**

 

**Value**

 

**Amortization**

 

**Net**

 

**Life**

Patents and trademarks

$

25,422

 

$

(6,290

)

$

19,132

 

10.2

Deferred financing costs

 

14,031

 

 

(3,084

)

 

10,947

 

6.1

Capitalized software development costs

 

31,282

 

 

(10,417

)

 

20,865

 

5.9

Acquired contract rights

 

98,521

 

 

(29,427

)

 

69,094

 

9.4

Non-compete and employment agreements

 

1,893

 

 

(117

)

 

1,776

 

4.6

Deposits and long-term prepayments

 

2,071

 

 

-  

 

 

2,071

 

 

 

$

173,220

 

$

(49,335

)

$

123,885

 

 

 

 

At December 31, 2006 and September 30, 2007, the carrying value assigned to patents and trademarks that were not subject to amortization was $3.0 million.

 

Amortization expense for the three and nine months ended September 30, 2006 was $4.1 million (of which $0.3 million was included in interest expense) and $12.1 million (of which $0.7 million was included in interest expense), respectively. Amortization expense for the three and nine months ended September 30, 2007 was $6.8 million (of which $0.5 million was included in interest expense and $0.9 was amortized against revenue) and $16.0 million (of which $1.0 million was included in interest expense and $0.9 was amortized against revenue), respectively. Estimated amortization expense related to intangibles, excluding deferred financing costs, the fair value of acquired Syscon in-process operating contracts and other assets, at September 30, 2007 and for each of the next five years through September 30, 2012 and thereafter is summarized as follows (in thousands):

 

Page 10

 

 

  

**Period Ended September 30 (Unaudited)**

 

 

 

 

 

2008

$

18,344

 

 

 

2009

 

16,740

 

 

 

2010

 

14,460

 

 

 

2011

 

12,780

 

 

 

2012

 

8,571

 

 

 

Thereafter

 

33,013

 

 

 

 

$

103,908

 

 

 

The fair value of Syscon’s in-process operating contracts and customer agreement acquired of $5.1 million will be amortized against revenue over the remaining life of the contracts using the percentage of completion method of accounting in accordance with EITF 01-3, “*Accounting in a Business Combination for Deferred Revenue of an Acquiree*”, which is estimated to be over the next 18 months. As of September 30, 2007, $0.9 million was amortized. The fair value represents the remaining amount to be billed under the acquired contractual obligations reduced by the estimated direct and indirect costs to complete and an allowance for the normal profit margin related to the activities to be performed.

 

Accrued liabilities consist of the following (in thousands):

 

 

 

**December 31,**

 

 

**September 30,**

 

 

 

 

 

**2006**

 

 

 

**2007**

 

 

 

 

 

 

 

 

**(Unaudited)**

 

 

Accrued expenses

$

26,395

 

 

$

26,773

 

 

 

Accrued compensation

 

6,066

 

 

 

6,389

 

 

 

Accrued exit costs

 

111

 

 

 

358

 

 

 

Accrued taxes

 

1,026

 

 

 

711

 

 

 

Accrued interest and other

 

5,797

 

 

 

2,028

 

 

 

 

$

39,395

 

 

$

36,259

 

 

 

Restructuring charges of $0.6 million were incurred during the second quarter of 2007 related to the consolidation of our internal customer care function into the Dallas office, comprised of $0.2 million of severance expense and $0.4 million of facility exit costs for our Selma, Alabama location. All of the severance expenses were paid during the second quarter of 2007.

 

**Note 4 –** **Goodwill**

 

 

**Direct**

 

**Offender**

 

 

 

**Call**

 

**Management**

 

 

 

**Provisioning**

 

**Software**

 

**Total**

Balance at December 31, 2006

$

37,936

 

$

-  

 

$

37,936

Allocation of goodwill from Syscon acquisition

 

- 

 

 

27,058

 

 

27,058

Foreign currency translation

 

 

 

 

1,791

 

 

1,791

Balance at September 30, 2007

$

37,936

 

$

28,849

 

$

66,785

 

 **Note 5 –** **Debt**

 

Debt consists of the following (in thousands):

 

 

 

**December 31,**

 

 

**September 30,**

 

 

 

 

 

**2006**

 

 

 

**2007**

 

 

 

 

 

 

 

 

**(Unaudited)**

 

 

Revolving credit facility

$

3,225

 

 

$

14,119

 

 

 

Second-priority senior notes

 

154,000

 

 

 

194,000

 

 

 

Senior subordinated notes

 

58,756

 

 

 

66,970

 

 

 

Total debt

 

215,981

 

 

 

275,089

 

 

 

Less unamortized discount on Second-priority Senior Secured Notes and senior subordinated notes

 

(5,339

)

 

 

(5,768

)

 

 

 

$

210,642

 

 

$

269,321

 

 

 

 

Page 11

 

 

 

*Revolving Credit Facility.*  We have a revolving credit facility (the “Revolver”) with a syndicate of banks and other lending institutions with a borrowing base limitation equal to 80% of “eligible receivables” and 50% of inventory, as defined in the credit agreement.  The Revolver provides for financing on a revolving basis of up to $30.0 million and a $22.5 million letter of credit facility that expires on September 9, 2009.  To the extent that letters of credit outstanding are greater than $10.0 million, the incremental letters of credit outstanding over $10.0 million reduces our availability.  Our maximum permitted annual capital expenditures are $30.0 million and $22.0 million for the years ended December 31, 2006 and 2007, respectively. Amounts unused under theRevolver are subject to a fee, due quarterly, based on a per annum rate of 0.375%.  Advances bear simple interest at an annual rate at our option equal to one of the following, (i) the Prime Rate or (ii) a rate equal to the Eurodollar Rate as adjusted by the Eurodollar Reserve Percentage plus 2.0%. Interest is payable following the end of each calendar quarter. Advances received on the Revolver bore interest at our option using the prime rate, which was 8.25% at December 31, 2006 and 7.75% on September 30, 2007, as well as an advance of $10.0 million based on the Eurodollar Rate. We draw from the available credit on the Revolver to cover normal business cash requirements.  As of December 31, 2006 and September 30, 2007, we had $26.8 million and $15.9 million, respectively, of borrowing availability under the Revolver.

 

*Second-priority Senior Secured Notes.*  On September 9, 2004, we issued $154.0 million of 11% Second-priority Senior Secured Notes. These notes were issued at a discount of $3.6 million, or 97.651% of face value, and the proceeds were used to finance the acquisition of Evercom and to repay then outstanding long-term debt obligations. On June 29, 2007, we issued $40 million aggregate principal amount of our 11% Second-priority Senior Secured Notes due 2011 under an Indenture dated September 9, 2004, as amended on June 27, 2007, in a private offering (“the 2007 Notes”). The 2007 Notes were issued at a discount of $0.9 million, or 97.651% of face value, and the proceeds were used to finance the acquisition of Syscon. In connection with our issuance of the 2007 Notes, we entered into a registration rights agreement withthe initial purchaser pursuant to which we were required to register with the Securities and Exchange Commission (the “SEC”) up to $40.0 million aggregate principal amount of new 11% Second-priority Senior Secured Notes due 2011 and offer to exchange such notes for our outstanding 2007 Notes. On September 17, 2007, we exchanged all of the 2007 Notes for new 11% Second-priority Secured Notes due 2011.

 

All $194.0 million of principal is due September 9, 2011. To the extent the Company generates excess cash flow (as defined in the indenture) in any calendar year, we are required by the Second-priority Senior Secured Notes to offer to repay principal equal to 75% of such excess cash flow at a rate of 104% of face value.  No excess cash flow payment was due for the year ended December 31, 2006 because no excess cash flow was generated.  Interest is payable semiannually on March 1 and September 1. The effective interest rate is 11.5% on the Second-priority Senior Secured Notes. 

 

*Senior Subordinated Notes.*  On September 9, 2004, we issued $40.0 million of Senior Subordinated Notes, unsecured and subordinate to the Revolving Credit Facility and the Senior Notes, that bear interest at an annual rate of 17%.  Interest is payable at the end of each calendar quarter, or, as restricted by the Company’s Revolving Credit Facility, is paid-in-kind by adding accrued interest to the principal balance of the Senior Subordinated notes.  All outstanding principal, including interest paid-in-kind, is due on September 9, 2014 and a mandatory prepayment equal to $20.0 million plus 50% of all outstanding interest paid-in-kind is due on September 9, 2013.  In connection with the issuance of the Senior Subordinated Notes, we issued warrants to acquire 51,011 shares of our common stock at anexercise price of $0.01 per share to the Senior Subordinated Note holders.  As a result, we discounted the face value of the SeniorSubordinated Notes by $2.9 million, representing the estimated fair value of the warrants at the time of issuance.  Proceeds obtained from the issuance of the Senior Subordinated Notes were used to finance the acquisition of Evercom, repay outstanding long-term debt obligations, and for general operating purposes.   During the nine months ended September 30, 2007, $8.2 million of paid-in-kind interest was added to the principal balance of the Notes.  The effective interest rate is 18.8% on the Senior Subordinated Notes.  In order to enter into additional financing to complete the Syscon acquisition, the Company incurred a non-cash consent fee of $0.4 million payable to the Senior Subordinated Noteholders.  This fee was added to the principalbalance of the Senior Subordinated Notes.

 

All of the Company’s domestic subsidiaries and certain of the Company’s foreign subsidiaries (the “Subsidiary Guarantors”) are fully, unconditionally, and jointly and severably liable for the Revolving Credit Facility, Second-priority Senior Secured Notes and Senior Subordinated Notes. We have not included separate financial statements of our subsidiaries because (a) the aggregate assets, liabilities, earnings and equity of the Company are presented on a consolidated basis and (b) we believe that separate financial statements and other disclosures concerning subsidiaries are not material to investors.

 

Our credit facilities contain financial and operating covenants, among other items, that require the maintenance of certain financial ratios, including specified interest coverage ratios, maintenance of minimum levels of operating cash flows (as defined), and maximum capital expenditure limitations. These covenants also limit our ability to incur additional indebtedness, make certain payments including dividends to shareholders, invest and divest company assets, and sell or otherwise dispose of capital stock. In the event that the Company fails to comply with the covenants and restrictions, as specified in the credit agreements, we may be in default at which time payment of the long term debt and unpaid interest may be accelerated and become immediately due and payable.

 

Page 12

 

 

 

As of September 30, 2007, we were not in compliance with certain financial covenants required by our revolving credit facility.  Specifically, we were not in compliance with the Interest Coverage Ratio which requires us to maintain a ratio of EBITDA (as defined) to Cash Interest (as defined) above 1.75.  This ratio is required to be calculated on a pro forma basis for the impact of acquisitions, such as our acquisition of Syscon in June 2007.   The revolver facility lenders amended the credit agreement which effectively waived this non-compliance for the period ended September 30, 2007.   

 

Additionally, as of September 30, 2007, we did not maintain a Credit Facility Coverage Ratio above 1.75 as required by the indenture governing our Second-priority Senior Secured Notes.  This financial covenant is calculated by dividing Credit Facility Cash Flow (as defined) by Credit Facility Interest Expense (as defined) and is calculated on a pro forma basis for the impact of acquisitions, such as our acquisition of Syscon in June 2007.    The non-compliance with this covenant did not result in a default under the indenture as the indenture requires two consecutive quarters of non-compliance with the Credit Facility Coverage Ratio for a default to exist.  

 

In order to avoid future potential defaults, the Company’s Board of Directors intends to review all options, including asking existing Class A common shareholders to contribute additional equity.  Under the indenture governing our Second-priority Senior Secured Notes, equity contributions are added to our EBITDA, and thus to Credit Facility Cash Flow, for purposes of calculating our financial covenants. The Company’s majority shareholder, HIG Capital, has committed to invest up to $10 million of junior capital in the Company. The amount of equity needed by the Company will be determined as the Company finalizes results for the year ending December 31, 2007 and its forecast for 2008.  To the extent there is non-compliance, which is probable, as of December 31, 2007 or forecasted non-compliance in 2008, the Company plans to ask its shareholders for sufficient equity to becontributed to remedy such non-compliance.  This remedy would be automatic under the indenture governing the Second-priority Senior Secured Notes as the definition of the Credit Facility Coverage Ratio allows contributed junior capital to be included in the ratio calculation.   The revolving credit facility lenders have amended the revolving credit facility to similarly allow contributed junior capital to be included in both the Minimum EBITDA and Interest Coverage Ratio covenant calculations.  Should the plan not be executed, or be insufficient to cure any future non-compliance, the Company’s lenders could choose to enforce their default rights and demand repayment of all outstanding obligations.  The Company expects to be in full compliance with its credit facilities at December 31, 2007 and throughout 2008 and to be able to meet all of its obligations.  The Board also may consider other options in addition to the equity resource plan.      

 

In the event that cash in excess of the amounts generated from on-going business operations and available under our credit facilities or through equity contributions from shareholders is required to fund our operations, we may be required to reduce or eliminate discretionary selling, general and administrative costs, and sell or close certain of our operations.   In addition to its revolving credit facility, the Company also executed a $5.0 million unsecured demand note with a financial institution on August 17, 2007.  

 

An affiliate of H.I.G. T-Netix, Inc., our majority stockholder, agreed to guarantee this $5.0 million unsecured financing and to make available up to an additional $2.5 million of financing to the Company.  In connection with H.I.G. T-Netix’s guarantee, the Company is required to issue warrants to purchase up to 14,542 shares of its Class A common stock.  The guarantee and the $2.5 million commitment will be reduced dollar for dollar in the event that H.I.G. invests additional capital under its new $10 million commitment. The Company had no outstanding borrowings under these facilities as of November 14, 2007.

 

**Note 6 –** **Segment Information**

 

SFAS No. 131, “*Disclosures About Segments of an Enterprise and Related Information”*, establishes standards for reporting operating segments in annual financial statements. SFAS No. 131 also establishes standards for disclosures about products and services, geographic areas and major customers.

 

Historically, our management has chosen to organize the enterprise around differences in products and services. We have had four reportable segments: Direct Call Provisioning, Solutions Services, Telecommunications Services, and Equipment Sales. Our acquisition of Syscon provides the Company with a comprehensive Offender Management Software solutions segment. Through these segments, we provide inmate telecommunication products and services for correctional facilities, including security enhanced call processing, call validation and billing services for inmate calling, and software solutions to manage and monitor inmate, parole and probation activity. Depending upon the contractual relationship at the site and the type of customer, we provide these products and services through service agreements with other telecommunications service providers, including, Global Tel*Link, AT&T (formerlySBC), Embarq and FSH Communications (i.e., Telecommunication Services segment and Solutions Services segment) and through direct contracts between the Company and correctional facilities (i.e., Direct Call Provisioning segment). In addition, we sold systems to certain telecommunication providers (i.e., Equipment Sales segment).

 

We evaluate performance of each segment based on operating results. Total assets are those owned by or allocated to each segment. Assets included in the “Corporate and Other” column of the following table include all assets not specifically allocated 

 

Page 13

 

 

to a segment. There are no intersegment sales. Our reportable segments are specific business units that offer different products and services and have varying operating costs associated with such products. The accounting policies of the reportable segments are the same as those described in the summary of significant accounting policies. We use estimation to allocate certain direct costs and selling, general and administrative costs, as well as for depreciation and amortization,  goodwill, and capital expenditures. Estimation is required in these cases because we do not have the capability to specifically identify such costs to a particular segment. The estimation is based on relevant factors such as proportionate share of revenue of each segment to the total business. 

 

Segment information for the nine months ended September 30, 2006 (unaudited) is as follows (in thousands):

 

 

 

**Direct**

 

 

 

 

 

 

 

 

**Equipment**

 

 

 

 

 

 

 

 

 

**Call**

 

 

**Solutions**

 

 

**Telecommunications**

 

 

**Sales**

 

 

**Corporate**

 

 

 

 

 

 

**Provisioning**

 

 

**Services**

 

 

**Services**

 

 

**& Other**

 

 

**& Other**

 

 

**Total**

 

Revenue from external customers

$

251,721

 

$

35,161

 

$

11,077

 

$

494

 

$

-  

 

$

298,453

 

Segment gross margin

$

54,791

 

$

8,847

 

$

5,656

 

$

127

 

$

-  

 

$

69,421

 

Depreciation and amortization

 

19,789

 

 

987

 

 

428

 

 

-  

 

 

103

 

 

21,307

 

Other operating costs and expenses

 

5,856

 

 

337

 

 

-  

 

 

-  

 

 

32,586

 

 

38,779

 

Operating income (loss)

$

29,146

 

$

7,523

 

$

5,228

 

$

127

 

$

(32,689

)

 

9,335

 

Interest and other expenses, net

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

20,742

 

Segment loss before income taxes

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(11,407

)

Capital expenditures

$

19,174

 

$

-  

 

$

-  

 

$

-  

 

$

108

 

$

19,282

 

September 30, 2006:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total assets

$

213,270

 

$

23,523

 

$

1,499

 

$

-  

 

$

23,520

 

$

261,812

 

Goodwill

$

37,936

 

$

-  

 

$

-  

 

$

-  

 

$

-  

 

$

37,936

 

 

 

 Segment information for the nine months ended September 30, 2007 (unaudited) is as follows (in thousands): 

 

 

 

**Direct**

 

 

 

 

 

 

 

 

**Offender**

 

 

**Equipment**

 

 

 

 

 

 

 

 

 

**Call**

 

 

**Solutions**

 

 

**Telecommunications**

 

 

**Management**

 

 

**Sales**

 

 

**Corporate**

 

 

 

 

 

 

**Provisioning**

 

 

**Services**

 

 

**Services**

 

 

**Software**

 

 

**& Other**

 

 

**& Other**

 

 

**Total**

 

Revenue from external customers

$

257,633

 

$

28,042

 

$

6,063

 

$

4,798

 

$

462

 

$

-  

 

$

296,998

 

Segment gross margin

$

53,862

 

$

9,211

 

$

3,371

 

$

1,342

 

$

98

 

$

-  

 

$

67,884

 

Depreciation and amortization

 

24,235

 

 

669

 

 

1,575

 

 

923

 

 

-  

 

 

93

 

 

27,495

 

Other operating costs and expenses

 

6,397

 

 

255

 

 

-  

 

 

1,291

 

 

-  

 

 

38,299

 

 

46,242

 

Operating income (loss)

$

23,230

 

$

8,287

 

$

1,796

 

$

(872

)

$

98

 

$

(38,392

)

 

(5,853

)

Interest and other expenses, net

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

22,531

 

Segment loss before income taxes

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(28,384

)

Capital expenditures

$

16,827

 

$

-  

 

$

-  

 

$

16

 

$

-  

 

$

105

 

$

16,948

 

September 30, 2007:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total assets

$

200,344

 

$

14,141

 

$

555

 

$

63,133

 

$

-  

 

$

24,358

 

$

302,531

 

Goodwill

$

37,936

 

$

-  

 

$

-  

 

$

28,849

 

$

-  

 

$

-  

 

$

66,785

 

  

 

Page 14

 

 

                

Segment information for the three months ended September 30, 2006 (unaudited) is as follows (in thousands):

 

 

 

**Direct**

 

 

 

 

 

 

 

 

**Equipment**

 

 

 

 

 

 

 

 

**Call**

 

 

**Solutions**

 

 

**Telecommunications**

 

 

**Sales**

 

**Corporate**

 

 

 

 

 

 

**Provisioning**

 

 

**Services**

 

 

**Services**

 

 

**& Other**

 

**& Other**

 

 

**Total**

 

Revenue from external customers

$

84,094

 

$

11,183

 

$

2,744

 

$

64

$

-  

 

$

98,085

 

Segment gross margin

$

17,223

 

$

2,564

 

$

1,437

 

$

46

$

-  

 

$

21,270

 

Depreciation and amortization

 

7,083

 

 

348

 

 

143

 

 

-  

 

35

 

 

7,609

 

Other operating costs and expenses

 

1,803

 

 

113

 

 

-  

 

 

-  

 

10,448

 

 

12,364

 

Operating income (loss)

$

8,337

 

$

2,103

 

$

1,294

 

$

46

$

(10,483

)

 

1,297

 

Interest and other expenses, net

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

6,892

 

Segment loss before income taxes

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(5,595

)

Capital expenditures

$

6,174

 

$

-  

 

$

-  

 

$

-  

$

23

 

$

6,197

 

  

Segment information for the three months ended September 30, 2007 (unaudited) is as follows (in thousands): 

 

 

 

**Direct**

 

 

 

 

 

 

 

 

**Offender**

 

 

**Equipment**

 

 

 

 

 

 

 

 

 

**Call**

 

 

**Solutions**

 

 

**Telecommunications**

 

 

**Management**

 

 

**Sales**

 

 

**Corporate**

 

 

 

 

 

 

**Provisioning**

 

 

**Services**

 

 

**Services**

 

 

**Software**

 

 

**& Other**

 

 

**& Other**

 

 

**Total**

 

Revenue from external customers

$

79,462

 

$

8,422

 

$

1,698

 

$

4,798

 

$

222

 

$

-  

 

$

94,602

 

Segment gross margin

$

16,535

 

$

2,904

 

$

943

 

$

1,342

 

$

33

 

$

-  

 

$

21,757

 

Depreciation and amortization

 

8,051

 

 

107

 

 

792

 

 

923

 

 

-  

 

 

31

 

 

9,904

 

Other operating costs and expenses

 

2,206

 

 

69

 

 

-  

 

 

1,291

 

 

-  

 

 

13,776

 

 

17,342

 

Operating income (loss)

$

6,278

 

$

2,728

 

$

151

 

$

(872

)

$

33

 

$

(13,807

)

 

(5,489

)

Interest and other expenses, net

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

7,744

 

Segment loss before income taxes

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(13,233

)

Capital expenditures

$

5,278

 

$

-  

 

$

-  

 

$

16

 

$

-  

 

$

66

 

$

5,360

 

 

 

**Note 7 –** **Stockholders’ Equity**

 

 

*Common Stock*

 

Our authorized common stock consists of  925,000 shares of Class A common stock and 75,000 shares of Class B common stock. At September 30, 2007, 589,463.65 shares of Class A common stock and 72,084.32 shares of the Class B common stock were outstanding. Shares of Class B common stock are subject to vesting as described below. Other than provisions related to vesting, holders of the shares of Class A common stock and Class B common stock have identical rights and privileges except that the holders of Class A common stock have a $57 per share liquidation preference. On June 29, 2007, 45,604 shares of our Class A common stock were issued in connection with the acquisition of Syscon (see Note 2-Acquisition). Our credit facilities restrict our ability to pay dividends to holders of common stock. 

 

 

 

Page 16

 

 

 

*Warrants*

 

We issued warrants to purchase 51,011 shares of common stock to holders of the Senior Subordinated Notes in connection with the financing of the acquisition of Evercom on September 9, 2004. The warrant exercise price is $0.01 per share, and the warrants expire on September 9, 2014. As a result, we discounted the face value of the Senior Subordinated Notes by $2.9 million representing the estimated fair value of the warrants at the time of issuance. 

 

In connection with H.I.G. T-Netix’s guarantee of up to $5 million of unsecured indebtedness, we will issue warrants to H.I.G. T-Netix to purchase 14,542 shares of its Class A common stock.  The warrants will have an exercise price of $.01 per share.

 

 

*Restricted Stock Purchase Plan*

 

We adopted the 2004 Restricted Stock Purchase Plan under which certain of our employees may purchase shares of our Class B common stock. On March 15, 2007, our stockholders approved an increase in the number of shares of Class B Common Stock authorized by the plan and our certificate of incorporation to 75,000, which equals 10.5% of our total issued and outstanding shares of common stock on a fully diluted basis, subject to adjustment for changes in our capital structure such as stock dividends, stock splits, stock subdivisions, mergers and recapitalizations.

 

Our Board of Directors administers the 2004 Restricted Stock Purchase Plan. The plan is designed to serve as an incentive to attract and retain qualified and competent employees. The per share purchase price for each share of Class B common stock is determined by our Board of Directors. Class B common stock will vest based on performance criteria or ratably over a period or periods, as provided in the related restricted stock purchase agreement.

 

As of September 30, 2007, 72,084.32 shares of Class B common stock were issued under the 2004 Restricted Stock Purchase Plan, of which 6,433.56 shares were issued during the nine months ended September 30, 2007. 26,340.96 of these shares were acquired by our Chief Executive Officer (“CEO”) pursuant to a restricted stock purchase agreement. These shares are subject to forfeiture pursuant to the terms of the 2004 Restricted Stock Purchase Plan and the restrictions described hereafter. With respect to 36.6% of the stock, the restriction period ends upon the sale of the Company’s stock by certain of the Company’s other stockholders. The restriction period for 31.7% of the stock ends upon the lapse of time, 6.3% each December 31 and June 30 beginning December 31, 2004. With respect to the remaining shares, the restriction period ends upon the Companyattaining certain performance measures determined by the Company’s Board of Directors.

 

We measure compensation expense on these restricted shares commensurate with their vesting schedules. For the portion of the restricted shares that vest contingently with the occurrence of certain events, we record compensation expense when such events become probable. The incremental compensation expense on the restricted shares issued was determined based on the grant date fair value of the Class B common stock, which resulted in compensation charges of approximately $83,000 and $51,000 for the nine months ended September 30, 2006 and 2007, respectively. 

 

**Note 8 –** **Legal Proceedings**

 

From time to time we have been, and expect to continue to be, subject to various legal and administrative proceedings or various claims in the normal course of business. We believe the ultimate disposition of these matters will not have a material affect on our financial condition, liquidity, or results of operations.

From time to time, inmate telecommunications providers, including Securus, are parties to judicial and regulatory complaints and proceedings initiated by inmates, consumer protection advocates or individual called parties alleging, among other things, that excessive rates are being charged with respect to inmate collect calls, commissions paid by inmate telephone service providers to the correctional facilities are too high, that a call was wrongfully disconnected, that security notices played during the call disrupt the call, that the billed party did not accept the collect calls for which they were billed or that rate disclosure was not provided or was inadequate. We are also on occasion the subject of regulatory complaints regarding our compliance with various matters including tariffing, access charges and payphone compensation requirements and rate disclosure issues.

In the case captioned Sandra Judd, et al. v. AT&T, et al., initially brought in King County Superior Court in Seattle, T-Netix and several other telecommunication companies were sued on allegations of failure to comply with the audible, pre-connect disclosure of inmate call rates as required by Washington law. T-Netix and AT&T, the remaining defendants, obtained summary judgment in their favor in September 2006, but the ruling was overturned by the Court of Appeals. T-Netix’s Petition for Review by the Washington State Supreme Court is pending. We cannot predict the outcome of this appeal at this time.

In May 2005, TIP Systems, LLC and TIP Systems Holdings Co., Inc. (“TIPS”) filed suit in the United States District Court for the Southern District of Texas (Houston Division) against numerous defendants including us. In TIP Systems, we, along with 

 

Page 17

 

 

other inmate telecommunications providers, were alleged to have infringed on patents concerning “cord-free” or “hands-free” inmate phone technology. This lawsuit against us was dismissed on March 1, 2007, when our motion for summary judgment was granted on the issue of non-infringement. TIPS has appealed to the U.S. Court of Appeals. Additionally, the TIPS entities have filed a lawsuit in the Southern District of Texas against us which alleges substantially similar allegations concerning patent infringement claims for “cord-free” or “hands-free” inmate phone technology. We have denied any wrongdoing and will vigorously defend each and every allegation in the case. We cannot evaluate the likelihood of any outcome or make a reasonable estimate of range of potential loss at this time.

In October 2003, Value-Added Communications, Inc. (“VAC”) filed suit in the District Court of Dallas County, Texas against T-NETIX for alleged breach of a Patent License Agreement between VAC and T-NETIX. VAC filed the lawsuit seeking, among other things, an interpretation of certain provisions of the agreement, revival of the agreement, a license to any of T-NETIX’s improvements to the originally licensed technology, and an award of its attorneys’ fees. T-NETIX filed counter-claims against VAC for, among other things, VAC’s failure to assign certain improvements in technology that VAC has developed since 1996. On March 6, 2007, the Dallas District Court presiding over the lawsuit signed an interlocutory summary judgment order in T-NETIX’s favor finding, among other things, that VAC is not entitled to any of T-NETIX’s technology other than theoriginally licensed patents and that VAC is required to automatically assign any improvements or additions it makes to the original technology to T-NETIX, with VAC maintaining the right to continue using improvements or additions it makes. The Court also found that neither party is entitled to an award of attorneys’ fees from the other for claims relating to the issues resolved in the March 6, 2007 order. T-NETIX will continue to proceed against VAC on its affirmative claims for VAC’s failure to assign its improvements and additions and will continue to vigorously defend against VAC’s claim for attorneys’ fees and VAC’s efforts to reinstate the Agreement on grounds unrelated to the March 6, 2007 order. Trial is tentatively set for February 2008, but will likely be postponed due to a new judge being assigned to the matter. We cannot evaluate the likelihood of any outcome or make a reasonable estimate of range of potential loss at this time.

In April 2005, we filed suit in the United States District Court for the Northern District of Texas (Dallas Division) against VAC for patent infringement. VAC filed an answer and a counterclaim in this matter. VAC seeks declaratory judgments as to non-infringement and invalidity. Discovery is on-going at this time. Trial in this matter is set for March 2008. We cannot evaluate the likelihood of any outcome at this time.

In November 2005, we filed suit in the District Court of Dallas County, Texas, against AGM Telecom Corporation and former employees of our various affiliates, and related individuals, including David McEvilly, George McNitt, Thomas Miller, Steven Capitano, Brian Dietert, Christopher McNitt, Robert G. Sargeant, James F. Winstead, Pablo Xiques, Henry Chang, and Mie Mie Change, alleging, among other things, breach of contract and misappropriation of trade secrets. In the lawsuit, various defendants have counterclaimed for alleged violations of the Texas Business & Commerce Code, disparagement, defamation, and tortious interference. Some defendants moved to stay the case and have requested the court compel arbitration of the matter, and some defendants filed special appearances objecting to the court’s jurisdiction.  The court has granted some of the defendants’ motion tocompel arbitration and to stay the case as to them. We have denied any wrongdoing with respect to the alleged counterclaims and will vigorously defend each and every counterclaim asserted by the defendants. We cannot evaluate the likelihood of any outcome at this time.  

 

In October 2006, we filed suit in the U.S. Federal District Court for the Eastern District of Texas against Global Tel*Link Corporation; AGM Telecom Corporation; Inmate Calling Solutions, Inc.; and FSH Communications, LLC for patent infringement of several patents related to the inmate correctional services and telecommunications industry by each such defendant. This case is in its early stages and we cannot predict the outcome at this time.

In May 2007, Global-Tel Link Corporation (“GTL”) and Verizon Business (“Verizon”) filed formal protest petitions against the Florida Department of Corrections (“FDOC”) (the “Protests”). The Protests challenge FDOC’s intended award to us of a five-year initial term contract for provision of Statewide Inmate Telephone Services. More specifically, the Protests seek entry of recommended and final orders either (1) awarding the contract to the protestor or (2) rejecting all proposals. The Protests were before the Florida Division of Administrative Hearings (“DOAH”). On September 20, 2007, the DOAH denied GTL and Verizon’s joint motion to stay. In addition, the Appellate Court has denied GTL and Verizon's emergency motion for stay pending appeal, filed September 12, 2007.  As a result of the foregoing rulings, the FDOCContract was executed on September 25, 2007.

 

Finally, the FCC has asked for public comment on a proposal from an inmate advocacy group to impose a federal rate cap on interstate inmate calls. This proceeding could have a significant impact on the rates that we and other companies in the inmate telecommunications business may charge. Although similar proposals have been pending before the FCC for more than three years without action by the agency, this newest proceeding is nonetheless in its early stages, and we cannot predict the outcome at this time.

 

 

Page 18

 

 

**Note 9 –** **Guarantees**

 

FASB Staff Position (“FSP”) No. 45-3 amends Interpretation No. 45, *Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others*, to require a guarantor to recognize a liability for the estimated fair value of guarantee obligations entered into after January 1, 2006 and disclosure of the maximum amount that could be paid under the guarantee obligation. In February 2006, we entered into an agreement with a telecommunications vendor, primarily for local and long distance services, whereby we guarantee a minimum purchase commitment over a two to three year period. Management has reviewed the agreements and believes the fair value of the guarantee to be zero. The maximum amount to be paid under this guarantee totaled $15.0 million at September 30, 2007.

 

**ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

The following discussion and analysis of the Company’s financial condition and results of operations should be read in conjunction with our historical consolidated financial statements and related notes, our audited consolidated financial data and related notes and other financial information included elsewhere in this Form 10-Q. Certain information contained in the discussion and analysis set forth below includes forward-looking statements that involve risks and uncertainties. See “Special Note Regarding Forward-Looking Statements.”

 

**Special Note Regarding Forward-Looking Statements**

 

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of the federal securities laws. These forward-looking statements reflect, among other things, our current expectations, plans and strategies, and anticipated financial results, all of which are subject to known and unknown risks, uncertainties and factors that may cause our actual results to differ materially from those expressed or implied by these forward-looking statements. Many of these risks are beyond our ability to control or predict. Any statements contained in this quarterly report that are not statements of historical fact, including statements about our beliefs and expectations, are forward-looking statements and should be evaluated as such. The words “anticipates,” “believes,” “expects,” “intends,” “seeks to,” “plans,”“estimates,” “targets,” “projects,” “should,” “may,” “will” and similar words and expressions are intended to identify forward-looking statements. All forward-looking statements are based on information available to the Company on the date hereof, and investors should not rely on forward-looking statements because they are subject to a variety of risks, uncertainties, and other factors that could cause actual results to differ materially from our expectations, and we expressly do not undertake any duty to update forward-looking statements. These factors include, but are not limited to: (i) competition in our industry and in the telecommunications industry generally; (ii) our substantial amount of debt; (iii) our accumulated deficits; (iv) our financial results being dependent on the success of our billing and bad debt management systems; (v) loss of major partners or customers and recent trends in theinmate telecommunications industry and the risks of government contracts; (vi) protection of our proprietary technology and ensuring that we do not infringe on the proprietary technology of other companies; (vii) our ability to adapt new technologies and respond effectively to customer requirements or provide new products and services; (viii) control by our equity investors; (ix) our ability to adapt to changes in state and federal regulations that apply to the inmate telecommunications industry; (x) extensive government legislation and regulations; and (xi) other factors detailed from time to time in our filings with the SEC.

 

**Overview**

 

We are one of the largest independent providers of inmate communications services to correctional facilities operated by city, county, state and federal authorities and other types of confinement facilities such as juvenile detention centers, private jails and halfway houses in the United States and Canada. As of September 30, 2007, we provided service to approximately 2,800 correctional facilities. 

 

Our communications business consists of installing, operating, servicing and maintaining sophisticated call processing systems in correctional facilities and providing related services. We typically enter into multi-year agreements (generally three to five years) directly with the correctional facilities in which we serve as the exclusive provider of telecommunications services to inmates. In exchange for the exclusive service rights, we pay a negotiated commission to the correctional facility based upon revenues generated by actual inmate telephone use. In addition, on larger contracts we typically have partnered with regional 

bell operating companies, or RBOCs, local exchange carriers, or LECs, and interexchange carriers, or IXCs as well as independent telecommunications companies, for which we provide our equipment and, as needed, back office support, including validation, billing and collections services, and charge a fee for such services. Based on the particular needs of the corrections industry and the requirements of the individual correctional facility, we also sell platforms and specialized equipment and services such as law enforcement management systems, call activity reporting and call blocking. Our telecommunications business is 

 

Page 19

 

 

conducted through two of our subsidiaries: T-Netix, which we acquired in March 2004, and Evercom, which we acquired in September 2004.

 

On June 29, 2007, we acquired all of the outstanding capital stock of Syscon Holdings Ltd., a British Columbia company and certain of its affiliates (“Syscon”).  Syscon is an enterprise software development company for the correctional facility industry. Syscon’s core product is a sophisticated and comprehensive software system utilized by correctional facilities and law enforcement agencies for complete offender management. Syscon’s system provides correctional facilities with the ability to manage and monitor inmate parole and probation activity and development at a sophisticated level. Syscon’s customers operate more than 250 correctional facilities and probation offices maintaining records for over 300,000 offenders in the United States, Canada, the United Kingdom and Australia. Syscon is the largest offender management software provider to Electronic DataSystems for the U.K.’s National Offender Management System for Her Majesty’s Prison Service.

 

**Revenues**

 

We derived approximately 84% and 87% of our revenues for the nine months ended September 30, 2006 and 2007, respectively, from our direct operation of inmate telecommunication systems and the provision of related services located in correctional facilities within 47 states and the District of Columbia. We enter into multi-year agreements under direct, or “prime” contracts with the correctional facilities, pursuant to which we serve as the exclusive provider of telecommunications services to inmates within each facility. In exchange for the exclusive service rights, we pay a commission to the correctional facility based upon inmate telephone use. Our commission rates averaged approximately 44% of direct call provisioning revenues for the year ended December 31, 2006, and averaged 44% and 45% for the nine months ended September 30, 2006 and 2007, respectively. We install andgenerally retain ownership of the telephones and the associated equipment and provide additional services tailored to the specialized needs of the corrections industry and to the requirements of each individual correctional facility, such as call activity recording and call blocking. In our direct call provisioning business, we earn the full retail value of the call and pay corresponding line charges and commissions. As a result, our direct call provisioning business gross profit dollars are higher, but our gross profit margin is lower, than in our services business.

 

We also offer our solutions services, as described below, and the sale of equipment to RBOCs, LECs, IXCs and independent telecommunications companies as customers, to support their telecommunication contracts with correctional facilities. We derived approximately 12% and 9% of our revenues for the nine months ended September 30, 2006 and 2007, respectively, from our solutions business. The solutions business consists of providing validation, uncollectible account management and billing services. In this business, accounts receivable generated from calls placed by inmates in correctional facilities are typically purchased from the third party inmate telecommunication providers and we accept responsibility for call validation, uncollectible accounts, and billing and collections costs, with no recourse to the RBOC, LEC, IXC or independent customer. However, all purchased receivables must beprocessed and validated through our risk management system prior to allowing the call to be completed and also must be billed through our proprietary billing systems. Revenues from our solutions services equal the difference between the face value of the receivables purchased and the amount we pay the RBOC, LEC, IXC or independent customers for the discounted accounts receivable. Because revenues associated with our solutions business represent only a percentage of the face value of the receivables purchased, the associated billing and collection fees and uncollectible account expense represent a much higher percentage of revenues as compared to our direct call provisioning business. In the solutions business, we do not bear any of the costs of facility commissions, equipment, line charges or direct sales charges, but bear the risk of unbillable and uncollectible accounts receivable.

 

We derived approximately 4% and 2% of our revenues for the nine months ended September 30, 2006 and 2007, respectively, by providing telecommunication services to RBOCs, LECs, IXCs, and independent telecommunications companies, our service partners, typically through subcontracts in connection with the RBOCs’, LECs’ or IXCs’ separate contracts with larger correctional institutions. In such instances, we provide equipment, security enhanced call processing, call validation, and service and support though the telecommunications provider, rather than directly to the facility. Although our revenues for services to telecommunications service providers are lower than in our direct call provisioning business, where we provide the service to the facility directly and receive the retail value of the call, we do not incur all the additional capital costs related to these largercontracts that can require up-front or guaranteed commission payments. Our gross margin percentage for providing telecommunications services is higher than the margin for our direct call provisioning business because we do not incur commissions, transport costs or risk of collection. 

 

We derived approximately 1.6% our revenues for the nine months ended September 30, 2007 from our offender management software business since the acquisition of Syscon. Offender management systems are platforms that allow facilities managers and law enforcement personnel to analyze data to reduce costs, prevent and solve crimes and facilitate rehabilitation through a single user interface. We believe that Syscon has the most functionally complete offender management system available on the market. Our offender management software business will complement the direct call provisioning business and the two segments have comparable margins.

 

 

Page 20

 

 

We also sell equipment, typically consisting of our inmate calling system, to a limited number of telecommunication services providers. 

 

In our direct call provisioning business and solutions services, we accumulate call activity data from our various installations and bill our revenues related to this call activity primarily through direct billing agreements with LEC billing agents, or in some cases through billing aggregators. We also receive payment on a prepaid basis for a significant portion of our services and record deferred revenue until the prepaid balances are used. For the nine months ended September 30, 2007, one-third of our direct call provisioning revenues were collected on a prepaid basis. In each case, we recognize revenue when the calls are completed and accrue the related telecommunication costs for validating, transmitting, billing and collection, bad debt, and line and long-distance charges, along with commissions payable to the facilities. In our telecommunications services business, our service partnerbills the called party and we either share the revenues with our service partner or receive a prescribed fee for each call completed. We also charge fees for additional services such as customer support and advanced validation. 

 

**Cost of Service**

 

Our principal cost of service for our direct call provisioning business consists of commissions paid to correctional facilities which are typically expressed as a percentage of either gross or net direct revenues and are typically fixed for the term of the agreements with the facilities; bad debt expense, consisting of unbillable and uncollectible accounts; billing charges; customer service costs; telecommunication costs such as telephone line access, long distance and other charges, field operations and maintenance costs, which consist primarily of field service on our installed base of inmate telephones; and selling, general, and administrative costs. We pay monthly line and usage charges to RBOCs and other LECs for interconnection to the local network for local calls, which are computed on a flat monthly charge plus, for certain LECs, a per message or per minute usage rate based on thetime and duration of the call. We also pay fees to RBOCs and other LECs and long distance carriers based on usage for long distance calls. Third-party billing charges consist of payments to LECs and other billing service providers for billing and collecting revenues from called parties. Customer service costs represent either in-house or contracted customer service representatives who handle questions and concerns and take payments from billed parties.

 

Cost of service associated with the solutions business generally includes billing and collection, call validation, and the risk of unbillable and uncollectible accounts receivable.

 

Cost of service associated with telecommunication services consists primarily of service administration costs for correctional facilities, including salaries and related personnel expenses, and inmate calling systems repair and maintenance expenses. Cost of service associated with telecommunication services also includes costs associated with call validation procedures (primarily network expenses and database access charges). 

 

Cost of service associated with our offender management software business primarily includes salaries and related costs of employees and contractors who provide technological services to develop, customize or enhance the software for our clients.

 

*Facility Commissions*. In our direct call provisioning business, we pay a facility commission typically based on a percentage of our billed revenues from such facility. Commissions are set at the beginning of each facility contract. Commission rates are one of the primary bases of competition for obtaining and retaining facility contracts. 

 

*Bad Debt*. We account for bad debt as a cost of providing telecommunications in our direct call provisioning and solutions business lines. We accrue the related telecommunications cost charges along with an allowance for unbillable and uncollectible calls, based on historical experience. Charges for inmate telephone calls on a collect basis are considered unbillable, in cases when there is no billing address for the telephone number called, or uncollectible, when the billed party is unable or unwilling to pay for the call. We use a proprietary, specialized billing and bad-debt management system to integrate our billing with our call blocking, validation, and customer inquiry procedures. We seek to manage our higher risk revenues by proactively requiring certain billed parties to prepay collect calls or be directly billed by us. This system utilizes multi-variablealgorithms to minimize bad debt expense by adjusting our credit policies and billing. For example, when unemployment rates are high, we may decrease credit to less creditworthy-billed parties or require them to purchase prepaid calling time in order to receive inmate calls. This system, combined with the direct billing to LECs, has enabled us to realize what we believe to be industry-low bad debt margins. Bad debt tends to rise as the economy worsens, and is subject to numerous factors, some of which may not be known. To the extent our bad debt management system overcompensates for bad debt exposure by limiting credit to billed parties, our revenues and profitability may decline as fewer calls are permitted to be made. 

 

*Field Operations and Maintenance Costs*. Field operations and maintenance costs consist of service administration costs for correctional facilities, including salaried and related personnel expenses, and inmate calling systems (including related equipment) repair and maintenance. The costs of providing telecommunications services primarily consist of service administration costs for correctional facilities, including salaries and related personnel expenses and inmate calling systems repair and maintenance expenses. 

 

Page 21

 

 

 

*SG&A*. SG&A expenses consist of corporate overhead and selling expenses, including marketing, accounting, legal, regulatory and research and development costs. 

 

**Industry Trends**

 

We provide our products and services to telecommunications and solutions service providers such as Global Tel*Link, Public Communications Services (PCS), AT&T/SBC and Embarq, among other call providers. For the three months and nine months ended September 30, 2007, 10.7% and 11.5%, respectively, of our total revenues were generated from contracts with telecommunications and solutions service providers. The following table lists our largest telecommunications and solutions service provider contracts for the three and nine months ended September 30, 2007: 

 

 

**Solutions Services**

 

**Telecommunications Services**

 

 

 

**Three**

 

**Nine**

 

**Three**

 

**Nine**

 

 

 

**Months**

 

**Months**

 

**Months**

 

**Months**

 

 

 

**Ended**

 

**Ended**

 

**Ended**

 

**Ended**

 

**Contract**

 

**September 30,**

 

**September 30,**

 

**September 30,**

 

**September 30,**

 

**Expiration**

 

**2007**

 

**2007**

 

**2007**

 

**2007**

 

**Date****

Global Tel*Link*

74

%

 

75

%

 

37

%

 

36

%

 

March 1, 2008

Embarq (formerly Sprint)

25

%

 

23

%

 

12

%

 

11

%

 

Month-to-Month

AT&T*** 

-  

%

 

-  

%

 

33

%

 

30

%

 

April 28, 2008

FSH Communications

-  

%

 

-  

%

 

15

%

 

20

%

 

Month-to-Month

 

*

AT&T sold its inmate telecommunications business to Global Tel*Link in 2005. Verizon sold its inmate telecommunications business to Public Communications Services, Inc. in 2005.

  

**

Represents expiration dates for master customer contracts. Below the master customer contracts, subcontracts govern site-specific contract durations, which are typically consistent with the terms of our partners’ prime contracts with the underlying correctional facilities. In some cases, our subcontracts with such customers for certain correctional facilities may extend beyond the term of the related master contract, in which case our agreements with these customers generally extend through the term of the subcontract.

 

 

***

SBC changed its name to AT&T.

 

Since the first quarter of 2005, large industry participants such as Verizon and AT&T have been exiting the direct inmate telecommunications business. Both Verizon and AT&T subsequently sold their inmate telecommunications businesses to Securus’ competitors in 2005. As a result of this trend and the Verizon and AT&T sales, we anticipate that our revenue and profits associated with these product lines will continue to decline.

 

We anticipate that our revenues and profits associated with our customer, Global Tel*Link, will continue to decline and that agreements we have in place with them will not be renewed upon expiration. Global Tel*Link has been eliminating our services and we believe it is reasonable to expect that they will continue to do so over time as underlying contracts come to term. We therefore expect our solutions and telecommunications services business with Global Tel*Link to decline to zero within the next few years. Contractually, our solutions and telecommunications services customers can replace our services as their underlying phone contracts with correctional facilities expire.

 

Notwithstanding the foregoing developments and the anticipated declining revenue stream associated with our solutions and telecommunication services product lines, we believe that the departure of large industry participants such as Verizon and AT&T from the direct call provisioning business may present significant opportunities for us and other independent providers in the future. However, we anticipate that contracts to service the facilities will likely be subject to competitive bidding. Moreover, as we seek to secure inmate telecommunications contracts with larger county and state departments of corrections, we may be required to provide multi-million dollar up front payments, surety bonds or guaranteed commissions, as well as incur the cost of equipment and similar costs. 

 

Page 22

 

 

 

**Results of Operations**

 

The following table (in thousands) sets forth, for the three months and nine months ended September 30, 2006 and 2007, the results of operations of the Company.

 

 

**For the Three Months Ended**

 

 

**For the Nine Months Ended**

 

**September 30,**

 

**September 30,**

 

 

 

**September 30,**

 

**September 30,**

 

 

**2006**

 

**2007**

 

 

 

**2006**

 

**2007**

 

 

**(Unaudited)**

 

 

**(Unaudited)**

Revenue:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Direct call provisioning

$

84,094

 

$

79,462

 

 

 

$

251,721

 

$

257,633

 

Solutions services

 

11,183

 

 

8,422

 

 

 

 

35,161

 

 

28,042

 

Telecommunications services

 

2,744

 

 

1,698

 

 

 

 

11,077

 

 

6,063

 

Offender management software

 

-  

 

 

4,798

 

 

 

 

-  

 

 

4,798

 

Equipment sales and other

 

64

 

 

222

 

 

 

 

494

 

 

462

 

Total revenue

$

98,085

 

$

94,602

 

 

 

$

298,453

 

$

296,998

 

Expenses:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cost of services

$

76,815

 

$

72,845

 

 

 

$

229,032

 

$

229,114

 

Selling, general and administrative

 

12,364

 

 

17,342

 

 

 

 

38,779

 

 

45,628

 

Restructuring costs

 

-  

 

 

-  

 

 

 

 

-  

 

 

614

 

Depreciation and amortization

 

7,609

 

 

9,904

 

 

 

 

21,307

 

 

27,495

 

Total operating costs and expenses

 

96,788

 

 

100,091

 

 

 

 

289,118

 

 

302,851

 

Operating income (loss)

$

1,297

 

$

(5,489

)

 

 

$

9,335

 

$

(5,853

)

 

  

**Total Variance**

 

 

 

 

 

**Total Variance**

 

 

 

 

**In Dollars**

 

 

 

 

 

**In Dollars**

 

 

 

 

**Between the**

 

 

 

 

 

**Between the**

 

 

 

 

**Three Months**

 

 

 

 

 

**Nine Months**

 

 

 

 

**Ended September 30,**

 

**%**

 

 

 

**Ended September 30,**

 

**%**

 

 

**2006 and 2007**

 

**Change**

 

 

 

**2006 and 2007**

 

**Change**

 

**(Dollars in thousands)**

**(Unaudited)**

 

 

 

**(Unaudited)**

 

Revenue:

 

 

 

 

 

 

 

 

 

 

 

 

Direct call provisioning

$

(4,632

) 

(5.5

) %

 

 

$

5,912

 

2.3

%

Solutions services

 

(2,761

)

(24.7

)

 

 

 

(7,119

)

(20.2

)

Telecommunications services

 

(1,046

)

(38.1

)

 

 

 

(5,014

)

(45.3

)

Offender management software

 

4,798

 

-  

 

 

 

 

4,798

 

-  

 

Equipment sales and other

 

158

 

246.9

 

 

 

 

(32

)

(6.5

)

Total revenue

 

(3,483

)

(3.6

)

 

 

 

(1,455

)

(0.5

)

Total cost of service

 

(3,970

)

(5.2

)

 

 

 

82

 

-  

 

Selling, general and administrative

 

4,978

 

40.3

 

 

 

 

6,849

 

17.7

 

Restructuring costs

 

-  

 

-  

 

 

 

 

614

 

-  

 

Depreciation and amortization

 

2,295

 

30.2

 

 

 

 

6,188

 

29.0

 

Total operating costs and expenses

 

3,303

 

3.4

 

 

 

 

13,733

 

4.7

 

Operating income (loss)

$

(6,786

)

(523.2

)

 

 

$

(15,188

)

(162.7

)

 

 

**RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2007 COMPARED TO THE THREE MONTHS ENDED SEPTEMBER 30, 2006**

 

The corrections industry, which includes the inmate calling market, is and can be expected to remain highly competitive.  We compete directly with numerous other suppliers of inmate call processing systems and other corrections related products (including our own telecommunications and solutions service provider customers) that market their products to our same customer base.

 

***Revenues***.  Compared to the third quarter of 2006, consolidated revenues decreased $3.5 million, or 3.6%, to $94.6 million due primarily to the loss of contracts with the Pennsylvania and Alabama Department of Corrections and due to the continuing decline in our telecommunications services and solutions services segments.  Our Offender management software segment became part of our consolidated results of operations after our acquisition of Syscon on June 29, 2007. The primary components of the changes in revenues are discussed below:

 

Page 23

 

 

 

 

Direct call provisioning revenues decreased $4.6 million, or 5.5%, to $79.5 million primarily due to:

 

 

 

 

 

 

 

A reduction of $1.2 million due to the loss of a prime business contract with the Alabama Department of Corrections

 

 

 

 

 

 

 

A reduction of $3.6 million due to the transition of the State of Pennsylvania interim contract to MCI (now owned by Global Tel*Link), who was awarded the long-term contract in 2006. We began serving the State of Pennsylvania on an interim basis in late April 2006, as a result of Verizon’s desire to exit their existing contract. The interim contract generated approximately $1.2 million per month of revenue for us and expired in the second quarter of 2007.

 

 

 

 

 

 

 

New prime contracting business won from competitors, net of accounts not renewed, of approximately $0.9 million, substantially offset by the introduction of more restrictive credit policies designed to reduce bad debt.  Because of the six to nine month lag before bad debt results from local exchange carrier billing agents are realized, the impact of more restrictive credit policies immediately impact revenue but generally do not result in bad debt savings until subsequent periods.

 

We were awarded the State of Florida Department of Corrections direct provisioning account in early 2007.  After a delay due to an ongoing protest of the award by several competitors, we began installing this account in October and expect to be completely installed by January.  We do not expect to derive incremental profit from this account in the fourth quarter of 2007 due to normal start-up costs of such a large account, but do expect to generate a minimum of approximately $3 million of revenue per quarter by the first quarter of 2008.

 

 

Solutions services revenues decreased by $2.8 million, or 24.7%, to $8.4 million. Solutions services revenues declined primarily due to terminations of service by Global Tel*Link as their underlying facility contracts expired. We expect solutions services revenues to decline by approximately $1.0 million between the third and fourth quarter of 2007 and expect continuing declines thereafter.

 

Telecommunications services revenues decreased by $1.0 million, or 38.1%, to $1.7 million primarily attributable to accounts 

that we did not retain upon contract renewal or accounts that converted to direct provisioning revenue. We have not retained a significant amount of our telecommunications services contracts upon renewal as a result of our strategy to focus on growing our direct provisioning business. The departures of AT&T and Verizon from the inmate telecommunications market and resulting sale of those businesses to our competitors contributed to the decline. We expect telecommunications services revenue to continue to decline, albeit at a somewhat more gradual rate, through the remainder of 2007 and 2008.

 

Offender management software revenues of $4.8 million are now part of our consolidated results of operations as a result of the acquisition of Syscon on June 29, 2007.  As required by Financial Accounting Standards Board Statement No. 141, Emerging Issues Task Force 01-3, and related rules, Syscon’s balance sheet reflects fair values of assets and liabilities on the acquisition date.  Consequently, we fair valued Syscon’s customer contracts and related deferred revenues, which will impact the amount of booked revenue and profit that Securus will be able to recognize prospectively.  As a result, during the three months ended September 30, 2007, Syscon’s reported revenue and operating profit were $0.9 million lower than would have been reported had no acquisition occurred, representing the current period amortization of fair value of contracts acquired.   The majority ofSyscon’s revenues are currently associated with Syscon’s ongoing implementation of its software for Her Majesty’s Prison Service in the United Kingdom, through a sub-contracting agreement with Electronic Data Systems, Inc.   We expect revenues from the U.K. project to decline in the next two quarters by $2 million to $3 million as the client has delayed the project ramp-up which they indicate is due to current fiscal year budgetary constraints. However, we expect that total revenue and profit over the life of this contract will be on target with original expectations. We are being told by the customer that the project should ramp back up in the second quarter of 2008 coincident with the beginning of their new fiscal year.  We anticipate new Syscon customer contracts in the United States and Australia will partially offset the U.K. revenue decline in the next two quarters. 

 

 

Equipment sales and other services revenues increased by $0.2 million from the prior year; however, we do not expect to generate significant equipment sales revenue in the future.

 

 

Page 24

 

 

 

***Cost of Service.*** Total cost of service decreased by $4.0 million, or 5.2%, to $72.8 million. The decrease was due primarily to decreased revenues and lower bad debt and commission expenses, offset by the expenses related to the newly acquired offender management software business. A comparison of the components of our business segment gross margins is provided below:

   

 

**For the Three Months**

 

 

**For the Three Months**

 

**Ended September 30,**

 

 

**Ended September 30,**

 

**2006**

 

 

**2007**

 

**(Unaudited)**

 

 

**(Unaudited)**

Direct call provisioning

 

 

 

 

 

 

 

 

 

 

 

 

Revenue

$

84,094

 

 

 

 

 

$

79,462

 

 

 

Cost of service

 

66,871

 

79.5

%

 

 

 

62,927

 

79.2

%

Segment gross margin

$

17,223

 

20.5

%

 

 

$

16,535

 

20.8

%

Solutions services

 

 

 

 

 

 

 

 

 

 

 

 

Revenue

$

11,183

 

 

 

 

 

$

8,422

 

 

 

Cost of service

 

8,619

 

77.1

%

 

 

 

5,518

 

65.5

%

Segment gross margin

$

2,564

 

22.9

%

 

 

$

2,904

 

34.5

%

Telecommunications services

 

 

 

 

 

 

 

 

 

 

 

 

Revenue

$

2,744

 

 

 

 

 

$

1,698

 

 

 

Cost of service

 

1,307

 

47.6

%

 

 

 

755

 

44.5

%

Segment gross margin

$

1,437

 

52.4

%

 

 

$

943

 

55.5

%

Offender management software

 

 

 

 

 

 

 

 

 

 

 

 

Revenue

$

-  

 

 

 

 

 

$

4,798

 

 

 

Cost of service

 

-  

 

-  

 

 

 

 

3,456

 

72.0

%

Segment gross margin

$

-  

 

-  

 

 

 

$

1,342

 

28.0

%

Equipment sales and other

 

 

 

 

 

 

 

 

 

 

 

 

Revenue

$

64

 

 

 

 

 

$

222

 

 

 

Cost of service

 

18

 

28.1

%

 

 

 

189

 

85.1

%

Segment gross margin

$

46

 

71.9

%

 

 

$

33

 

14.9

%

 

Our direct call provisioning, solutions services, and telecommunications services revenues decreased. Operating costs are a substantially higher component of revenues in the direct call provisioning, solutions services, and offender management software businesses than in the telecommunications services and equipment sales businesses. 

 

Cost of service in our direct provisioning business as a percentage of revenue decreased to 79.2% from 79.5% primarily due to lower bad debt expenses, partially offset by higher billing and collection costs associated with higher prepaid revenues, coupled with increasing commission expenses due to competitive market forces.   Bad debt, although improving in 2007 vs. 2006, was negatively impacted by approximately $0.7 million of additional write-offs associated with complications of our billing system conversion during the second quarter of 2007.  We believe all unusual costs associated with the billing system conversion have been incurred and we anticipate no further such costs after third quarter 2007.

 

Cost of service in our solutions segment as a percentage of our revenue decreased to 65.5% from 77.1% as a result of lower bad debt expense, which is the major component of our cost of service of the solutions segment and also the most volatile cost of our service.  Bad debt expense has declined in the segment, as in our direct call provisioning segment, principally due to various initiatives to more precisely identify and treat high risk customers.

 

Cost of service in our telecommunications segment as a percentage of revenue decreased to 44.5% from 47.6% due to a shift in profitability of the remaining accounts in service and the relative profitability of those accounts deinstalled over the last year.

 

Cost of service in our offender management software segment as a percentage of revenue is 72.0% which primarily represents salaries and related costs of employees and contractors who provide technological services to develop, customize or enhance the software for our clients.    

 

Cost of service in our equipment sales and other segment increased as a percentage of revenue to 85.1% from 28.1%, which is reflective of the gross margin received on a sale during the quarter ended September 30, 2007.

 

*SG&A.*SG&A expenses of $17.3 million were $5.0 million, or 40.3%, higher than the prior year quarter. The increase was due primarily to $1.6 million of higher legal costs related to various lawsuits, a $0.5 million settlement of a dispute with a former telecommunications service partner relating to prior years, $0.4 million higher health insurance costs due primarily to an unusual 

 

Page 25

 

 

number of large claims, a $0.6 million increase due primarily to cost of living increases, $0.6 million of other costs primarily due to a lower allocation rate of certain overhead expenses to cost of service in 2007, and $1.3 million related to Syscon operations.   We incurred $0.2 million of expenses for our ongoing efforts to comply with the Sarbanes Oxley Act in the third quarter of 2007.

 

*Depreciation and Amortization Expenses.* Depreciation and amortization expenses were $7.6 million and $9.9 million for the three months ended September 30, 2006 and 2007, respectively. The increase of $2.3 million was attributable to depreciation and amortization related to 2006 and 2007 additions to property and equipment and intangible assets and a reduction in the useful life of certain telecommunications equipment to reflect the installation, over the next several years, of our new packet-based architecture. Additionally, 2007 depreciation and amortization includes $0.9 million related to Syscon operations associated primarily with the write up of Syscon’s assets to fair market value as of the acquisition date.

 

*Interest and Other Expenses, net*. Interest and other expenses, net, were $6.9 million and $7.7 million for the three months ended September 30, 2006 and 2007, respectively. The increase relates primarily to the increasing principal on the Senior Subordinated notes due to interest being paid-in-kind and interest expense on the $40 million 11% Second-priority Senior Secured Notes due 2011 issued on June 29, 2007, offset by foreign exchange transaction gains of $1.1 million.

 

*Income Tax Expense*. The Company had income tax expense of $0.4 million and $0 for the three months ended September 30, 2006 and September 30, 2007, respectively. The Company generates tax expense despite operating losses due principally to changes in deferred tax balances.

 

**RESULTS OF OPERATIONS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2007 COMPARED TO THE NINE MONTHS ENDED SEPTEMBER 30, 2006**

 

***Revenues*****.**  The Company’s revenue for the nine months ended September 30, 2007 decreased $1.5 million, or 0.5%, to $297.0 million. The primary components of the decrease in revenues, offset by an increase in our direct call provisioning revenues, are discussed below.

 

Direct call provisioning revenues increased a net  $5.9 million, or 2.3%, to $257.6 million primarily due to:

 

 

 

 

  

 

 

New prime business contracts won from competitors, net of accounts not renewed, coupled with initiatives to both stimulate additional prepaid demand and reduce bad debt from existing customers of approximately $7.8 million; and

 

 

 

 

 

 

 

A decrease in prime business with the State of Pennsylvania of $0.6 million.  We began serving the State of Pennsylvania on an interim basis in late April 2006 as a result of Verizon’s desire to exit their existing contract and continued to provide services on an interim basis until the second quarter of 2007.  The interim contract generated approximately $1.2 million of revenue per month.

 

 

 

A reduction of $1.3 from the loss of a direct provisioning contract with the Alabama Department of Corrections.

 

 

We were awarded the State of Florida Department of Corrections direct provisioning account earlier in 2007.  After a delay due to an ongoing protest of the award by several competitors, we began installing this account in October and expect to be completely installed by January.  We do not expect to derive incremental profit from this account in the fourth quarter of 2007 due to normal start-up costs of such a large account, but do expect to generate a minimum of approximately $3 million of revenue per quarter by the first quarter of 2008.

 

 

 

Solutions services revenues decreased by $7.1 million, or 20.2%, to $28.0 million primarily due to terminations of service by Global Tel*Link as their underlying facility contracts expired. We expect solutions services revenues to decline by approximately $1.0 million for the fourth quarter of 2007 and expect further declines thereafter.

 

 

Telecommunications services revenues decreased by $5.0 million, or 45.3%, to $6.1 million primarily attributable to accounts that we did not retain upon contract renewal or accounts that converted to direct provisioning revenue. We have not retained a significant amount of our telecommunications services contracts upon renewal as a result of our strategy to focus on growing our direct provisioning business. The departures of AT&T and Verizon from the inmate telecommunications market and resulting sale of those businesses to our competitors contributed to the decline. We expect telecommunications services revenue to continue to decline, albeit at a somewhat more gradual rate, through the remainder of 2007 and 2008.

 

Offender management software revenues of $4.8 million are now part of our consolidated results of operations as a result of the acquisition of Syscon on June 29, 2007.  As required by Financial Accounting Standards Board Statement No. 141, Emerging Issues Task Force 01-3, and related rules, Syscon’s balance sheet reflects fair values of assets and liabilities on the acquisition date.  Consequently, we fair valued Syscon’s customer contracts and related deferred revenues, which will impact the amount of booked revenue and profit that Securus will be able to recognize prospectively.  As a result, during the three months ended 

 

Page 26

 

 

September 30, 2007, Syscon’s reported revenue and operating profit were $0.9 million lower than would have been reported had no acquisition occurred, representing the current period amortization of fair value of contracts acquired.   The majority of Syscon’s revenues are currently associated with Syscon’s ongoing implementation of its software for Her Majesty’s Prison Service in the United Kingdom, through a sub-contracting agreement with Electronic Data Systems, Inc.   We expect revenues from the U.K. project to decline in the next two quarters by $2 million to $3 million as the client has delayed the project ramp-up which they indicate is due to current fiscal year budgetary constraints. However, we expect that total revenue and profit over the life of this contract will be on target with original expectations. We are being told by the client that the project should ramp back up in thesecond quarter of 2008 coincident with the beginning of their new fiscal year.  We anticipate new Syscon customer contracts in the United States and Australia will partially offset the U.K. revenue decline in the next two quarters. 

 

Equipment sales and other services revenues stayed flat between 2006 and 2007. We do not expect to generate significant equipment sales revenue in the future.

 

***Cost of Service*****.**  Total cost of service remained approximately the same for the nine months ended September 30, 2007. A comparison of the components of our gross margins is provided below.

 

 

**For the Nine Months**

 

 

**For the Nine Months**

 

**Ended September 30,**

 

 

**Ended September 30,**

 

**2006**

 

 

**2007**

 

**(Unaudited)**

 

 

**(Unaudited)**

Direct call provisioning

 

 

 

 

 

 

 

 

 

 

 

 

Revenue

$

251,721

 

 

 

 

 

$

257,633

 

 

 

Cost of service

 

196,930

 

78.2

%

 

 

 

203,771

 

79.1

%

Segment gross margin

$

54,791

 

21.8

%

 

 

$

53,862

 

20.9

%

Solutions services

 

 

 

 

 

 

 

 

 

 

 

 

Revenue

$

35,161

 

 

 

 

 

$

28,042

 

 

 

Cost of service

 

26,314

 

74.8

%

 

 

 

18,831

 

67.2

%

Segment gross margin

$

8,847

 

25.2

%

 

 

$

9,211

 

32.8

%

Telecommunications services

 

 

 

 

 

 

 

 

 

 

 

 

Revenue

$

11,077

 

 

 

 

 

$

6,063

 

 

 

Cost of service

 

5,421

 

48.9

%

 

 

 

2,692

 

44.4

%

Segment gross margin

$

5,656

 

51.1

%

 

 

$

3,371

 

55.6

%

Offender management software

 

 

 

 

 

 

 

 

 

 

 

 

Revenue

$

-  

 

 

 

 

 

$

4,798

 

 

 

Cost of service

 

-  

 

-  

 

 

 

 

3,456

 

72.0

%

Segment gross margin

$

-  

 

-  

 

 

 

$

1,342

 

28.0

%

Equipment sales and other

 

 

 

 

 

 

 

 

 

 

 

 

Revenue

$

494

 

 

 

 

 

$

462

 

 

 

Cost of service

 

367

 

74.3

%

 

 

 

364

 

78.8

%

Segment gross margin

$

127

 

25.7

%

 

 

$

98

 

21.2

%

  

Our direct call provisioning revenues increased while our solutions services, telecommunications services and equipment sales and other revenues decreased. Historically, operating costs are a substantially higher component of revenues in the direct call provisioning, solutions services, and offender management software businesses than in the telecommunications services and equipment sales businesses. 

 

Cost of service in our direct provisioning business as a percentage of revenue increased to 79.1% from 78.2%.  Bad debt was negatively impacted by approximately $0.7 million of additional write-offs in the third quarter associated with complications of our billing system conversion in the second quarter of 2007.  We believe all unusual costs associated with the billing system conversion have been incurred and we anticipate no further such costs after the third quarter 2007.  The increase in cost of service was also due to higher commission expenses as a result of normal competitive market forces.

 

Cost of service in our solutions segment as a percentage of our revenue decreased to 67.2% from 74.8% as a result of lower bad debt expense, which is the major component of our cost of service of the solutions segment and also the most volatile cost of our service.

 

Cost of service in our telecommunications segment as a percentage of revenue decreased to 44.4% from 48.9%. This decrease is due to a shift in profitability of the remaining accounts in service and the relative profitability of those accounts deinstalled over the last year.

 

Page 27

 

 

 

Cost of service in our offender management software segment as a percentage of revenue is 72.0% which primarily represents salaries and related costs of employees and contractors who provide technological services to develop, customize or enhance the software for our clients.    

 

Cost of service in our equipment sales and other segment increased as a percentage of revenue to 78.8% from 74.3%. We believe future cost of service as a percentage of revenue in this segment is consistent with long-term historical trends.

 

*SG&A.* SG&A expenses of $45.6 million were $6.8 million, or 17.7%, higher than the prior year nine month period. The increase was due primarily to $2.2 million of higher legal costs associated with various lawsuits, $0.2 million in lease exit costs to close a warehouse, $0.5 million of bonuses related to the closing of the Syscon acquisition, $0.3 million of personnel costs associated with severance and death benefits to the family of an executive, a $0.5 million settlement of a dispute with a former telecommunications service partner relating to prior years, higher health care costs and other cost of living increases, and incremental Syscon SG&A of $1.3 million. 

 

*Restructuring Costs*. Restructuring charges of $0.6 million were incurred in 2007 related to the consolidation of our customer care function into the Dallas office, comprised of $0.2 million of severance expense and $0.4 million of facility exit costs for our Selma, Alabama location.

 

*Depreciation and Amortization Expenses*. Depreciation and amortization expenses of $27.5 million were $6.2 million, or 29.0%, higher than the prior year nine month period. The increase was attributable to depreciation and amortization related to 2006 and 2007 additions to property of equipment and intangible assets and a reduction in the useful life of certain telecommunications equipment to reflect the installation, over the next several years, of our new packet-based architecture. Additionally, 2007 depreciation and amortization includes $0.9 million related to Syscon operations associated primarily with the step up in basis of Syscon’s assets to fair value as of the acquisition date.

 

*Interest and Other Expenses, net*. Interest and other expenses, net, were $20.7 million and $22.5 million for the nine months ended September 30, 2006 and 2007, respectively. The increase relates primarily to the increasing principal on the Senior Subordinated notes due to interest being paid-in-kind and interest expense on the $40 million 11% Second-priority Senior Secured Notes due 2011 issued on June 29, 2007. In addition, we booked an impairment charge of $0.1 million related to our investment in Accudata due to a downturn in Accudata’s business prior to the sale of our interest in Accudata.  These charges are offset by foreign exchange transaction gains of $1.1 million.

 

*Income Tax Expense.*Income tax expense for the nine months ended September 30, 2006 and 2007 was $1.0 million and $0.8 million, respectively. The Company generated tax expense despite operating losses due principally to changes in deferred tax liability balances.

 

**Liquidity and Capital Resources**

 

The Company’s principal liquidity requirements are to service and repay our debt and meet our capital expenditure and operating needs. We are significantly leveraged. As of September 30, 2007, we had $275.1 million in total debt outstanding before considering $3.3 million of original issue discount on our Second-priority Senior Secured Notes and $2.5 million of fair value attributable to warrants issued in connection with our senior subordinated debt financing, all of which is reflected as discounts to outstanding long-term debt in our condensed consolidated financial statements (see additional information on our long and short term debt under "Debt and Other Obligations" below). As of September 30, 2007, we had cash of $2.1 million, unused capacity of $15.9 million under our working capital credit facility and a total stockholders’ deficit of$78.0 million.  As of November 13, 2007, we had unused capacity of $21.9 million under our working capital credit facility.  In addition, at November 14, 2007, we had additional borrowing commitments and an equity resource plan as discussed below.

 

Our ability to make payments on and to refinance our indebtedness, and to fund planned capital expenditures will depend on our ability to generate cash in the future and our ability to maintain compliance under our credit facilities, which, to a certain extent, is subject to general economic, financial, competitive, legislative, regulatory and other factors that are beyond our control.  

 

As of September 30, 2007, we were not in compliance with certain financial covenants required by our revolving credit facility.  Specifically, we were not in compliance with the Interest Coverage Ratio which requires us to maintain a ratio of EBITDA (as defined) to Cash Interest (as defined) above 1.75.  This ratio is required to be calculated on a pro forma basis for the impact of acquisitions, such as our acquisition of Syscon in June 2007.   The revolver facility lenders amended the credit agreement which effectively waived this non-compliance for the period ended September 30, 2007.   

 

Additionally, as of September 30, 2007, we did not maintain a Credit Facility Coverage Ratio above 1.75 as required by the indenture governing our Second-priority Senior Secured Notes.  This financial covenant is calculated by dividing Credit Facility Cash Flow (as defined) by Credit Facility Interest Expense (as defined) and is calculated on a pro forma basis for the impact of 

 

Page 28

 

 

acquisitions, such as our acquisition of Syscon in June 2007.    The non-compliance with this covenant did not result in a default under the indenture as the indenture requires two consecutive quarters of non-compliance with the Credit Facility Coverage Ratio for a default to exist.  

 

In order to avoid future potential defaults, the Company’s Board of Directors intends to review all options, including asking existing Class A common shareholders to contribute additional equity.  Under the indenture governing our Second-priority Senior Secured Notes, equity contributions are added to our EBITDA, and thus to Credit Facility Cash Flow, for purposes of calculating our financial covenants. The Company’s majority shareholder, HIG Capital, has committed to invest up to $10 million of junior capital in the Company. The amount of equity needed by the Company will be determined as the Company finalizes results for the year ending December 31, 2007 and its forecast for 2008.  To the extent there is non-compliance, which is probable, as of December 31, 2007 or forecasted non-compliance in 2008, the Company plans to ask its shareholders for sufficient equity to becontributed to remedy such non-compliance.  This remedy would be automatic under the indenture governing the Second-priority Senior Secured Notes as the definition of the Credit Facility Coverage Ratio allows contributed junior capital to be included in the ratio calculation.   The revolving credit facility lenders have amended the revolving credit facility to similarly allow contributed junior capital to be included in both the Minimum EBITDA and Interest Coverage Ratio covenant calculations.  Should the plan not be executed, or be insufficient to cure any future non-compliance, the Company’s lenders could choose to enforce their default rights and demand repayment of all outstanding obligations.  The Company expects to be in full compliance with its credit facilities at December 31, 2007 and throughout 2008 and to be able to meet all of its obligations.  The Board also may consider other options in addition to the equity resource plan.      

 

In the event that cash in excess of the amounts generated from on-going business operations and available under our credit facilities or through equity contributions from shareholders is required to fund our operations, we may be required to reduce or eliminate discretionary selling, general and administrative costs, and sell or close certain of our operations.   In addition to its revolving credit facility, the Company also executed a $5.0 million unsecured demand note with a financial institution on August 17, 2007.  

 

An affiliate of H.I.G. T-Netix, Inc., our majority stockholder, agreed to guarantee this $5.0 million unsecured financing and to make available up to an additional $2.5 million of financing to the Company.  In connection with H.I.G. T-Netix’s guarantee, the Company is required to issue warrants to purchase up to 14,542 shares of its Class A common stock.  The guarantee and the $2.5 million commitment will be reduced dollar for dollar in the event that H.I.G. invests additional capital under its new $10 million commitment. The Company had no outstanding borrowings under these facilities as of November 14, 2007.

 

**Cash Flows**

 

Our cash flows from operations are primarily attributable to the operations of our direct call provisioning business, which represents 87% of our revenues for the nine months ended September 30, 2007. The level of our cash flow depends on multiple factors, including contract renewals and new business, as well as growth in inmate populations. Our net cash provided by operating activities is also affected by the level of our operating and other expenses. 

 

 

The following table provides cash flow data for the nine months ended September 30, 2006 and 2007:

 

 

 

**For the Nine Months Ended**

 

 

 

 

**September 30,**

 

 

 

**September 30,**

 

 

 

 

**2006**

 

 

 

**2007**

 

 

 

**(Unaudited)**

 

Net cash provided by operating activities

 

$

7,309

 

 

$

11,809

 

Net cash used in investing activities

 

$

(19,282

)

 

$

(59,564

)

Net cash provided by financing activities

 

$

9,763

 

 

$

50,507

 

 

**Cash Flows for the nine months ended September 30, 2007 Compared to the nine months ended September 30, 2006**

 

Net cash provided by operating activities for the nine months ended September 30, 2007, consisted primarily of $21.6 million of operating income before considering non-cash expenses including $27.5 million of depreciation and amortization, $8.4 million of working capital benefit, offset by $18.3 million of cash paid for interest expense. The working capital benefit is principally the result of a change in billing policies, whereby records are now being transmitted to our LEC billing agents faster in 2007 than in 2006, which has resulted in faster cash collections and a decline in our receivables balances.  Net cash provided by operating activities for the nine months ended September 30, 2006, consisted primarily of $30.6 million of operating income before considering non-cash expenses including $21.3 million of depreciation and amortization, offset by $17.3 million ofcash paid for interest expense and $5.8 million of working capital use. 

 

 

Page 29

 

 

Cash used in investing activities was $19.3 million and $59.6 million for the nine months ended September 30, 2006 and 2007, respectively. In June 2007, we utilized $43.7 million in connection with the acquisition of Syscon (See Note 2 – Acquisition). Additionally, we invested $16.9 million in equipment and intangibles to maintain and grow the direct call provisioning business, a decline of $2.3 million in spending from 2006. The decline was principally due to savings associated with the deployment of our new packet-based architecture for new or renewal business in 2007. We expect our capital expenditures to continue to decline in the future due to the gradual deployment of our new packet-based architecture.  However, our capital expenditures in the fourth quarter will be higher as a result of the State of Florida installation.

 

Cash provided by financing activities was $9.8 million and $50.5 million for the nine months ended September 30, 2006 and 2007, respectively. On June 29, 2007, we issued an additional $40.0 million of 11% Second-priority Senior Secured Notes at a discount from face value of $0.9 million to fund the Syscon acquisition, and incurred $5.0 million of financing costs related to the issuance. Net draws on the Company’s revolving credit facility increased by $3.6 million in 2007 primarily to fund the costs associated with the Syscon acquisition. Syscon’s previous stockholder also left $5.0 million of cash in Syscon’s bank accounts upon the closing of the Syscon acquisition, which we will use to help fund Syscon’s operations in the near future. We will pay Syscon’s previous stockholder up to $5.0 million as Syscon generates Net Cash Flow (as defined in the Syscon Stock Purchase Agreement). Asof November 13, 2007, there were $8.1 million of borrowings under the revolving credit facility. 

 

**Debt and other Obligations********

 

***Working Capital Facility***. We have a working capital facility which provides for up to $30.0 million in revolving availability, with a sublimit for letters of credit. As of September 30, 2007, $14.1 million was drawn under our working capital facility and we have outstanding approximately $13.7 million of letters of credit issued under the facility.

 

Our working capital facility has a $22.5 million letter of credit facility, with a sub-limit of $10 million. Letters of credit issued in an aggregate amount greater than $10.0 will reduce revolver borrowing availability under the working capital facility. Borrowing costs for the applicable interest rate margin on our Eurodollar loans are 2.0%. The obligations under our working capital facility are guaranteed on a secured, first priority basis by us and all of our domestic subsidiaries and certain of our foreign subsidiaries. The loans are secured by a first priority lien on substantially all of our assets including, but not limited to the capital stock of each of our subsidiaries and all of our subsidiaries’ tangible and intangible non-real estate properties and assets. 

 

The working capital facility contains a number of customary affirmative and negative covenants that are subject to significant exceptions. Subject to certain exceptions, the negative covenants restrict our ability and the ability of our subsidiaries to, among other things, incur additional indebtedness, create and incur liens on assets, repay other indebtedness, sell assets, engage in transactions with affiliates, make loans, investments, guarantees or acquisitions, declare dividends, redeem or repurchase equity interests or make other restricted payments, and engage in mergers, acquisitions, asset sales and sale-leaseback transactions. The working capital facility also includes specified financial covenants, including maintaining a minimum interest coverage ratio and capital expenditure limits. See “Liquidity and Capital Resources” for a discussion of our covenant compliance.

 

In addition to its working capital facility, the Company also recently entered into a $5.0 million unsecured demand note with a financial institution on August 17, 2007.  An affiliate of H.I.G. T-Netix, Inc., our majority stockholder, guaranteed this $5.0 million unsecured financing and agreed to make available up to an additional $2.5 million of financing to the Company. These funding sources will be replaced to the extent equity is contributed as discussed in the “Liquidity and Capital Resources” section above.

 

***Second-priority Senior Secured Notes**.*On September 9, 2004, we issued $154.0 million aggregate principal amount of our 11% Second-priority Senior Secured Notes. The Second-priority Senior Secured Notes were issued at a discount to face value of $3.6 million. Proceeds obtained from the issuance of the Second-priority Senior Secured Notes were used to finance the acquisition of Evercom and to repay outstanding long-term debt obligations. On June 29, 2007, we issued an additional $40 million aggregate principal amount of our 11% Second-priority Senior Secured Notes due 2011 under an Indenture dated September 9, 2004, as amended on June 27, 2007, in a private offering. Interest is payable on March 1 and September 1 of each year. The Second-priority Senior Secured Notes are secured bysecond-priority security interests in substantially all of our assets including but not limited to the capital stock of each of our domestic subsidiaries and certain of our foreign subsidiaries and all of our domestic subsidiaries’ and certain of our foreign subsidiaries’ tangible and intangible non-real estate properties and assets. 

 

***Senior Subordinated Notes**.*We have outstanding $67.0 million of senior subordinated notes which includes $26.9 million of paid-in-kind interest. The senior subordinated notes are unsecured and subordinated to the Second-priority Senior Secured Notes and amounts owed under our working capital facility. Our obligations under the senior subordinated notes are irrevocably and unconditionally guaranteed on a senior subordinated basis by our****domestic subsidiaries and certain of our foreign subsidiaries. The senior subordinated notes bear interest at a fixed annual rate of 17%. Interest is payable at the end of each calendar quarter, or, as restricted by the working capital facility, is paid in-kind by adding accrued interest to the principal balance of the senior subordinated notes. 

 

Page 30

 

 

 

The note purchase agreement governing the senior subordinated notes contains a number of customary affirmative and negative covenants. Subject to certain exceptions, these covenants restrict our ability and the ability of our subsidiaries to, among other things, incur additional indebtedness, create and incur liens on assets, repay pari passu our subordinated indebtedness, sell assets, engage in transactions with affiliates, make loans, investments, guarantees or acquisitions, declare dividends, redeem or repurchase equity interests or make other restricted payments, and engage in mergers, acquisitions, asset sales and sale-leaseback transactions. The senior subordinated notes also include specified financial covenants consistent with those contained in the indenture governing the second-priority senior notes. See “Liquidity and Capital Resources” for a discussion of our covenant compliance.

 

***Other Long-Term Liabilities**.*Other long-term liabilities represent approximately $1.6 million of tenant improvement concessions pertaining to the Company’s lease of its primary facility that will be amortized over the life of the lease as prescribed by SFAS No. 13 and FASB Technical Bulletin 88-1. The Company recorded amortization totaling $135,000 for these improvement concessions during the nine months ended September 30, 2007.

 

**Capital Requirements**

 

 

As of September 30, 2007, our contractual cash obligations and commitments on an aggregate basis are as follows:

 

 

**For the Twelve Months Ended September 30,**

 

 

 

**2008**

 

**2009**

 

**2010**

 

**2011**

 

**2012**

 

**Thereafter**

 

Long-term debt (1)

 

$

 

*

$

14,119

*

$

 

 

$

194,000 

*

$

 

 

$

66,970

*

Operating leases

 

 

2,435

 

 

2,286

 

 

1,989

 

 

1,678

 

 

1,454

 

 

3,451

 

Total contractual cash obligations and commitments

 

$

2,435

 

$

16,405

 

$

1,989

 

$

195,678

 

$

1,454

 

$

70,421

 

 

*

Assumes no repurchases of Second-priority Senior Secured Notes or senior subordinated notes during such periods. These amounts also do not give effect to mandatory purchases of second-priority senior secured notes, if any, with excess cash flow.

 

 

(1)

Does not include any amounts that may be drawn under our working capital facility, which expires on September 9, 2009, or accrued interest under our long-term debt.

 

**Critical Accounting Policies**

 

A “critical accounting policy” is one that is both important to the portrayal of a company’s financial condition and results and requires management’s most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. The condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States, or GAAP. The process of preparing the condensed consolidated financial statements in conformity with GAAP requires us to use estimates and assumptions to determine certain of our assets, liabilities, revenues and expenses. We base these determinations upon the best information available to us during the period in which we are accounting for our results. Our estimates and assumptions could change materially as conditionswithin and beyond our control change or as further information becomes available. Further, these estimates and assumptions are affected by management’s application of accounting policies. Changes in our estimates are recorded in the period the change occurs. Our critical accounting policies include, among others:

 

 

revenue recognition and bad debt reserve estimates;

 

 

 

goodwill and other intangible assets;

 

 

 

accounting for income taxes; and

 

 

 

acquisition-related assets and liabilities.

 

The following is a discussion of our critical accounting policies and the related management estimates and assumptions necessary for determining the value of related assets or liabilities.

 

**Revenue Recognition**

 

Revenues from direct call provisioning are recognized at the time the telephone call is completed and revenues from telecommunications and Solutions services are recognized in the period in which calls are processed through our systems. Revenues from equipment sales are recognized when the equipment is shipped to customers. We record deferred revenues for advance billings to customers, or prepayments by customers.

 

Page 31

 

 

 

In evaluating the collectibility of our trade receivables, we assess a number of factors including our historical cash resources held by our LEC billing agents and collection rates with our billing agents and a specific customer’s ability to meet the financial obligations to us, as well as general factors, such as the length of time the receivables are past due and historical collection experience. Based on these assessments, we record reserves for uncollectibles to reduce the related receivables to the amount we ultimately expect to collect from our customers. If circumstances related to specific customers change or economic conditions worsen such that our past collection experience is no longer relevant, our estimate of the recoverability of our trade receivables could be further reduced or increased from the levels provided for in our financial statements. Because the majority ofour receivables are collected through our LEC billing agents and such agents typically do not provide us with visibility as to collection results for on average a six to nine month period, our bad debt reserves are estimated and may be subject to substantial variation.

Syscon derives revenues from licenses of software and related services, which include assistance in implementation, integration, customization, maintenance, training and consulting. Revenue is recognized for software and related services in accordance with Statement of Position (SOP) 81-1, “Accounting for Certain Construction Type and Certain Production Type Contracts,” SOP 97-2, “Software Revenue Recognition,” as modified by SOP 98-9, “Modification of SOP 97-2, Software Revenue Recognition with Respect to Certain Transactions,” and SEC Staff Accounting Bulletin (SAB) 104, “Revenue Recognition.” 

 

**Goodwill and Other Intangible Assets**

 

The calculation of amortization expense is based on the cost and estimated economic useful lives of the underlying intangible assets, intellectual property assets and capitalized computer software, and patent license rights. Goodwill represents the excess of costs over fair value of assets of businesses acquired. Goodwill and intangible assets acquired in a purchase business combination and determined to have an indefinite useful life are not amortized, but instead tested for impairment at least annually in accordance with the provisions of SFAS No. 142, *Goodwill and Other Intangible Assets*. Intangible assets with estimable useful lives are amortized over their respective estimated useful lives to their estimated residual values, and reviewed for impairment in accordance with SFAS No. 144, *Accounting forImpairment or Disposal of Long-Lived Assets*. We review our unamortized intangible assets whenever events or changes in circumstances indicate that the carrying amount may not be recoverable or the estimated useful life has been reduced. We estimate the future cash flows expected to result from operations, and if the sum of the expected undiscounted future cash flows is less than the carrying amount of the intangible asset, we recognize an impairment loss by reducing the unamortized cost of the long-lived asset to its estimated fair value.

 

**Accounting for Income Taxes**

 

The Company accounts for income taxes under the provisions of SFAS No. 109, *Accounting for Income Taxes*. Under SFAS No. 109, deferred tax assets and liabilities for the expected future tax consequences of transactions and events. Under this method, deferred tax assets and liabilities are determined based on the difference between the financial statement and tax bases of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. If necessary,  deferred tax assets are reduced by a valuation allowance to an amount that is determined to be more likely than not recoverable. We must make significant estimates and assumptions about future taxable income and future tax consequences when determining the amount of the valuation allowance.

 

**Acquisition Related Assets and Liabilities**

 

Accounting for the acquisition of a business as a purchase transaction requires an allocation of the purchase price to the assets acquired and the liabilities assumed in the transaction at their respective estimated fair values. The most difficult estimations of individual fair values are those involving long-lived assets, such as properties, plant and equipment and intangible assets. We use all available information to make these fair value determinations and, for major business acquisitions, engage an independent valuation specialist to assist in the fair value determination of the acquired long-lived assets. Due to inherent subjectivity in determining the estimated fair value of long-lived assets and the significant number of business acquisitions that we have completed, we believe that the recording of acquired assets and liabilities is a critical accounting policy.

 

**Changes in Accounting Standards**

 

The Company adopted EITF Issue No. 06-3, “*How Taxes Collected from Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement (That is, Gross versus Net Presentation)”,* in the first quarter of 2007. The scope of this issue includes any tax assessed by a governmental authority that is both imposed on and concurrent with a specific revenue-producing transaction between a seller and a customer, and may include, but is not limited to, sales, use, value added, and some excise taxes. The presentation of revenues on either a gross or a net basis is an accounting policy decision that should be disclosed under Accounting Principals Board (APB) Opinion No. 22. The Company’s policy is to report revenues using a net presentation. 

 

Page 32

 

 

 

In July 2006, the FASB issued Interpretation No. 48, “*Accounting for Uncertainty in Income Taxes*” (“FIN No. 48”), which clarifies the accounting for uncertainty in income taxes recognized in the financial statements in accordance with SFAS No. 109. FIN No. 48 provides guidance on the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN No. 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosures, and transition.  The Company adopted the provisions of FIN No. 48 on January 1, 2007.  The adoption of these provisions did not have any impact on the financial condition or results of operations of the Company.

 

The Company recognized no adjustment in the liability for unrecognized tax benefits upon the adoption of FIN 48. As of the date of adoption, the Company’s unrecognized tax benefits totaled $0.1 million, including interest and penalties of $0. The amount of unrecognized tax benefits that would impact the effective rate, if recognized, would be $0.1 million.  The amount of the unrecognized tax benefits that would impact goodwill, if recognized, would be $0.6 million.  The Company does not anticipate a significant change to the total amount of unrecognized tax benefits over the next twelve months.

 

The Company or one of its subsidiaries file income tax returns in the US federal jurisdiction, Canada, the United Kingdom, Austrailia and various states. The Company has open tax years for the U.S. federal return from 1996 forward with respect to its net operating loss (“NOL”) carryforwards, where the IRS may not raise tax for these years, but can reduce NOLs. Otherwise, with few exceptions, the Company is no longer subject to federal, foreign, state, or local income tax examinations for years prior to 2003.

 

The Company recognizes potential accrued interest and penalties related to unrecognized tax benefits in income tax expense. For the quarter ended and year to date September 30, 2007, the Company recognized $0.09 million in potential interest and penalties with respect to unrecognized tax benefits.

 

In September 2006, the FASB issued SFAS No. 157, *“Fair Value Measurement”*(“SFAS No. 157”), which defines fair value, establishes a framework for measuring fair value in GAAP and expands disclosure about fair value measurements. This statement does not require any new fair value measurements; rather, it applies whenever other accounting pronouncements require or permit fair value measurements. The provisions of this statement are to be applied prospectively as of the beginning of the fiscal year in which this statement is initially applied, with any transition adjustment recognized as a cumulative-effect adjustment to the opening balance of retained earnings. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007 and interim periods within those fiscal years. The Company will berequired to adopt SFAS No. 157 in the first quarter of fiscal year 2008. The Company has not completed its evaluation of the effect of SFAS No. 157. 

 

In February 2007, the FASB issued SFAS No. 159, *“The Fair Value Option for Financial Assets and Financial Liabilities — Including an amendment of FASB Statement No.* *115”*(“SFAS No. 159”), which permits entities to choose to measure many financial instruments and certain other items at fair value. The objective of SFAS No. 159 is to improve financial reporting by providing entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. SFAS No. 159 is effective for fiscal years beginning after November 15, 2007. The Company has the option of adopting SFAS No. 159 on January 1, 2008. The Company has notcompleted its evaluation of the effect SFAS No. 159 would have on the Company if adopted.

 

**ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

 

We are exposed to market rate risk for changes in interest rates related to our revolving line of credit. Interest expense on our floating rate debt will increase more than expected if interest rates rise. Our $30.0 million revolving line of credit bears an interest rate equal to one of the following, at our option: (i) the Prime Rate or (ii) a rate equal to the Eurodollar Rate as adjusted by the Eurodollar Reserve Percentage plus 2% and is calculated on amounts borrowed under the facility. The effect of a 10% fluctuation in the interest rate on our revolving line of credit would have had an effect of about $0.1 million on our interest expense for the nine month periods ended September 30, 2006 and September 30, 2007.

 

**ITEM 4. CONTROLS AND PROCEDURES**

 

**1. Disclosure Controls and Procedures**

 

Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934) as of September 30, 2007. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were (1) designed to ensure that material information relating to the Company, including its consolidated subsidiaries, is made known to the Company’s Chief Executive Officer and Chief Financial 

 

Page 33

 

 

Officer by others within those entities, particularly during the period in which this report was being prepared and (2) effective, in that they provide reasonable assurance that information required to be disclosed by us in the reports that we file or submit under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. 

 

**2. Changes in Internal Control Over Financial Reporting**

 

No change in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934) occurred during the fiscal quarter ended September 30, 2007 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

 **PART II — OTHER INFORMATION**

 

**ITEM 1. LEGAL PROCEEDINGS**

 

From time to time we have been, and expect to continue to be, subject to various legal and administrative proceedings or various claims in the normal course of its business. We believe the ultimate disposition of these matters will not have a material affect on our financial condition, liquidity, or results of operations.

From time to time, inmate telecommunications providers, including Securus, are parties to judicial and regulatory complaints and proceedings initiated by inmates, consumer protection advocates or individual called parties alleging, among other things, that excessive rates are being charged with respect to inmate collect calls, commissions paid by inmate telephone service providers to the correctional facilities are too high, that a call was wrongfully disconnected, that security notices played during the call disrupt the call, that the billed party did not accept the collect calls for which they were billed or that rate disclosure was not provided or was inadequate. We are also on occasion the subject of regulatory complaints regarding our compliance with various matters including tariffing, access charges and payphone compensation requirements and rate disclosure issues.

In the case captioned Sandra Judd, et al. v. AT&T, et al., initially brought in King County Superior Court in Seattle, T-Netix and several other telecommunication companies were sued on allegations of failure to comply with the audible, pre-connect disclosure of inmate call rates as required by Washington law. T-Netix and AT&T, the remaining defendants, obtained summary judgment in their favor in September 2006, but the ruling was overturned by the Court of Appeals. T-Netix’s Petition for Review by the Washington State Supreme Court is pending. We cannot predict the outcome of this appeal at this time.

In May 2005, TIP Systems, LLC and TIP Systems Holdings Co., Inc. (“TIPS”) filed suit in the United States District Court for the Southern District of Texas (Houston Division) against numerous defendants including us. In TIP Systems, we, along with other inmate telecommunications providers, were alleged to have infringed on patents concerning “cord-free” or “hands-free” inmate phone technology. This lawsuit against us was dismissed on March 1, 2007, when our motion for summary judgment was granted on the issue of non-infringement. TIPS has appealed to the U.S. Court of Appeals. Additionally, the TIPS entities have filed a lawsuit in the Southern District of Texas against us which alleges substantially similar allegations concerning patent infringement claims for “cord-free” or “hands-free” inmate phone technology. We have denied anywrongdoing and will vigorously defend each and every allegation in the case. We cannot evaluate the likelihood of any outcome or make a reasonable estimate of range of potential loss at this time.

In October 2003, Value-Added Communications, Inc. (“VAC”) filed suit in the District Court of Dallas County, Texas against T-NETIX for alleged breach of a Patent License Agreement between VAC and T-NETIX. VAC filed the lawsuit seeking, among other things, an interpretation of certain provisions of the agreement, revival of the agreement, a license to any of T-NETIX’s improvements to the originally licensed technology, and an award of its attorneys’ fees. T-NETIX filed counter-claims against VAC for, among other things, VAC’s failure to assign certain improvements in technology that VAC has developed since 1996. On March 6, 2007, the Dallas District Court presiding over the lawsuit signed an interlocutory summary judgment order in T-NETIX’s favor finding, among other things, that VAC is not entitled to any of T-NETIX’s technology other than theoriginally licensed patents and that VAC is required to automatically assign any improvements or additions it makes to the original technology to T-NETIX, with VAC maintaining the right to continue using improvements or additions it makes. The Court also found that neither party is entitled to an award of attorneys’ fees from the other for claims relating to the issues resolved in the March 6, 2007 order. T-NETIX will continue to proceed against VAC on its affirmative claims for VAC’s failure to assign its improvements and additions and will continue to vigorously defend against VAC’s claim for attorneys’ fees and VAC’s efforts to reinstate the Agreement on grounds unrelated to the March 6, 2007 order. Trial is tentatively set for February 2008, but will likely 

 

Page 34

 

 

be postponed due to a new judge being assigned to the matter. We cannot evaluate the likelihood of any outcome or make a reasonable estimate of range of potential loss at this time.

In April 2005, we filed suit in the United States District Court for the Northern District of Texas (Dallas Division) against VAC for patent infringement. VAC filed an answer and a counterclaim in this matter. VAC seeks declaratory judgments as to non-infringement and invalidity. Discovery is on-going at this time. Trial in this matter is set for March 2008. We cannot evaluate the likelihood of any outcome at this time.

In November 2005, we filed suit in the District Court of Dallas County, Texas, against AGM Telecom Corporation and former employees of our various affiliates, and related individuals, including David McEvilly, George McNitt, Thomas Miller, Steven Capitano, Brian Dietert, Christopher McNitt, Robert G. Sargeant, James F. Winstead, Pablo Xiques, Henry Chang, and Mie Mie Change, alleging, among other things, breach of contract and misappropriation of trade secrets. In the lawsuit, various defendants have counterclaimed for alleged violations of the Texas Business & Commerce Code, disparagement, defamation, and tortious interference. Some defendants  moved to stay the case and have requested the court compel arbitration of the matter, and some defendants filed special appearances objecting to the court’s jurisdiction.  The court has granted some of the defendants’ motion tocompel arbitration and to stay the case as to them. We have denied any wrongdoing with respect to the alleged counterclaims and will vigorously defend each and every counterclaim asserted by the defendants. We cannot evaluate the likelihood of any outcome at this time.  

 

In October 2006, we filed suit in the U.S. Federal District Court for the Eastern District of Texas against Global Tel*Link Corporation; AGM Telecom Corporation; Inmate Calling Solutions, Inc.; and FSH Communications, LLC for patent infringement of several patents related to the inmate correctional services and telecommunications industry by each such defendant. This case is in its early stages and we cannot predict the outcome at this time.

In May 2007, Global-Tel Link Corporation (“GTL”) and Verizon Business (“Verizon”) filed formal protest petitions against the Florida Department of Corrections (“FDOC”) (the “Protests”). The Protests challenge FDOC’s intended award to us of a five-year initial term contract for provision of Statewide Inmate Telephone Services. More specifically, the Protests seek entry of recommended and final orders either (1) awarding the contract to the protestor or (2) rejecting all proposals. The Protests were before the Florida Division of Administrative Hearings (“DOAH”). On September 20, 2007, the DOAH denied GTL and Verizon’s joint motion to stay. In addition, the Appellate Court has denied GTL and Verizon's emergency motion for stay pending appeal, filed September 12, 2007.  As a result of the foregoing rulings, the FDOCContract was executed on September 25, 2007.

 

Finally, the FCC has asked for public comment on a proposal from an inmate advocacy group to impose a federal rate cap on interstate inmate calls. This proceeding could have a significant impact on the rates that we and other companies in the inmate telecommunications business may charge. Although similar proposals have been pending before the FCC for more than three years without action by the agency, this newest proceeding is nonetheless in its early stages, and we cannot predict the outcome at this time.

**ITEM 1A. RISK FACTORS**

 

You should carefully consider those risk factors discussed in Forward-Looking Statements set forth previously in this document, as well as the other factors detailed from time to time in the filings with the SEC. These risks are not the only risks facing us. Additional risks and uncertainties not currently known to us, or those we currently view to be immaterial may also materially and adversely affect our business, financial condition, or results of operations.

 

The majority of Syscon’s revenues are currently associated with Syscon’s ongoing implementation of its software for Her Majesty’s Prison Service in the United Kingdom, through a sub-contracting agreement with Electronic Data Systems, Inc.   We expect revenues from the U.K. project to decline in the next two quarters by $2 million to $3 million as the client has delayed the project ramp-up which they indicate is due to current fiscal year budgetary constraints. However, we expect that total revenue and profit over the life of this contract will be on target with original expectations and we are being told by the client that the project should ramp back up in the second quarter of 2008 coincident with the beginning of their new fiscal year.  We anticipate new Syscon customer contracts in the United States and Australia will partially offset the U.K. revenue decline in the nexttwo quarters. 

 

As of September 30, 2007, we were not in compliance with certain financial covenants required by our revolving credit facility.  Specifically, we were not in compliance with the Interest Coverage Ratio which requires us to maintain a ratio of EBITDA (as defined) to Cash Interest (as defined) above 1.75.  This ratio is required to be calculated on a pro forma basis for the impact of acquisitions, such as our acquisition of Syscon in June 2007.   The revolver facility lenders amended the credit agreement which effectively waived this non-compliance for the period ended September 30, 2007.   

 

 

Page 35

 

 

Additionally, as of September 30, 2007, we did not maintain a Credit Facility Coverage Ratio above 1.75 as required by the indenture governing our Second-priority Senior Secured Notes.  This financial covenant is calculated by dividing Credit Facility Cash Flow (as defined) by Credit Facility Interest Expense (as defined) and is calculated on a pro forma basis for the impact of acquisitions, such as our acquisition of Syscon in June 2007.    The non-compliance with this covenant did not result in a default under the indenture as the indenture requires two consecutive quarters of non-compliance with the Credit Facility Coverage Ratio for a default to exist.  

 

In order to avoid future potential defaults, the Company’s Board of Directors intends to review all options, including asking existing Class A common shareholders to contribute additional equity.  Under the indenture governing our Second-priority Senior Secured Notes, equity contributions are added to our EBITDA, and thus to Credit Facility Cash Flow, for purposes of calculating our financial covenants. The Company’s majority shareholder, HIG Capital, has committed to invest up to $10 million of junior capital in the Company. The amount of equity needed by the Company will be determined as the Company finalizes results for the year ending December 31, 2007 and its forecast for 2008.  To the extent there is non-compliance, which is probable, as of December 31, 2007 or forecasted non-compliance in 2008, the Company plans to ask its shareholders for sufficient equity to becontributed to remedy such non-compliance.  This remedy would be automatic under the indenture governing the Second-priority Senior Secured Notes as the definition of the Credit Facility Coverage Ratio allows contributed junior capital to be included in the ratio calculation.   The revolving credit facility lenders have amended the revolving credit facility to similarly allow contributed junior capital to be included in both the Minimum EBITDA and Interest Coverage Ratio covenant calculations.  Should the plan not be executed, or be insufficient to cure any future non-compliance, the Company’s lenders could choose to enforce their default rights and demand repayment of all outstanding obligations.  The Company expects to be in full compliance with its credit facilities at December 31, 2007 and throughout 2008 and to be able to meet all of its obligations.  The Board also may consider other options in addition to the equity resource plan.      

 

In the event that cash in excess of the amounts generated from on-going business operations and available under our credit facilities or through equity contributions from shareholders is required to fund our operations, we may be required to reduce or eliminate discretionary selling, general and administrative costs, and sell or close certain of our operations.   In addition to its revolving credit facility, the Company also executed a $5.0 million unsecured demand note with a financial institution on August 17, 2007.  

 

An affiliate of H.I.G. T-Netix, Inc., our majority stockholder, agreed to guarantee this $5.0 million unsecured financing and to make available up to an additional $2.5 million of financing to the Company.  In connection with H.I.G. T-Netix’s guarantee, the Company is required to issue warrants to purchase up to 14,542 shares of its Class A common stock.  The guarantee and the $2.5 million commitment will be reduced dollar for dollar in the event that H.I.G. invests additional capital under its new $10 million commitment. The Company had no outstanding borrowings under these facilities as of November 14, 2007.

**ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS**

 

 None.

**ITEM 3. DEFAULTS UPON SENIOR SECURITIES**

 

None.

 

**ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS**

 

 None.

 

**ITEM 5. OTHER INFORMATION**

 

(a)  None

 

(b)  None

 

 

Page 36

 

 

**ITEM 6. EXHIBITS**

 

**Exhibit** **Index**

 

2.1

 

Stock Purchase Agreement, dated April 11, 2007, by and among Securus Technologies, Inc., Appaloosa Acquisition Company, 0787223 B.C. Ltd, and 0787223 B.C. Ltd’s sole stockholder, incorporated by reference from form 8-K filed April 16, 2007.

 

 

 

3.1

 

Amended and Restated Certificate of Incorporation of Securus Technologies, Inc., filed on August 6, 2004, incorporated by reference from the form S-4 filed May 26, 2005.

 

 

 

3.1.1

 

Certificate of Amendment of Amended and Restated Certificate of Incorporation of Securus Technologies, Inc., filed on March 15, 2007.

 

 

 

3.2

 

Amended and Restated Bylaws of Securus Technologies, Inc., incorporated by reference from the form S-4 filed May 16, 2005.

 

 

 

3.3

 

Certificate of Incorporation of T-Netix, Inc., filed on September 7, 2001, as amended, incorporated by reference from the form S-4 filed May 16, 2005..

 

 

 

3.4

 

Bylaws of T-Netix, Inc, incorporated by reference from the form S-4 filed May 16, 2005..

 

 

 

3.5

 

Articles of Incorporation of Telequip Labs, Inc., filed on November 9, 1987, as amended, incorporated by reference from the form S-4 filed May 16, 2005.

 

 

 

3.6

 

Amended and Restated Bylaws of Telequip Labs, Inc., incorporated by reference from the form S-4 filed May 16, 2005.

 

 

 

3.7

 

Articles of Incorporation of T-NETIX Telecommunications Services, Inc., filed on February 11, 1988, as amended, incorporated by reference from the form S-4 filed May 16, 2005.

 

 

 

3.8

 

Bylaws of T-NETIX Telecommunications Services, Inc., incorporated by reference from form S-4 filed May 16, 2005.

 

 

 

3.9

 

Certificate of Incorporation of Evercom Holdings, Inc., filed on November 25, 2002, as amended, incorporated by reference from the form S-4 filed May 16, 2005.

 

 

 

3.10

 

Bylaws of Evercom Holdings, Inc., incorporated by reference from the form S-4 filed May 16, 2005.

 

 

 

3.11

 

Amended and Restated Certificate of Incorporation of Evercom, Inc., filed on February 19, 2003, incorporated by reference from the form S-4 filed May 16, 2005.

 

 

 

3.12

 

Bylaws of Evercom, Inc., incorporated by reference from the form S-4 filed May 16, 2005.

 

 

 

3.13

 

Certificate of Incorporation of Evercom Systems, Inc., filed on August 22, 1997, as amended, incorporated by reference from form S-4 filed May 16, 2005.

 

 

 

3.14

 

Bylaws of Evercom Systems, Inc., incorporated by reference from form S-4 filed May 16, 2005.

 

 

 

3.15

 

Certificate of Incorporation of Syscon Justice Systems Canada Ltd., incorporated by reference from the form S-4 filed August 1, 2007.

 

 

 

3.16

 

Articles of Syscon Justice Systems Canada Ltd., incorporated by reference from the form S-4 filed August 1, 2007.

 

 

 

3.17

 

Articles of Incorporation of Syscon Justice Systems, Inc. incorporated by reference from the form S-4 filed August 1, 2007.

 

 

 

3.18

 

Bylaws of Syscon Justice Systems, Inc. incorporated by reference from the form S-4 filed August 1, 2007.

 

 

 

 

 

Page 38

 

 

 

3.19

 

Articles of Organization of Modeling Solutions LLC incorporated by reference from the form S-4 filed August 1, 2007.

 

 

 

3.20

 

Operating Agreement of Modeling Solutions LLC incorporated by reference from the form S-4 filed August 1, 2007.

 

 

 

3.21

 

Articles of Organization of Modeling Solutions, LLC incorporated by reference from the form S-4 filed August 1, 2007.

 

 

 

3.22

 

Operating Agreement of Modeling Solutions, LLC incorporated by reference from the form S-4 filed August 1, 2007.

 

 

 

4.1

 

Form of 11% Second-priority Senior Secured Notes due 2011, incorporated by reference from form S-4 filed May 16, 2005.

  

 

 

4.2

 

Indenture, dated as of September 9, 2004, by and among Securus, T-Netix, Inc., a Delaware corporation, T-NETIX Telecommunications Services, Inc., a Texas corporation, T-Netix Monitoring Corporation, a Colorado corporation, SpeakEZ, Inc., a Colorado corporation, Telequip Labs, Inc., a Nevada corporation, Evercom Holdings, Inc., Evercom, Inc., EverConnect, Inc., a Delaware corporation, Evercom Systems, Inc., a Delaware corporation, and The Bank of New York Trust Company, N.A., incorporated by reference from form S-4 filed May 16, 2005.

 

 

 

4.2.1

 

Supplemental Indenture, dated June 27, 2007, by and among Appaloosa Acquisition Company Ltd., a British Columbia company, T-NETIX, Inc., a Delaware corporation, T-NETIX Telecommunications Services, Inc., a Texas corporation, Telequip Labs, Inc., a Nevada corporation, Evercom Holdings, Inc., a Delaware corporation, Evercom, Inc., a Delaware corporation, Evercom Systems, Inc., a Delaware corporation, as guarantors, and The Bank of New York, as trustee, incorporated by reference from Form 8-k filed July 2, 2007.

 

 

 

4.2.2

 

Supplemental Indenture, dated June 29, 2007, by and among Appaloosa Acquisition Company Ltd., a British Columbia company, Syscon Justice Systems Canada Ltd., a British Columbia company, Syscon Holdings Ltd., a British Columbia corporation, Syscon Justice Systems, Inc., a California corporation, Modeling Solutions, LLC, a Wisconsin limited liability company, Modeling Solutions LLC, a Nevada limited liability company, and The Bank of New York, as trustee, incorporated by reference from Form S-4 filed August 1, 2007.

 

 

 

4.4

 

Amended and Restated Security Agreement, dated June 29, 2007, by and among Appaloosa Acquisition Company Ltd., a British Columbia company, Modeling Solutions, LLC, a Wisconsin limited liability company, Modeling Solutions LLC, a Nevada limited liability company, Syscon Justice Systems International Pty Limited, an Australia company, Syscon Justice Systems International Limited, a United Kingdom company, Syscon Justice Systems Canada Ltd., a British Columbia company, Syscon Justice Systems, Inc., a California corporation, as guarantors, and The Bank of New York Trust Company, N.A., incorporated by reference from Form S-4 filed August 1, 2007.

 

 

 

4.4.1

 

Supplement to Amended and Restated Security Agreement, dated June 29, 2007, incorporated by reference from Form S-4 filed August 1, 2007.

 

 

 

4.5

 

Amended and Restated Patent Security Agreement, dated June 29, 2007, by and among Securus Technologies, Inc., T-Netix, Inc., a Delaware corporation, T-NETIX Telecommunications Services, Inc., a Texas corporation, Telequip Labs, Inc., a Nevada corporation, Evercom Holdings, Inc., Evercom, Inc., Evercom Systems, Inc., a Delaware corporation, Modeling Solutions, LLC, a Wisconsin limited liability company, Modeling Solutions LLC, a Nevada limited liability company, Syscon Justice Systems, Inc., a California corporation, and The Bank of New York Trust Company, N.A., incorporated by reference from Form S-4 filed August 1, 2007.

 

 

 

4.6

 

Amended and Restated Trademark Security Agreement, dated June 29, 2007, by and among Securus Technologies, Inc., T-Netix, Inc., a Delaware corporation, T-NETIX Telecommunications Services, Inc., a Texas corporation, Telequip Labs, Inc., a Nevada corporation, Evercom Holdings, Inc., Evercom, Inc., Evercom Systems, Inc., a Delaware corporation, Modeling Solutions, LLC, a Wisconsin limited liability company, Modeling Solutions LLC, a Nevada limited liability company, Syscon Justice Systems, Inc., a California corporation, and The Bank of New York Trust Company, N.A., incorporated by reference from Form S-4 filed August 1, 2007.

 

 

 

4.7

 

Amended and Restated Pledge Agreement, dated June 29, 2007, by and among Appaloosa Acquisition Company Ltd., a British Columbia company, Syscon Justice Systems, Inc., a California corporation, and T-Netix, Inc., Evercom Holdings, Inc., Evercom, Inc., each a Delaware corporation, incorporated by reference from Form S-4 filed August 1, 2007.

 

 

Page 40

 

 

 

 

 

 

4.7.1

 

Supplement No. 1 to Amended and Restated Pledge Agreement, dated June 29, 2007, incorporated by reference from Form S-4 filed August 1, 2007.

 

 

 

4.8

 

Credit Agreement, dated September 9, 2004, by and among Securus Technologies, Inc., as the Borrower, the Subsidiaries of the Borrower, as Guarantors, the Financial Institutions party thereto as the Lenders, and ING Capital LLC as the Issuing Lender and Administrative Agent, incorporated by reference from form S-4 filed May 16, 2005.

 

 

 

4.8.1

 

First Amendment to Credit Agreement, dated October 12, 2005 among Securus Technologies, Inc., the subsidiary guarantors, ING Capital LLC, as syndicated issuing lender, alternative issuing lender and administrative agent, and lenders from time to time parties thereto, incorporated by reference from the Company’s current report on Form 8-K filed as Exhibit 10.1 on October 13, 2005.

 

 

 

4.8.2

 

Second Amendment to Credit Agreement, dated April 17, 2006 among Securus Technologies, Inc., the subsidiary guarantors, ING Capital LLC, as syndicated issuing lender, alternative issuing lender and administrative agent, and lenders from time to time parties thereto, incorporated by reference from Form 10-Q filed May 15, 2006.

 

 

 

4.8.3

 

Third Amendment to Credit Agreement, dated June 29, 2007, by and among Securus Technologies, Inc., as the Borrower, the Subsidiaries of the Borrower, as Guarantors, the Financial Institutions party thereto as the Lenders, and ING Capital LLC as the Issuing Lender and Administrative Agent incorporated by reference from Form 8-k filed July 2, 2007.

 

 

 

4.8.4*

 

Fourth Amendment to Credit Agreement, dated November 12, 2007, by and among Securus Technologies, Inc., as the Borrower, the Subsidiaries of the Borrower, as Guarantors, the Financial Institutions party thereto as the Lenders, and ING Capital LLC as the Issuing Lender.

 

 

 

4.9

 

Subordination and Intercreditor Agreement, dated as of September 9, 2004, by and among Laminar Direct Capital, L.P., a Delaware limited partnership, Securus Technologies, Inc., T-Netix, Inc., a Delaware corporation, T-NETIX Telecommunications Services, Inc., a Texas corporation, T-Netix Monitoring Corporation, a Colorado corporation, SpeakEZ, Inc., a Colorado corporation, Telequip Labs, Inc., a Nevada corporation, Evercom Holdings, Inc., a Delaware corporation, Evercom, Inc., a Delaware corporation, EverConnect, Inc., a Delaware corporation, Evercom Systems, Inc., a Delaware corporation, and The Bank of New York Trust Company, N.A., incorporated by reference from Form S-4 filed May 16, 2005.

 

 

 

4.9.1

 

First Amendment to Subordination and Intercreditor Agreement, dated as of June 29, 2007, by and among Laminar Direct Capital, L.P., a Delaware limited partnership, Securus, T-Netix, Inc., a Delaware corporation, T-NETIX Telecommunications Services, Inc., a Texas corporation, Telequip Labs, Inc., a Nevada corporation, Evercom Holdings, Inc., a Delaware corporation, Evercom, Inc., a Delaware corporation, Evercom Systems, Inc., a Delaware corporation, Syscon Justice Systems, Inc., a California corporation, Modeling Solutions, LLC, a Wisconsin limited liability company, Modeling Solutions LLC, a Nevada limited liability company, and The Bank of New York Trust Company, N.A., incorporated by reference from Form S-4 filed August 1, 2007.

 

 

 

4.10

 

Intercreditor Agreement, dated as of September 9, 2004, by and among ING Capital, LLC, as Intercreditor Agent, The Bank of New York Trust Company, N.A., as Trustee, Securus Technologies, Inc., and each subsidiary of Securus Technologies, Inc., incorporated by reference from form S-4 filed May 16, 2005.

 

 

 

4.11

 

Note Purchase Agreement, dated as of September 9, 2004, by and among Securus Technologies, Inc., T-Netix, Inc., Telequip Labs, Inc., T-Netix Telecommunications Services, Inc., SpeakEZ, Inc., T-Netix Monitoring Corporation, Evercom Holding, Inc., Evercom, Inc., Evercom Systems, Inc., FortuneLinX, Inc., and Everconnect, Inc. and Laminar Direct Capital L.P., incorporated by reference from the Company’s Form 10-K/A filed September 13, 2006.

 

 

 

4.11.1

 

June 2007 Amendment to Note Purchase Agreement, dated June 29, 2007, by and among Securus Technologies, Inc., T-Netix, Inc., Telequip Labs, Inc., T-Netix Telecommunications Services, Inc., Evercom Holding, Inc., Evercom, Inc., Evercom Systems, Inc., Appaloosa Acquisition Company Ltd., a British Columbia company, Modeling Solutions, LLC, a Wisconsin limited liability company, Modeling Solutions LLC, a Nevada limited liability company, Syscon Justice Systems International Pty Limited, an Australia company, Syscon Justice Systems International Limited, a United Kingdom company, Syscon Justice Systems Canada Ltd., a British Columbia company, Syscon Justice Systems, Inc., a California corporation, and Laminar Direct Capital L.P., incorporated by reference from the Company’s Form 8-K filed July 2, 2007.

 

 

Page 41

 

 

 

 

 

 

4.12

 

Form of 11% Second-priority Senior Secured Notes due 2011, incorporated by reference from Form S-4 filed August 1, 2007.

 

 

 

 

 

 

4.13

 

Security Agreement, dated June 29, 2007, by and among Appaloosa Acquisition Company Ltd., a British Columbia company, Syscon Justice Systems Canada Ltd., a British Columbia company, Syscon Holdings Ltd., a British Columbia corporation and The Bank of New York, as trustee, incorporated by reference from Form S-4 filed August 1, 2007.

 

 

 

4.14

 

Pledge Agreement, dated June 29, 2007, by and among Appaloosa Acquisition Company Ltd., a British Columbia company, Syscon Justice Systems Canada Ltd., a British Columbia company, and Syscon Holdings Ltd., a British Columbia corporation, The Bank of New York, as trustee, incorporated by reference from Form S-4 filed August 1, 2007.

 

 

 

4.15

 

Tradmark Security Agreement, dated June 29, 2007, by and among Appaloosa Acquisition Company Ltd., a British Columbia company, Syscon Justice Systems Canada Ltd., a British Columbia company, Syscon Holdings Ltd., a British Columbia corporation and The Bank of New York, as trustee, incorporated by reference from Form S-4 filed August 1, 2007.

 

 

 

4.16

 

Copyright Security Agreement, dated June 29, 2007, by and among Appaloosa Acquisition Company Ltd., a British Columbia company, Syscon Justice Systems Canada Ltd., a British Columbia company, Syscon Holdings Ltd., a British Columbia corporation and The Bank of New York, as trustee, incorporated by reference from Form S-4 filed August 1, 2007.

 

 

 

10.1

 

Stockholders Agreement, dated September 9, 2004, by and among Securus Technologies, Inc., H.I.G., T-Netix, Inc., a company organized under the laws of the Cayman Islands, American Capital Strategies, Ltd., a Delaware corporation, Laminar Direct Capital, L.P., a Delaware limited partnership, and each of the other investors then or thereafter set forth on the signature pages thereto, incorporated by reference from form S-4 filed May 16, 2005.

 

 

 

10.2

 

Amended and Restated Consulting Services Agreement, dated as of September 9, 2004, by and between T-Netix, Inc., Evercom Systems, Inc. and H.I.G. Capital, LLC, incorporated by reference from form S-4 filed May 16, 2005.

 

 

 

10.3

 

Amended and Restated Professional Services Agreement, dated as of September 9, 2004, by and between T-Netix, Inc., Evercom Systems, Inc., and H.I.G. Capital, LLC, incorporated by reference from form S-4 filed May 16, 2005.

 

 

 

10.4

 

Office Lease Agreement, dated as of November 8, 2004, by and between T-Netix, Inc. and the Prudential Insurance Company of America, incorporated by reference from the Company’s Form 10-Q as filed with the SEC on August 15, 2005.

 

 

 

10.5

 

First Amendment to the Office Lease Agreement, dated as of November 19, 2004, by and between T-Netix, Inc. and the Prudential Insurance Company of America, incorporated by reference from the Company’s Form 10-Q as filed with the SEC on August 15, 2005.

 

 

 

10.6

 

Restricted Stock Purchase Agreement, dated as of September 9, 2004 between Securus Technologies, Inc. and Richard Falcone, incorporated by reference from Form S-4 filed May 16, 2005.

 

 

 

10.7

 

2004 Restricted Stock Purchase Plan, incorporated by reference from Form 10-Q filed November 14, 2006.

 

 

 

10.7.1

 

First Amendment to 2004 Restricted Stock Purchase Plan and Stockholder Consent, increasing authorized shares under the plan, incorporated by reference from Form 10-K filed March 30, 2007.

 

 

 

10.8

 

Employment Agreement, dated November 13, 2006, by and between the Company and Richard Falcone, incorporated by reference from Form 10-K filed November 14, 2006.

 

 

 

10.9

 

Restricted Stock Purchase Agreement, dated September, 2006 between Securus Technologies, Inc. and Richard Falcone, incorporated by reference from Form 10-K filed November 14, 2006.

 

 

 

10.10*

 

Equity Commitment Letter dated November 12, 2007, issued by H.I.G. Capital Partners III, L.P.

 

 

Page 42

 

 

 

 

 

 

21.1*

 

Subsidiaries of the Company.

 

 

 

31.1*

 

Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley of 2002.

 

 

 

31.2*

 

Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley of 2002.

 

 

 

32.1*

 

Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley of 2002.

 

 

 

32.2*

 

Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley of 2002.

 

 

 

 

*

 

Filed herewith.

 

 

Page 43

 

 

 **Signatures**

 

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

 

**SECURUS TECHNOLOGIES, INC.**

(Registrant)

 

 

 

DATE: November 14, 2007

By:

/s/ RICHARD FALCONE

 

 

Richard Falcone,

 

 

Chairman of the Board, President, and

 

 

Chief Executive Officer

 

 

 

 

 

 

DATE: November 14, 2007

By:

/s/ KEITH KELSON

 

 

Keith Kelson

 

 

Chief Financial Officer

 

 

**EXHIBIT INDEX**

 

 

**Exhibit No.**

 

**Description of Exhibit**

 

 

 

 

 

4.8.4

 

Fourth Amendment to Credit Agreement, dated November 12, 2007, by and among Securus Technologies, Inc., as the Borrower, the Subsidiaries of the Borrower, as Guarantors, the Financial Institutions party thereto as the Lenders, and ING Capital LLC as the Issuing Lender.

 

 

 

 

 

10.10

 

Equity Commitment Letter dated November 12, 2007, issued by H.I.G. Capital Partners III, L.P.

 

 

 

 

 

21.1

 

Subsidiaries of the Company.

 

 

 

 

 

31.1

 

Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley of 2002.

 

 

 

 

 

31.2

 

Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley of 2002.

 

 

 

 

 

32.1

 

Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley of 2002.

 

 

 

 

 

32.2

 

Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley of 2002.

 

 

 

 

Page 43

 

 

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