**UNITED        STATES**

**SECURITIES AND EXCHANGE COMMISSION**

WASHINGTON, D.C. 20549

 

 

**FORM        10-K**

 

| x | **ANNUAL                    REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF                    1934** |
|---|--------------------------------------------------------------------------------------------------------------------------------|

For the        fiscal year ended December 31, 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 or other jurisdiction of

incorporation or organization) |   | (I.R.S. Employer

Identification Number) |

14651        Dallas Parkway, Suite 600

Dallas,        Texas 75254-8815

(972) 277-0300

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

 

Securities registered pursuant to Section 12(b) of the Act:

**None**

Securities registered pursuant to Section 12(g) of the Act:

**11%        Second-priority Senior Secured Notes due 2011**

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as        defined in Rule 405 of the Securities Act. YesoNox

Indicate by check mark if the registrant is not required to file reports        pursuant to Section 13 or Section 15 (d) of the Act. YesoNox

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. YesxNoo

Indicate by check mark if disclosure of delinquent filers pursuant to        Item 405 of Regulation S-K is not contained herein, and will not be contained, to the        best of the registrant’s knowledge, in definitive proxy or information statements        incorporated by reference in Part III of this Form 10-K or any amendment to this Form        10-K.x

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

Large        accelerated fileroAccelerated        fileroNon-accelerated filerx

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

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 December 31,2007** |
|----------------------|--------|-------------------------------------|
| Common Stock         |   | 604                                 | shares |
| Class B Common Stock |   | 73                                  | shares |

         

         

**Documents Incorporated By Reference**

(i)        Certificate of Amendment to Securus’ Articles of Incorporation

(ii)        First Amendment to 2004 Restricted Stock Plan 

 

 

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**Table        Of Contents**

 

| **PART I**   | **3**                                                                                                                                       |
|--------------|---------------------------------------------------------------------------------------------------------------------------------------------|
|         | **ITEM 1. BUSINESS**                                                                                                                        | **3** |
|         | **ITEM 1A. RISK                    FACTORS**                                                                                                | **16** |
|         | **ITEM 1B. UNRESOLVED STAFF                    COMMENTS**                                                                                   | **30** |
|         | **ITEM 2.                    PROPERTIES**                                                                                                   | **30** |
|         | **ITEM 3. LEGAL                    PROCEEDINGS**                                                                                            | **30** |
|         | **ITEM 4. SUBMISSION OF MATTERS TO A VOTE                    OF SECURITY HOLDERS**                                                          | **32** |
| **PART II**  | **33**                                                                                                                                      |
|         | **ITEM 5. MARKET FOR REGISTRANT’S                    COMMON EQUITY AND RELATED STOCKHOLDER MATTERS**                                  | **33** |
|         | **ITEM 6. SELECTED FINANCIAL INFORMATION                    AND OTHER DATA**                                                                | **35** |
|         | **ITEM 7. MANAGEMENT’S DISCUSSION                    AND ANALYSIS OF FINANCIAL CONDITION OF RESULTS OF                    OPERATION** | **36** |
|         | **ITEM 7A. QUANTITATIVE AND QUALITATIVE                    DISCLOSURE ABOUT MARKET RISK**                                                   | **51** |
|         | **ITEM 9A. CONTROLS AND                    PROCEDURES**                                                                                     | **86** |
|         | **ITEM 9B. OTHER                    INFORMATION**                                                                                           | **87** |
| **PART III** | **88**                                                                                                                                      |
|         | **ITEM 10.                    MANAGEMENT**                                                                                                  | **88** |
|         | **ITEM 11. EXECUTIVE                    COMPENSATION**                                                                                      | **91** |
|         | **ITEM 12. SECURITY OWNERSHIP OF CERTAIN                    BENEFICIAL OWNERS AND MANAGEMENT**                                              | **99** |
|         | **ITEM 13. CERTAIN RELATIONSHIPS AND                    RELATED PARTY TRANSACTIONS**                                                        | **99** |
|         | **ITEM 14. PRINCIPAL ACCOUNTANT FEES AND                    SERVICES**                                                                      | **102** |
| **PART IV**  | **103**                                                                                                                                     |
|         | **ITEM 15. EXHIBITS AND FINANCIAL                    STATEMENT SCHEDULES**                                                                  | **103** |

 

 

 

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**PART I**

 

***ITEM 1. BUSINESS***

 

**Overview**

         

We are one of the largest independent providers of inmate telecommunications        services to correctional facilities operated by city, county, state and federal authorities        and other types of confinement facilities, such as juvenile detention centers, private        jails and halfway houses in the United States and Canada. With 52 patents and some 80        patent applications filed or in process, we believe we are the leading technology innovator        in the correctional industry. As of December 31, 2007, we:

 

| **•** | Provided service to approximately                    2,700 correctional facilities in the United States and Canada; and |
|------------|-------------------------------------------------------------------------------------------------------------------------|
|       |                                                                                                                    |
| **•** | processed over 12 million                    calls per month.                                                      |

         

Our core business consists of installing, operating, servicing and        maintaining sophisticated call processing systems and communications systems in        correctional facilities and providing related services. We generally 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 typically pay a negotiated commission to the        correctional facility generally based upon revenues generated by actual inmate telephone        use. Additionally, on larger contracts we have historically often partnered with regional        bell operating companies, or RBOCs, local exchange carriers, or LECs, and interexchange        carriers, or IXCs, and other independent telecommunication carriers, for which we have        provided our equipment and back office support including validation and billing and        collections services, and charged 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.

         

We sell information management systems that work in conjunction with our        communications systems and allow facilities managers and law enforcement personnel to        analyze and manage data to reduce costs, prevent and solve crimes and facilitate inmate        rehabilitation through a single user interface. We also offer investigative tools and bad        debt risk management services based on the particular needs of the corrections industry and        the requirements of the individual correctional facility.

         

In addition, we sell offender management systems and related systems and        services. We believe our offender management software represents the leading enterprise        solution for the corrections industry. Our offender management software 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.

         

The inmate telecommunications industry requires highly specialized systems        and related services in order to address the unique needs of the corrections industry.        Security and public safety concerns require that correctional facilities have the ability        to control inmate access to telephones and certain telephone numbers and to monitor inmate        telephone activity. In addition, concerns regarding fraud and the credit quality of the        parties billed for inmate telephone usage have led to the development of billing and        validation systems and procedures unique to this industry. Inmate telecommunications        services in the United States are operated by a large and diverse group of service        providers, including RBOCs, LECs and IXCs, such as Global Tel*Link, Verizon/MCI, and Embarq        and independent public pay telephone and inmate telephone companies.

         

 

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We estimate that the inmate telecommunications market opportunity for city,        county, state and federal correctional facilities in the United States is approximately        $1.4 billion, and the offender management technology market opportunity is approximately        $700 million worldwide.

         

Our business is conducted primarily through our three principal        subsidiaries: T-Netix, which we acquired in March 2004, Evercom, which we acquired in        September 2004 and Syscon, acquired on June 29, 2007.

         

For the year ended December 31, 2007, our revenues were        $390.0 million, of which approximately 87% represented direct call provisioning to        correctional facilities, 11% represented the provision of solutions, telecommunications and        billing services to RBOC, LEC, IXC, and other independent telecommunication carrier        partners, and 2% represented sales and services related to our offender management        software.

         

Securus was incorporated in Delaware on January 12, 2004. We maintain a        web site with the address www.securustech.net. We are not including the information        contained on our web site as a part of, or incorporating it by reference into, this Annual        Report on Form 10-K.

         

**Industry        Overview**

         

The corrections industry has experienced sustained growth over the last        decade as a result of societal and political trends. Anti-crime legislation, limitations on        parole and spending authorizations for crime prevention and construction of additional        correctional facilities have contributed to this industry growth.

         

The United States has one of the highest incarceration rates of any country        in the world. The U.S. Department of Justice estimates that as of year end 2006, there were        approximately 2.3 million inmates housed in U.S. correctional facilities, or        approximately one inmate for every 133 U.S. residents. Of this total, approximately        two-thirds were housed in federal and state prisons and approximately one-third was housed        in city and county correctional facilities.

         

According to U.S. Department of Justice statistics, the inmate population in        federal and state prisons, which generally house inmates for longer terms than city and        county facilities, increased from approximately 1.1 million at December 31, 1995 to        approximately 1.5 million at December 31, 2006, representing an average annual growth        rate of approximately 2.9%. The inmate population in city and county facilities, which        generally house inmates for terms of one year or less, increased from approximately 500,000        at December 31, 1995 to approximately 765,000 at December 31, 2006, an annual growth        rate of approximately 4.0%. Between December 31, 1995 and December 31, 2006, the overall        incarcerated population grew an average 3.2% annually. Population growth during the        12-month period ending December 31, 2006 was higher in state prisons (up 3.2%) than in        federal prison, (up 2.4%) and local jails (up 2.5%).

         

The corrections industry requires specialized information technology,        telecommunications systems and related services. Security and public safety concerns        associated with inmate telephone use require that correctional facilities have the ability        to control inmate access to telephones and to certain telephone numbers and to monitor        inmate telephone activity. In addition, concerns regarding fraud and the credit quality of        the parties billed for inmate telephone usage have also led to the development of systems        and procedures unique to this industry. Correctional facilities also have unique        information technology requirements relating to managing and monitoring inmate (and        probation) activity and development. These include offender management, financial        applications, health and activity records as well as predictive tools for future inmate        behavior. Facilities are increasingly seeking to utilize enhanced automated systems to        offset the challenges of budget cuts, understaffing and prison overpopulation.

         

Within the inmate telecommunications industry, companies compete for the        right to serve as the exclusive provider of inmate calling services within a particular        correctional facility. Contracts may be awarded on a facility-by-facility basis, such as        for most city or county correctional systems, which generally include small and        medium-sized facilities, or system-wide, such as for most state and the federal

 

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prison        systems. Generally, contracts for federal facilities and state systems are awarded pursuant        to a competitive bidding process, while contracts for city and county facilities are        awarded both through competitive bidding and negotiations with a single party. Contracts        generally have multi-year terms and typically contain renewal options. As part of the        service contract, the service provider generally installs, operates, and maintains all        inmate telecommunications equipment. In exchange for the exclusive contract rights, the        service provider pays a commission to the operator of the correctional facility based upon        inmate telephone use. These commissions have historically been used by the facilities to        support their law enforcement activities.

         

Historically, offender management systems have been developed independently        and internally by government agencies to provide basic information management capabilities        to run the business of an incarceration facility. Often, these agencies have outsourced        design, or certain aspects thereof, to third party consultants. We are one of a very small        group of providers offering a comprehensive off-the-shelf software package for offender        management and related activities. The market is highly fragmented and it is our belief        that most of the “home-grown” systems may not effectively manage the inmate,        parole and probation populations. We believe that only a fraction of the market has been        outsourced to firms that develop enterprise inmate systems like we do, and that we have the        largest portion of the outsourced market. Our systems currently track an estimated 300,000        of the approximate 9 million people estimated to be incarcerated worldwide. For larger        projects, we often partner with larger systems integrators, such as Electronic Data        Systems.

         

 **Competition**

         

In the inmate telecommunications business, we compete with numerous        independent providers of inmate telephone systems such as Global Tel*Link, as well as        RBOCs, LECs, and IXCs that include AT&T and Embarq. Unisys also has recently entered        the market. Several of our competitors are larger, better capitalized, and have        significantly greater financial resources than we have. We believe that the principal        competitive factors in the inmate telecommunications industry are system features and        functionality, system reliability and service, the ability to customize inmate call        processing systems to the specific needs of the particular correctional facility,        relationships with correctional facilities, rates of commissions paid to the correctional        facilities, end-user rates, and the ability to identify and manage credit risks and bad        debt and calling rates. We seek to compete for business on local, county, state and federal        levels, and in privately managed correctional facilities.

         

Historically, federal and state correctional facilities, which are generally        bid on a system-wide basis, have been served by RBOCs, large LECs and IXCs, which are able        to leverage their brand and network infrastructure to serve these large, high-volume        customers through sub-contracting with independent providers for their platform and back        office operations. Unisys also has recently entered the market. These same service        providers, however, have generally not focused to the same degree on the smaller city and        county correctional systems. Because of the variance in the level of service required by        these relatively small facilities, service providers must maintain a more extensive service        infrastructure in order to compete within this portion of the corrections industry. Due to        greater costs associated with serving smaller facilities and their lower volume of        telecommunications traffic, we believe that large service providers have historically found        the smaller facilities less attractive to serve. As a result, a significant portion of city        and county correctional facilities are served by independent inmate telephone and public        pay telephone companies. We believe that the market for city and county correctional        facilities is fragmented and is occupied by a number of competing service        providers.

         

In the first quarter of 2005, large industry participants Verizon and the        former AT&T began to exit the inmate telecommunications sector. During 2004, Verizon        and AT&T were our two largest telecommunications services customers, and AT&T was        our largest solutions customer. The exit of Verizon and AT&T continued the trend of        large dominant telecommunications carriers exiting the direct inmate telecommunications        business. Both Verizon and AT&T subsequently sold their inmate telecommunications        business to our competitors in 2005. As a result of this trend and the Verizon and AT&T        sales, our revenue associated with these product lines declined by 18.8% in 2006 and 25.2%        in 2007 and is expected to continue to decline. The new AT&T who is another one of our        customers, has also indicated they are

 

6

 

 

gradually        exiting the market and consequently telecommunications and solutions revenues are expected        to further decline in the future.

 

We believe that we are well positioned to expand our market share by        offering new and enhanced products to our existing customers, and attracting new facilities        with “one stop shopping” for their communications and technology needs, at a        lower cost than our competitors. As the traditional providers of inmate telecommunications,        such as RBOCs, LECs and IXCs, exit the business, the larger county and state facilities        will be served by independent inmate communications companies as the facilities’        contracts come up for renewal. We believe we are well positioned relative to our        competitors because of our belief that our costs are lower as a result of our packet based        architecture and proprietary bad debt risk management systems. These lower costs coupled        with our technological capabilities are expected to enable us to make attractive bids while        retaining our historical direct margins. Further, we believe our acquisition of Syscon        provides us greater access for our direct provisioning business to new geographic markets        where Syscon has significant relationships.

         

In the offender management market, we compete with a small group of offender        management software providers, each of whom we believe is much smaller than we are. We also        compete with large and small software consultant organizations who do not offer        off-the-shelf prepackaged software, but who can develop systems from scratch to the        client’s specifications.

         

**Primary        Sources of Revenues**

         

The following chart summarizes the primary sources of our revenues for the        year ended December 31, 2007.

         

|                                              | **% of Total** |         |
|---------------------------------------------------|----------------|--------------|
| **Revenue Source**                                |           | **Revenues** |   | **Description** |
| Direct Call                    Provisioning       |           | 87           | % |   | Direct call provisioning services                    through multi-year contracts directly to local correctional facilities as well                    as large county jails and state departments of corrections                    facilities. |
| Solutions and Billing                    Services |           | 9            | % |   | Solutions and billing services                    (validation, fraud management and billing and collection services) to third                    parties including some of the world’s largest communication service                    providers. |
| Telecommunications                    Services    |           | 2            | % |   | Telecommunications services                    (equipment, security enhanced call processing, validation and customer service                    and support) to corrections facilities through contracts with other inmate                    telecommunications providers. |
| Offender Management                    Software   |           | 2            | % |   | Software sales and development                    services for complete offender management, providing correctional facilities                    with the ability to manage and monitor inmate, parole and probation activity                    and development at a sophisticated level. |

 

***Direct Call Provisioning***

         

We provide inmate telecommunications services directly as a state        certificated telecommunications provider to correctional facilities. In a typical        arrangement, we operate under a site-specific, exclusive contract, generally for a period        of three to five years. We provide the equipment, security-enhanced call processing,        validation, and customer service and support directly to the facility. We bill the majority        of our calls via the billed party’s LEC bill or, in some cases, using the services of        third party aggregators. We also bill a portion of our calls through our own proprietary        bill rendering platform. Additionally, a significant portion of our calls are prepaid by        either the inmate or called party. Direct call provisioning revenues are substantially        higher than that of our telecommunications and solutions services because we receive the        entire retail value of the collect call. In our direct call provisioning business, we are        responsible for customer commissions, line charges and other operating costs, including        billing and bad debt costs. Consequently, our gross profit dollars are higher but our gross        margins are lower as compared to our telecommunications services and solutions        businesses.

 

7

 

 

 

***Solutions***

         

Our solutions business consists of offering inmate telecommunications        products and services, including validation, bad debt management and billing services, to        RBOCs, LECs, IXCs and others to support their telecommunications contracts with larger        county, state and federal correctional facilities. In this business, we enter into either        long-term or evergreen contracts with the RBOCs, LECs, IXCs, and other telecommunication        carriers pursuant to which we will typically purchase accounts receivable generated from        calls placed by inmates in correctional facilities and accept responsibility for call        validation, uncollectible accounts and billing and collections costs, with no recourse to        the customer. These purchased receivables are processed and validated through our risk        management system prior to allowing the call to be completed and are also typically        processed through our proprietary systems and billed through LECs.

         

Our revenues from the solutions service equal the difference between the        face value of the receivables purchased and the amount we pay the customer for the        discounted accounts receivable. Because our revenues associated with the 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 other direct sales charges, but bear the risk of unbillable and        uncollectible accounts receivable. In light of the industry trend of large dominant        industry telecommunications carriers exiting the business, we experienced a decline of        revenues generated from the solutions services business of $9.2 million from fiscal        year 2006 to 2007. We expect our solutions revenues to decline significantly in the future        because the majority of our solutions revenues are generated from a customer that has been        eliminating our services, and has indicated an intention to continue to do so.

 

***Telecommunications Services***

         

In our telecommunications services business, we have historically often        partnered with RBOCs, LECs and IXCs on larger contracts where the working capital        requirements to win the contract were significant. For example, some of the larger county        and state departments of corrections inmate telecommunications contracts often require        multi-million dollar up-front payments, surety bonds and/or guaranteed commissions. In such        cases, we provide at our expense some or all of our equipment, technology, security        enhanced call processing, call validation and other services and/or customer service        through the provider, rather than directly to the facility. Our telecommunications service        customer does the billing and we either share the revenues or receive a prescribed fee from        them for each call completed, but have no exposure to bad debt. We do, however, incur        typical capital expenditures related to installing our equipment and technology at the        corrections facility. We receive additional fees for validating the phone numbers dialed by        inmates, digital recording systems, voice security and other services we provide. By        partnering with some of the largest industry participants on capital intensive, larger        contracts, we increase our likelihood of participating in the contract, which increases our        market penetration, leverages our infrastructure and generates additional income. In light        of the industry trend of large dominant industry telecommunications carriers exiting the        business, we experienced a decline of $5.7 million of revenue generated from the        telecommunications services business from fiscal year 2006 to 2007. We expect further        declines in the future.

 

***Offender Management Software***

         

We develop enterprise software for the correctional facility industry. Our        core product is a sophisticated and comprehensive software system, “TAG,”        utilized by correctional facilities and law enforcement agencies for complete offender        management. Our system enables correctional facilities and law enforcement agencies to        address the increasing challenge of managing an ever growing number of offenders in        confinement and on parole and probation on a cost efficient basis.

         

Our offender management software is the centerpiece for the project, with        EDS providing overall project management and certain testing and consulting services. We        are the largest offender management

 

8

 

 

software        provider to Electronic Data Systems (“EDS”) for the United Kingdom’s        National Offender Management System for Her Majesty’s Prison Service. Our offender        management 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.

         

Our offender management revenues have four main components:

         

| **•** | License fees: The product                    purchase cost, providing customers with the license to use the core                    platform;                                                                                                                                                                              |
|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|       |                                                                                                                                                                                                                                                                                                                       |
| **•** | Implementation fees: The revenue                    associated with the physical installation of the system;                                                                                                                                                                                                               |
|       |                                                                                                                                                                                                                                                                                                                       |
| **•** | Consulting fees: Most of this                    work is done prior to implementation. The primary activities include: planning,                    design, consultation, debugging, customization, etc. Consulting revenue is the                    largest revenue category making, up two thirds of total revenue; and |
|       |                                                                                                                                                                                                                                                                                                                       |
| **•** | Software maintenance and support:                    These post sale fees provide a future annuity stream as we continue to generate                    fees from assistance with new modules, training, version upgrades,                    etc.                                                                         |

 

***Equipment Sales***

         

In addition to our direct call provisioning, solutions businesses,        telecommunications services and offender management software, we also sell our products,        including our inmate calling applications and facility management products, to a limited        number of telecommunications service provider customers. As a result of changes in the        industry and departure of several RBOCs and IXCs, we expect equipment sales will remain a        small percentage of our total sales.

         

***Customers***

         

We have direct contracts to provide inmate telecommunications services on        either an exclusive basis or jointly with another provider to approximately 2,700        correctional facilities ranging in size from small municipal jails to large, state-operated        facilities, as well as other types of confinement facilities, including juvenile detention        centers, private jails and halfway houses.

         

Most of our direct call provisioning contracts have multi-year terms        (generally three to five years) and typically contain renewal options while our solutions        contracts generally have shorter terms. We often seek to negotiate extensions of our        contracts before the end of their stated terms. For the year ended December 31, 2007,        we retained approximately 78% of our annualized revenue up for renewal. This includes, the        impact of not renewing the State of Alabama Department of Corrections account. Many of our        contracts provide for automatic renewal unless terminated by written notice within a        specified period of time before the end of the current term.

         

In the offender management software segment, our customers consist typically        of large national and state or provincial incarceration agencies including Her        Majesty’s Prison Service in the United Kingdom via a sub-contracting agreement with        Electronic Data Systems, along with several states and provinces in the United States,        Canada, and Australia. We believe that once a customer has selected us for offender        management software and related services, it is less likely to switch systems due to the        high cost of switching. As a result, we have a strong growing base of customers for our new        versions, modules and ongoing maintenance. We believe that this allows us to derive        sustainable revenue from new modules and versions of our software rather than from        long-term contracts.

 

***Direct Customers***

         

We provide our direct call provisioning products and services directly to        correctional facilities. For the year ended December 31, 2007, 87% of our revenues        were generated from direct contracts with correctional facilities as the exclusive provider        of telecommunications services to inmates within the

 

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facility.        No direct customer accounted for more than 7% of our total direct call provisioning        revenues for the year ended December 31, 2007.

 

***Telecommunications and Solutions Service Provider        Customers***

         

We provide our products and services to telecommunications and solutions        service providers such as Global Tel*Link, FSH Communications, AT&T and Embarq, among        other call providers. For the year ended December 31, 2007, 11% 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 year ended December 31, 2007:

|               |   | **Approximate** |   | **Approximate**        |   |            |   |           |   |
|--------------------|--------|-----------------|--------|------------------------|--------|-----------------|--------|----------------|--------|
|               |   | **% of Total**  |   | **% of Total**         |   |            |   |           |   |
|               |   | **Solutions**   |   | **Telecommunications** |   | **Approximate** |   | **Contract**   |
|               |   | **Services**    |   | **Services**           |   | **% of Total**  |   | **Expiration** |
|               |   | **Revenue**     |   | **Revenue**            |   | **Revenue**     |   | **Date(2)**    |
| Global Tel*Link(1) |   | 74              | %      |                   | 34     | %               |   | 8              | %      |   | March 1, 2008 |
| Embarq             |   | 24              | %      |                   | 11     | %               |   | -    | %      |   | Month to Month |
| AT&T           |   | -     |   |                   | 31     | %               |   | 1         | %      |   | April 28, 2008 |
| FSH Communications |   | -     |   |                   | 19     | %               |   | -    | %      |   | Month to Month |

 

| **(1)**   | The former AT&T sold its                    inmate telecommunications business to Global Tel*Link in 2005. We expect                    revenue from Global to continue to decline to zero in the future.                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
|---------------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| **(2)**             | 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. |

         

No other telecommunications and solutions service provider customer        accounted for more than 3% of our total telecommunications and solutions service provider        revenues for the year ended December 31, 2007.

         

 ***Offender Management Software        Customers***

         

We are the largest offender management software provider to Electronic Data        Systems for the United Kingdom’s National Offender Management System for Her        Majesty’s Prison Service has offices in United States, Canada, the United Kingdom and        Australia, serving federal, state and local government agencies in all of these geographic        locations. This Electronic Data Systems account represented 66% of our offender management        revenue for the year ended December 31, 2007.

 

**Marketing**

         

We seek new direct contracts by participating in competitive bidding        processes and by negotiating directly with the individuals or entities responsible for        operating correctional facilities. We market our inmate telecommunications services through        a sales staff largely made up of former law enforcement officials and others with        experience in the corrections and telecommunications industries who understand the        specialized needs of correctional facilities. Our marketing strategy emphasizes our        specialized products and services, our proprietary technology, our knowledge, experience        and reputation in the inmate telecommunications industry and our high level of service. We        believe we have the largest national sales force dedicated to serving the inmate        telecommunications industry. We rely on the experience and background of our sales staff to        effectively communicate our capabilities to both existing and potential

 

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customers.        In addition to conducting in-person sales calls to the operators of correctional        facilities, we participate in trade shows and are active in local law enforcement        associations.

 

**Principal Products and Services**

         

We believe that the specialized products and services we offer differentiate        us from our competitors. Unlike many of our competitors who specialize in specific segments        of the market (i.e. call management systems, jail management systems, etc.), our strategy        is centered on the production and distribution of applications and services focused on the        entire operation of a facility.  Our applications are designed to streamline the        operations of corrections facilities and empower administrators with administrative,        investigative and economic capabilities. Our principal specialized applications and        services include:

         

***SCA ArchitectureTM***

         

Our*SCA        Architecture*TM is comprised of a robust data repository        housing multiple data marts, each holding billions of bytes of stored information gathered        from multiple sources. SCA’s intelligent retrieval system intelligently retrieves all        this information and processes all user requests through a cross application, cross        data-mart retrieval process. The backbone of our entire system, SCA is expected to result        in significantly lower operating and capital costs as its full implementation is realized.         We currently operate multiple inmate calling applications that preceded our        development of this architecture.We expect        that the majority of our customer installations in the future will migrate to our new        systems utilizing this architecture as current contracts expire, a process likely to take        several years.

         

***SCN Secure Connect NetworkTM***

         

Our*SCN Secure Connect        Network*TM is a packet-based, digital transmission system for        all communications transport. SCN allows our calling platform to provide real-time turn-on/        turn-off flexibility for most system features; 24-7 offsite monitoring; immediate system        upgrades and repairs from one central location.

         

***Secure Call PlatformTM***

         

Our*Secure Call        Platform*TM call management system services correctional        facilities as well as detainees and friends and family members. Utilizing SCN allows this        fully integrated inmate calling applications manager to offer innovative feature        applications that give facilities extensive administrative and investigative control. The        system offers networking functions, robust system and application stability and redundancy,        heightened security features, user auditing, and password-specific utilities.

         

***The Securus User        Interface*** 

         

Access to many of our applications is accomplished through        S-*GATE*TM user interface. This        portal provides single point access to programs, applications and services.

         

***Securus Support***

         

We provide support through professional, dedicated customer support        centers:

 

| **•** | Accessible 24-7                                                                                                                                                                     |
|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|       |                                                                                                                                                                                |
| **•** | Independent visibility into                    customers account activity and information                                                                                           |
|       |                                                                                                                                                                                |
| **•** | Site status is monitored                    continuously by support systems and proactive actions are instituted to correct                    issues before customers are impacted |
|       |                                                                                                                                                                                |
| **•** | Our field support services                    provides nationwide support by local area responsive technicians                                                                      |

         

 

11

 

 

***Prepaid Calling Programs***

         

Inmate telecommunications systems customarily allow calls to be placed as        collect only, without the involvement of a live operator. Our prepaid calling offerings        provide flexibility in the utilization of called party prepaid calling and inmate prepaid        calling. Our prepaid calling systems offer a paperless, card-free prepaid calling solution        for both the called parties and the inmates. The prepaid account is managed by either the        called party’s phone number or the inmate’s PIN. Our prepaid calling platform        allows correctional facilities to offer inmate families an alternative to collect calls and        acts as a cash management tool to help those families budget more effectively for calls.        Additionally, because prepayment virtually eliminates bad debt, fewer calls are blocked and        correctional facilities recognize the financial benefits of higher call volumes.

         

We also continue to provide paper prepaid calling cards for facilities that        desire a fast and simple calling solution for their inmates. These are sold to the inmates        through the facility’s commissary service. The cards may be used for both domestic        and international calling. Many of our competitors provide similar prepaid        services.

         

***Correctional Billing Services (CBS)***

         

We are one of the few companies in the industry to provide a nationwide        customer care and billing center dedicated to the inmate’s friends and family        members. We provide dedicated customer service to the called party 24 hours per day,        365 days per year. We also offer multiple payment options including prepayment of        charges, remittance directly to the local phone company, credit card payments and check by        phone.

         

***Intelligent Call and Billing Management Solution        (ICBS)***

         

We develop and provide our customers with an Intelligent Call and Billing        Management Solution, or ICBS system which is a proprietary call validation and billing        technology that is designed to minimize bad debt expense. Our solutions services include        ICBS technology. Specifically, ICBS allows us to rapidly identify and prevent or block        collect calls from being connected to potential non-paying call recipients through a        continuously growing and improving database. As an enhancement to revenues, the blocked        call recipient is notified that an inmate has attempted contact and, upon request, can        receive inmate calls through various prepaid methods. We believe that our technology        provides us with generally lower bad debt expense as a percentage of revenues in the        industry, while offering the broadest, most sophisticated suite of payment method        alternatives in the industry.

         

***Additional Securus Applications***

         

We also offer a multitude of additional applications/features that provide        task-specific solutions designed to satisfy focused areas of a facility’s operations.        Our applications assist:

         

| **•** | Investigators          |
|------------|------------------------|
|       |                   |
| **•** | Detainees              |
|       |                   |
| **•** | Friends & families |
|       |                   |
| **•** | Administrators         |
|       |                   |
| **•** | Support personnel      |

         

Many of our applications are interoperable, working seamlessly together. We        provide applications designed to service communications, administrative, and support        functions, trust account funding, recidivism programs, investigative capabilities, fraud        prevention functions, and detainee identification.

         

 

12

 

 

***“TAG” Software***

         

The TAG system provides correctional facilities with the ability to manage        inmates and monitor parole and probation activity and development at a very sophisticated        level. The key functions of the system include management of incarcerated prisoners,        management and monitoring of offenders on parole and probation, financial applications and        electronic health records. The TAG system has 30 different modules and is a smart software        system that not only provides monitoring tools, but has predictive tools for future inmate        behavior.

         

We are continually developing new suites of applications that are designed        to provide a wide array of solutions-based, technologically advanced, integrated        applications and services for the criminal justice community. These applications and        services are focused on providing solutions targeted at the identified needs of the        criminal justice community. 

         

**Systems        and Equipment**

         

We currently utilize automated operator calling systems that consist of        third-party and internally developed software applications installed on specialized        equipment. We expect the majority of our customer installations to transition from these        legacy systems to our Secure Connect Network in the future as existing contracts expire.        Our specialized systems limit inmates to collect calls or prepaid calls, validate and        verify the payment history of each number dialed for billing purposes, and confirm that the        destination number has not been blocked. If the number is valid and has not been blocked,        the system automatically requests the inmate’s name, records the inmate’s        response, and waits for the called party to answer. When the call is answered the system        informs the called party that there is a collect call, plays back the name of the inmate in        the inmate’s voice, and instructs the called party to accept or reject the call. The        system completes calls that have been accepted by the called party.

         

The system automatically records the number called and the length of the        call and transmits the data to our centralized billing center for bill processing and input        into our call activity database. Our database of telephone numbers and call activity allows        us to provide extensive call activity reports to correctional facilities and law        enforcement authorities, in addition to identifying numbers appropriate for blocking, thus        helping to reduce the number of uncollectible calls. These include reports that can further        assist law enforcement authorities in connection with ongoing investigations. We believe        this database offers competitive advantages, particularly within states in which we have        achieved substantial market penetration.

         

**Maintenance, Service and Support Infrastructure**

         

We provide and install telephone systems in correctional facilities at no        cost to the facility and generally perform all maintenance activities. We maintain a        geographically dispersed staff of trained field service technicians and independent        contractors, which allows us to respond quickly to service interruptions and perform        on-site repairs and maintenance. In addition, we have the ability to make some repairs        remotely through electronic communication with the installed equipment without the need of        an on-site service call. We believe that system reliability and service quality are        particularly important in the inmate telecommunications industry because of the potential        for disruptions among inmates if telephone service remains unavailable for extended        periods.

         

**Billing        and Collection**

         

We use LEC direct billing agreements and third-party clearinghouse billing        agreements to bill and collect phone charges. Under both agreements, the LEC includes        collect call charges for our services on the local telephone bill sent to the recipient of        the inmate collect call. We generally receive payment from the LEC for such calls        60 days after the end of the month in which the call is submitted to the LEC for        billing. The payment that we receive is net of a service fee and net of write-offs of        uncollectible accounts for which we previously received payment, or net of a reserve for        future uncollectible accounts.

         

 

13

 

 

Unlike many smaller independent service providers with lower        telecommunications traffic, we have been able to enter into direct billing agreements with        LECs in most of our markets because of our high market penetration. We believe that direct        billing agreements with LECs decrease bad debt expense and billing expenses by eliminating        an additional third-party billing entity, while expediting and increasing collectibility.        In addition, direct billing agreements help us resolve disputes with billed parties by        facilitating direct communication between us and the called party, thereby reducing the        number of charge-offs.

         

In the absence of a LEC direct billing arrangement, we bill and collect our        collect calls through third-party billing and collection clearinghouses that have billing        and collection agreements with LECs, or through our proprietary direct billing. When we        employ third-party billing and collection clearinghouses, the account proceeds are        forwarded by the various LECs to the clearinghouses, which then forward the proceeds to us,        less a processing fee. With both LEC direct and third-party billing and collection        agreements, we reconcile our call records with collections and write-offs on a regular        basis. The entire billing and collection cycle (including reconciliation), takes on        average, between six to nine months after we submit the call record to the LEC or to        third-party billing and collection clearinghouses.

         

Our specialized billing and bad debt management system integrates our LEC        direct billing arrangements with our call blocking, validation and customer inquiry        procedures.

         

**Research        and Product Development**

         

We believe that the timely development of new products and enhancements to        existing products is essential to maintain our competitive position. We conduct ongoing        research and development for the development of new products and enhancement of existing        products that are complementary to the existing product line.

         

Our current research and development efforts are focused on further        improvements to our bad debt management systems, enhanced three-way call detection,        advanced call validation systems, and general improvements to our Secure Connect Network        and other call processing platforms in order to improve operating efficiency and reduce        capital costs of new installations, and to continue to deliver state- of-the-art products        and services to our correctional facilities and law enforcement customers. We recently        enhanced our bad debt management by reducing the processing time of call records through        our back office systems. In addition, we are developing products and services that will        provide law enforcement officials with greater access to communications capabilities,        inmate information and intelligence on inmate calls within a correctional facility as well        as on inmate calls between correctional facilities and other law enforcement        agencies.

         

**Patents        and Other Proprietary Rights**

         

We rely on a combination of patents, copyrights and trade secrets to        establish and protect our intellectual property rights. We have been issued 52 patents. We        consider any patents issued or licensed to us to be a significant factor in enabling us to        more effectively compete in the inmate calling industry.

         

We believe that our intellectual property portfolio provides our customers        leading edge technology recognized as technologically superior within the inmate        telecommunications industry. We believe that we currently hold the broadest intellectual        property portfolio in the industry, with 52 issued patents and some 80 patent applications        filed and/or in process. We believe that the duration of applicable patents is adequate        relative to our product and service offerings.

         

Although we have filed many patent applications and hold several patents        relating to our internally developed call processing and other technology, such technology        and intellectual property rights could infringe on other parties’ intellectual        property rights and could be contested or challenged. Should our call processor or any        material feature of our call processor or other proprietary technology be determined to        violate applicable patents, we may be required to cease using these features or to obtain        appropriate

 

14

 

 

licenses        for the use of that technology and could be subject to material damages if our infringement        were determined to be lengthy or willful.

 

**Regulation**

         

The inmate telecommunications industry is subject to varying degrees of        federal, state, and local regulation. Regulatory actions have affected, and are likely to        continue to affect, our correctional facility customers, our telecommunications service        provider customers, our competitors and us.

         

The inmate telecommunications market is regulated at the federal level by        the FCC and at the state level by public utilities commissions or equivalent agencies        (“PUCs”) of the various states. In addition, from time to time, Congress or the        various state legislatures may enact legislation that affects the telecommunications        industry generally and the inmate telecommunications industry specifically. Court decisions        interpreting applicable laws and regulations may also have a significant effect on the        inmate telecommunications industry. Changes in existing laws and regulations, as well as        the adoption of new laws and regulations applicable to our activities or other        telecommunications businesses, could have a material adverse effect on us. See “Risk        Factors — Regulatory Risks.”

         

***Federal Regulation***

         

Prior to 1996, the federal government’s role in the regulation of the        inmate telecommunications industry was relatively limited. The enactment of the        Telecommunications Act of 1996 (the “Telecom Act”), however, marked a        significant change in scope of federal regulation of the inmate telecommunications service.        Generally, the Telecom Act (i) opened local exchange service to competition and        preempted states from imposing barriers preventing such competition, (ii) imposed new        unbundling and interconnection requirements on incumbent local exchange carrier networks,        (iii) removed prohibitions on inter-LATA services and manufacturing where certain        competitive conditions are met, (iv) transferred any remaining requirements of the        consent decree governing the 1984 Bell System divestiture (including its nondiscrimination        provisions) to the FCC’s jurisdiction, (v) imposed requirements to conduct        certain competitive activities only through structurally separate affiliates, and        (vi) eliminated many of the remaining cable and telephone company cross-ownership        restrictions.

         

This legislation and related rulings significantly changed the competitive        landscape of the telecommunications industry as a whole. For the inmate telecommunications        industry, the Telecom Act added Section 276 to the principal U.S. federal communications        statute, the Communications Act of 1934. Section 276 directed the FCC to implement rules to        overhaul the regulation of the provisioning of pay phone service, which Congress defined to        include the provisioning of inmate telecommunications service in correctional        institutions.

         

Before the adoption of the Telecom Act, the regulatory landscape allowed the        LECs to subsidize their inmate telecommunications operations from regulated revenues. This        allowed the LECs to offer commissions to correctional facilities that were often        significantly higher than those that independent inmate telecommunications service        providers can offer. The Telecom Act directed the FCC to adopt regulations to end the        subsidization. Congress also directed the FCC to ensure that the RBOCs could not        discriminate in favor of their own operations to the competitive detriment of independent        inmate telecommunications service providers. Finally, Congress required the FCC to ensure        that all inmate telecommunications service providers were fairly compensated for        “each and every” call made from their telephone.

 

***State Regulation***

         

In many states, inmate telecommunications service providers must obtain        prior authorization from, or register with, the PUC and file tariffs or price lists of        their rates. The most significant state involvement in the economic regulation of inmate        telecommunications service is the limit on the maximum rates that can be charged for        intrastate collect calls set by most states, referred to as “rate caps.” Since        collect calls are the

 

15

 

 

only kind        of calls that can be made by inmates at many facilities, such state-imposed rate caps can        have a significant effect on our business.

 

In many states, the rate caps on inmate collect calls are tied to the rates        charged by the LEC or “dominant” long distance carrier and subject to state        regulatory approval. Thus, where the LEC or dominant long distance carrier chooses not to        raise their rates, independent inmate telecommunications service providers are precluded        from raising theirs. Prior to the passage of the Telecom Act, the LECs and dominant long        distance carriers had less incentive to raise their rates than independent inmate        telecommunications service providers because they were able to subsidize their inmate        telecommunications service operations and discriminate in their favor, as described above.        See “Federal Regulation.”

         

In its rulemaking in implementing the Telecom Act, the FCC declined to        address these state rate caps. The FCC ruled that inmate telecommunications providers must        first seek relief from the state rate caps at the state level. The outcome of any such        proceedings at the state level, if undertaken, is uncertain. Further, despite reserving the        right to do so, it is uncertain whether the FCC would intervene or if so, how, in the event        a state failed to provide relief.

         

In addition to imposing rate caps, the states may regulate various other        aspects of the inmate telecommunications industry. While the degree of regulatory oversight        varies significantly from state to state, state regulations generally establish minimum        technical and operating standards to ensure that public interest considerations are met.        Among other things, most states have established rules that govern the service provider in        the form of postings or verbal announcements, and requirements for rate quotes upon        request

         

The foregoing discussion does not describe all present and proposed federal,        state and local regulations, legislation, and related judicial or administrative        proceedings relating to the telecommunications industry, including inmate        telecommunications services, and thereby affecting our business. The effect of increased        competition on our operations will be influenced by the future actions of regulators and        legislators, who are increasingly advocating competition. While we would attempt to modify        our customer relationships and our service offerings to meet the challenges resulting from        changes in the telecommunications competitive environment, there is no assurance we would        be able to do so.

         

**Employees**

         

As of December 31, 2007, we employed 709 full-time equivalent        employees, of which 416 are salaried and 293 are hourly employees. None of our employees        are represented by a labor union, and we have not experienced any material work stoppages        to date. We believe that our management currently has a good relationship with our        employees.

         

**FORWARD LOOKING STATEMENTS**

 

This Annual Report on Form 10-K and, in particular, the description of our        Business set forth in Item 1 and our Management’s Discussion and Analysis of        Financial Condition and Results of Operations set forth in Item 7 contain or        incorporate a number of forward-looking statements within the meaning of Section 27A        of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934,        including statements regarding:

         

| **•** | projected future sales                    growth;                                                                                                    |
|------------|------------------------------------------------------------------------------------------------------------------------------------------------------|
|       |                                                                                                                                                 |
| **•** | expected future revenues,                    operations, expenditures and cash needs;                                                                |
|       |                                                                                                                                                 |
| **•** | estimates of the potential for                    our products and services, including the anticipated drivers for future                    growth; |
|       |                                                                                                                                                 |
| **•** | sales and marketing                    plans;                                                                                                        |

 

 

16

 

 

 

|       |                                                                        |
|------------|-----------------------------------------------------------------------------|
| **•** | assessment of competitors and                    potential competitors; and |
|       |                                                                        |
| **•** | potential mergers or                    acquisitions.                       |

 

In addition, any statements contained in or incorporated by reference into        this report that are not statements of historical fact should be considered forward-looking        statements. You can identify these forward-looking statement by use of the words        “believes,” “expects,” “anticipates,”        “plans,” “may,” “will,” “would,”        “intends,” “estimates” and other similar expressions, whether in        the negative or affirmative. We cannot guarantee that we actually will achieve the plans,        intentions or expectations disclosed in the forward looking statements made. There are a        number of important risks and uncertainties that could cause our actual results to differ        materially from those indicated by such forward-looking statements. These risks and        uncertainties include, without limitation, those set forth below under the heading        “Risk Factors.” We do not intend to update publicly any forward-looking        statements whether as a result of new information, future events or otherwise.

         

***ITEM 1A. RISK FACTORS***

 

*You should carefully consider the risks described below, together with        all of the other information contained in this Form 10-K, before making an investment        decision. The risks described below are not the only ones facing us. Additional risks and        uncertainties not currently known to us or that we currently deem to be immaterial may also        materially and adversely affect our financial condition, results of operations or cash        flow. Any of the following risks could materially and adversely affect our financial        condition or results of operations.*

         

**Risks        Related to our Senior Notes**

 

 

***We        have a substantial amount of debt outstanding and will have significant interest        payments.***

 

We have a significant amount of debt outstanding. As of December 31,        2007, we had $263.3 million of long-term debt outstanding (net of $3.1 million of        OID for our 11% Second-priority Senior Secured Notes due 2011 and $2.5 million of fair        value attributable to warrants) and stockholders’ deficit of $88.9        million.

         

Our        substantial debt could have important consequences. For example, it could:

         

| **•** | require us to dedicate a                    substantial portion of our cash flow from operations to make payments on our                    debt, thereby reducing funds available for operations, future business                    opportunities and other purposes; |
|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|       |                                                                                                                                                                                                                                                                    |
| **•** | limit our flexibility in planning                    for, or reacting to, changes in our business and the industry in which we                    operate;                                                                                                              |
|       |                                                                                                                                                                                                                                                                    |
| **•** | make it more difficult for us to                    satisfy our obligations with respect to our debt obligations;                                                                                                                                                       |
|       |                                                                                                                                                                                                                                                                    |
| **•** | limit our ability to borrow                    additional funds, or to sell assets to raise funds, if needed, for working                    capital, capital expenditures, acquisitions or other purposes;                                                             |
|       |                                                                                                                                                                                                                                                                    |
| **•** | increase our vulnerability to                    general adverse economic and industry conditions, including changes in interest                    rates;                                                                                                              |
|       |                                                                                                                                                                                                                                                                    |
| **•** | place us at a competitive                    disadvantage compared to our competitors that have less                    debt; and                                                                                                                                  |
|       |                                                                                                                                                                                                                                                                    |

 

 

17

 

 

 

| **•** | prevent us from raising the funds necessary to repurchase notes                    tendered to us if there is a change of control, which would constitute a                    default under the indenture governing the notes and our revolving credit                    facility.

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

         

We cannot assure you that we will generate sufficient cash flow to service        and repay our debt and have sufficient funds left over to achieve or sustain profitability        in our operations, meet our working capital and capital expenditure needs or compete        successfully in our markets. In December 2007, we issued $10.2 million of Series A        Redeemable Convertible Preferred Stock mostly to our majority stockholder, to prevent a        default under the indenture for our Senior Secured Notes and to provide working capital for        2008. If we cannot meet our debt service and repayment obligations, we would be in default        under the terms of the agreements governing our debt, which would allow the lenders under        our revolving credit facility to declare all borrowings outstanding to be due and payable,        which would in turn trigger an event of default under the indenture and the agreements        governing our senior subordinated debt. In addition, our lenders could compel us to apply        all of our available cash to repay our borrowings. If the amounts outstanding under our        revolving credit facility or the notes were to be accelerated, we cannot assure you that        our assets would be sufficient to repay in full the money owed to the lenders or to our        other debt holders. In addition, we may need to refinance our debt, obtain additional        financing or sell assets, which we may not be able to do on commercially reasonable terms        or at all. Any failure to do so on commercially reasonable terms could have a material        adverse effect on our business, operations and financial condition.

         

 

***We        may be able to incur more debt, including secured debt, and some or all of this debt may        effectively rank senior to the notes and the guarantees.***

 

Subject to the restrictions in our revolving credit facility, the indenture        governing the notes and the senior subordinated debt financing agreements, we may be able        to incur additional debt, including secured debt that would effectively rank senior to the        notes. As of December 31, 2007, we would have been able to incur approximately        $19.5 million of additional secured debt under our revolving credit facility. Although        the terms of our revolving credit facility, the indenture and the senior subordinated debt        financing agreements contain restrictions on our ability to incur additional debt, these        restrictions will be subject to a number of important exceptions. If we incur additional        debt, the risks associated with our substantial leverage, including our ability to service        our debt, would increase.

         

***There        may not be sufficient collateral to pay all or any of the notes.***

 

Indebtedness under our revolving credit facility (referred to herein as the        “First-Priority Lien Obligations”) is secured by a first-priority lien on        substantially all of our and our subsidiary guarantors’ tangible and intangible        assets, except for certain excluded collateral (such as hedging agreements and any real        estate interests). The notes are secured by a second-priority lien on the assets that        secure the First-Priority Lien Obligations, other than our current assets. In the event of        a bankruptcy, liquidation, dissolution, reorganization or similar proceeding against us or        any future domestic subsidiary, the assets that are pledged as shared collateral securing        the First-Priority Lien Obligations and the notes must be used first to pay the        First-Priority Lien Obligations, as well as any other obligation secured by a priority lien        on the collateral, in full before making any payments on the notes.

         

At December 31, 2007, $5.0 million of senior indebtedness        (excluding the notes and guarantees) was outstanding, all of which would have constituted        First-Priority Lien Obligations. As of the same date, we could have borrowed approximately        $19.5 million additional First-Priority Lien Obligations under our revolving credit        facility.

         

Certain of our assets, such as our accounts receivable and inventory and any        proceeds thereof, are not part of the collateral securing the notes, but do secure the        First-Priority Lien Obligations. With respect to those assets that are not part of the        collateral securing the notes but that secure other obligations, the notes will be        effectively junior to these obligations to the extent of the value of such assets. There is        no requirement that the lenders under the First-Priority Lien Obligations first look to        these excluded assets before foreclosing, selling or otherwise acting upon the collateral        shared with the notes.

         

 

18

 

 

         

The value of the collateral for our indebtedness at any time will depend on        market and other economic conditions, including the availability of suitable buyers for the        collateral. By their nature, some or all of the pledged assets may be illiquid and may have        no readily ascertainable market value. The value of the assets pledged as collateral for        the notes could be impaired in the future as a result of changing economic conditions, our        failure to implement our business strategy, competition and other future trends. In the        event of a foreclosure, liquidation, bankruptcy or similar proceeding, no assurance can be        given that the proceeds from any sale or liquidation of the collateral will be sufficient        to pay our obligations under the notes, in full or at all, after first satisfying our        obligations in full under the First-Priority Lien Obligations and any other obligations        secured by a priority lien on the collateral.

         

Accordingly, there may not be sufficient collateral to pay all or any of the        amounts due on the notes. Any claim for the difference between the amount, if any, realized        by holders of the notes from the sale of the collateral securing the notes and the        obligations under the notes will rank equally in right of payment with all of our other        unsecured unsubordinated indebtedness and other obligations, including trade        payables.

         

***Holders of notes do not control decisions regarding        collateral.***

 

The holders of the First-Priority Lien Obligations control substantially all        matters related to the collateral securing the First-Priority Lien Obligations and the        notes. The holders of the First-Priority Lien Obligations may cause their administrative        agents to dispose of, release or foreclose on, or take other actions with respect to the        shared collateral with which holders of the notes may disagree or that may be contrary to        the interests of holders of the notes. The security documents generally provide that, so        long as the First-Priority Lien Obligations are in effect, the holders of the        First-Priority Lien Obligations may change, waive, modify or vary the security documents        without the consent of the holders of the notes, provided that any such change, waiver or        modification does not disproportionately affect the rights of the holders of the notes        relative to the other secured creditors. Furthermore, as long as no event of default under        the indenture governing the notes has occurred, the security documents generally allow us        and our subsidiaries to remain in possession of, retain exclusive control over, to freely        operate, and to collect, invest and dispose of any income from, the collateral securing the        notes.

         

***The        capital stock securing the notes will automatically be released from the second-priority        lien and no longer be deemed to be collateral to the extent the pledge of such capital        stock would require the filing of separate financial statements for any of our subsidiaries        with the SEC.***

 

The indenture governing the notes and the security documents provide that,        to the extent that separate financial statements of any of our subsidiaries would be        required by the rules of the SEC (or any other governmental agency) due to the fact that        such subsidiary’s capital stock or other securities secure the notes, then such        capital stock or other securities will automatically be deemed not to be part of the        collateral securing the notes to the extent necessary to not be subject to such        requirement. As a result, holders of the notes could lose a portion of their security        interest in the capital stock or other securities while any such rule is in effect. The        provisions described above would have the effect of limiting the amount of capital stock of        T-Netix, Evercom and Syscon that constitutes collateral to, in each case, 19.9% of the        outstanding capital stock.

 

***The        indenture and revolving credit facility contain covenants that can limit the discretion of        our management in operating our business and could prevent us from capitalizing on business        opportunities and taking other corporate actions.***

 

The indenture, our revolving credit facility and the senior subordinated        debt financing agreements impose significant operating and financial restrictions on us.        These restrictions will limit or restrict, among other things, our and most of our        subsidiaries’ ability to:

         

| **•** | incur additional debt and issue                    certain types of preferred stock; |
|------------|--------------------------------------------------------------------------------------|

 

 

19

 

 

 

|       |                                                                                                                                                           |
|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------|
| **•** | make restricted payments,                    including paying dividends on, redeeming, repurchasing or retiring our capital                    stock;          |
|       |                                                                                                                                                           |
| **•** | make investments and prepay or                    redeem debt;                                                                                                 |
|       |                                                                                                                                                           |
| **•** | enter into agreements restricting                    our subsidiaries’ ability to pay dividends, make loans or transfer assets                    to us; |
|       |                                                                                                                                                           |
| **•** | create liens;                                                                                                                                                  |
|       |                                                                                                                                                           |
| **•** | sell or otherwise dispose of                    assets, including capital stock of subsidiaries;                                                               |
|       |                                                                                                                                                           |
| **•** | engage in transactions with                    affiliates;                                                                                                     |
|       |                                                                                                                                                           |
| **•** | engage in sale and leaseback                    transactions;                                                                                                  |
|       |                                                                                                                                                           |
| **•** | make capital                    expenditures;                                                                                                                  |
|       |                                                                                                                                                           |
| **•** | engage in business other than                    telecommunications businesses; and                                                                       |
|       |                                                                                                                                                           |
| **•** | consolidate or merge.

                                                                                                                                   |

 

In addition, the indenture governing the notes, our revolving credit        facility and our senior subordinated debt financing agreements require, and any future        credit facilities may require, us to comply with specified financial covenants, including,        in each case, interest coverage ratios and, in the case of our revolving credit facility,        minimum EBITDA levels and capital expenditure limits. Our ability to comply with these        covenants may be affected by events beyond our control. Furthermore, the indenture        governing the notes requires us to use a significant portion of our cash generated from        operations to make an offer to purchase notes on a pro rata basis. The restrictions        contained in the indenture, our revolving credit facility and the senior subordinated debt        financing agreements could:

         

| **•** | limit our ability to plan for or                    react to market conditions, meet capital needs or otherwise restrict our                    activities or business plans; and      |
|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|       |                                                                                                                                                                                        |
| **•** | adversely affect our ability to                    finance our operations, enter into acquisitions or engage in other business                    activities that would be in our interest. |

         

A breach of any of the covenants contained in our revolving credit facility        or any other future credit facilities, or our inability to comply with the financial ratios        could result in an event of default, which would allow the lenders to declare all        borrowings outstanding to be due and payable, which would in turn trigger an event of        default under the indenture. In addition, our lenders could compel us to apply all of our        available cash to repay our borrowings. If the amounts outstanding under our revolving        credit facility or the notes were to be accelerated, we cannot assure you that our assets        would be sufficient to repay in full the money owed to the lenders or to our other debt        holders. As of September 30, 2007, we were not in compliance with our revolving credit        facilities and were required to obtain a waiver of the default. We also amended the        revolving credit facility to provide that any equity issue be added to EBITDA (as defined        in the revolving credit facility) for the fourth quarter of 2007 through 2008.

         

         

 

20

 

***We are a holding company and we may not have access to sufficient cash        to make payments on the notes. In addition, the notes are effectively subordinated to the        liabilities of our subsidiaries.***

         

Securus Technologies, Inc., the issuer of the notes, is a holding company        with no direct operations. Its principal assets are the equity interests it holds, directly        and indirectly, in its subsidiaries. Since all of our operations are conducted through our        subsidiaries, our ability to service our indebtedness, including the notes, will be        dependent upon the earnings of our subsidiaries and the distribution of those earnings, or        upon loans or other payments of funds, by our subsidiaries to us. Our subsidiaries are        legally distinct from us and have no obligation to pay amounts due on our debt or to make        funds available to us for such payment. The payment of dividends and the making of loans        and advances to us by our subsidiaries may be subject to various restrictions, including        restrictions under our working capital facility more fully described below. In addition,        the ability of our subsidiaries to make such payments or advances to us may be limited by        the laws of the relevant jurisdictions in which our subsidiaries are organized or located,        including, in some instances, by requirements imposed by regulatory bodies that oversee the        telecommunications industry in such jurisdictions. In certain circumstances, the prior or        subsequent approval of such payments or advances by our subsidiaries to us is required from        such regulatory bodies or other governmental entities. The notes, therefore, without giving        effect to any guarantees of the notes, will be effectively subordinated to creditors        (including trade creditors) of our subsidiaries. Although the indenture contains        limitations on the amount of additional indebtedness that we and our restricted        subsidiaries may incur, the amounts of such indebtedness could be substantial and such        indebtedness may be First-Priority Lien Obligations. In addition, each of our subsidiaries        has other liabilities, including contingent liabilities (including the guarantee        obligations under our revolving credit facility and the senior subordinated debt financing)        that may be significant.

         

In addition, our revolving credit facility will restrict all payments from        our subsidiaries to us during the continuance of a payment default and will also restrict        payments to us for a period of up to 180 days during the continuance of a non-payment        default.

         

Our revolving credit facility is, and future credit facilities may be,        guaranteed by our domestic restricted subsidiaries and certain foreign subsidiaries.        Although the indenture contains limitations on the amount of additional indebtedness that        we and our restricted subsidiaries may incur, the amounts of such indebtedness could be        substantial and such indebtedness may be secured. As of December 31, 2007, we would have        been able to incur approximately $19.5 million of additional secured debt constituting        First-Priority Lien Obligations under our revolving credit facility.

         

***U.S.        bankruptcy or fraudulent conveyance law may interfere with the payment of the notes and the        guarantees and the enforcement of the security interests.***

 

Our incurrence of debt, such as the notes and the guarantees, as well as the        security interests related to the notes and the guarantees, may be subject to review under        U.S. federal bankruptcy law or relevant state fraudulent conveyance laws if a        bankruptcy proceeding or lawsuit is commenced by or on behalf of our unpaid creditors.        Under these laws, if in such a proceeding or lawsuit a court were to find that, at the time        we incurred debt (including debt represented by the notes and the guarantees),

         

| **•** | we incurred such debt with the                    intent of hindering, delaying or defrauding current or future                    creditors; or                                                                                                                                                    |
|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|       |                                                                                                                                                                                                                                                                                                     |
| **•** | we received less than reasonably                    equivalent value or fair consideration for incurring such debt and                    we:                                                                                                                                                            |
|       |                                                                                                                                                                                                                                                                                                     |
| **•** | were insolvent or were rendered                    insolvent by reason of any of the transactions;                                                                                                                                                                                                       |
|       |                                                                                                                                                                                                                                                                                                     |
| **•** | were engaged, or about to engage,                    in a business or transaction for which our remaining assets constituted                    unreasonably small capital to carry on our business;                                                                                                     |
|       |                                                                                                                                                                                                                                                                                                     |
| **•** | intended to incur, or believed                    that we would incur, debts beyond our ability to pay as these debts matured (as                    all of the foregoing terms are defined in or interpreted under the relevant                    fraudulent transfer or conveyance statutes); or |
|       |                                                                                                                                                                                                                                                                                                     |

 

 

21

 

 

 

| **•** | were defendants in an action for                    money damages or had a judgment for money damages entered against us (if, in                    either case, after final judgment such judgment is unsatisfied); |
|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

then that        court could avoid or subordinate the amounts owing under the notes to our presently        existing and future debt, void or decline to enforce the security interest and take other        actions detrimental to you.

 

The measure of insolvency for purposes of the foregoing considerations will        vary depending upon the law of the jurisdiction that is being applied in any proceeding.        Generally, a company would be considered insolvent if, at the time it incurred the        debt:

         

| **•** | the sum of its debts (including                    contingent liabilities) was greater than its assets, at fair                    valuation;                                                                                                                                                     |
|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|       |                                                                                                                                                                                                                                                                                              |
| **•** | the present fair saleable value                    of its assets was less than the amount required to pay the probable liability                    on its total existing debts and liabilities (including contingent liabilities)                    as they became absolute and mature; or |
|       |                                                                                                                                                                                                                                                                                              |
| **•** | it could not pay its debts as                    they became due.                                                                                                                                                                                                                                 |

 

         

We cannot predict what standards a court would use to determine whether we        or our subsidiary guarantors were solvent at the relevant time, or whether the notes, the        guarantees or the security interests would be avoided or further subordinated on another of        the grounds set forth above.

         

 

***We        may be unable to repurchase the notes upon a change of control as required by the        indenture.***

         

Upon the occurrence of a change of control, we will be required to make an        offer to repurchase all outstanding notes. In addition, our revolving credit facility        contains prohibitions of certain events that would constitute a change of control or        require such senior indebtedness to be repurchased or repaid upon a change of control.        Moreover, the exercise by the holders of their right to require us to repurchase the notes        could cause a default under such agreements, even if the change of control itself does not,        due to the financial effect of such repurchase on us. Under any of these circumstances, we        cannot assure you that we will have sufficient funds available to repay all of our senior        debt and any other debt that would become payable upon a change of control and to        repurchase the notes. Our failure to purchase the notes would be a default under the        indenture, which would in turn trigger a default under our revolving credit facility. We        would need to refinance our revolving credit facility or cure the defaults thereunder        before making the change of control offer.

         

The definition of change of control includes a phrase relating to the sale        or other transfer of “all or substantially all” of our assets. There is no        precise definition of the phrase under applicable law. Accordingly, in certain        circumstances there may be a degree of uncertainty in ascertaining whether a particular        transaction would involve a disposition of “all or substantially all” of our        assets, and therefore it may be unclear as to whether a change of control has occurred and        whether the holders of the notes have the right to require us to repurchase such        notes.

         

 

***Rights of holders of notes in the collateral may be adversely affected        by bankruptcy proceedings.***

 

The right of the administrative agent of the First Lien Priority Obligations        to repossess and dispose of the collateral securing the notes upon acceleration is likely        to be significantly impaired by federal bankruptcy law if bankruptcy proceedings are        commenced by or against us or any of our subsidiaries prior to or possibly even after the        administrative agent has repossessed and disposed of the collateral. Under the        U.S. Bankruptcy Code, a secured creditor, such as the administrative agent, is        prohibited from repossessing its security from a debtor in a bankruptcy case, or from        disposing of security repossessed from a debtor, without bankruptcy court approval.        Moreover, bankruptcy law permits the debtor to continue to retain and to use collateral,        and the proceeds, products, rents or profits of the collateral, even though the debtor is        in

 

22

 

 

default        under the applicable debt instruments, provided that the secured creditor is given        “adequate protection.” The meaning of the term “adequate        protection” may vary according to circumstances, but it is intended in general to        protect the value of the secured creditor’s interest in the collateral and may        include cash payments or the granting of additional security, if and at such time as the        court in its discretion determines, for any diminution in the value of the collateral as a        result of the stay of repossession or disposition or any use of the collateral by the        debtor during the pendency of the bankruptcy case. In view of the broad discretionary        powers of a bankruptcy court, it is impossible to predict how long payments under the notes        could be delayed following commencement of a bankruptcy case, whether or when the        administrative agent would repossess or dispose of the collateral, or whether or to what        extent holders of the notes would be compensated for any delay in payment or loss of value        of the collateral through the requirements of “adequate protection.”        Furthermore, in the event the bankruptcy court determines that the value of the collateral        is not sufficient to repay all amounts due on the notes, the holders of the notes would        have “undersecured claims” as to the difference. Federal bankruptcy laws do not        permit the payment or accrual of interest, costs and attorneys’ fees for        “undersecured claims” during the debtor’s bankruptcy case.

         

**Risk        Factors Relating to Our Business**

 

***We        did not generate sufficient cash from operations in 2007 to comply with the financial        covenants in the indenture for our Second-Priority Senior Secured Notes.***

         

If we are unable to generate sufficient cash from operations, we may not be        able to meet our obligations under our credit facilities. We did not generate sufficient        cash from operations to maintain a Credit Facility Coverage Ratio above 1.75 for the third        and fourth quarters of 2007, as required by the indenture for our Second-Priority Senior        Secured Notes. The Credit Facility Coverage Ratio 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 indenture provides that two consecutive quarters of non-compliance with the        Credit Facility Coverage Ratio will cause a default. The definition of the Credit Facility        Coverage Ratio provides that the proceeds from equity we issue are added to Credit Facility        Cash Flow. In order to avoid a default under the indenture, we issued $10.2 million of        Series A Redeemable Convertible Preferred Stock to our stockholders, H.I.G.-TNetix,        Inc.

         

Our inability to maintain the minimum Credit Facility Coverage Ratio was due        primarily to (a) new customer contracts being awarded later than we expected, (b) declines        in our telecommunications and solutions revenues, and (c) increases in our selling, general        and administrative costs. With respect to the latter, we have implemented certain cost        cutting measures, including headcount reduction, primarily in our field service personnel,        decreases in line and long distance costs and an increase in our prepaid collections.        Although we believe our cost cutting measures together with recent new direct provisioning        business and an increase in our offender management installations will increase our cash        from operations, they may not be sufficient to offset the impact of the recent economic        downturn and the expected decline in our telecommunications and solutions revenues.        Consequently, although we expect to be to be able to meet our obligations through 2008,        there is no guarantee that we will generate sufficient cash from operations to do        so.

         

***Our        financial results are dependent on the success of our billing and bad debt risk management        systems.***

 

The inmate telecommunications business is subject to significant risk of bad        debt or uncollectible accounts receivable. In 2007, our direct provisioning bad debt        expense was approximately 11% of our direct provisioning revenues. Most calls are collect        calls paid by the called or billed party. Historically, such billed party’s ability        to pay for collect calls has been tied to the economic conditions, and unemployment rates        in particular, that exist in their community. Our exposure to bad debt risk increases as        unemployment rises and the economy worsens. In other cases, the billed party may still be        unable or unwilling to pay for the call. With the recent economic downturn, this risk is        increased.

         

 

23

 

 

We bill for our direct and Solutions services through LECs and billing        aggregators, which aggregate our charges with other service providers and bill through the        applicable LEC. Our agreements with the LECs and the billing aggregators specify that the        LECs get paid their portion of a bill prior to ours and we share the remaining risk of        nonpayment with other non-LEC service providers. In certain circumstances, LECs are unable        to trace the collect call to a proper billed number and the call is unbillable. We are also        subject to the risks that the LEC decides not to charge for a call on the basis of billing        or service error and that we may be unable to retain our current billing collection        agreements with LECs, many of which are terminable at will.

         

There is a significant lag time (averaging six to nine months) between the        time a call is made and the time we learn that the billed party has failed to pay for a        call. During this period, we may continue to extend credit to the billed party prior to        terminating service and thus increase our exposure to bad debt. Additionally, because of        the significant lag time, deteriorating trends in collection rates may not be immediately        visible and bad debt may therefore increase prior to our ability to adjust our algorithms        and reduce credit limits. This risk is heightened considering the recent economic downturn.        We seek to minimize our bad debt expense by using multi-variable algorithms to adjust our        credit policies and billing. In 2007 we enhanced our bad debt management systems by        reducing the processing time of call records through our back office systems. We cannot        assure you that these initiatives will be successful or that our algorithms are accurate or        will remain accurate as circumstances change. Moreover, to the extent we overcompensate for        bad debt exposure by limiting credit to billed parties, our revenues and profitability may        decline as we allow fewer calls to be made. To the extent our billing and bad debt risk        management systems are less than effective or we are otherwise adversely affected by the        foregoing factors, our financial position, results of operations.

         

***We        expect significant declines in our solutions and telecommunications revenues, which if not        replaced by direct call provisioning or other revenues, could have an adverse impact on our        financial condition.***

         

We expect our telecommunications and solutions revenues to decrease        significantly over the next few years, which accounted for approximately 11% of our        revenues in 2007. Our solutions and telecommunications customers have historically been        comprised of large telecommunications carriers, which began exiting the inmate        telecommunications business in early 2005. Since their exit, the larger county and state        facilities that they served are increasingly being serviced by independent inmate        communications companies. As a result, our solutions revenues decreased by approximately        $9.2 million, or 20.1%, and our telecommunications revenues decreased by approximately        $5.7, or 42.7%, from 2006 to 2007. Global Tel*Link comprised 74% of our solutions revenue        and 34% of our telecommunications revenue in 2007. Global has been decreasing the services        we provide to it in accordance with its existing agreements. Global’s master        agreement with us expired on March 1, 2008 and we will stop providing services to them as        their underlying agreements expire. As a result, we expect our solutions and        telecommunications businesses to continue to decline significantly.

         

***We        are dependent on third party vendors for our information, billing and offender management        systems.***

         

Sophisticated information and billing systems are vital to our ability to        monitor and control costs, bill customers, process customer orders, provide customer        service and achieve operating efficiencies. We currently rely on internal systems and third        party vendors to provide all of our information and processing systems. Some of our        billing, customer service and management information systems have been developed by third        parties for us and may not perform as anticipated. In addition, our plans for developing        and implementing our information and billing systems rely substantially on the delivery of        products and services by third party vendors.

         

We also license critical third-party software for our offender management        products that we incorporate into our own software products and are likely to incorporate        additional third-party software into our new product offerings. The operation of our        products would be impaired if errors occur in the third-party software that we utilize. It        may be more difficult for us to correct any defects in third-party software because the        software is not within our control. Accordingly, our business could be adversely affected        in the event of any errors in this software. There can be no assurance that these third        parties will continue to

 

24

 

 

invest the        appropriate levels of resources in their products and services to maintain and enhance the        capabilities of their software. If the cost of licensing any of these third-party software        products significantly increases, our gross margin levels could significantly        decrease.

         

Our right to use these systems is dependent upon license agreements with        third party vendors. Some of these agreements are cancelable by the vendor, and the        cancellation or nonrenewable nature of these agreements could impair our ability to process        orders, bill our customers or sell our offender management products. Since we rely on third        party vendors to provide some of these services or products, any switch in vendors could be        costly and could affect operating efficiencies.

         

Additionally, if our relations with any of our third-party information and        offender management systems providers are impaired or the third-party software infringes        upon another party’s intellectual property rights, our business could be        harmed.Although these third party software vendors generally        indemnify us against claims that their technology infringes on the proprietary rights of        others, such indemnification is not always available for all types of intellectual        property. Sometimes software vendors are not well capitalized and may not be able to        indemnify us in the event that their technology infringes on the proprietary rights of        others. Defending such infringement claims, regardless of their validity, could result in        significant cost and diversion of resources. As a result, we may face substantial exposure        to liability in the event that technology we license from a third-party infringes on        another party’s proprietary rights.

         

***We        may face challenges in integrating Syscon and may not realize the expected benefits of the        acquisition.***

 

Our future success, and our ability to pay interest and principal on the        notes, will depend in part on our ability to integrate Syscon into our business. Every        acquisition involves integrating the operations of two separate and distinct companies and        management teams as well as implementing our operating and growth strategies. The        acquisition and integration of Syscon involves a number of special risks        including:

         

| **•** | failure of Syscon to achieve the                    results we expect;                                                                                                 |
|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|       |                                                                                                                                                                   |
| **•** | potential disruption of our                    business;                                                                                                               |
|       |                                                                                                                                                                   |
| **•** | greater demands on our management                    and administrative resources;                                                                                     |
|       |                                                                                                                                                                   |
| **•** | difficulties and unexpected costs                    in integrating Syscon’s operations, personnel, services, technologies and                    other systems; |
|       |                                                                                                                                                                   |
| **•** | possible unexpected loss of key                    employees, customers and suppliers;                                                                                 |
|       |                                                                                                                                                                   |
| **•** | unanticipated liabilities and contingencies of Syscon

                                                                                                           |

         

If we are unable to integrate or manage Syscon successfully, we may not        realize our anticipated revenue growth, which may result in reduced profitability or        operating losses and may materially and adversely affect our business, financial condition        and results of operations.

         

***A        number of our customers individually account for a large percentage of our revenues, and        therefore the loss of one or more of these customers could harm our        business.***

 

If we lose existing customers and do not replace them with new customers,        our revenues will decrease and may not be sufficient to cover our costs. For the year ended        December 31, 2007, Global Tel*Link accounted for approximately 8% of our total        revenues and our top five customers accounted for approximately22.6%, of our total revenues. Our master agreement with Global expired on        March 1, 2008. Global has been reducing the services we provide to them throughout the term        of the master agreement and we expect Global to stop using our services entirely. If we do        not replace Global with other customers or if

 

25

 

 

we lose one        or more other significant customers, if our telecommunications revenue decreases faster        than we expect, or, if we cannot transition our subcontracts to prime contracts, our        revenues will be adversely affected, which could harm our business.

         

***Our        success depends on our ability to protect our proprietary technology and ensure that our        systems are not infringing on the proprietary technology of other        companies.***

         

Our success depends to a significant degree on our protection of our        proprietary technology, particularly in the areas of three-way call prevention, automated        operators and call processing technology, bad debt risk management, revenue generation and        ancillary products and services. The unauthorized reproduction or other misappropriation of        our proprietary technology could enable third parties to benefit from our technology        without paying us for it. Although we have taken steps to protect our proprietary        technology, these steps may be inadequate. We rely on a combination of patent and copyright        law and non-disclosure agreements to establish and protect our proprietary rights in our        systems. However, existing trade secret, patent, copyright and trademark laws offer only        limited protection. Despite our efforts to protect our proprietary rights, unauthorized        parties may attempt to copy aspects of our products or obtain and use trade secrets or        other information we regard as proprietary. If we resort to legal proceedings to enforce        our intellectual property rights, the proceedings would be burdensome and expensive and        could involve a high degree of risk.

         

We cannot assure you that a third party will not accuse us of infringement        on their intellectual property rights. There has been litigation in the telecommunications        industry regarding alleged infringement of certain of the technology used in internet        telephony services. Although this litigation involves companies unrelated to us, and we        believe, technology different from ours, it is possible that similar litigation could be        brought against us in the future. Certain parties to such litigation have significantly        greater financial and other resources than us. Any claim of infringement could cause us to        incur substantial costs defending against the claim, even if the claim is not valid, and        could perhaps prevent us from adequately defending the claim. Such a claim would also        distract our management from our business. A claim may also result in a judgment involving        substantial damages or an injunction or other court order that could prevent us from        selling our products and services or operating our network architecture. Any of these        events could have a material adverse effect on our business, operating results and        financial condition.

         

***We        may not be able to adapt successfully to new technologies, to respond effectively to        customer requirements or to provide new services.***

 

The communications and software industries, including inmate communications        and offender management systems are subject to rapid and significant changes in technology,        frequent new service introductions and evolving industry standards. As a result, it is        difficult for us to estimate the life cycles of our products. Technological developments        may reduce the competitiveness of our services and require unbudgeted upgrades, significant        capital expenditures and the procurement of additional services that could be expensive and        time consuming. To the extent our existing or future competitors are successful in        developing competitive technologies, including through deployment of the packet based        architecture that we believe provides us with a competitive advantage, our competitive        position, market share and the price we receive for services may be adversely affected. To        be competitive, we must develop and introduce product enhancements and new products. New        products and new technology often render existing information services or technology        infrastructure obsolete, excessively costly, or otherwise unmarketable. As a result, our        success depends on our ability to create and integrate new technologies into our current        products and services and to develop new products. If we fail to respond successfully to        technological changes or obsolescence or fail to obtain access to important new        technologies, we could lose customers and be limited in our ability to attract new        customers or sell new services to our existing customers. The failure to adapt to new        technologies could have a material adverse effect on our business, financial condition and        results of operations.

         

The successful development of new services, which is an element of our        business strategy, is uncertain and dependent on many factors, and we may not generate        anticipated revenues from such services. In

 

26

 

 

addition,        as communications networks are modernized and evolve from analog-based to digital-based        systems, certain features offered by us may diminish in value. We cannot guarantee that we        will have sufficient technical, managerial or financial resources to develop or acquire new        technology or to introduce new services or products that would meet our customers’        needs in a timely manner.

         

***Our        business could be adversely affected if our products and services fail to perform or be        performed properly.***

 

Products as complex as ours may contain undetected errors or        “bugs,” which could result in product failures or security breaches and render        us unable to satisfy customer expectations. Further, our products must integrate with the        many computer systems and software programs of our customers. Any failure of our systems or        an inability of our customer to implement our products could result in a claim for        substantial damages against us, regardless of our responsibility for the failure. Although        we test our products and maintain general liability insurance, including coverage for        errors and omissions, we cannot assure you that we will detect every error or that our        existing coverage will continue to be available on reasonable terms or will be available in        amounts sufficient to cover one or more large claims, or that the insurer will not disclaim        coverage as to any future claim. The occurrence of errors could result in a loss of data to        us or our customers, which could cause a loss of revenues, failure to achieve acceptance,        diversion of development resources, injury to our reputation, or damages to our efforts to        build brand awareness, any of which could have a material adverse effect on our market        share and, in turn, our operating results and financial condition.

         

***A        system failure could cause delays or interruptions of service, which could cause us to lose        customers.***

 

To be successful, we will need to continue to provide our customers with        reliable service. Some of the events that could adversely affect our ability to deliver        reliable service include:

         

| **•** | physical damage to our network                    operations centers; |
|------------|-----------------------------------------------------------------------|
|       |                                                                  |
| **•** | disruptions beyond our                    control;                    |
|       |                                                                  |
| **•** | power surges or                    outages; and                  |
|       |                                                                  |
| **•** | software defects.                                                     |

         

Disruptions may cause interruptions in service or reduced capacity for        customers, either of which could cause us to lose customers and incur unexpected        expenses.

         

***We        are dependent on the communications industry, which subjects our business to risks        affecting the communications industry generally.***

 

Although we focus on the inmate communications industry, our business is        directly affected by risks facing the communications industry in general. The        communications industry has been, and we believe it will continue to be, characterized by        several trends, including the following:

         

| **•** | substantial regulatory change due                    to the passage and implementation of the Telecommunications Act, which included                    changes designed to stimulate competition for both local and long distance                    telecommunications services; |
|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|       |                                                                                                                                                                                                                                                                               |
| **•** | rapid development and                    introduction of new technologies and services;                                                                                                                                                                                            |
|       |                                                                                                                                                                                                                                                                               |
| **•** | increased competition within                    established markets from current and new market entrants that may provide                    competing or alternative services;                                                                                                    |
|       |                                                                                                                                                                                                                                                                               |
| **•** | the increase in mergers and                    strategic alliances that allow one telecommunications provider to offer                    increased services or access to wider geographic markets; and                                                                       |

 

 

27

 

 

 

|       |                                                                                                            |
|------------|-----------------------------------------------------------------------------------------------------------------|
| **•** | continued changes in the laws and                    regulations affecting rates for collect and prepaid calls. |

         

The market for communications services is highly competitive. Our ability to        compete successfully in our markets will depend on several factors, including the        following:

         

| **•** | how well we market our existing                    services and develop new technologies;                                                                                                                                                                                                                                                                                                                                                                                                 |
|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| **•** | the quality and reliability of                    our network and service;                                                                                                                                                                                                                                                                                                                                                                                                                |
|       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| **•** | our ability to anticipate and                    respond to various competitive factors affecting the communications industry,                    including a changing regulatory environment that may affect us differently from                    our competitors, pricing strategies and the introduction of new competitive                    services by our competitors, changes in consumer preferences, demographic                    trends and economic conditions; and |
|       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| **•** | our ability to successfully                    defend claims against us.                                                                                                                                                                                                                                                                                                                                                                                                                  |

         

Competition could intensify as a result of new competitors and the        development of new technologies, products and services. Some or all of these risks may        cause us to have to spend significantly more in capital expenditures than we currently        anticipate in order to keep existing, and attract new, customers.

         

Many of our competitors, such as RBOCs, LECs and IXCs, such as Verizon/MCI        and Embarq, have brand recognition and financial, personnel, marketing and other resources        that are significantly greater than ours. In addition, due to consolidation and strategic        alliances within the communications industry, we cannot predict the number of competitors        that will emerge, especially as a result of existing or new federal and state regulatory or        legislative actions. Increased competition from existing and new entities could lead to        higher commissions paid to correctional facilities, loss of customers, reduced operating        margins or loss of market share.

         

***Most        of our customers are governmental entities that require us to adhere to certain policies        that may limit our ability to attract and retain customers.***

 

Our customers include U.S. and foreign federal, state and local        governmental entities responsible for the administration and operation of correctional        facilities. We are subject, therefore, to the administrative policies and procedures        employed by, and the regulations that govern the activities of, these governmental        entities, including policies, procedures, and regulations concerning the procurement and        retention of contract rights and the provision of services. Our operations may be adversely        affected by the policies and procedures employed by, or the regulations that govern the        activities of, these governmental entities and we may be limited in our ability to secure        additional customer contracts, renew and retain existing customer contracts, and consummate        acquisitions as a result of such policies, procedures and regulations.

         

***Our        offender management software’s lengthy sales cycle and limited number of large        non-recurring licenses sales make it difficult to predict quarterly revenue levels and        operating results.***

 

It is difficult for us to forecast the timing and recognition of revenues        from sales of our offender management products because our existing and prospective        customers often take significant time evaluating our products before licensing them. The        sales process for our offender management software products is lengthy and can exceed one        year. License and implementation fees for our offender management software products tend to        be substantial when they occur. Additionally, the purchasing of our offender management        software products is relatively discretionary and the purchasing decision typically        involves members of our customers’ senior management. Accordingly, the timing of our        license revenues is difficult to predict. The delay of an order could cause our quarterly        revenues to fall substantially below our expectations and those of public market analysts        and investors. Moreover, to the extent that we succeed in

 

28

 

 

shifting        customer purchases away from individual software products and toward more costly integrated        suites of software and services, our sales cycle may lengthen, which could increase the        likelihood of delays and cause the effect of a delay to become more pronounced. Delays in        our offender management software sales could cause significant shortfalls in our revenues        and operating results for any particular period. The period between initial customer        contact and a purchase by a customer may vary from nine months to more than one year.        During the evaluation period, prospective customers may decide not to purchase or may scale        down proposed orders of our products for various reasons, including:

         

| **•** | reduced demand for offender                    management software solutions; |
|------------|-------------------------------------------------------------------------------|
|       |                                                                          |
| **•** | introduction of products by our                    competitors;               |
|       |                                                                          |
| **•** | lower prices offered by our                    competitors; and               |
|       |                                                                          |
| **•** | reduced need to upgrade existing                    systems.                  |

         

Additionally, because our customers and potential customers are federal,        state and local government agencies that may have limited funds allocated to information        technology, decreases in any of our customer’s budgets for information technology        could result in order cancellations that could have a significant adverse affect on our        revenues and quarterly results.

         

***We        may not be successful in convincing potential customers to migrate to our        products.***

 

Many correctional institutions have historically used internally developed        software for their offender management systems and to manage other resources. These        institutions may not be willing to incur the costs or invest the resources necessary to        initially implement our software products or complete upgrades to current or future        releases of our products. Consequently, it may be difficult for us to convince these        institutions to make substantial capital expenditures to migrate to our products. This may        impede our ability to increase our market share in existing markets as well as penetrate        other geographic markets or to generate new or recurring revenues.

         

         

***Our        international operations and sales subject us to risks associated with unexpected        events.***

 

The international reach of our business could cause us to be subject to        unexpected, uncontrollable and rapidly changing events and circumstances. The following        factors, among others, could adversely affect our business and earnings:

         

| **•** | failure to properly comply with                    foreign laws and regulations applicable to our foreign activities including,                    without limitation, software localization requirements;                                                                                       |
|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|       |                                                                                                                                                                                                                                                                                             |
| **•** | compliance with multiple and                    potentially conflicting regulations in Europe, Australia and North America,                    including export requirements, tariffs, import duties and other trade barriers,                    as well as intellectual property requirements; |
|       |                                                                                                                                                                                                                                                                                             |
| **•** | difficulties in managing foreign                    operations and appropriate levels of staffing;                                                                                                                                                                                               |
|       |                                                                                                                                                                                                                                                                                             |
| **•** | longer collection                    cycles;                                                                                                                                                                                                                                                     |
|       |                                                                                                                                                                                                                                                                                             |
| **•** | seasonal reductions in business                    activities, particularly throughout Europe;                                                                                                                                                                                                   |
|       |                                                                                                                                                                                                                                                                                             |
| **•** | reduced protection for                    intellectual property rights in some countries;                                                                                                                                                                                                        |
|       |                                                                                                                                                                                                                                                                                             |
| **•** | proper compliance with local tax                    laws which can be complex and may result in unintended adverse tax                    consequences;                                                                                                                                          |
|       |                                                                                                                                                                                                                                                                                             |

 

 

29

 

 

 

| **•** | anti-American sentiment due to                    the war in Iraq and other American policies that may be unpopular in certain                    countries;                                                                                                                                                                               |
|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|       |                                                                                                                                                                                                                                                                                                                                       |
| **•** | difficulties in enforcing                    agreements through foreign legal systems;                                                                                                                                                                                                                                                     |
|       |                                                                                                                                                                                                                                                                                                                                       |
| **•** | fluctuations in exchange rates                    may affect product demand and may adversely affect the profitability in                    U.S. dollars of products and services provided by us in foreign markets                    where payment for our products and services is made in the local                    currency; |
|       |                                                                                                                                                                                                                                                                                                                                       |
| **•** | changes in general economic and                    political conditions in countries where we operate; and                                                                                                                                                                                                                                 |
|       |                                                                                                                                                                                                                                                                                                                                       |
| **•** | restrictions on downsizing                    operations in Europe and expenses and delays associated with any such                    activities.                                                                                                                                                                                         |

         

**Regulatory Risks**

 

***The        FCC is currently reviewing challenges and alternatives to the exclusive-provider system        that, if implemented, could have an adverse effect on our business.***

         

Most correctional facilities grant exclusive contracts to a single provider        of inmate telecommunications services. The FCC has opened several rulemaking proceedings        that question whether the current regulatory regime applicable to the provision of inmate        telecommunications services is responsive to the needs of correctional facilities, inmate        telecommunications service providers, the inmates and their families. Parties participating        in these proceedings generally include prison inmates and their families, parties receiving        calls from inmates, several national inmate advocacy organizations such as Citizens United        for the Rehabilitation of Errants and providers of inmate telecommunications services. In        general, the position of those challenging the current regulatory regime is that inmate        telecommunications service rates are excessive due to lack of competitive market forces and        that the FCC should make the exclusive service arrangements unlawful, permit open access by        multiple inmate telecommunications service providers, establish rate caps, prohibit        commissions to correctional facilities and mandate the offering by inmate        telecommunications service providers of debit (prepaid) card alternatives to collect        calling. Such a regime would require a new and complex set of federal regulations that, if        adopted, could immediately reduce our revenues derived from existing contracts and could        lead to increased costs associated with regulatory compliance. Moreover, if implementation        of these regulations leads to technological or structural changes in the industry, it could        render our technology obsolete, diminish the value of our intellectual property and our        customer relationships and lead to a reduction of volume and profitability of calls        originating from correctional facilities.

         

***We        operate in a highly regulated industry, and are subject to restrictions in the manner in        which we conduct our business and a variety of claims relating to such        regulation.***

         

Our operations are subject to federal regulation, and we must comply with        the Communications Act of 1934, as amended, and FCC regulations promulgated thereunder. We        are also subject to the applicable laws and regulations of various states and other state        agencies, including regulation by public utility commissions. Federal laws and FCC        regulations generally apply to interstate telecommunications (including international        telecommunications that originate or terminate in the United States), while state        regulatory authorities generally have jurisdiction over telecommunications that originate        and terminate within the same state. Generally, we must obtain and maintain prior        authorization from and/or register with, regulatory bodies in most states where we offer        intrastate services and must obtain or submit prior regulatory approval of rates, terms and        conditions for our intrastate services in most of these jurisdictions. We are also in some        cases required, along with other telecommunications providers, to contribute to federal and        state funds established for universal service, number portability, payphone compensation        and related purposes. Laws and regulations in this industry such as those identified above,        and others including those regulating call recording and call rate announcements, and        billing, collection, customer collection

 

30

 

 

management,        and solicitation practices are all highly complex and burdensome, making it difficult to        always be in complete compliance. The difficulty is sometimes exacerbated by technology        issues. Although we actively seek to comply with all laws and regulations and remedy areas        in which we become aware of non-compliance, we may not always be in full compliance with        all regulations applicable to us. Once non-compliance is identified, remedies are sought,        but we may not always remain in compliance with all future applicable requirements. Failure        to comply with these requirements can result in potentially significant fines, penalties,        regulatory sanctions and claims for substantial damages. Claims may be widespread, as in        the case of class actions commenced on behalf of inmates or the called parties of inmates.        Significant fines, penalties, regulatory sanctions and damage claims could be material to        our business, operating results and financial condition. Additionally, regulation of the        telecommunications industry is changing rapidly, and the regulatory environment varies        substantially from state to state. Future regulatory, judicial or legislative activities        may have an adverse effect on our operations or financial condition, and domestic or        international regulators or third parties may raise material issues with regard to our        compliance or non-compliance with applicable regulations.

         

***ITEM 1B. UNRESOLVED STAFF        COMMENTS***

 

None.

 

***ITEM 2. PROPERTIES***

 

Our principal executive office is located in, and a portion of our        operations are conducted from, leased premises located at 14651 Dallas Parkway,        Suite 600, Dallas, Texas 75254-8815. We also lease additional regional facilities from        which we conduct our operations located in Bedford, Massachusetts; Raleigh, North Carolina;        Irving, San Antonio and Allen, Texas; Atlanta, Georgia; Foxboro, Massachusetts;        Springfield, Illinois; and Camp Hill, Pennsylvania. We use our Irving facility as a        warehouse location, the Allen and Atlanta locations as data centers, and the other        facilities as regional sales offices. We also have offices in London, Sacramento and        Sydney, Australia and Richmond, British Columbia. We believe that our facilities are        suitable and the space contained by them adequate for their respective        operations.

         

***ITEM 3. 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 us, are        parties to judicial and regulatory complaints and proceedings initiated by inmates,        consumer protection advocates or individual called parties alleging, among other things,        that excessive rates are being charged with respect to inmate collect calls, that        commissions paid by inmate telephone service providers to the correctional facilities are        too high, that a call was wrongfully disconnected, that security notices played during the        call disrupt the call, that the billed party did not accept the collect calls for which        they were billed or that rate disclosure was not provided or was inadequate. 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 June 2000, T-NETIX was named, along with        AT&T**,**in a lawsuit in the Superior        Court of King County, Washington, in which two private citizens allege violations of state        rules requiring pre-connect audible disclosure of rates as required by Washington statutes        and regulations**.** T-Netix and other        defendants successfully obtained dismissal and a "primary jurisdiction" referral in        2002.  In 2005, after several years of inactivity before the Washington Utilities and        Transportation Commission -- the state telecommunications regulatory agency -- T-Netix        prevailed at the trial court in securing an Order entering

 

31

 

 

summary        judgment on grounds of lack of standing, but that decision was reversed by an intermediate        Washington state appellate court in December        2006**.**  T-Netix’s        subsequentPetition for Review by the Washington Supreme Court was denied in January 2008,        entitling plaintiffs to continue to pursue their claims against T-Netix and        AT&T. Currently pending before the trial court are motions by plaintiffs to vacate        the prior summary judgment and to reinstate the primary jurisdiction referral, and a        second motion by AT&T for summary judgment. T-Netix has opposed the plaintiffs' motion        in part and intends, at the appropriate time, to oppose AT&T's motion as well.         Given the absence of any significant judicial discovery to date, however, we cannotestimate        the company's potential exposure or predict the outcome of this dispute.

         

In September 2004, 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 TIPS, 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, and oral arguments before the Appellate Court are set for April 9,        2008. Additionally, TIPS has 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. This lawsuit        against us was similarly dismissed on January 10, 2008, when our motion for summary        judgment was granted on the issues of non-infringement and a finding that we were not a        proper defendant in the lawsuit. TIPS has indicated that it plans to appeal this order to        the U.S. Court of Appeals.

         

In October 2003, Value-Added Communications, Inc. (“VAC”) filed        suit in the District Court of Dallas County, Texas against our subsidiary T-NETIX for        alleged breach of a Patent License Agreement between VAC and T-NETIX (the        “Agreement”). VAC filed the lawsuit seeking, among other things, an        interpretation of certain provisions of the Agreement, a declaration that the Agreement        remains in effect, 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 breach of various        provisions in the contract including, but not limited to, failure to assign certain        improvements in technology that VAC has allegedly developed since 1996. After the jury for        the trial announced that they were deadlocked, the judge granted a mistrial. The new trial        is set for August 5, 2008. T-NETIX will continue to proceed against VAC on its affirmative        claims for VAC’s failure to assign its improvements and additions and other breaches        of the Patent License Agreement and will continue to vigorously defend against VAC’s        claim for attorneys’ fees and VAC’s efforts to have the Court declare that the        Patent License Agreement remains in effect. 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 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 February 2,        2009. 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, AGM Telecom Corporation, Christopher McNitt, Robert G. Sargeant,        James F. Winstead, Pablo Xiques, Henry Chang, and Mie Mie Chang, 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 requested the court compel arbitration of the matter, which request        was granted, and some defendants filed special appearances objecting to the court’s        jurisdiction. In mid January 2008, the Court granted the special appearances of Sargeant,        Winstead and Chang, due to their lack of contacts with Texas and dismissed them from the        case. The parties have since agreed to abate the state court litigation and submit all        claims between the company and the remaining defendants to arbitration. We have denied any        wrongdoing

 

32

 

 

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. In November 2007, Inmate Calling Solutions, Inc. entered into a        Settlement Agreement and Mutual Release, and a Patent License Agreement with us, and was        dismissed from the suit. We cannot evaluate the likelihood of any outcome as to the        remaining defendants at this time.

         

In May 2007, GlobalTel*Link Corporation brought a declaratory judgment        action in Montgomery County Circuit Court in Alabama, against the State of Alabama, the        Alabama Department of Finance, Isaac Kervin (Director of Purchasing), and T-NETIX,Inc        regarding the Inmate Phone Services contract award. On June 5, 2007, the Judge entered an        order that there is a valid, binding contract between the State and GTL and that the State        shall fully comply with the contract, and that the effective date of the contract shall be        June 1, 2007. On July 16, 2007, the State filed a Motion (and Amended Motion) to Stay        Execution Pending Appeal, which the court denied on July 25, 2007. The State filed a Motion        to Stay Execution Pending Appeal before the Supreme Court of Alabama on July 30, 2007.        T-Netix filed its Joinder in the State’s Motion to Stay on August 1, 2007. Appellate        briefing has been filed and the parties await the ruling of the Supreme Court of Alabama.        T-Netix has not admitted any wrongdoing and has vigorously denied each and every allegation        in the case. No evaluation of the likelihood of any outcome or reasonable estimate of range        of potential loss can be made at this time.

         

In July 2007, GlobalTel*Link Corporation filed suit in the Circuit Court of        Montgomery County against T-Netix Inc., the State of Alabama, and the Alabama Department of        Finance and Alabama Department of Corrections. This proceeding relates to the protest        matter in Alabama. We filed a Motion to Dismiss, which was denied; however, Global conceded        that several of its claims were not viable, and in its amended complaint included only one        count, the intentional interference with business and contractual relations claim. Both        parties agreed that the appeal of the Alabama Protest Matter could be dispositive, or at        least highly persuasive, of the outcome of this second lawsuit; therefore, the Judge agreed        to hold off on setting any scheduling deadlines and recently postponed the trial date of        August 4, 2008. The Judge also ordered the parties to mediate the case, but did not specify        a deadline. T-Netix has not admitted any wrongdoing and has vigorously denied each and        every allegation in the case. No evaluation of the likelihood of any outcome or reasonable        estimate of range of potential loss can be made at this time.

         

In March 2007, the FCC asked for public comment on a proposal from an inmate        advocacy group to impose a federal rate cap on interstate inmate calls. This proceeding        could have a significant impact on the rates that we and other companies in the inmate        telecommunications 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 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY        HOLDERS***

 

No matters were submitted to a vote of our security holders during the        fourth quarter of the year ended December 31, 2007.

         

 

33

 

 

**PART        II**

 

***ITEM 5. MARKET FOR REGISTRANT’S COMMON        EQUITY AND RELATED STOCKHOLDER MATTERS***

 

***Market Information.***  Our        common stock is not registered and there is currently no established public trading market        for our issued and outstanding equity securities.

         

***Holders of        Record**.*  As of March 3, 2008,        the Company had 3 holders of Series A Redeemable Convertible Preferred Stock, 11 holders of        its Common Stock and 12 holders of its Class B Common Stock. In December 2007, Securus        effected a 1 for 1,000 reverse stock split for its Common Stock and Class B Common Stock in        connection with the issuance of the Series A Redeemable Convertible Preferred        Stock.

         

***Dividends**.*  We        have never declared or paid any cash dividends on our common stock.  Our Series A        Redeemable Convertible Preferred Stock accrues dividends at 12.5% annually. We currently        intend to retain earnings, if any, to support our business strategy and do not anticipate        paying cash dividends in the foreseeable future.  Payment of future dividends, if        any, will be at the sole discretion of our board of directors after taking into account        various factors, including restrictions on our ability to pay dividends, our financial        condition, operating results, capital requirements and any plans for        expansion.  Our revolving credit facility, the indenture governing our        Second-priority Senior Secured Notes, and the note purchase agreement governing our senior        subordinated notes contain certain negative covenants that restrict our ability to declare        dividends. See “Management’s Discussion and Analysis of Financial Conditions        and Results of Operations—Debt and Other Obligations.”

         

***Securities Authorized for Issuance Under Equity Compensation        Plans*****.**  The following        table provides information about the securities authorized for issuance under our equity        compensation plans as of December 31, 2007:

  

|                                                                             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    | **Equity                    Compensation Plan Information** |
|----------------------------------------------------------------------------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|-------------------------------------------------------------|
|                                                                             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    | **(a)**                                                     |   | **(b)** |   | **(c)** |
|                                                                             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |                                                        |   |   |   |   | **Number of                    Securities** |
|                                                                             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    | **Number                    of**                            |   |   |   |   | **remaining                    available** |
|                                                                             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    | **securities**                                              |   |   |   |   | **for future                    issuance** |
|                                                                             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    | **to be                    issued**                         |   | **Weighted-average** |   | **under                    equity** |
|                                                                             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    | **upon                    exercise**                        |   | **exercise                    price** |   | **compensation                    plans** |
|                                                                             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    | **of                    outstanding**                       |   | **of                    outstanding** |   | **(excluding                    securities** |
|                                                                             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    | **options,                    warrants**                    |   | **options,                    warrants** |   | **reflected                    in** |
| **Plan                    category**                                             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    | **and                    rights(1)(2)**                     |   | **and                    rights** |   | **column                    (a)** |
| Equity compensation plans approved by security                    holders        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    | 73.49                                                       |   | $ | .01 |   | 74,926.51 |
| Equity compensation plans not approved by security                    holders(1) |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    | -                                                           |   |   | - |   | - |
| Total                                                                            |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    | 73.49                                                       |   | $ | .01 |   | 74,926.51 |
|  

**(1)**                                                        |  

Our only equity compensation plan                    is our 2004 restricted stock plan which has been approved by shareholders.                    There are 75,000 shares authorized under the plan. During the fourth quarter of                    2007, and prior to a 1 for 1,000 reverse stock split, we issued 4,940 shares of                    Class B Common Stock pursuant to our 2004 Restricted Stock Purchase Plan, which                    resulted in us issuing 2,021 more shares of Class B Common Stock than were                    authorized by the plan and our certificate of incorporation at that time. Our                    stockholders have ratified the over-issuance. On December 15, 2007, in                    connection with our issuance of Series A Redeemable Convertible Preferred                    Stock, our shareholders approved the equivalent of a 1 for 1,000 reverse stock                    split and approved an amendment to our certificate of incorporation. We have                    elected to continue to authorize 75,000 shares of Class B Common Stock under                    the plan. Except as otherwise noted, all shares, options and warrants have been                    restated to give retroactive effect to the reverse split. All per share                    disclosures retroactively reflect shares outstanding or issuable as though the                    split had occurred as of December 31, 2006. |
| **(2)**                                                                | Includes 73.49 shares of                    restricted stock issued under the 2004 restricted stock plan.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
|                                                                                  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |                                                             |  |  |  |  |  |  |

         

 

34

 

 

***Unregistered Sales of Equity        Securities**.* During the year ended        December 31, 2007, we sold 11.4 restricted shares of Class B Common Stock at a purchase        price of $10.00 per share pursuant to the 2004 Restricted Stock Plan to certain members of        management.  The shares are subject to certain contractual limitations, including        provisions regarding forfeiture and disposition, as provided in management’s        respective Restricted Stock Purchase Agreements and the 2004 Restricted Stock Plan. The        restricted period ends upon the occurrence of certain events or the lapse of        time.  The sale of the Class B Common Stock was made pursuant to the exemption        set forth in Section 4(2) of the Securities Act of 1933 for transactions not involving a        public offering, and regulations promulgated thereunder.

         

In connection with our acquisition of Syscon on June 29, 2007, we issued        45.6 shares of our Common Stock to Syscon’s sole stockholder. We issued these shares        in reliance on Section 4(2) of the Securities Act of 1933, as amended.

         

On August 17, 2007, H.I.G. T-Netix, Inc., our majority stockholder,        guaranteed a $5.0 million unsecured revolving credit facility for us. In connection with        such guarantee, we issued warrants to purchase up to 14.5 shares of Common Stock. We issued        these warrants in reliance on Section 4(2) of the Securities Act of 1933, as amended.The        guarantee and the revolving credit facility were cancelled and H.I.G. T-Netix exercised its        warrant in connection with our issuance of Series A Redeemable Convertible Preferred Stock        discussed below. We had no borrowings under this facility.

         

On December 29, 2007 we issued 5,100 shares of Series A Redeemable        Convertible Preferred Stock, par value $.01 per share, for $2,000 per share, or an        aggregate of $10.2 million. H.I.G. T-Netix, Inc., our majority stockholder, and its        affiliate purchased substantially all of the Series A Redeemable Convertible Preferred        Stock. We issued these shares in reliance on Section 4(2) of the Securities Act of 1933, as        amended.

         

 

35

 

 

***ITEM        6. SELECTED FINANCIAL INFORMATION AND OTHER DATA***

 

The following selected consolidated historical financial and other data        should be read in conjunction with “Management’s Discussion and Analysis of        Financial Condition and Results of Operations” and the consolidated financial        statements and the related notes thereto appearing elsewhere in this Form 10-K. The        selected historical consolidated financial and other data presented below for the fiscal        years ended December 31, 2005, 2006 and 2007 have been derived from our audited        consolidated financial statements.

 

|                                                                            | **Predecessor**  |          |            |   |             |          |               |                                |            |          |   |   |   |           |   |   |   |
|---------------------------------------------------------------------------------|------------------|---------------|-----------------|--------|------------------|---------------|--------------------|-------------------------------------|-----------------|---------------|--------|--------|--------|----------------|--------|--------|--------|
|                                                                            |             |          |            |   |             |          |               |                                | **Period From** |          |   |   |   |           |   |   |   |   |   |   |   |
|                                                                            | **For the Year** |          | **Period From** |   | **January 1,**   |          |               |                                |            |          |   |   |   |           |   |   |   |
|                                                                            |             | **Ended**     |            |   | **January 1**    |          | **(Inception) to** |                                |            |          |   |   |   |           |   |   |   |   |   |
|                                                                            | **December 31,** |          | **To March 2,** |   | **December 31,** |          |               | **For the Year Ended December 31,** |            |
|                                                                            |             | **2003**      |            |   |             | **2004(1)**   |               |                                |            | **2004(2)**   |   |   |   | **2005**       |   |   |   | **2006** |   |   |   | **2007** |   |
| **Consolidated Statement of Operations**                                        |             |          |            |   |             |          |               |                                |            |          |   |   |   |           |   |   |   |   |   |   |   |   |   |
| Operating revenues                                                              | $                | 117.2         |            |   | $                | 17.4          |               |                                | $               | 173.4         |   |   | $      | 377.2          |   |   | $      | 400.6 |   |   | $ | 390.0 |   |
| Cost of service                                                                 |             | 75.7          |            |   |             | 11.4          |               |                                |            | 130.9         |   |   |   | 289.0          |   |   |   | 308.8 |   |   |   | 300.9 |   |
| Selling, general and administrative                                             |             | 26.3          |            |   |             | 3.6           |               |                                |            | 27.5          |   |   |   | 48.5           |   |   |   | 52.4 |   |   |   | 58.4 |   |
| Depreciation and amortization                                                   |             | 11.9          |            |   |             | 1.6           |               |                                |            | 13.2          |   |   |   | 23.9           |   |   |   | 30.3 |   |   |   | 37.1 |   |
| Non-cash impairment of assets                                                   |             | 0.7           |            |   |             | 0.3           |               |                                |            | 50.6          |   |   |   | -         |   |   |   | - |   |   |   | - |   |
| Other operating expenses (3)                                                    |             | (0.4          | )               |   |             | 5.3           |               |                                |            | 5.6           |   |   |   | 0.6            |   |   |   | - |   |   |   | 0.6 |   |
| Income (loss) from operations                                                   |             | 3.0           |            |   |             | (4.8          | )                  |                                |            | (54.4         | )      |   |   | 15.3           |   |   |   | 9.1 |   |   |   | (7.0 | ) |
| **Other Income Expense:**                                                       |             |          |            |   |             |          |               |                                |            |          |   |   |   |           |   |   |   |   |   |   |   |   |   |
| Patent litigation settlement, net of expense (4)                                |             | 9.9           |            |   |             | -   |               |                                |            | -   |   |   |   | -    |   |   |   | - |   |   |   | - |   |
| Transaction expenses and other charges (5)                                      |             | -   |            |   |             | (5.4          | )                  |                                |            | (1.0          | )      |   |   | -    |   |   |   | - |   |   |   | - |   |
| Interest and other expenses, net                                                |             | (3.7          | )               |   |             | (2.2          | )                  |                                |            | (14.0         | )      |   |   | (26.6          | )      |   |   | (27.8 | ) |   |   | (31.5 | ) |
| Income (loss) from continuing operations before income                    taxes |             | 9.2           |            |   |             | (12.4         | )                  |                                |            | (69.4         | )      |   |   | (11.3          | )      |   |   | (18.7 | ) |   |   | (38.5 | ) |
| Income tax expense (benefit)                                                    |             | 2.7           |            |   |             | (2.6          | )                  |                                |            | (12.7         | )      |   |   | (2.2           | )      |   |   | 1.4 |   |   |   | 1.9 |   |
| Net income (loss) applicable to common stockholders                             |             | 6.5           |            |   |             | (9.8          | )                  |                                |            | (56.7         | )      |   |   | (9.1           | )      |   |   | (20.1 | ) |   |   | (40.4 | ) |
| **Other Financial Data:**                                                       |             |          |            |   |             |          |               |                                |            |          |   |   |   |           |   |   |   |   |   |   |   |   |   |
| Total direct provisioning revenues                                              | $                | 56.7          |            |   | $                | 9.6           |               |                                | $               | 120.9         |   |   | $      | 303.2          |   |   | $      | 340.4 |   |   | $ | 337.4 |   |
| Total solutions services revenues                                               |             | -   |            |   |             |  -  |               |                                |            | 18.5          |   |   |   | 47.4           |   |   |   | 45.7 |   |   |   | 36.5 |   |
| Total telecommunications services revenues                                      |             | 50.6          |            |   |             | 7.6           |               |                                |            | 30.3          |   |   |   | 25.3           |   |   |   | 13.4 |   |   |   | 7.7 |   |
| Offender management software                                                    |             | -             |            |   |             | -             |               |                                |            | -             |   |   |   | -              |   |   |   | - |   |   |   | 7.9 |   |
| Total equipment sales and other revenues                                        |             | 9.9           |            |   |             | 0.2           |               |                                |            | 3.7           |   |   |   | 1.3            |   |   |   | 1.1 |   |   |   | 0.5 |   |

 

 

 

 

36

 

 

 

|                                             | **Predecessor**  |          |            |   |             |          |               |                                |            |          |   |   |   |          |   |   |   |
|--------------------------------------------------|------------------|---------------|-----------------|--------|------------------|---------------|--------------------|-------------------------------------|-----------------|---------------|--------|--------|--------|---------------|--------|--------|--------|
|                                             |             |          |            |   |             |          |               |                                | **Period From** |          |   |   |   |          |   |   |   |   |   |   |   |
|                                             | **For the Year** |          | **Period From** |   | **January 1,**   |          |               |                                |            |          |   |   |   |          |   |   |   |
|                                             |             | **Ended**     |            |   | **January 1**    |          | **(Inception) to** |                                |            |          |   |   |   |          |   |   |   |   |   |
|                                             | **December 31,** |          | **To March 2,** |   | **December 31,** |          |               | **For the Year Ended December 31,** |            |
|                                             |             | **2003**      |            |   |             | **2004(1)**   |               |                                |            | **2004(2)**   |   |   |   | **2005**      |   |   |   | **2006** |   |   |   | **2007** |   |
| **Other Data:**                                  |             |          |            |   |             |          |               |                                |            |          |   |   |   |          |   |   |   |   |   |   |   |   |   |
| Ratio of earnings to fixed charges               | $                | 2.9           |            |   | $                | -   |               |                                | $               | -   |   |   | $      | -   |   |   | $      | -   |   |   | $ | -   |   |
| Deficiency of earnings to fixed charges          |             | -   |            |   |             | 9.8           |               |                                |            | 56.7          |   |   |   | 9.1           |   |   |   | 20.1 |   |   |   | 40.4 |   |
| **Consolidated Cash Flow Data:**                 |             |          |            |   |             |          |               |                                |            |          |   |   |   |          |   |   |   |   |   |   |   |   |   |
| Cash flows from operating activities             | $                | 26.8          |            |   | $                | (3.8          | )                  |                                | $               | (1.8          | )      |   | $      | 29.8          |   |   | $      | 19.1 |   |   | $ | 20.5 |   |
| Cash flows from investing activities             |             | (6.8          | )               |   |             | (0.6          | )                  |                                |            | (213.1        | )      |   |   | (26.3         | )      |   |   | (27.1 | ) |   |   | (64.0 | ) |
| Cash flows from financing activities (6)         |             | (3.7          | )               |   |             | (0.9          | )                  |                                |            | 216.7         |   |   |   | (2.8          | )      |   |   | 6.0 |   |   |   | 46.5 |   |
| Capital Expenditures                             |             | 6.5           |            |   |             | 0.6           |               |                                |            | 12.4          |   |   |   | 26.3          |   |   |   | 27.2 |   |   |   | 21.4 |   |
| **Balance Sheet Data (End of Period)**           |             |          |            |   |             |          |               |                                |            |          |   |   |   |          |   |   |   |   |   |   |   |   |   |
| Cash and cash equivalents and restricted cash    | $                | 22.9          |            |   | $                | 17.6          |               |                                | $               | 3.2           |   |   | $      | 4.0           |   |   | $      | 2.0 |   |   | $ | 3.6 |   |
| Total current assets (7)                         |             | 40.0          |            |   |             | 45.7          |               |                                |            | 78.1          |   |   |   | 80.7          |   |   |   | 76.4 |   |   |   | 62.9 |   |
| Net property and equipment                       |             | 21.5          |            |   |             | 20.0          |               |                                |            | 36.2          |   |   |   | 43.9          |   |   |   | 46.4 |   |   |   | 40.8 |   |
| Total assets                                     |             | 68.9          |            |   |             | 74.7          |               |                                |            | 272.1         |   |   |   | 266.9         |   |   |   | 259.6 |   |   |   | 292.1 |   |
| Total long-term debt (including current portion) |             | 19.2          |            |   |             | 18.3          |               |                                |            | 189.9         |   |   |   | 198.0         |   |   |   | 210.6 |   |   |   | 263.3 |   |
| Stockholders’ equity (deficit)             | $                | 35.2          |            |   | $                | 25.4          |               |                                | $               | (22.8         | )      |   | $      | (31.9         | )      |   | $      | (51.9 | ) |   | $ | (88.9 | ) |

 

| (1) | This column presents the data for                    T-Netix (Predecessor) for the 62-day period from January 1, 2004 to                    March 2, 2004, prior to our acquisition of T-Netix on March 3,                    2004                                                                                                                                                                                                        |
|-----|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (2) | This column does not include                    information for T-Netix (Predecessor) for the period from January 1, 2004                    to March 2, 2004 prior to our acquisition of T-Netix on March 3,                    2004, or information for Evercom for the period from January 1, 2004 to                    September 8, 2004, prior to our acquisition of Evercom on                    September 9, 2004 |
| (3) | Gain on sale of assets,                    compensation expense on employee options, severance and restructuring costs,                    and loss on debt extinguishment                                                                                                                                                                                                                                                                               |
| (4) | Reflects income from a one-time                    litigation settlement, net of legal expenses                                                                                                                                                                                                                                                                                                                                                          |
| (5) | Represents one-time transaction                    expenses related to Securus’ purchase of T-Netix on March 3,                    2004, and Securus’ purchase of Evercom on September 9,                    2004                                                                                                                                                                                                             |
| (6) | The 2007 amount reflects $40                    million of indebtedness incurred through the issuance of additional                    Second-priority Senior Secured Notes in connection with our acquisition of                    Syscon                                                                                                                                                                                                              |
| (7) | Current assets decrease in 2007                    from 2006, primarily as a result of a decline in receivables due to a                    significant increase in prepaid revenues as a percentage of total revenues,                    coupled with a decline in overall Direct and Solutions revenues                                                                                                                                               |

 

 

***ITEM        7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF        OPERATIONS***

 

The following information should be read in conjunction with our historical        consolidated financial statements and related notes, our audited consolidated financial        data and related notes and other financial information included elsewhere in this Form        10-K.

         

 

37

 

 

**Overview**

         

We are one of the largest independent providers of inmate telecommunications        services to correctional facilities operated by city, county, state and federal authorities        and other types of confinement facilities such as juvenile detention centers, private jails        and halfway houses in the United States and Canada. As of December 31, 2007, we provided        service to approximately 2,700 correctional facilities.

         

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

         

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 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.

         

**Revenues**

         

We derived approximately 85% and 87% of our revenues for the years ended        December 31, 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 including 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% and 45% of direct call provisioning revenues for the years        ended December 31, 2006 and 2007, respectively. We install and generally retain ownership        of the telephones and the associated equipment and provide additional services tailored to        the specialized needs of the corrections industry and to the requirements of each        individual correctional facility, such as call activity recording and call blocking. In our        direct call provisioning business, we earn the full retail value of the call and pay        corresponding line charges and commissions. As a result, our direct call provisioning        business gross profit dollars are higher, but our gross profit margin is lower, than in our        telecommunications and solutions services businesses.

         

We offer our solutions services 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 years ended December 31, 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 be        processed 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

 

38

 

 

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.

 

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. In each case we recognize revenue when the calls are completed and we        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 partner bills the        called party and we either share the revenues with our service partner or receive a        prescribed fee for each call completed. We also charge fees for additional services such as        customer support and advanced validation.

         

We derived approximately 3% and 2% of our revenues for the years ended        December 31, 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 our service partners’ separate contracts with        larger correctional institutions. In such instances, we provide equipment, security        enhanced call processing, call validation, and service and support through 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 larger contracts that may 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 2% of our revenues from our acquisition of        Syscon’s offender management software business from June 29, 2007 through December        31, 2007. 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 we have the most        functionally complete offender management system available on the market. Our offender        management software business will complement the direct call provisioning        business.

         

We also sell equipment, typically consisting of our inmate calling system        and digital recording systems, to a limited number of telecommunication services providers        and some direct facilities.

         

**Cost of        Services**

         

Our principal cost of service for our direct call provisioning business        consists of commissions paid to correctional facilities which are typically expressed as a        percentage of either gross or net direct call provisioning revenues and are typically fixed        for the term of the agreements with the facilities; bad debt expense, consisting of        unbillable and uncollectible accounts, and billing charges; 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 the time 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.

         

 

39

 

 

Cost of service associated with the solutions business generally includes        billing and collection and 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, communication costs 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-variable algorithms to minimize bad debt expense by adjusting our        credit policies and billing. For example, when unemployment rates are high, we may decrease        credit to less creditworthy-billed parties or require them to purchase prepaid calling time        in order to receive inmate calls. 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. We anticipate that if the U.S. economy worsens in        the coming months that either our bad debt expense will rise, our revenues from marginal        billed parties will decline, or a combination of both will occur.

         

*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 services        primarily consist of service administration costs for correctional facilities, including        salaries and related personnel expenses, communication costs, and inmate calling systems        repair and maintenance expenses.

         

*SG&A*. SG&A expenses consist of        corporate overhead and selling expenses, including accounting, marketing, 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, AT&T, FSH Communications and Embarq, among        other call providers. For the year ended December 31, 2007, 2 % and 9 %, 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 year ended December 31, 2007.

         

 

 

40

 

 

|               |   | **Approximate % of** |   | **Approximate % of Total** |   | **Contract**   |
|--------------------|--------|----------------------|--------|----------------------------|--------|----------------|
|               |   | **Total Solutions**  |   | **Telecommunications**     |   | **Expiration** |
| **Customer**       |   | **Services Revenue** |   | **Services Revenue**       |   | **Date(2)**    |
| Global Tel*Link(1) |   | 74                   | %      |                       | 34     | %              |   | March 1, 2008 |
| Embarq             |   | 24                   | %      |                       | 11     | %              |   | Month to Month |
| AT&T           |   | -          |   |                       | 31     | %              |   | April 28, 2008 |
| FSH Communications |   | -          |   |                       | 19     | %              |   | Month to Month |

         

| (1) | AT&T sold its inmate                    telecommunications business to Global Tel*Link in 2005. We expect revenue from                    Global to continue to decline in the future                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
|-----|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (2) | 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                    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. |

         

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. 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 businesses        with Global Tel*Link to decline to zero over the next several years. Contractually, our        solutions and telecommunications services customers can replace our services as their        underlying phone contracts with correctional facilities expire. Similarly, AT&T has        been gradually exiting the inmate telecommunications business and we expect our related        services will be steadily eliminated in the near future.

         

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.

         

The following table sets forth, for the years ended 2005, 2006 and 2007,        respectively, our results of operations (in thousands).

|                                                                   |   |   | **2005** |   | **2006** |   |   | **2007**  |
|------------------------------------------------------------------------|--------|--------|----------|--------|----------|--------|--------|----------------|
| **Revenues**                                                           |   |   |     |   |     |   |   |           |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Direct call                    provisioning                            |   | $      | 303,174  |   |     | 80     | %      |           | $ | 340,420 |   |   | 85 | % |   | $ | 337,418 |   |   | 87 | % |
| Solutions                    services                                  |   |   | 47,398   |   |     | 13     |   |           |   | 45,702 |   |   | 12 |   |   |   | 36,496 |   |   | 9 |   |
| Telecommunications                    services                         |   |   | 25,313   |   |     | 7      |   |           |   | 13,365 |   |   | 3 |   |   |   | 7,657 |   |   | 2 |   |
| Offender management                    software                        |   |   | -        |   |     | -      |   |           |   | - |   |   | - |   |   |   | 7,933 |   |   | 2 |   |
| Equipment sales and                    other                           |   |   | 1,321    |   |     | -      |   |           |   | 1,113 |   |   | - |   |   |   | 456 |   |   | - |   |
| Total revenues                                                         |   |   | 377,206  |   |     | 100    |   |           |   | 400,600 |   |   | 100 |   |   |   | 389,960 |   |   | 100 |   |
| **Expenses**                                                           |   |   |     |   |     |   |   |           |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Cost                    of service                                     |   |   | 288,985  |   |     | 77     |   |           |   | 308,802 |   |   | 77 |   |   |   | 300,873 |   |   | 77 |   |
| Selling, general and administrative                                    |   |   | 48,454   |   |     | 13     |   |           |   | 52,387 |   |   | 13 |   |   |   | 58,420 |   |   | 16 |   |
| Severance and restructuring costs                                      |   |   | 633      |   |     | -      |   |           |   | - |   |   | - |   |   |   | 614 |   |   | - |   |
| Depreciation and amortization                                          |   |   | 23,852   |   |     | 6      |   |           |   | 30,258 |   |   | 8 |   |   |   | 37,048 |   |   | 10 |   |
| Operating income (loss)                                                |   |   | 15,282   |   |     | 4      |   |           |   | 9,153 |   |   | 2 |   |   |   | (6,995 | ) |   | (2 | ) |
| Interest and other expenses, net                                       |   |   | 26,608   |   |     | 7      |   |           |   | 27,811 |   |   | 7 |   |   |   | 31,487 |   |   | 8 |   |
| Loss                    from continuing operations before income taxes |   |   | (11,326  | )      |     | (3     | )      |           |   | (18,658 | ) |   | (5 | ) |   |   | (38,482 | ) |   | (10 | ) |
| Income tax expense (benefit)                                           |   |   | (2,174   | )      |     | (1     | )      |           |   | 1,461 |   |   | - |   |   |   | 1,922 |   |   | - |   |
| Net                    loss applicable to common stockholders          |   | $      | (9,152   | )      |     | (2     | )%     |           | $ |   | (20,119 | ) | (5 | )% |   | $ |   | (40,404 | ) | (10 | )% |  |

 

 

41

 

 

 

 

 

 

Variances in the results of our operations (in thousands) are as        follows:

         

|                                                   |   | **Total**         |   |   |          |   |   |   |   | **Total**         |   |       |   |
|--------------------------------------------------------|--------|-------------------|--------|--------|---------------|--------|--------|--------|--------|-------------------|--------|------------|--------|
|                                                   |   | **Variance**      |   |   |          |   |   |   |   | **Variance**      |   |       |   |
|                                                   |   | **Between the**   |   |   |          |   |   |   |   | **Between the**   |   |       |   |
|                                                   |   | **Years Ended**   |   |   |          |   |   |   |   | **Years Ended**   |   |       |   |
|                                                   |   | **December 31,**  |   |   | **%**         |   |   |   |   | **December 31,**  |   | **%**      |   |
|                                                   |   | **2005 and 2006** |   |   | **Change**    |   |   |   |   | **2006 and 2007** |   | **Change** |   |
| **Revenues**                                           |   |              |   |   |          |   |   |   |   |              |   |       |   |
| Direct call                    provisioning            | $      | 37,246            |   |   | 12.3          | %      |   |   | $      | (3,002            | )      | (0.9       | )%     |
| Solutions                    services                  |   | (1,696            | )      |   | (3.6          | )      |   |   |   | (9,206            | )      | (20.1      | )      |
| Telecommunications                    services         |   | (11,948           | )      |   | (47.2         | )      |   |   |   | (5,708            | )      | (42.7      | )      |
| Offender management                    software        |   | -       |   |   | -   |   |   |   |   | 7,933             |   | 100.0      |   |
| Equipment sales and                    other           |   | (208              | )      |   | (15.7         | )      |   |   |   | (657              | )      | (59.0      | )      |
| Total revenue                                          |   | 23,394            |   |   | 6.2           |   |   |   |   | (10,640           | )      | (2.7       | )      |
| Total cost of                    service               |   | 19,817            |   |   | 6.9           |   |   |   |   | (7,929            | )      | (2.6       | )      |
| Selling, general and                    administrative |   | 3,933             |   |   | 8.1           |   |   |   |   | 6,033             |   | 11.5       |   |
| Severance and                    restructuring costs   |   | (633              | )      |   | (100          | )      |   |   |   | 614               |   | 100.0      |   |
| Depreciation and                    amortization       |   | 6,406             |   |   | 27.3          |   |   |   |   | 6,790             |   | 22.4       |   |
| Total operating costs and                    expenses  |   | 29,523            |   |   | 8.2           |   |   |   |   | 5,508             |   | 1.4        |   |
| Operating income                    (loss)             | $      | (6,129            | )      |   | (40.1         | )      |   |   | $      | (16,148           | )      | (176.4     | )      |

 

***Results of Operations for the Year Ended        December*** ***31, 2007 Compared        to December*** ***31,        2006***

         

***Revenues***

         

Compared to the year ended December 31, 2006, consolidated revenues        decreased for the year ended December 31, 2007 by $10.6 million, or 2.7 %, to $390.0        million. The primary components of the decrease in revenues are discussed below:

         

| **•** | Direct call provisioning revenues                    decreased $3.0 million, or 0.9 %, to $337.4 million primarily due                    to: |
|------------|----------------------------------------------------------------------------------------------------------------------------------------------------|
|       |                                                                                                                                               |
|       | -                                                                                                                                                  | A reduction of $3.9 million as a                    result of the loss of a prime business contract with the Alabama Department of                    Corrections. |
|       |                                                                                                                                               |
|       | -                                                                                                                                                  | A reduction of $4.5 million due                    to the transition of the State of Pennsylvania interim contract to 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 and expired in                    the second quarter of 2007 |
|       |                                                                                                                                               |

 

 

42

 

 

 

|       | -                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             | An increase in new prime business                    contracts won from competitors, net of accounts not renewed, of approximately                    $5.3 million, offset by the introduction of more restrictive credit policies                    designed to reduce bad debt. We were awarded the State of Arizona and Cook                    County, Illinois in late 2007 and the installation of these accounts is                    expected in the second quarter of 2008. Together, they are estimated at $18                    million of annual revenue. 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 completed installation in December. We expect this                    contract to generate a minimum of approximately $3 million of revenue per                    quarter starting in the first quarter of 2008 |
|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| **•** | Solutions services revenues                    decreased by $9.2 million, or 20.1 %, to $36.5 million. Solutions services                    revenues declined primarily due to terminations of service by Global Tel*Link                    as their underlying facility contracts expired. Solutions services revenues are                    expected to decline in the future because Global Tel*Link has indicated that it                    intends to eliminate our services as contracts expire. Solutions services                    revenues have declined by approximately $0.5 million per quarter for the                    last year and we expect continuing declines of $1.0 million to $2.0 million per                    quarter in the next several quarters                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
|       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| **•** | Telecommunications services                    revenues decreased by $5.7 million, or 42.7%, to $7.7 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 the former AT&T and Verizon from the inmate                    telecommunications market contributed to the decline. We expect the significant                    decline in telecommunication services revenue to continue, although at a more                    gradual rate, through 2008. 

 

Although the                    recent economic downturn has not noticeably impacted our direct call                    provisioning, solutions, or telecommunications services performance, it is                    likely we will see a deterioration if the severity of the downturn in the                    economy intensifies                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
|       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| **•** | Offender management software                    revenues of $7.9 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 Issue No. 01-3, and related rules, Syscon’s balance sheet reflects                    the fair values of assets and liabilities on the acquisition date.                    Consequently, we adjusted Syscon’s existing customer contracts and                    related deferred revenues to fair value, which will decrease the amount of                    booked revenue and profit that we will be able to recognize prospectively. As a                    result , during the period from June 29, 2007 through December 31, 2007, our                    reported revenue and operating profit for offender management software were                    $1.4 million lower than would have been reported had no acquisition occurred,                    representing the current period amortization of the fair value of contracts                    acquired. The majority of our revenues for offender management software are                    currently associated with our ongoing implementation of our software for Her                    Majesty’s Prison Service in the United Kingdom, through a sub-contracting                    agreement with Electronic Data Systems, Inc. Revenues from this contract                    declined in the fourth quarter from the previous quarter by several million                    dollars as a result of the United Kingdom’s desire to conduct a budgetary                    review. We expect revenue to increase from this contract in the upcoming                    quarters based on recent communications by Her Majesty’s Prison Service                    to our representatives, and a significant ramp up has been underway in the                    first quarter of 2008. Revenues from this contract are expected to exceed the                    third quarter of 2007 level on average for the last three quarters of                    2008 |
|       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| **•** | Equipment sales and other                    services revenues represented a minor component of our total                    revenues.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |

 

 

43

 

 

***Cost of Service**.*Total cost of service for the year ended December 31, 2007 decreased by        $7.9 million over cost of service for the year ended December 31, 2006, or 2.6%, to        $300.9 million. The decrease was due primarily to a decline in our operating revenues.        A comparison of the components of our business segment gross margins is provided below        (dollars in thousands):

 

|                                                |     | **Ended December 31,** |     |
|-----------------------------------------------------|----------|------------------------|----------|
|                                                | **2006** |                   | **2007** |
| **Direct Call                    Provisioning**     |     |                   |     |   |   |   |   |   |   |   |   |   |
| Revenue                                             | $        | 340,240                |     |   |   |   | $ | 337,418 |   |   |   |   |
| Cost of                    service                  |     | 267,388                |     | 78.5 | % |   |   | 266,171 |   |   | 78.9 | % |
| Segment gross                    margin             | $        | 73,032                 |     | 21.5 | % |   | $ | 71,247 |   |   | 21.1 | % |
| **Solutions                    Services**           |     |                   |     |   |   |   |   |   |   |   |   |   |
| Revenue                                             | $        | 45,702                 |     |   |   |   | $ | 36,496 |   |   |   |   |
| Cost of                    service                  |     | 34,235                 |     | 74.9 | % |   |   | 24,755 |   |   | 67.8 | % |
| Segment gross                    margin             | $        | 11,467                 |     | 25.1 | % |   | $ | 11,741 |   |   | 32.2 | % |
| **Telecommunications                    Services**  |     |                   |     |   |   |   |   |   |   |   |   |   |
| Revenue                                             | $        | 13,365                 |     |   |   |   | $ | 7,657 |   |   |   |   |
| Cost of                    service                  |     | 6,425                  |     | 48.1 | % |   |   | 3,515 |   |   | 45.9 | % |
| Segment gross                    margin             | $        | 6,940                  |     | 51.9 | % |   | $ | 4,142 |   |   | 54.1 | % |
| **Offender Management                    Services** |     |                   |     |   |   |   |   |   |   |   |   |   |
| Revenue                                             | $        | -            |     |   |   |   | $ | 7,933 |   |   |   |   |
| Cost of                    service                  |     | -            |     | -   | % |   |   | 6,110 |   |   | 77.0 | % |
| Segment gross                    margin             | $        | -            |     | -   | % |   | $ | 1,823 |   |   | 23.0 | % |
| **Equipment Sales and                    Other**    |     |                   |     |   |   |   |   |   |   |   |   |   |
| Revenue                                             | $        | 1,113                  |     |   |   |   | $ | 456 |   |   |   |   |
| Cost of                    service                  |     | 754                    |     | 67.7 | % |   |   | 322 |   |   | 70.6 | % |
| Segment gross                    margin             | $        | 359                    |     | 32.3 | % |   | $ | 134 |   |   | 29.4 | % |

 

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 increased as a        percentage of revenue as a result of an increase in commission expenses due to competitive        market forces. This was offset by declining long distance costs and bad debt expenses due        to cost savings initiatives, tighter credit policies and other bad debt savings initiatives        during 2007.  Bad debt expense improved over the prior year even though it was        negatively impacted by approximately $1.7 million of write-offs associated with        complications of our billing system conversion, and although we received a $0.5 million        insurance settlement related to our losses from Hurricane Katrina in 2006.  In 2007,        we also benefited from a one-time $0.8 million excise tax refund that reduced our cost of        service. Before considering the prevailing economy, we expect total cost of service as a        percentage of revenue to decline in 2008 as we achieve operating efficiencies through our        new packet-based architecture, which will continue to be rolled out over the next several        years.  We also expect to further benefit from cost savings in 2008 as our tighter        credit policies, network optimization and other initiatives will decrease our cost        structure over the long term. Historically, our bad debt has been highly correlated to        unemployment rates. We have also developed statistical methods to identify high risk        customers who we require to prepay. For 2007, approximately 35% of our direct provisioning        revenues were prepaid, and this percentage grew to approximately 39% in the fourth quarter        of 2007. With the recent economic downturn, it is possible that bad debt results could        deteriorate. Because our bad debt visibility is delayed by, on average, six to nine months,        risk exists that we will incur future write-offs and that our bad debt will increase. Thus        far, we have not experienced such an increase in our realized results.

         

Cost of service in our solutions segment as a percentage of our revenue        decreased from 74.9% to 67.8% as a result of our bad debt savings initiatives. Cost of        service is a more volatile component of solutions services relative to our other business        units because most of the cost is comprised of bad debt expense. As noted above, with the        recent economic downturn, bad debt may increase in the future.

         

 

44

 

 

Cost of service in our telecommunications segment as a percentage of revenue        decreased from 48.1% to 45.9 % 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 77.0 % and 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 decreased as a        percentage of revenue due to the variable profitability arising from declining sales        volumes.

         

***SG&A***. SG&A expenses of $58.4        million were $6.0 million, or 11.5%, higher than the year ended December 31, 2006.         The increase was due primarily to (a) incremental Syscon SG&A of $2.6 million (b) $1.0        million of excise taxes representing gross receipts taxes that were not able to be passed        on to consumers, which related primarily to our interim contract with the State of        Pennsylvania, (c) $0.9 million higher legal fees related to various lawsuits, (d) $0.5        million of bonuses related to the closing of the Syscon acquisition, (e) $0.5 million        higher software maintenance costs related to our new packet-based architecture, (f) a $0.5        million settlement of a dispute with a former telecommunications service partner relating        to prior years, (g) $0.3 million of personnel costs associated with severance and death        benefits to the family of an executive, (h) $0.2 million in lease exit costs to close a        warehouse, and (i) higher personnel-related costs due to rising healthcare costs and cost        of living increases. These increases were partially offset by a $2.1 million        lower employee bonus accrual impacting the fourth quarter.  We also spent $0.8        million for Sarbanes Oxley cost in 2007.

         

In the fourth quarter, SG&A was $12.8 million, which included $1.3        million of Syscon SG&A. The $12.8 million included a $0.6 million unusual excise tax        charge. However, legal fees were only $0.7 million in the fourth quarter after averaging        $1.9 million per quarter for the first three quarters of 2007. In the first quarter of 2008        a significant intellectual property suit went to trial. Accordingly, we expect legal fees        to increase in the first quarter of 2008. The fourth quarter of 2007 also reflected a        $2.1 million reversal of employee bonuses.

 

***Severance and Restructuring Costs.***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.

         

***Depreciation and Amortization Expenses***.        Depreciation and amortization expenses were $37.0  million for the year ended December        31, 2007 and increased $6.8  million over the year ended December 31, 2006. The        increase was attributable to depreciation and amortization related to additions to property        and equipment and intangible assets and a change in the estimated useful life of certain        telecommunications equipment related to our new packet-based architecture. The change in        the useful life increased depreciation expense by $1.9 million in 2007. Additionally, 2007        depreciation and amortization includes $1.9 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, of $31.5 million for the year ended December 31, 2007        increased by $3.7 million over the year ended December 31, 2006. 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 $1.5 million.

         

***Income Tax Expense*****.**We had income tax expense of $1.5 million and $1.9 million for the years        ended December 31, 2006 and December 31, 2007, respectively. We can generate tax expense        despite operating losses principally due to changes in deferred tax balances.

         

 

45

 

 

 

***Results of Operations for the Year Ended        December*** ***31, 2006 Compared        to December*** ***31,        2005***

         

***Total Revenues**.*Compared to the year ended December 31, 2005, consolidated revenues        increased for the year ended December 31, 2006 by $23.4 million, or 6.2%, to        $400.6 million. The primary components of the increase in revenues are discussed        below:

         

| **•** | Direct call provisioning revenues                    increased $37.2 million, or 12.3%, to $340.4 million primarily due                    to                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
|       | -                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               | New prime business contracts won                    from competitors, net of accounts not renewed, of approximately                    $24.9 million; and |
|       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
|       | -                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               | New prime business with the State                    of Pennsylvania of $10.2 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 |
|       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
| **•** | Solutions services revenues                    decreased by $1.7 million, or 3.6%, to $45.7 million. Solutions                    services revenues declined primarily due to terminations of service by Global                    Tel*Link as their underlying facility contracts expired                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
|       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
| **•** | Telecommunications services                    revenues decreased by $11.9 million, or 47.2%, to $13.4 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 the former AT&T and Verizon from the inmate                    telecommunications market and resulting sale of those businesses to our                    competitors contributed to the decline |
|       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
| **•** | Equipment sales and other                    services revenues represented a minor component of our total                    revenues                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |

         

***Cost of Services**.*Total cost of service for the year ended December 31, 2006 increased by        $19.8 million over cost of service for the year ended December 31, 2005, or 6.9%, to        $308.8 million. The increase was due primarily to the change in the mix of our        operating revenues. 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 and solutions services businesses than in the        telecommunications services and equipment sales businesses.

         

Cost of service in our direct provisioning business decreased as a        percentage of revenue primarily as a result of declining bad debt expense and declining        long distance costs, due to our cost savings initiatives and overall marketplace trends.        These benefits were partially offset by higher costs associated with the addition of the        State of Pennsylvania account, coupled with increases in commission expense and billing        costs. In the fourth quarter of 2006, our insurance carrier agreed to reimburse us for        costs associated with Hurricane Katrina in the amount of $0.5 million, which substantially        offset seasonally higher bad debt expense. We have received the majority of final bad debt        write-offs related to Hurricane Katrina from our local exchange carrier billing agents and        we believe we are adequately reserved to cover any remaining exposure.

         

Cost of service in our solutions segment as a percentage of our revenue        improved as a result of favorable bad debt trends. Cost of service is a more volatile        component of solutions services relative to our other business units because most of the        cost is comprised of bad debt expense.

         

Cost of service in our telecommunications segment as a percentage of revenue        increased as a result of the changing mix of contracts as a significant number of accounts        were deinstalled. Cost of service in the telecommunications segment is expected to be        relatively stable in the future, although some quarter to quarter variance is        expected.

         

 

46

 

 

Cost of service in our equipment sales and other segment increased as a        percentage of revenue due to the settlement of a customer dispute.

         

***SG&A.***SG&A expenses of        $52.3 million for the year ended December 31, 2006 were $3.9 million, or 8.2%,        higher than the year ended December 31, 2005. The increase in expense was due primarily to        $2.6 million higher legal fees incurred in 2006 primarily as a result of several        ongoing intellectual property lawsuits, $0.9 million higher costs incurred to comply        with the requirements of Sarbanes Oxley Act of 2002, and $0.5 million signing bonus paid to        our Chief Executive Officer in conjunction with the execution of a new employment contract        in the fourth quarter of 2006. We incurred approximately $1.4 million of SG&A expenses        in 2006 related to our ongoing efforts to comply with the Sarbanes Oxley Act of        2002.

         

***Depreciation and Amortization        Expenses**.*Depreciation and amortization        expenses were $30.3 million for the year ended December 31, 2006 and increased        $6.4 million over the year ended December 31, 2005. The increase was attributable to        depreciation and amortization related to additions to property and equipment and intangible        assets consisting primarily of investments required for growth in the direct provisioning        business, back-office systems as a result of merger consolidation and cost saving        initiatives, investments in a new packet-based architecture, and investments in new        products and services.

         

***Interest and Other Expenses, Net**.*Interest and other expenses, net of $27.8 million for the year ended        December 31, 2006 increased by $1.2 million over the year ended December 31, 2005. The        increase relates primarily to the increasing principal on the Senior Subordinated notes due        to interest being paid-in-kind.

         

***Income Tax Expense (Benefit).***We had        income tax expense of $1.4 million for the year ended December 31, 2006 and had a        $2.2 million tax benefit for the year ended December 31, 2005.

 

**Liquidity and Capital Resources**

 

***General***

         

Our principal liquidity requirements are to service and repay our debt and        meet our capital expenditure and operating needs. We are significantly leveraged. As of        December 31, 2007, we had $268.8 million in total debt outstanding before considering $3.1        million of original issue discount on our second-priority senior secured notes and        $2.5 million of fair value attributable to warrants issued (See Note 9, for issuance        of warrants) in connection with our senior subordinated debt financing, both of which are        reflected as discounts to our outstanding long-term debt on our financial statements. As of        December 31, 2007, we had unused capacity of $19.5 million under our working capital        credit facility and total stockholders’ deficit of $88.9 million.

         

The indenture for our Second-priority Senior Secured Notes requires us to        maintain a Credit Facility Coverage Ratio above 1.75. For the quarter ended September 30,        2007, we did not maintain the required ratio. 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 indenture provides that two consecutive quarters of        non-compliance with the Credit Facility Coverage Ratio will cause a default. The definition        of the Credit Facility Coverage Ratio provides that the proceeds from equity we issued are        added to Credit Facility Cash Flow. In order to avoid a default under the indenture, we        issued $10.2 million of Series A Redeemable Convertible Preferred Stock to our        stockholders. We also failed to comply with certain financial covenants for the third        quarter of 2007 required by our revolving credit facility.  We were not in compliance        with the Minimum EBITDA covenant which requires us to maintain $35.0 million of trailing        twelve month EBITDA (as defined) and the Interest Coverage Ratio which requires a ratio of        EBITDA (as defined) to Cash Interest (as defined) above 1.75.  These ratios are        required to be calculated on a pro forma basis for the impact of acquisitions, such as the        acquisition of Syscon in June 2007.   The revolving credit facility lenders        waived this non-compliance for the period ended September 30, 2007 and amended the        revolving credit facility to allow equity we issue to be added to EBITDA for the fourth        quarter of 2007 through 2008.   Although we expect to be in full compliance with        our credit facilities and to be able to meet our obligations through 2008, there is no        guarantee that the proceeds of the preferred stock issuance will prevent a future default        under our credit facilities.

 

47

 

 

Our accounts receivable decreased on a net basis by approximately $13.4        million as of December 31, 2007 compared to December 31, 2006.  The decline was        primarily due to a reduction in our telecommunications and solutions revenues and an        increase in our prepaid revenues.  The lower accounts receivable balance has resulted        in a reduction in the amount we can borrow under our revolving credit facility.

 

***Cash Flows***

         

The following table provides our cash flow data for the years ended        December 31, 2005, 2006 and 2007 (in thousands):

|                                                                    |   |   | **For the Year Ended December 31,** |   |
|-------------------------------------------------------------------------|--------|--------|-------------------------------------|--------|
|                                                                    |   |   | **2005**                            |   |   |   | **2006** |   |   |   | **2007** |   |
| Net cash provided by operating                    activities            |   | $      | 29,832                              |   |   | $ | 19,080 |   |   | $ | 20,459 |   |
| Net cash used in investing                    activities                |   | $      | (26,327                             | )      |   | $ | (27,126 | ) |   | $ | (64,000 | ) |
| Net cash provided by (used                    in)

financing activities |   | $      | (2,754                              | )      |   | $ | 5,974 |   |   | $ | 46,506 |   |

 

Net cash provided by operating activities was $29.8 million, $19.1        million, and $20.5 million for the years December 31, 2005, December 31, 2006 and December        31, 2007, respectively. Net cash provided by operating activities of $20.5 million        consisted of operating income of $30.1 million before considering non-cash depreciation and        amortization of $37.0 million, and $9.1 million of working capital benefit, principally due        to a change in the billing system, which resulted in quicker transmissions of invoice data        to our billing agents in 2007, coupled with an increase in prepaid revenues, offset by        $18.7 million of cash interest.

         

Cash used in investing activities was $26.3 million, $27.1 million and        $64.0 million for the year ended December 31, 2005, 2006 and 2007, respectively. In June        2007, we utilized $43.7 million in connection with the acquisition of Syscon. Additionally,        cash used in investing activities represents an investment of $21.4 million in equipment        and intangibles to maintain and grow the direct call provisioning business. We experienced        a decline of $5.8 million in capital spending from 2006 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 architecture over the next several years.

         

Cash used in financing activities was $2.8 million for the year ended        December 31, 2005 and cash provided by financing activities was $6.0 million and $46.5        million for the years ended December 31, 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 $5.3        million of financing costs related to the issuance, $0.4 million of which was a        non-cash consent added to the principal balance of the Senior Subordinated Notes. Net draws        on our revolving credit facility increased by $1.8 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 have used to fund Syscon’s operations, and is to be        repaid.

         

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, which, to a certain extent, is subject to general economic, financial, competitive,        legislative, regulatory and other factors that are beyond our control. Based on our current        and expected level of operations, we believe our cash flow from operations, available cash        and available borrowings under our $30.0 million working capital facility will be        adequate to meet our liquidity needs for our operations for the foreseeable future. In the        event we wish to make additional acquisitions, we may need to seek additional financing. We        cannot assure you, however, that our business will generate sufficient cash flow from        operations or that future borrowings will be available to us under our working capital        facility in an amount sufficient to enable us to service our indebtedness or to fund our        other liquidity needs. In the event that cash in excess of the amounts generated from        on-going business operations and available under our working capital facility is required        to fund our operations, we

 

48

 

 

may be        required to reduce or eliminate discretionary capital expenditures, further reduce or        eliminate discretionary selling, general and administrative costs, and sell or close        certain of our operations.

         

***Debt        and other Obligations***

         

*Revolving Credit Facility*— We have a        revolving credit facility 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 revolving credit facility        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.  Letters of credit outstanding reduce our availability to the extent they        exceed $10.0 million and the borrowing base collateral, as defined by our revolving        credit facility, principally comprised of receivables and inventory less defined reserves,        falls below $40 million.  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 the revolving credit facility 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 revolving credit facility bore interest at our option using the        prime rate, which was 8.25% at December 31, 2006 and 7.25% as of December 31, 2007, as        well as an advance of $5.0 million based on the Eurodollar Rate, which was 6.97% as of        December 31, 2007. We draw from the available credit on the revolving credit facility to        cover normal business cash requirements.  As of December 31, 2006 and        December 31, 2007, we had $26.8 million and $19.5 million, respectively, of borrowing        availability under the revolving credit facility.

         

*Second-priority Senior Secured Notes*— We        have $194.0 million of 11% Second-priority Senior Secured Notes outstanding, $154.0 of        which were issued on September 9, 2004 at a discount of $3.6 million, or 97.651%. and        $40.0 million of which were issued on June 29, 2007 at a discount of $0.9 million, or        97.651% of face value. The 2007 notes were issued to finance the acquisition of        Syscon.

         

All $194.0 million of the 11% Second-priority Senior Secured Notes is due        September 9, 2011. To the extent we generate excess cash flow (as defined in the        indenture) in any calendar year, we are required by the Second-priority Senior Secured        Notes to offer to repay principal equal to 75% of such excess cash flow at a rate of 104%        of face value.  No excess cash flow payment was due for the years ended        December 31, 2006 and December 31, 2007 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*— We have $70        million of Senior Subordinated Notes outstanding. They are unsecured and subordinate to the        revolving credit facility, and bear interest at an annual rate of 17%. Interest is payable        at the end of each calendar quarter, or, as restricted by our working capital 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. A mandatory prepayment equal to $20.0 million plus 50% of all        outstanding interest paid-in-kind is due on September 9, 2013. In connection with the        issuance of the Senior Subordinated Notes, we issued warrants to acquire 51.01 shares of        our common stock at an exercise price of $10 per share to the Senior Subordinated Note        holders. 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. During the year ended December 31, 2007, $10.7 million of paid-in-kind        interest was added to the principal balance of the Senior Subordinated Notes. The effective        interest rate is 18.76 % on the Senior Subordinated Notes. In order to enter into        additional financing to complete the Syscon acquisition, we incurred a non-cash consent fee        of $0.4 million payable to the Senior Subordinated Noteholders. This fee was added to the        principal balance of the Senior Subordinated Notes.

         

All of our domestic subsidiaries and certain of our foreign subsidiaries        (the “Subsidiary Guarantors”) are fully, unconditionally, and jointly and        severably liable for our revolving credit facility, Senior Subordinated Notes and        Second-priority Senior Secured Notes. The Subsidiary Guarantors are wholly-

 

49

 

 

owned. We        have not included separate financial statements of our subsidiaries because (a) the        aggregate assets, liabilities, earnings and equity are presented on a consolidated basis        and (b) we believe that separate financial statements and other disclosures concerning        subsidiaries are not material to investors.

 

Our credit facilities contain financial and operating covenants, 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 we fail to comply with the covenants and restrictions, as        specified in the credit agreements, we may be in default, at which time payment of the long        term debt and unpaid interest may be accelerated and become immediately due and        payable.

         

***Capital Requirements***

         

As of December 31, 2007, our contractual obligations and commitments on        an aggregate basis are as follows:

|                                                                  |   | **Payments by Period** |
|-----------------------------------------------------------------------|--------|------------------------|
|                                                                  |   |                   | **2008** |   |   | **2009** |   |   | **2010** |   |   | **2011** |   |   | **2012** |   |   | **Thereafter** |
| Long-term debt (1)                                                    |   | $                      | - |   | $ | 5,000 |   | $ | - |   | $ | 194,000 |   | $ | - |   | $ | 69,834 |
| Unrecognized tax                    benefits                          |   |                   | -   |   |   | -   |   |   | -   |   |   | -   |   |   | -   |   |   | 663 |
| Operating leases                                                      |   |                   | 2,439 |   |   | 2,299 |   |   | 1,889 |   |   | 1,617 |   |   | 1,409 |   |   | 3,032 |
| Total contractual cash                    obligations and commitments |   | $                      | 2,439 |   | $ | 7,299 |   | $ | 1,889 |   | $ | 195,617 |   | $ | 1,409 |   | $ | 73,529 |

         

| **(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. Assumes                    no repurchases of second-priority senior secured notes or senior subordinated                    notes during such periods.  Also does not give effect to mandatory                    purchases of second-priority senior secured notes, if any, with excess cash                    flow |
|---------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

         

**Critical        Accounting Policies**

         

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

         

| **•** | 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.

         

         

 

50

 

 

***Revenue Recognition and Bad Debt Reserve Estimates***

         

Revenues related to collect and prepaid calling services generated by the        direct call provisioning segment are recognized during the period in which the calls are        made. In addition, during the same period, we accrue the related telecommunication costs        for validating, transmitting, billing and collection, and line and long distance charges,        along with commissions payable to the facilities and allowances for unbillable and        uncollectible calls, based on historical experience.

         

Revenues related to the telecommunication services and solutions services        segments are recognized in the period in which the calls are processed through the billing        system, or when equipment and software is sold. During the same period, we accrue the        related telecommunications costs for validating, transmitting, and billing and collection        costs, along with allowances for unbillable and uncollectible calls, as applicable, based        on historical experience.

         

We apply Emerging Issues Task Force (“EITF”) Issue        No. 99-19,*Reporting Revenue Gross as a Principal versus net        as an Agent.*Based on this consensus, all revenues related to the        Telecommunications Services and Solutions Services segments are presented in the statement        of operations at the net amount. In the case of Solution Services, this is the amount        charged to the end user customer less the amount paid to the inmate telecommunication        provider.

         

Revenues related to the Offender Management software is recognized under        Statement of Position 97-2,*Software Revenue        Recognition*, as amended. Revenue is recognized when the fair        value of vendor specific objective evidence (“VSOE”) is determined. If the VSOE        of fair value cannot be determined for any undelivered element or any undelivered element        is essential to the functionality of the delivered element, revenue is deferred until such        criteria are met or recognized as the last element is delivered. Under the residual method,        the fair value of the undelivered elements is deferred and the difference between the total        arrangement fee and the amount recorded as deferred revenue for the undelivered elements is        recognized as revenue related to the delivered elements.

 

Services related to the implementation, customization, and modification of        software are not separable and are essential to the functionality for the customer.        Accordingly, we account for the combined upfront software license fee and customization        revenue under contract accounting, recognizing revenue and related costs using the        percentage-of-completion method in accordance with AICPA Statement of Position 81-1,*Accounting for Performance of Construction-Type and Certain        Production-Type Contracts*. The percentage of completion is        calculated using hours incurred to date compared to total estimated hours to complete the        project. Our estimates are based upon the knowledge and experience of its project managers        and other personnel, who review each project to assess the contracts schedule, performance,        technical matters and estimated hours to complete. When the total cost estimate exceeds        revenue, the estimated project loss is recognized immediately. Support contracts, which        require the our ongoing involvement, are billed in advance and recorded as deferred revenue        and amortized over the term of the contract, typically one year.

         

We applied EITF Issue No. 01-13,*Income Statement        Display of Business Interruption Insurance Recoveries,*for a        $0.5 million business interruption insurance settlement in 2006 related to Hurricane        Katrina.

         

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 of our receivables        are collected through our LEC billing agents and such agents typically do not

 

51

 

 

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.

 

***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 FASB Statement 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 FASB Statement No. 144,*Accounting for Impairment 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***

         

We recognize deferred tax assets and liabilities for the expected future tax        consequences of transactions and events. Under this method, deferred tax assets and        liabilities are determined based on the difference between the financial statement and tax        bases of assets and liabilities using enacted tax rates in effect for the year in which the        differences are expected to reverse. If necessary, deferred tax assets are reduced by a        valuation allowance to an amount that is determined to be more likely than not recoverable.        We must make significant estimates and assumptions about future taxable income and future        tax consequences when determining the amount of the valuation allowance.

         

***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 significance of the business acquisitions that we have completed,        we believe that the recording of acquired assets and liabilities is a critical accounting        policy.

         

**Financial Reporting Changes**

 

See Note 1, paragraph (u) of the Consolidated Financial Statements for        information about recent accounting pronouncements.

         

***ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE        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 credit facility would have had an effect of about        $0.1 million on our interest expense for 2007.

 

52

 

 

**Report        of Independent Registered Public Accounting Firm**

 

 

The Board        of Directors and Stockholders

Securus        Technologies, Inc.:

 

We have audited the accompanying consolidated balance sheets of Securus        Technologies, Inc. and subsidiaries as of December 31, 2006 and 2007, and the related        consolidated statements of operations, stockholders’ deficit and comprehensive loss,        and cash flows for each of the years in the three-year period ended December 31, 2007.        These consolidated financial statements are the responsibility of the Company’s        management. Our responsibility is to express an opinion on these consolidated financial        statements based on our audits.

         

We conducted our audits in accordance with the standards of the Public        Company Accounting Oversight Board (United States). Those standards require that we plan        and perform the audit to obtain reasonable assurance about whether the financial statements        are free of material misstatement. An audit includes examining, on a test basis, evidence        supporting the amounts and disclosures in the financial statements. An audit also includes        assessing the accounting principles used and significant estimates made by management, as        well as evaluating the overall financial statement presentation. We believe that our audits        provide a reasonable basis for our opinion.

         

In our opinion, the consolidated financial statements referred to above        present fairly, in all material respects, the financial position of Securus Technologies,        Inc. and subsidiaries as of December 31, 2006 and 2007, and the results of its        operations and its cash flows for each of the years in the three-year period ended        December 31, 2007, in conformity with U.S. generally accepted accounting        principles.

         

As discussed in Note 1 to the consolidated financial statements, the Company        adopted the provisions of Financial Accounting Standards Board Interpretation No.        48,*Accounting for Uncertainty in Income        Taxes*, on January 1, 2007 and adopted the provisions of Statement        of Financial Accounting Standards No.123(R),*Share-Based        Payment*, on January 1, 2006.

         

KPMG        LLP

Dallas,        Texas

March 27,        2008

 

 

 

53

 

 

***ITEM        8. CONSOLIDATED FINANCIAL STATEMENTS***

 

**SECURUS TECHNOLOGIES, INC.**  **AND SUBSIDIARIES**

**CONSOLIDATED BALANCE SHEETS**

**(Amounts in thousands, except share and per share amounts)**

 

|                                                                                                                                                                                                                                                                                | **December 31,** |    |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------------|---------|
|                                                                                                                                                                                                                                                                                | **2006**         |    |   | **2007** |   |
| **ASSETS**                                                                                                                                                                                                                                                                          |             |    |   |   |   |   |   |
| Cash and cash equivalents                                                                                                                                                                                                                                                           | $                | 558     |   |   | $ | 2,072 |   |
| Restricted cash                                                                                                                                                                                                                                                                     |             | 1,461   |   |   |   | 1,535 |   |
| Accounts receivable, net                                                                                                                                                                                                                                                            |             | 64,174  |   |   |   | 50,788 |   |
| Prepaid expenses                                                                                                                                                                                                                                                                    |             | 5,063   |   |   |   | 5,437 |   |
| Current deferred income taxes                                                                                                                                                                                                                                                       |             | 5,155   |   |   |   | 3,034 |   |
| Total current assets                                                                                                                                                                                                                                                                |             | 76,411  |   |   |   | 62,866 |   |
| Property and equipment, net                                                                                                                                                                                                                                                         |             | 46,429  |   |   |   | 40,797 |   |
| Intangibles and other assets, net                                                                                                                                                                                                                                                   |             | 98,873  |   |   |   | 119,427 |   |
| Goodwill                                                                                                                                                                                                                                                                            |             | 37,936  |   |   |   | 69,035 |   |
| Total assets                                                                                                                                                                                                                                                                        | $                | 259,649 |   |   | $ | 292,125 |   |
|                                                                                                                                                                                                                                                                                |             |    |   |   |   |   |   |
| **LIABILITIES, REDEEMABLE, CONVERTIBLE PREFERRED STOCK AND                    STOCKHOLDERS’ DEFICIT**                                                                                                                                                                         |             |    |   |   |   |   |   |
| Accounts payable                                                                                                                                                                                                                                                                    | $                | 42,728  |   |   | $ | 28,161 |   |
| Due to related party                                                                                                                                                                                                                                                                |             | -       |   |   |   | 1,000 |   |
| Accrued liabilities                                                                                                                                                                                                                                                                 |             | 39,395  |   |   |   | 40,188 |   |
| Deferred revenue and customer advances                                                                                                                                                                                                                                              |             | 8,801   |   |   |   | 16,674 |   |
| Current deferred income taxes                                                                                                                                                                                                                                                       |             | -       |   |   |   | 1,261 |   |
| Total current liabilities                                                                                                                                                                                                                                                           |             | 90,924  |   |   |   | 87,284 |   |
| Deferred income taxes                                                                                                                                                                                                                                                               |             | 8,262   |   |   |   | 15,352 |   |
| Due to related party, net                                                                                                                                                                                                                                                           |             | -       |   |   |   | 3,510 |   |
| Long-term debt                                                                                                                                                                                                                                                                      |             | 210,642 |   |   |   | 263,276 |   |
| Other long-term liabilities                                                                                                                                                                                                                                                         |             | 1,694   |   |   |   | 1,593 |   |
| Total liabilities                                                                                                                                                                                                                                                                   |             | 311,522 |   |   |   | 371,015 |   |
| Commitments and contingencies                                                                                                                                                                                                                                                       |             |    |   |   |   |   |   |
|                                                                                                                                                                                                                                                                                |             |    |   |   |   |   |   |
| Series A redeemable convertible preferred stock, $2,000 stated                    value, total redemption value $10,200,000; 5,100 shares authorized: zero shares                    outstanding at December 31, 2006 and 5,100 outstanding at December 31,                    2007 |             | -       |   |   |   | 9,971 |   |
|                                                                                                                                                                                                                                                                                |             |    |   |   |   |   |   |
| Stockholders’ deficit:                                                                                                                                                                                                                                                        |             |    |   |   |   |   |   |
| Common stock, $0.001 stated value; 1,290,000 shares authorized;                    610 shares issued and outstanding at December 31, 2006;  677 shares issued                    and outstanding at December 31, 2007                                                          |             | 6       |   |   |   | 7 |   |
| Additional paid-in capital                                                                                                                                                                                                                                                          |             | 34,140  |   |   |   | 35,620 |   |
| Accumulated other comprehensive income                                                                                                                                                                                                                                              |             | -       |   |   |   | 1,935 |   |
| Accumulated deficit                                                                                                                                                                                                                                                                 |             | (86,019 | ) |   |   | (126,423 | ) |
| Total stockholders’ deficit                                                                                                                                                                                                                                                   |             | (51,873 | ) |   |   | (88,861 | ) |
| Total liabilities, redeemable, convertible preferred                    stock and stockholders’ deficit                                                                                                                                                                  | $                | 259,649 |   |   | $ | 292,125 |   |

 

See        accompanying notes to consolidated financial statements.

 

54

 

 

**SECURUS TECHNOLOGIES, INC.**  **AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF OPERATIONS**

**For        the Years Ended December** **31, 2005,        2006 and 2007**

**(Amounts in thousands)**

 

 

|                                                                                                        | **For the Year Ended December 31,** |     |
|-------------------------------------------------------------------------------------------------------------|-------------------------------------|----------|
|                                                                                                        |                                | **2005** |   |   |   | **2006** |   |   |   | **2007** |   |
| **Revenue**:                                                                                                |                                |     |   |   |   |   |   |   |   |   |   |
| Direct call                    provisioning                                                                 | $                                   | 303,174  |   |   | $ | 340,420 |   |   | $ | 337,418 |   |
| Solutions                    services                                                                       |                                | 47,398   |   |   |   | 45,702 |   |   |   | 36,496 |   |
| Telecommunication                    services                                                               |                                | 25,313   |   |   |   | 13,365 |   |   |   | 7,657 |   |
| Offender management                    software                                                             |                                | -        |   |   |   | - |   |   |   | 7,933 |   |
| Equipment sales and                    other                                                                |                                | 1,321    |   |   |   | 1,113 |   |   |   | 456 |   |
| Total revenue                                                                                               |                                | 377,206  |   |   |   | 400,600 |   |   |   | 389,960 |   |
| **Cost of service (exclusive of depreciation and amortization                    shown separately below):** |                                |     |   |   |   |   |   |   |   |   |   |
| Direct call provisioning,                    exclusive of bad debt expense                                  |                                | 200,483  |   |   |   | 226,558 |   |   |   | 228,395 |   |
| Direct call provisioning                    bad debt expense                                                |                                | 38,878   |   |   |   | 40,830 |   |   |   | 37,776 |   |
| Solutions                    expense                                                                        |                                | 37,816   |   |   |   | 34,235 |   |   |   | 24,755 |   |
| Telecommunication                    services                                                               |                                | 11,489   |   |   |   | 6,425 |   |   |   | 3,515 |   |
| Offender management                    software                                                             |                                | -        |   |   |   | - |   |   |   | 6,110 |   |
| Cost of equipment sold                    and other                                                         |                                | 319      |   |   |   | 754 |   |   |   | 322 |   |
| Total cost of                    service                                                                    |                                | 288,985  |   |   |   | 308,802 |   |   |   | 300,873 |   |
| Selling, general and                    administrative                                                      |                                | 48,454   |   |   |   | 52,387 |   |   |   | 58,420 |   |
| Severance and restructuring                    costs                                                        |                                | 633      |   |   |   | - |   |   |   | 614 |   |
| Depreciation and                    amortization                                                            |                                | 23,852   |   |   |   | 30,258 |   |   |   | 37,048 |   |
| Total operating costs and                    expenses                                                       |                                | 361,924  |   |   |   | 391,447 |   |   |   | 396,955 |   |
| Operating income                    (loss)                                                                  |                                | 15,282   |   |   |   | 9,153 |   |   |   | (6,995 | ) |
| Interest and other expenses,                    net                                                         |                                | 26,608   |   |   |   | 27,811 |   |   |   | 31,487 |   |
| Loss before income                    taxes                                                                 |                                | (11,326  | ) |   |   | (18,658 | ) |   |   | (38,482 | ) |
| Income tax expense                    (benefit)                                                             |                                | (2,174   | ) |   |   | 1,461 |   |   |   | 1,922 |   |
| Net loss                                                                                                    | $                                   | (9,152   | ) |   | $ | (20,119 | ) |   | $ | (40,404 | ) |

 

See        accompanying notes to consolidated financial statements.

 

55

 

 

**SECURUS TECHNOLOGIES, INC.**  **AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ DEFICIT**

**AND COMPREHENSIVE INCOME**

**For        the Years Ended December** **31, 2005,        2006 and 2007**

**(Amounts in thousands, except share amounts)**

 

|                                                                               |   |          |   |   |   |          |   |   |   |           |   |   |   |            |   |   |   | **Accumulated**   |   |   |   |                    |   |
|------------------------------------------------------------------------------------|--------|---------------|--------|--------|--------|---------------|--------|--------|--------|----------------|--------|--------|--------|-----------------|--------|--------|--------|-------------------|--------|--------|--------|-------------------------|--------|
|                                                                               |   |          |   |   |   |          |   |   |   | **Additional** |   |   |   |            |   |   |   | **Other**         |   |   |   | **Total**               |   |
|                                                                               |   | **Common**    |   |   |   |          |   |   |   | **Paid-In**    |   |   |   | **Accumulated** |   |   |   | **Comprehensive** |   |   |   | **Stockholders’** |   |
|                                                                               |   | **Shares**    |   |   |   | **Amount**    |   |   |   | **Capital**    |   |   |   | **Deficit**     |   |   |   | **Income**        |   |   |   | **Deficit**             |   |
| Balance at December 31,                    2004                                    |   | 561           |   |   | $      | 5             |   |   | $      | 33,902         |   |   | $      | (56,748         | )      |   | $      | -       |   |   | $      | (22,841                 | )      |
| Restricted stock                    grants                                         |   | 36            |   |   |   | -   |   |   |   | -    |   |   |   | -     |   |   |   | -       |   |   |   | -             |   |
| Stock based                    compensation                                        |   | -   |   |   |   | -   |   |   |   | 125            |   |   |   | -     |   |   |   | -       |   |   |   | 125                     |   |
| Net loss                                                                           |   | -   |   |   |   | -   |   |   |   | -    |   |   |   | (9,152          | )      |   |   | -       |   |   |   | (9,152                  | )      |
| Balance at December 31,                    2005                                    |   | 597           |   |   | $      | 5             |   |   | $      | 34,027         |   |   | $      | (65,900         | )      |   | $      | -       |   |   | $      | (31,868                 | )      |
| Restricted stock                    grants                                         |   | 13            |   |   |   | 1             |   |   |   | -    |   |   |   | -     |   |   |   | -       |   |   |   | 1                       |   |
| Stock based                    compensation                                        |   | -   |   |   |   | -   |   |   |   | 113            |   |   |   | -     |   |   |   | -       |   |   |   | 113                     |   |
| Net loss                                                                           |   | -   |   |   |   | -   |   |   |   | -    |   |   |   | (20,119         | )      |   |   | -       |   |   |   | (20,119                 | )      |
| Balance at December 31,                    2006                                    |   | 610           |   |   | $      | 6             |   |   | $      | 34,140         |   |   | $      | (86,019         | )      |   | $      | -       |   |   | $      | (51,873                 | )      |
| Issuance of common stock in                    conjunction with Syscon acquisition |   | 45            |   |   | $      | 1             |   |   | $      | 1,413          |   |   | $      | -     |   |   | $      | -       |   |   | $      | 1,414                   |   |
| Stock based                    compensation                                        |   | -   |   |   |   | -   |   |   |   | 67             |   |   |   | -     |   |   |   | -       |   |   |   | 67                      |   |
| Exercise of warrants                                                               |   | 14            |   |   |   | -   |   |   |   | -    |   |   |   | -     |   |   |   | -       |   |   |   | -             |   |
| Restricted stock                    grants                                         |   | 11            |   |   |   | -   |   |   |   | -    |   |   |   | -     |   |   |   | -       |   |   |   | -             |   |
| Forfeitures of restricted                    stock                                 |   | (3            | )      |   |   | -   |   |   |   | -    |   |   |   | -     |   |   |   | -       |   |   |   | -             |   |
| Foreign currency                    translation                                    |   | -   |   |   |   | -   |   |   |   | -    |   |   |   | -     |   |   |   | 1,935             |   |   |   | 1,935                   |   |
| Net loss                                                                           |   | -   |   |   |   | -   |   |   |   | -    |   |   |   | (40,404         | )      |   |   | -       |   |   |   | (40,404                 | )      |
| Total comprehensive                    loss                                        |   |          |   |   |   |          |   |   |   |           |   |   |   |            |   |   |   |              |   |   |   | (38,469                 | )      |
| Balance at December 31,                    2007                                    |   | 677           |   |   | $      | 7             |   |   | $      | 35,620         |   |   | $      | (126,423        | )      |   | $      | 1,935             |   |   | $      | (88,861                 | )      |

 

 

See        accompanying notes to consolidated financial statements.

 

56

 

 

**SECURUS TECHNOLOGIES, INC.**  **AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

**For        the Years Ended December** **31, 2005,        2006 and 2007**

**(Amounts in thousands)**

 

|                                                                                                                          | **For the Year Ended** |     |
|-------------------------------------------------------------------------------------------------------------------------------|------------------------|----------|
|                                                                                                                          |                   | **2005** |   |   |   | **2006** |   |   |   | **2007** |   |
| **CASH FLOWS FROM OPERATING ACTIVITIES FROM CONTINUING                    OPERATIONS:**                                       |                   |     |   |   |   |   |   |   |   |   |   |
| Net                    loss from continuing operations                                                                        | $                      | (9,152   | ) |   | $ | (20,119 | ) |   | $ | (40,404 | ) |
| Adjustments to reconcile net loss to net cash provided by                    operating activities from continuing operations: |                   |     |   |   |   |   |   |   |   |   |   |
| Depreciation and amortization                                                                                                 |                   | 23,852   |   |   |   | 30,258 |   |   |   | 37,048 |   |
| Amortization of fair value of contracts acquired                                                                              |                   | -        |   |   |   | - |   |   |   | 1,360 |   |
| Deferred income taxes                                                                                                         |                   | (2,368   | ) |   |   | 1,123 |   |   |   | 922 |   |
| Conversion of interest paid “in kind” to secured                    subordinated notes                            |                   | 7,629    |   |   |   | 9,011 |   |   |   | 10,678 |   |
| Equity (income) loss from unconsolidated affiliate                                                                            |                   | (231     | ) |   |   | (354 | ) |   |   | 102 |   |
| Stock based compensation                                                                                                      |                   | 125      |   |   |   | 113 |   |   |   | 67 |   |
| Amortization of deferred financing costs and debt                    discounts                                                |                   | 1,340    |   |   |   | 1,550 |   |   |   | 2,251 |   |
| Changes in operating assets and liabilities, net of effects of                    acquisitions:                               |                   |     |   |   |   |   |   |   |   |   |   |
| Restricted cash                                                                                                               |                   | (49      | ) |   |   | (65 | ) |   |   | (74 | ) |
| Accounts receivable                                                                                                           |                   | 4,318    |   |   |   | (994 | ) |   |   | 20,459 |   |
| Prepaid expenses and other current assets                                                                                     |                   | (1,093   | ) |   |   | 596 |   |   |   | 191 |   |
| Other assets                                                                                                                  |                   | 62       |   |   |   | (727 | ) |   |   | 376 |   |
| Accounts payable                                                                                                              |                   | (865     | ) |   |   | (6,630 | ) |   |   | (11,251 | ) |
| Accrued liabilities                                                                                                           |                   | 6,264    |   |   |   | 5,318 |   |   |   | (1,266 | ) |
| Net cash provided by operating activities from continuing                    operations                                       | $                      | 29,832   |   |   | $ | 19,080 |   |   | $ | 20,459 |   |
|  

**CASH FLOWS FROM INVESTING ACTIVITIES:**                                                                             |                   |     |   |   |   |   |   |   |   |   |   |
| Purchase of property and equipment and intangible                    assets                                                   | $                      | (26,327  | ) |   | $ | (27,176 | ) |   | $ | (21,356 | ) |
| Cash                    consideration paid for acquired business                                                              |                   | -        |   |   |   | - |   |   |   | (43,717 | ) |
| Dividends received from affiliated company                                                                                    |                   | -        |   |   |   | 50 |   |   |   | - |   |
| Proceeds from sale of unconsolidated affiliate                                                                                |                   | -        |   |   |   | - |   |   |   | 985 |   |
| Property insurance proceeds                                                                                                   |                   | -        |   |   |   | - |   |   |   | 88 |   |
| Net cash used in investing activities                                                                                         | $                      | (26,327  | ) |   | $ | (27,126 | ) |   | $ | (64,000 | ) |

 

See        accompanying notes to consolidated financial statements.

 

 

 

57

 

 

**SECURUS TECHNOLOGIES, INC.**  **AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF CASH        FLOWS** **—** **(Continued)**

**For        the Years Ended December** **31, 2005,        2006 and 2007**

**(Amounts in thousands)**

 

|                                                                              |   |   |     |   |   |   |     |   |   |   |     |   |
|-----------------------------------------------------------------------------------|--------|--------|----------|--------|--------|--------|----------|--------|--------|--------|----------|--------|
|                                                                              |   |   | **2005** |   |   |   | **2006** |   |   |   | **2007** |   |
| **CASH FLOWS FROM FINANCING ACTIVITIES:**                                         |   |   |     |   |   |   |     |   |   |   |     |   |
| Proceeds from issuance of second-priority senior secured                    notes |   | $      | -        |   |   | $      | -        |   |   | $      | 39,060   |   |
| Cash                    overdraft                                                 |   |   | (1,598   | )      |   |   | 2,856    |   |   |   | (3,958   | )      |
| Net                    advances on revolving credit facility                      |   |   | -        |   |   |   | 3,225    |   |   |   | 1,775    |   |
| Debt                    issuance costs                                            |   |   | (1,039   | )      |   |   | -        |   |   |   | (4,853   | )      |
| Proceeds from loan payable to related party, net                                  |   |   | -        |   |   |   | -        |   |   |   | 4,510    |   |
| Payments on other debt                                                            |   |   | (117     | )      |   |   | (108     | )      |   |   | -        |   |
| Proceeds from issuance of common stock                                            |   |   | -        |   |   |   | 1        |   |   |   | 1        |   |
| Proceeds from issuance of Series A preferred stock                                |   |   | -        |   |   |   | -        |   |   |   | 10,200   |   |
| Series A preferred stock                    issuance costs                        |   |   | -        |   |   |   | -        |   |   |   | (229     | )      |
| Net cash provided by (used                    in) financing activities            |   | $      | (2,754   | )      |   | $      | 5,974    |   |   | $      | 46,506   |   |
| Effect of exchange rates on cash and cash equivalents                             |   |   | -        |   |   |   | -        |   |   |   | (1,451   | )      |
| Increase (decrease) in cash and equivalents                                       |   | $      | 751      |   |   | $      | (2,072   | )      |   | $      | 1,514    |   |
| Cash and cash equivalents at beginning of period                                  |   |   | 1,879    |   |   |   | 2,630    |   |   |   | 558      |   |
| Cash and cash equivalents at end of period                                        |   | $      | 2,630    |   |   | $      | 558      |   |   | $      | 2,072    |   |
|  

**SUPPLEMENTAL DISCLOSURES:**                                             |   |   |     |   |   |   |     |   |   |   |     |   |
| Cash                    paid during the period for:                               |   |   |     |   |   |   |     |   |   |   |     |   |
| Interest                                                                          |   | $      | 17,240   |   |   | $      | 17,483   |   |   | $      | $18,715  |   |
| Income taxes                                                                      |   | $      | 213      |   |   | $      | 266      |   |   | $      | 239      |   |
|  

**NONCASH FINANCING AND INVESTING ACTIVITIES:**                           |   |   |     |   |   |   |     |   |   |   |     |   |
| Non-Cash consent fee                                                              |   | $      | -        |   |   | $      | -        |   |   | $      | 400      |   |
| Leasehold improvements                                                            |   | $      | 1,800    |   |   | $      | -        |   |   | $      | -        |   |

 

See        accompanying notes to consolidated financial statements.

 

 

 

 

 

58

 

 

**SECURUS TECHNOLOGIES, INC. AND SUBSIDIARIES**

**NOTES        TO CONSOLIDATED FINANCIAL STATEMENTS**

 

**(1)** **BUSINESS AND        SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES**

         

Securus Technologies, Inc. and its subsidiaries (the “Company”        or “we”) provide inmate telecommunications services to correctional facilities        operated by city, county, state and federal authorities and other types of confinement        facilities in 47 states. The Company was incorporated in Delaware on January 12, 2004,        and effective March 3, 2004 and September 9, 2004, acquired, all of the        outstanding equity interests of T-Netix, Inc. (“T-Netix”) and Evercom Holdings,        Inc. (“Evercom”), respectively. On June 29, 2007, the Company acquired, as        further discussed in Note 2, 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 United        Kingdom and Australia. Syscon is included in the results of operations beginning on June        29, 2007.

         

***(a)*** ***Basis of Presentation***

         

During the periods presented, the Company had four reportable segments:        Direct Call Provisioning, Solutions Services, Telecommunications Services, and Equipment        Sales. Beginning on June 29, 2007, the Company acquired Syscon and added a fifth segment,        the Offender Management sofware segment. In this segment, the Company provides platform        systems that allow facility managers and law enforcement personnel to analyze data to        reduce costs, prevent and solve crimes and facilitate rehabilitation through a single user        interface. The system provides correctional facilities and law enforcement with the ability        to manage and monitor inmate parole and probation activity and development at a        sophisticated level. The software is licensed, installed and supported through our office        in Vancouver BC and by staff in the field primarily in Canada, the United States, Australia        and the United Kingdom. The Offender Management software business will complement the        direct call provisioning business and the two segments have comparable margins.

         

In the Direct Call Provisioning segment, the Company accumulates call        activity from our various installations and bill revenue related to this call activity        through major local exchange carriers (“LECs”) or through third-party billing        services for smaller volume LECs, all of which are granted credit in the normal course of        business with payment terms between 30 to 60 days. The Company performs ongoing        customer credit evaluations and maintains allowances for unbillable and uncollectible        amounts based on historical experience.  The Company also generates a significant        amount of our Direct Call Provisioning revenues on a prepaid basis. Deferred revenue is        recorded for customer prepayments prior to usage.

         

In the Solutions Services segment, the Company provides validation, fraud        and bad debt management, and billing services to other telecommunications service providers        such as Global Tel*Link and Embarq. In providing Solutions Services, the Company typically        assumes all risk of bad debt associated with the customers’ inmate telecommunications        revenues and all costs of billing and collection. In return, the Company earns a fee        generally based on a percentage of the providers’ gross customer revenues generated        from their inmate telecommunications businesses.

         

In the Telecommunications Services segment, the Company provides inmate        telecommunication software and equipment for correctional facilities, including        security-enhanced call processors and call validation and bill processing systems for        inmate calling. Depending upon the contractual relationship at the site and the type of        customer, the Company provides these products and services through service agreements with        other telecommunications services providers, such as Global Tel*Link, AT&T and Embarq.        Under these agreements, the Company generates revenue over a specified contract term. In        addition, the Company sells inmate call processing systems to certain telecommunication        providers and in these cases records Equipment Sales revenue and related cost of goods sold        when revenue is earned.

         

         

 

59

 

 

         

***(b)*** ***Principles of Consolidation***

         

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

         

***(c)*** ***Liquidity***

         

The Company’s principal liquidity requirements are to service and        repay debt and meet the Company’s capital expenditure and operating needs. The        Company’s ability to make payments on and to refinance indebtedness, and to fund        planned capital expenditures will depend on the Company’s ability to generate cash in        the future and its ability to maintain compliance under the Company’s credit        facilities, which, to a certain extent, is subject to general economic, financial,        competitive, legislative, regulatory and other factors that are beyond the Company’s        control. If we cannot meet our debt service and repayment obligations, we would be in        default under the terms of the agreements governing our debt, which would allow the lenders        under our revolving credit facility to declare all borrowings outstanding to be due and        payable, which would in turn, trigger an event of default under the indenture agreement and        the agreement governing our senior subordinated debt.  In the event that cash in        excess of the amounts generated from on-going business operations and available under the        credit facilities or through equity contributions from stockholders is required to fund        operations, the Company may be required to reduce or eliminate discretionary selling,        general and administrative costs, and sell or close certain operations.

         

***(d)*** ***Accounting Estimates***

         

The preparation of 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 financial statements        and the reported amounts of revenue and expenses during the reporting period. Significant        items subject to such estimates include the valuation allowances for receivables, the        carrying amount for property and equipment, goodwill, intangible and other assets, and        deferred income taxes. Actual results could differ from those estimates.

         

In the first quarter of 2007, the Company reduced its estimate of the useful        life of certain telecommunications equipment to reflect the installation, over the next        several years, of the Company’s new packet-based architecture. The change in the        depreciation period increased net loss by approximately $1.9 million for the year        ended December 31, 2007.

         

***(e)*** ***Risks and Uncertainties***

         

The Company generated approximately 8% of revenue from its largest customer        for the year ended December 31, 2007. The loss of this major customer could adversely        affect the Company’s operating results. Thirty four percent (34%) of the        Company’s telecommunications segment revenue was generated from this customer for the        year ended December 31, 2007. Seventy four percent (74%) of the solutions segment        revenue was generated from this customer for the year ended December 31, 2007. In        2004, the Company became aware of the intentions of its largest customer to exit the inmate        telecommunications market. The Company also became aware that a second customer, which was        the largest customer in the Company’s telecommunications services reporting segment,        also intended to exit the inmate telecommunications market. As a result, the Company        recorded a non-cash impairment charge in 2004. These two customers did exit the inmate        telecommunications market in 2005 by selling their businesses to competitors. As a result,        the Company’s revenues for both the telecommunications segment and the solutions        segment have been declining over the last several years and this trend is expected to        continue.

         

The Company had no customers that provided over 10% of our revenue during        the years ended December 31, 2006 and December 31, 2007.

 

60

 

 

 

         

***(f)*** ***Cash and Cash Equivalents and Restricted Cash***

         

Cash equivalents consist of highly liquid investments, such as certificates        of deposit and money market funds, with original maturities of 90 days or less.        Additionally, restricted cash accounts represent amounts established for the benefit of        certain customers in the event the Company does not perform under the provisions of the        respective underlying contract with these customers. Restricted cash was $1.5million at December 31, 2006 and December 31, 2007.

         

***(g)*** ***Trade Accounts Receivable***

         

Trade accounts receivable are recorded at the invoice amount and do not bear        interest. The majority of trade accounts receivable represent amounts billed or that will        be billed for calls placed through our telephone systems. The majority of these receivables        are billed using various LECs or third-party billing services and are reported net of an        allowance for unbillable and uncollectible calls for estimated chargebacks to be made by        the LECs and clearinghouses. The Company maintains an allowance for doubtful accounts for        estimated losses resulting from a customer’s inability to make payments on accounts        and it is net of amounts held by the LECs for estimated charge backs. The Company analyzes        the collectibility of a majority of its accounts receivables based on a 12-month average of        historical collections. The allowance for doubtful accounts is the Company’s best        estimate of the amount of probable credit losses in its existing accounts receivable. Our        policy is to write-off accounts after 180 days from invoice date, or after all        collection efforts have failed.

 The        following table includes the activity related to our allowance for doubtful accounts (in        thousands):

|                                                    | **For the Year Ended December 31,** |     |
|---------------------------------------------------------|-------------------------------------|----------|
|                                                    |                                | **2005** |   |   |   | **2006** |   |   |   | **2007** |   |
| Balance beginning of                    period          | $                                   | 13,232   |   |   | $ | 19,402 |   |   | $ | 15,045 |   |
| Opening balance of acquired                    business |                                | -        |   |   |   | -   |   |   |   | 115 |   |
| Additions charged to                    expense         |                                | 62,069   |   |   |   | 62,091 |   |   |   | 52,062 |   |
| Accounts written-off                                    |                                | (55,899  | ) |   |   | (66,448 | ) |   |   | (55,716 | ) |
| Balance at end of                    period             |                                | 19,402   |   |   |   | 15,045 |   |   |   | 11,507 |   |

 

***(h)*** ***Fair Value of Financial Instruments***

         

Statement of Financial Accounting Standards (“SFAS”)        No. 107,*Disclosure about Fair Value of Financial        Instruments*, requires certain disclosures regarding the fair        value of financial instruments. Cash and cash equivalents, receivables, accounts payable,        and accrued liabilities, approximate fair value due to their short maturities. Carrying        amounts and estimated fair value of debt are presented in Note 5.

         

***(i)*** ***Concentrations of Credit Risk***

         

Financial instruments, which potentially expose the Company to        concentrations of credit risk, consist primarily of cash and cash equivalents and accounts        receivable. The Company’s revenues are primarily concentrated in the United States in        the telecommunications industry. The Company had trade accounts receivable that comprised        42.1% (two telecommunication service providers) of trade accounts receivable at        December 31, 2007. The Company does not require collateral on accounts receivable        balances and provide allowances for potential credit losses. An allowance for doubtful        accounts has been established based on historical experience and management’s        evaluation of collectibility of outstanding accounts receivable at the end of the        accounting period.

         

 

61

 

 

The Company has significant revenue contracts denominated in US dollars and        UK pounds. Syscon uses the Canadian dollar as its functional currency. Fluctuations in        exchange rates between these currencies and the Canadian dollar could have a material        effect on the business, financial condition and results of operations. The Company has not        entered into any derivative contracts to mitigate the impact of foreign currency        fluctuations.

         

***(j)*** ***Property and Equipment***

         

Property and equipment is stated at cost and includes costs necessary to        place such property and equipment in service. Major renewals and improvements that extend        an asset’s useful life are capitalized, while repairs and maintenance are charged to        operations as incurred. Construction in progress represents the cost of material purchases        and construction costs for telecommunications hardware systems in various stages of        completion.

         

Depreciation is computed by the straight-line basis using estimated useful        lives of 3 to 5 years for telecommunications equipment, office and computer equipment        and furniture and fixtures. No depreciation is recorded on construction in progress until        the asset is placed in service.

         

***(k)*** ***Goodwill and Intangible and Other Assets***

         

Goodwill represents the excess of the purchase price over the fair value of        identifiable net assets acquired in business combinations accounted for as purchases.        Intangible and other assets include acquired operating contracts and customer agreements,        capitalized computer software, patents and license rights, patent application costs,        trademarks, trade names and other intellectual property, capitalized loan costs, deposits        and long-term prepayments and other intangible assets. The Company capitalizes interest        costs associated with internally developed software based on the effective interest rate on        aggregate borrowings. The Company capitalized interest in the amount of $0.2 million for        each of the years ended December 31, 2006 and December 31, 2007. No interest was        capitalized for the year ended December 31, 2005. The Company capitalized contract        acquisition costs representing up-front payments required by customers as part of the        competitive process to award a contract. These capitalized costs are included in operating        contracts and customer agreements and are commonly referred to as signing bonuses in the        industry.

         

We perform an annual impairment test of goodwill and other intangible assets        with indefinite useful lives as of the last day of each fiscal year in accordance with the        provisions of SFAS No. 142,*Goodwill and Other Intangible        Assets.*This test is a two-step process and requires goodwill to        be allocated to the Company’s reporting units. We define our reporting units to be        the same as the reportable segments (see Note 6). In the first step, the fair value of the        reporting unit is compared with the carrying value of the reporting unit. If the fair value        of the reporting unit is less than the carrying value, a goodwill impairment may exist and        the second step of the test is performed. In the second step, the implied fair value of the        goodwill is compared with the carrying value of the goodwill. An impairment loss is        recognized to the extent that the carrying value of the goodwill exceeds the implied fair        value of the goodwill. We recognize an impairment loss by reducing the carrying value of        the asset to its estimated fair value.

         

The Company also reviews intangible assets and other long-lived assets for        impairment in accordance with SFAS No. 144,*Accounting for        Impairment or Disposal of Long-Lived Assets*, whenever events or        changes in circumstances indicate that the carrying value of these assets may not be        recoverable. In reviewing for impairment, the carrying value of such assets is compared to        the estimated undiscounted future cash flows expected from the use of the assets and their        eventual disposition. When the estimated undiscounted future cash flows are less than their        carrying amount, an impairment loss is recognized equal to the difference between the        assets’ fair value and the respective carrying values.

         

Amortization is computed on the straight-line basis over 3 to 12 years        for operating contracts and customer agreements and patents and license rights. The        weighted average amortization period for all of the intangible assets as of the year ended        December 31, 2007, subject to amortization, is nine years. Amortization expense        was $13.1 million, $16.5 million and $18.9 million for the years ended        December 31, 2005, 2006 and 2007, respectively.   

 

62

 

 

         

The acquisition of Syscon has been accounted for using the purchase method        of accounting pursuant to SFAS No. 141,*Accounting for        Business Combinations.*As a result, the costs of acquiring Syscon        have been allocated to the assets acquired and liabilities assumed based upon estimated        fair values (See Note 2). The purchase price allocations resulted in the initial recording        of $28.9 million of goodwill (See Note 4). None of the goodwill is currently        deductible for income tax purposes.

         

***(l)*** ***Impairment of Long-Lived Assets***

         

In accordance with SFAS No. 144, long-lived assets, such as property,        plant, and equipment and purchased intangibles subject to amortization, are reviewed for        impairment whenever events or changes in circumstances indicate that the carrying amount of        an asset may not be recoverable. Recoverability of assets to be held and used is measured        by a comparison of the carrying amount of an asset to estimated undiscounted future cash        flows expected to be generated by the asset. If the carrying amount of an asset exceeds its        estimated future cash flows, an impairment charge is recognized by the amount by which the        carrying amount of the asset exceeds the fair value of the asset. Assets to be disposed of        would be separately presented in the balance sheet and reported at the lower of the        carrying amount or fair value less costs to sell, and are no longer depreciated. The assets        and liabilities of a disposal group classified as held for sale would be presented        separately in the appropriate asset and liability sections of the balance sheet.

         

***(m)*** ***Investments in Affiliated Companies***

         

Beginning with our adoption of SFAS No. 142, the excess of cost of the        stock of those affiliates over our share of their net assets at the acquisition date was        recognized as goodwill and is not being amortized. The Company would recognize a loss when        there is a loss in value in the equity method investment, which is other than a temporary        decline.

         

Investment in the common stock of Accudata Technologies, Inc.        (“Accudata”), an affiliated company owned 50% by us, was accounted for by the        equity method, and was included in the consolidated balance sheet as “Intangibles and        other assets, net” at December 31, 2006. Equity income (loss) in the results of        operations were $0.2 million, $0.4 million and ($0.1) million for the year ended        December 31, 2005, December 31, 2006 and December 31, 2007, respectively, and was        included in the consolidated statements of operations as “Interest and other        expenses, net”.

 

On August 9, 2007, Accudata purchased our 50% interest in its preferred        stock for $1.0 million. In connection with the sale of its stock, the Company agreed to        continue to conduct business with Accudata 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.

         

***(n)*** ***401(k) Plan***

         

The Company sponsors a 401(k) savings plan for the benefit of eligible        full-time employees. This plan is a qualified benefit plan in accordance with the Employee        Retirement Income Security Act (“ERISA”). Employees participating in the plan        can generally make contributions to the plan of up to 15% of their compensation. The plan        provides for the Company to make discretionary matching contributions of up to 50% of an        eligible employee’s contribution for the first 6%. Matching contributions and plan        expenses were $0.5 million, $0.5 million, and $0.6 million for the years ended        December 31, 2005, 2006 and 2007, respectively.

         

***(o)*** ***Income Taxes***

         

The Company accounts for income taxes under the provisions of SFAS        No. 109,*Accounting for Income        Taxes*. Under SFAS 109, deferred tax assets and liabilities are        recognized for the future tax consequences attributable to differences between the        financial statement carrying amounts of existing assets and liabilities and their        respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets        and liabilities are measured using enacted income tax rates expected to apply to taxable        income

 

63

 

 

in the        years in which those differences are expected to be recovered or settled. The effect on        deferred tax assets and liabilities of a change in income tax rates is recognized in the        results of operations in the period that includes the enactment date.

As of January 1, 2007, the Company adopted the provisions of Financial        Interpretation No. 48,*Accounting for Uncertainty in Income        Taxes—an Interpretation of FASB Statement No.* *109*(“FIN 48”). FIN 48 addresses        the determination of whether tax benefits claimed or expected to be claimed on a tax return        should be recorded in the financial statements. Under FIN 48, the tax benefit from an        uncertain tax position may be recognized only if it is more likely than not that the tax        position will be sustained on examination by the taxing authorities. The determination is        based on the technical merits of the position and presumes that each uncertain tax position        will be examined by the relevant taxing authority that has full knowledge of all relevant        information. The adoption of these provisions did not have any impact on our financial        condition or results of operations (See Note 7).

         

***(p)*** ***Stock-Based Compensation***

         

Prior to January 1, 2006, the Company utilized the intrinsic-value method as        provided by Accounting Principles Board Opinion (“APB”)        No. 25,*Accounting for Stock Issued to Employees,*in accounting for the Company’s stock options and restricted stock        plans and provide pro forma disclosure of the compensation expense determined under the        fair value provisions of SFAS No. 123,*Accounting for        Stock-Based Compensation*, as amended by SFAS No. 148,*Accounting for Stock-Based Compensation — Transition and        Disclosure.*

         

On January 1, 2006, the Company adopted SFAS No. 123R,        “*Share-Based Payment*”, which requires share-based compensation to be        recognized based on the grant date estimated fair value of each award, net of estimated        cancellations, over the employee’s requisite service period, which is generally the        vesting period of the equity grant. The Company elected to adopt SFAS No. 123R using the        modified prospective method, which requires compensation expense to be recorded for all        unvested share-based awards beginning in the first quarter of adoption. Accordingly, the        prior period presented in this Form 10-K has not been restated to reflect the fair value        method of expensing stock options. Also, because the value used to measure compensation        expense for unvested shares is the same for APB Opinion No. 25 and SFAS No. 123R, the        adoption of SFAS No. 123R did not have a material impact on our operating income, loss        before income taxes, net loss, or cash flows from operations or financing.

         

The Company recorded compensation expense of $0.1 million for each of the        three years ended December 31, 2005, 2006, and 2007 related to purchases of restricted        stock by certain executives and members of the board of directors (See Note 9).

         

***(q)*** ***Revenue Recognition***

         

Revenues related to collect and prepaid calling services generated by the        direct call provisioning segment are recognized during the period in which the calls are        made. In addition, during the same period, the Company accrued the related        telecommunication costs for validating, transmitting, billing and collection, and line and        long distance charges, along with commissions payable to the facilities and allowances for        unbillable and uncollectible calls, based on historical experience.

         

Revenues related to the telecommunication services and solutions services        segments are recognized in the period in which the calls are processed through the billing        system, or when equipment and software is sold. During the same period, the Company accrued        the related telecommunications costs for validating, transmitting, and billing and        collection costs, along with allowances for unbillable and uncollectible calls, as        applicable, based on historical experience.

         

The Company applies Emerging Issues Task Force (“EITF”) Issue        No. 99-19,*Reporting Revenue Gross as a Principal versus net        as an Agent.*Based on this consensus, all revenues related to the        Telecommunications Services and Solutions Services segments are presented in the statement        of operations

 

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at the net        amount. In the case of Solution Services, this is the amount charged to the end user        customer less the amount paid to the inmate telecommunication provider.

         

Revenues related to the Offender Management software is recognized under        Statement of Position 97-2,*Software Revenue        Recognition*, as amended. Revenue is recognized when the fair        value of vendor specific objective evidence (“VSOE”) is determined. If the VSOE        of fair value cannot be determined for any undelivered element or any undelivered element        is essential to the functionality of the delivered element, revenue is deferred until such        criteria are met or recognized as the last element is delivered. Under the residual method,        the fair value of the undelivered elements is recorded as deferred and the difference        between the total arrangement fee and the amount recorded as deferred revenue for the        undelivered elements is recognized as revenue related to the delivered elements.

 

Services related to the implementation, customization, and modification of        software are not separable and are essential to the functionality for the customer.        Accordingly, the Company accounts for the combined upfront software license fee and        customization revenue under contract accounting, recognizing revenue and related costs        using the percentage-of-completion method in accordance with AICPA Statement of Position        81-1, *Accounting for Performance of Construction-Type and Certain Production-Type        Contracts*. The percentage of completion is calculated using hours incurred to date        compared to total estimated hours to complete the project. The Company estimates are based        upon the knowledge and experience of its project managers and other personnel, who review        each project to assess the contracts schedule, performance, technical matters and estimated        hours to complete. When the total cost estimate exceeds revenue, the estimated project loss        is recognized immediately. Support contracts, which require our ongoing involvement, are        billed in advance and recorded as deferred revenue and amortized over the term of the        contract, typically one year.

         

The Company applied EITF Issue No. 01-13,*Income        Statement Display of Business Interruption Insurance Recoveries,*for a $0.5 million business interruption insurance settlement in 2006        related to Hurricane Katrina.

         

***(r)*** ***Foreign Currency Translation and Transaction Gains and        Losses***

         

Assets and liabilities of the non-U.S. subsidiary whose functional currency        is not the U.S. dollar are translated at the current exchange rates. Revenue and expense        accounts are translated using an average rate for the period. Translation gains and losses        are not included in determining net income, but are reflected in the comprehensive income        component of shareholders’ deficit.

The Company has transactions in functional currencies other than its        functional currency. Transaction gains and losses are recorded in the consolidated        statement of operations relating to the recurring remeasurement and settlement of such        transactions. As of December 31, 2007, included in other income on the Company’s        consolidated statement of operations was a $1.5 million gain related to foreign currency        transactions. There were no such transactions in 2005 or 2006.

         

***(s)*** ***Comprehensive Income***

         

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 year ended December 31, 2005, December 31, 2006        and December 31, 2007 was $9.2 million, $20.1 million, and $38.5 million, respectively.        Other comprehensive income or loss includes a $1.9 million foreign currency translation        gain in 2007. No other comprehensive income or loss was recorded in 2005 or        2006.

         

***(t)*** ***Commitments and Contingencies***

         

Liabilities        for loss contingencies, not within the scope of SFAS No. 143,*Accounting for Asset Retirement Obligations*,        arising from claims, assessments, litigation, fines, and penalties and other sources are        recorded when it is probable that a liability has been incurred and the amount of the        assessment and/or remediation

 

65

 

 

can be        reasonably estimated. Recoveries of environmental remediation costs from third parties,        which are probable of realization, are separately recorded as assets, and are not offset        against the related environmental liability, in accordance with FASB Interpretation        No. 39,*Offsetting of Amounts Related to Certain        Contracts*. Legal fees related to loss contingencies are expensed        as services are received.

 

***(t)*** ***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 the Company guarantees a minimum purchase        commitment over a two to three year period. Management has reviewed the agreements and        believes the fair value to be zero. The minimum amount payable under this guarantee totaled        $6.0 million at December 31, 2007.

         

***(u)*** ***Recently Issued Accounting Pronouncements***

         

In September 2006, the SEC issued Staff Accounting Bulletin        (“SAB”) No. 108,*Considering the Effects of Prior Year        Misstatement when Quantifying Misstatements in Current Year Financial        Statements*. SAB 108 addresses the views of the SEC staff        regarding the process of quantifying financial statements misstatements. SEC registrants        are expected to reflect the effects of initially applying the guidance in SAB 108 in their        annual financial statements covering the first fiscal year ending November 15, 2006. The        cumulative effect of the initial application should be reported in the carrying amounts of        assets and liabilities as of the beginning of that fiscal year and the offsetting        adjustment should be made to the opening balance of retained earnings for that year. The        Company adopted the interpretations in SAB 108 in the fourth quarter of 2006. The adoption        of SAB 108 did not have a material impact on the consolidated financial        statements.

         

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 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.        In February 2008, the FASB issued FSP No. FAS 157-2, *Effective Date of FASB Statement        No. 157*, which delays the effective date of SFAS No. 157 for one year for all        nonfinancial assets and nonfinancial liabilities, except those that are recognized or        disclosed at fair value in the financial statements on at least an annual basis. The        Company will be required to adopt SFAS No. 157 in the first quarter of fiscal year        2009.

         

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

 

66

 

 

after        November 15, 2007. The Company has the option of adopting SFAS No. 159 on        January 1, 2008. An evaluation has not been completed as to the effect SFAS        No. 159 would have on the company if adopted.

         

In December 2007, the FASB issued SFAS No. 141R,*Business Combinations,*which requires, the        acquiring entity in a business combination to recognize the full fair value of the assets        acquired, liabilities assumed and any noncontrolling interest as of the acquisition date;        the immediate expense recognition of transaction costs; and accounting for restructuring        plans separately from the business combination. This Statement applies prospectively to        business combinations for which the acquisition date is on or after the beginning of the        first annual reporting period beginning on or after December 15, 2008. Early adoption        is prohibited.

         

**(2)** **MERGERS AND        ACQUISITIONS**

         

On June 29, 2007, the Company 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 $41        million in cash and 45.6 shares of Securus Common Stock, subject to a working capital        adjustment. In addition, the Company 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 former stockholder still remains an employee.  Any        additional payments made will be reflected as compensation expense in the statement of        operations.  No additional consideration has been recognized as of        December 31, 2007 as it is not probable that payment will be required related to the        first year 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. The Company will pay Syscon’s previous        stockholder up to $5.0 million as Syscon generates Net Cash Flow (as defined in the        Purchase Agreement).  Approximately $0.4 million was paid in 2007,        $1.0 million is expected to be paid in 2008, and the remainder is to be paid in        2009.

         

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 United Kingdom’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. An        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 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 of the expected future returns to shareholders. Under this        method, each class of stock is modeled with a distinct claim on the shareholders' equity        value in us, creating three call options with various liquidation preference values that        represent significant milestones for our 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.

         

         

 

67

 

 

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

         

|   | **Purchase                    Price Calculation:**           |   |   |   |   |
|--------|--------------------------------------------------------------|--------|--------|--------|--------|
|   | Payment for                    tendered shares               | $      | 41,000 |   |   |
|   | Costs incurred                    related to the acquisition |   | 2,717  |   |   |
|   | Value of                    common stock                     |   | 1,414  |   |   |
|   |                                                         | $      | 45,131 |   |   |
|   | **Allocation of Purchase                    Price**:         |   |   |   |   |
|   | Accounts                    receivable, net                  | $      | 5,981  |   |   |
|   | Prepaid                    expenses and other assets         |   | 1,606  |   |   |
|   | Property, plant                    and equipment             |   | 886    |   |   |
|   | Goodwill                                                     |   | 28,948 |   |   |
|   | Intangibles                                                  |   | 25,728 |   |   |
|   | Accounts                    payable                          |   | (511   | )      |   |
|   | Accrued                    expenses                          |   | (2,398 | )      |   |
|   | Deferred                    revenue                          |   | (6,350 | )      |   |
|   | Net deferred                    tax liability                |   | (8,759 | )      |   |
|   | Total Allocation                                             | $      | 45,131 |   |   |

 

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.

         

|          |   | **For the Year Ended** |   |
|---------------|--------|------------------------|--------|
|          |   | **December 31,**       |   |   | **December 31,** |   |
|          |   | **2006**               |   |   | **2007** |   |
| Total revenue | $      | 421,418                |   | $ | 401,650 |   |
| Net loss      | $      | (29,498                | )      | $ | (44,959 | ) |

 

 

**(3)** **BALANCE        SHEET COMPONENTS**

         

Accounts receivable, net consist of the following at December 31 (in        thousands):

         

|   |                                                     |   | **2006** |    |   | **2007** |   |    |
|--------|----------------------------------------------------------|--------|----------|---------|--------|----------|--------|---------|
|   | **Accounts receivable,                    net:**         |   |     |    |   |     |   |    |   |   |
|   | Trade accounts                    receivable             |   | $        | 75,045  |   |     | $      | 59,684  |   |   |
|   | Advanced commissions                    receivable       |   |     | 3,306   |   |     |   | 2,347   |   |   |
|   | Other                    receivables                     |   |     | 868     |   |     |   | 263     |   |   |
|   |                                                     |   |     | 79,219  |   |     |   | 62,294  |   |   |
|   | Less: Allowance for                    doubtful accounts |   |     | (15,045 | )      |     |   | (11,506 | ) |   |
|   |                                                     |   | $        | 64,174  |   |     | $      | 50,788  |   |   |

 

Direct call provisioning bad debt expense for the year ended December 31,        2005 was $38.9 million or 12.8% of direct call provisioning revenue of $303.2 million. For        year ended, December 31, 2006, direct call provisioning bad debt expense was        $40.8 million or 12.0% of direct call provisioning revenue of $340.4 million.        Direct call provisioning bad debt expense for the year ended December 31, 2007 was $37.8        million or 11.2% of direct call provisioning revenue of $337.4 million.

         

At December 31, 2006 and December 31, 2007, the Company had        advanced commissions to certain facilities totaling $3.3 million and        $2.3 million, respectively, which are recoverable from such facilities as a

 

68

 

 

reduction        of earned commissions for specified monthly amounts. Amounts included in accounts        receivable represent the estimated recoverable amounts during the next fiscal        year.

 

Property and equipment, net consists of the following at December 31        (in thousands):

         

|   |                                                               |   | **2006** |    |   | **2007** |   |
|--------|--------------------------------------------------------------------|--------|----------|---------|--------|----------|--------|
|   | **Property and equipment,                    net:**                |   |     |    |   |     |   |   |   |
|   | Telecommunications                    equipment                    |   | $        | 47,420  |   |     | $      | 58,302 |   |
|   | Leasehold                    improvements                          |   |     | 3,400   |   |     |   | 3,555 |   |
|   | Construction in                    progress                        |   |     | 6,727   |   |     |   | 4,639 |   |
|   | Office                    equipment                                |   |     | 13,842  |   |     |   | 15,721 |   |
|   |                                                               |   |     | 71,389  |   |     |   | 82,217 |   |
|   | Less: Accumulated                    depreciation and amortization |   |     | (24,960 | )      |     |   | (41,420 | ) |
|   |                                                               |   | $        | 46,429  |   |     | $      | $40,797 |   |

 

Intangibles and other assets, net consist of the following at        December 31 (in thousands):

 

|                                   |   | **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 |   |   |   |

 

 

|                                   |   | **2007**     |
|----------------------------------------|--------|--------------|
|                                   |   | **Gross**    |   |   |   |   |   |   |   |   |   | **Weighted** |
|                                   |   | **Carrying** |   | **Accumulated** |   |   |   |   |   | **Average** |
|                                   |   | **Value**    |   | **Amortization** |   |   | **Net** |   |   | **Life** |
| Patents and trademarks                 |   | $            | 25,240 |   | $ | (6,952 | ) |   | $ | 18,288 |   |   | 10.2 |
| Deferred financing costs               |   |         | 14,275 |   |   | (3,585 | ) |   |   | 10,690 |   |   | 6.1 |
| Capitalized software development costs |   |         | 23,900 |   |   | (11,021 | ) |   |   | 12,879 |   |   | 3.9 |
| Custom software development costs      |   |         | 8,115 |   |   | (406 | ) |   |   | 7,709 |   |   | 10.0 |
| Acquired contract rights               |   |         | 99,098 |   |   | (32,997 | ) |   |   | 66,101 |   |   | 9.5 |
| Deposits and long-term prepayments     |   |         | 2,089 |   |   | -   |   |   |   | 2,089 |   |   | - |
| Non-compete and employment agreements  |   |         | 1,909 |   |   | (238 | ) |   |   | 1,671 |   |   | 4.6 |
|                                   |   | $            | 174,626 |   | $ | (55,199 | ) |   | $ | 119,427 |   |   |   |

         

At December 31, 2006 and 2007, the carrying amount of trademarks        assigned to patents and trademarks that were not subject to amortization was        $2.8 million and $2.8 million, respectively.

         

Amortization expense for the years ended December 31, 2005, 2006 and 2007        was $13.1 million, $16.5 million and $18.9 million, respectively. Estimated        amortization expense related to intangibles, excluding deferred financing costs, the fair        value of acquired Syscon in-process operating contracts and other assets, as of December        31, 2007 and for each of the next five years through December 31, 2012 and thereafter is        summarized as follows (in thousands):

         

 

69

 

 

 

|   | **Year Ended December                    31:** |   |    |   |
|--------|------------------------------------------------|--------|---------|--------|
|   | 2008                                           |   | 16,556  |   |
|   | 2009                                           |   | 17,238  |   |
|   | 2010                                           |   | 14,336  |   |
|   | 2011                                           |   | 11,664  |   |
|   | 2012                                           |   | 8,029   |   |
|   | Thereafter                                     |   | 32,279  |   |
|   |                                           | $      | 100,102 |   |

         

The fair value of Syscon’s in-process operating contracts and customer        agreement acquired of $5.2 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 December 31, 2007, $1.4 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 at December 31 (in        thousands):

         

|   |                                                |   | **2006** |   |   | **2007** |   |
|--------|-----------------------------------------------------|--------|----------|--------|--------|----------|--------|
|   | **Accrued                    liabilities:**         |   |     |   |   |     |   |   |   |
|   | Accrued                    expenses                 |   | $        | 26,395 |   |     | $      | 24,849 |   |
|   | Accrued                    compensation             |   |     | 6,066  |   |     |   | 5,507 |   |
|   | Accrued severance and                    exit costs |   |     | 111    |   |     |   | 321 |   |
|   | Accrued taxes                                       |   |     | 1,026  |   |     |   | 2,240 |   |
|   | Accrued interest and                    other       |   |     | 5,797  |   |     |   | 7,271 |   |
|   |                                                |   | $        | 39,395 |   |     | $      | 40,188 |   |

         

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.

         

During the year ended December 31, 2005, the Company entered into        separation agreements with certain executives. As a result of SFAS No. 88,*Employers’ Accounting for Settlements and Curtailments of Defined        Benefit Pension Plans and for Termination Benefits*, the Company        accrued approximately $0.6 million related to severance payment for these executives.        Accrued severance and exit costs as of December 31, 2007 consists of the following (in        thousands):

         

|                         |   | **Severance &** |    |   | **Leased Facility**   |   |          |   |   |   |   |
|------------------------------|--------|---------------------|---------|--------|-----------------------|--------|---------------|--------|--------|--------|--------|
|                         |   | **Related Costs**   |    |   | **& Other Costs** |   | **Total**     |   |   |
| Balance at December 31, 2005 |   | $                   | 557     |   |                  | $      | 111           |   |   | $      | 668    |   |   |
| Payments                     |   |                | (557    | )      |                  |   | -   |   |   |   | (557   | ) |   |
| Balance at December 31, 2006 |   |                | -  |   |                  |   | 111      |   |   |   | 111    |   |   |
| Additions                    |   |                | 216     |   |                  |   | 398           |   |   |   | 614    |   |   |
| Payments                     |   |                | (216    | )      |                  |   | (188          | )      |   |   | (404   | ) |   |
| Balance at December 31, 2007 |   | $                   | -       |   |                  | $      | 321           |   |   | $      | 321    |   |   |

         

The remaining leased facility and other costs reserve is expected to be        utilized by 2010.

         

         

 

70

 

**(4)** **GOODWILL**

         

The Company performed annual impairment tests as of December 31, 2005,        2006, and 2007. No impairment was recorded as a result of the testing performed at        December 31, 2005, 2006 and 2007.

         

Goodwill allocated to our reportable segments is summarized as follows (in        thousands):

 

|                                                                          |   |   |             |   |   |   | **Offender**   |   |   |   |      |   |
|-------------------------------------------------------------------------------|--------|--------|------------------|--------|--------|--------|----------------|--------|--------|--------|-----------|--------|
|                                                                          |   |   | **Direct Call**  |   |   |   | **Management** |   |   |   |      |   |
|                                                                          |   |   | **Provisioning** |   |   |   | **Software**   |   |   |   | **Total** |   |
| Balance at December 31, 2005                                                  |   | $      | 37,936           |   |   | $      | -    |   |   | $      | 37,936    |   |
| Balance at December 31, 2006                                                  |   | $      | 37,936           |   |   | $      | -    |   |   | $      | 37,936    |   |
| Goodwill allocation in connection with Syscon                    acquisitions |   |   | -      |   |   |   | 28,948         |   |   |   | 28,948    |   |
| Foreign currency translation                                                  |   |   | -      |   |   |   | 2,151          |   |   |   | 2,151     |   |
| Balance at December 31, 2007                                                  |   | $      | 37,936           |   |   | $      | 31,099         |   |   | $      | 69,035    |   |

 

**(5)** **DEBT**

         

Debt consists of the following at December 31 (in        thousands):

         

|                                                                                               |   | **2006** |          |   | **2007** |   |
|----------------------------------------------------------------------------------------------------|--------|----------|---------------|--------|----------|--------|
| Revolving credit                    facility                                                       |   | $        | 3,225         |   |     | $      | 5,000 |   |
| Second-priority senior secured                    notes                                            |   |     | 154,000       |   |     |   | 194,000 |   |
| Senior subordinated                    notes                                                       |   |     | 58,756        |   |     |   | 69,834 |   |
|                                                                                               |   |     | 215,981       |   |     |   | 268,834 |   |
| Less unamortized discount on senior secured notes and senior                    subordinated notes |   |     | (5,339        | )      |     |   | (5,558 | ) |
|                                                                                               |   |     | 210,642       |   |     |   | 263,276 |   |
| Less current portion of                    long-term debt                                          |   |     | -   |   |     |   | -   |   |
|                                                                                               |   | $        | 210,642       |   |     | $      | 263,276 |   |

         

*Revolving Credit Facility*— The Company        has a revolving credit facility 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 revolving credit facility        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.  Letters of credit outstanding reduce the Company’s availability to        the extent they exceed $10.0 million and the borrowing base collateral, as defined by the        revolving credit facility, principally comprised of receivables and inventory less defined        reserves, falls below $40 million. Subject to certain adjustments, the Company’s        maximum permitted annual capital expenditures are $30.0 million, $22.0 million        and $22.0 million for the years ended December 31, 2006, 2007 and 2008, respectively.        Amounts unused under the revolving credit facility 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 an 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 revolving credit facility bore interest at the Company’s option using the prime        rate, which was 8.25% at December 31, 2006 and 7.25% as of December 31, 2007, as well        as an advance of $5.0 million based on the Eurodollar Rate which was 6.97% as of December        31, 2007. The Company draws from the available credit on the Revolver to cover normal        business cash requirements.  As of December 31, 2006 and December 31, 2007,        the Company had $26.8 million and $19.5 million, respectively, of borrowing        availability under the Revolver.

         

*Second-priority Senior Secured Notes*— On        September 9, 2004, the Company 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, the Company        issued $40 million aggregate

 

71

 

 

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 the issuance of the 2007 Notes, the Company entered into a registration rights        agreement with the initial purchaser pursuant to which the Company is 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 outstanding 2007 Notes. On September 17, 2007, the Company        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,        the Company is required by the Second-priority Senior Secured Notes to offer to repay        principal equal to 75% of such excess cash flow at a rate of 104% of face        value.  No excess cash flow payment was due for the year ended December 31,        2006 and December 31, 2007 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, the Company issued $40.0 million of Senior Subordinated Notes,        unsecured and subordinate to the revolving credit facility, that bear interest at an annual        rate of 17%. Interest is payable at the end of each calendar quarter, or, as restricted by        our revolving credit facility, is paid-in-kind by adding accrued interest to the principal        balance of the Senior Subordinated notes. All outstanding principal, including interest        paid-in-kind, is due on September 9, 2014 and a mandatory prepayment equal to        $20.0 million plus 50% of all outstanding interest paid-in-kind is due on        September 9, 2013. In connection with the issuance of the Senior Subordinated Notes,        the Company issued warrants to acquire 51,011 shares of our Common Stock at an exercise        price of $0.01 per share to the Senior Subordinated Note holders. 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. 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 year ended December 31, 2007, $10.7 million of        paid-in-kind interest was added to the principal balance of the Senior Subordinated Notes.        The effective interest rate is 18.76 % on the Senior Subordinated Notes. In order to enter        into additional financing to complete the Syscon acquisition, we incurred a non-cash        consent fee of $0.4 million payable to the Senior Subordinated Noteholders. This fee was        added to the principal balance of the Senior Subordinated Notes.

         

All of the Company’s domestic subsidiaries and certain of its foreign        subsidiaries (the “Subsidiary Guarantors”) are fully, unconditionally, and        jointly and severably liable for the revolving credit facility, Senior Subordinated Notes        and Second-priority Senior Secured Notes. The Subsidiary Guarantors are wholly-owned. The        Company has not included separate financial statements of their subsidiaries because of        their (a)  aggregate assets, liabilities, earnings and equity are presented on a        consolidated basis and (b) the Company believes that separate financial statements and        other disclosures concerning subsidiaries are not material to investors.

         

The Company’s credit facilities contain financial and operating        covenants, 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 the Company’s ability to incur additional indebtedness, make certain payments        including dividends to shareholders, invest and divest company assets, and sell or        otherwise dispose of capital stock. In the event that the Company fails to comply with the        covenants and restrictions, as specified in the credit agreements, it may be in default, at        which time payment of the long term debt and unpaid interest may be accelerated and become        immediately due and payable.

         

As of September 30, 2007, the Company was not in compliance with certain        financial covenants required by the revolving credit facility. The Company was not in        compliance with the Minimum EBITDA covenant which requires the Company to maintain $35.0        million of trailing twelve month EBITDA (as

 

72

 

 

defined)        and the Interest Coverage Ratio which requires a ratio of EBITDA (as defined) to Cash        Interest (as defined) above 1.75. These ratios are required to be calculated on a pro forma        basis for the impact of acquisitions, such as the acquisition of Syscon in June 2007. The        revolving credit facility lenders waived this non-compliance for the period ended September        30, 2007 and amended the revolving credit facility to allow equity issued by Securus to be        included in EBITDA for the fourth quarter of 2007 through 2008.

 

The indenture for our Second-priority Senior Secured Notes requires the        Company to maintain a Credit Facility Coverage Ratio above 1.75. For the quarter ended        September 30, 2007, the Company did not maintain the required ratio. 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 indenture        provides that two consecutive quarters of non-compliance with the Credit Facility Coverage        Ratio will cause a default. The definition of the Credit Facility Coverage Ratio provides        that the proceeds from equity issued by Securus are added to Credit Facility Cash Flow. In        order to avoid a default under the indenture, the Company issued $10.2 million of Series A        Redeemable Convertible Preferred Stock to the Company’s stockholder, H.I.G.-TNetix,        Inc (“H.I.G.”). Although the Company expects to be in full compliance with its        credit facilities and to be able to meet its obligations through 2008, there is no        guarantee that the proceeds of the issuance will prevent a future default under our credit        facilities.

         

Future maturities of debt for each of the following five years and        thereafter are as follows (in thousands):

         

|   | **Year Ended December                    31:** |   |          |   |
|--------|------------------------------------------------|--------|---------------|--------|
|   | 2008                                           | $      | -   |   |
|   | 2009                                           |   | 5,000         |   |
|   | 2010                                           |   | -   |   |
|   | 2011                                           |   | 194,000       |   |
|   | 2012                                           |   | -   |   |
|   | Thereafter                                     |   | 69,834        |   |
|   |                                           | $      | 268,834       |   |

 

The credit facilities are collateralized by all of the Company’s        assets and capital stock, including those of its subsidiaries.

         

The fair value of our debt instruments as of December 31, 2007 is as        follows (in thousands):

         

|   | Revolving Credit                    Facility            | $      | 5,000   |   |
|--------|---------------------------------------------------------|--------|---------|--------|
|   | Second-priority Senior Secured                    Notes |   | 168,780 |   |
|   | Senior Subordinated                    Notes            |   | 69,834  |   |
|   |                                                    | $      | 243,614 |   |

         

The fair value of the revolving credit facility was equal to its carrying        value due to the variable nature of its interest rate. The fair value of the        Second-priority Senior Secured Notes is based on their quoted market value. The fair value        of the Senior Subordinated Notes is estimated based on its book value since these notes are        not publicly traded.

         

**(6)** **SEGMENT        INFORMATION — CONTINUING OPERATIONS**

         

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, the Company’s management has chosen to organize the        enterprise around differences in products and services. The Company has had four reportable        segments: Direct Call Provisioning, Solutions Services, Telecommunications Services, and        Equipment Sales. The acquisition of Syscon provides the

 

73

 

 

Company        with a comprehensive Offender Management Software solutions segment. Through these        segments, the Company provides 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, the Company provides these products and services through service        agreements with other telecommunications service providers, including, Global Tel*Link,        AT&T (formerly SBC), Embarq and FSH Communications (i.e., Telecommunication Services        segment and Solutions Services segment) and through direct contracts between us and        correctional facilities (i.e., Direct Call Provisioning segment). In addition, systems were        sold to certain telecommunication providers (i.e., Equipment Sales segment).

         

The Company evaluates performance of each segment based on operating        results. Total assets are those owned by or allocated to each segment. Assets included in        the “Corporate and Other” column of the following table include all assets not        specifically allocated to a segment. There are no intersegment sales. The Company’s        reportable segments are specific business units that offer different products and services        and have varying operating costs associated with such products. The accounting policies of        the reportable segments are the same as those described in the summary of significant        accounting policies. The Company uses 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 the        Company does 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 twelve months ended December 31, 2005 is as        follows (in thousands):

 

|                                                  |   | **Direct**       |   |   |   |          |   |   |   |                   |   |   |   | **Equipment**   |   |   |   |            |   |   |   |      |   |
|-------------------------------------------------------|--------|------------------|--------|--------|--------|---------------|--------|--------|--------|------------------------|--------|--------|--------|-----------------|--------|--------|--------|-----------------|--------|--------|--------|-----------|--------|
|                                                  |   | **Call**         |   |   |   | **Solutions** |   |   |   | **Telecommunications** |   |   |   | **Sales &** |   |   |   | **Corporate**   |   |   |   |      |   |
|                                                  |   | **Provisioning** |   |   |   | **Services**  |   |   |   | **Services**           |   |   |   | **Other**       |   |   |   | **& Other** |   |   |   | **Total** |   |
| Revenue from external                    customers    | $      | 303,174          |   |   | $      | 47,398        |   |   | $      | 25,313                 |   |   | $      | 1,321           |   |   | $      | -     |   |   | $      | 377,206   |   |
| Segment gross margin                                  | $      | 63,813           |   |   | $      | 9,582         |   |   | $      | 13,824                 |   |   | $      | 1,002           |   |   | $      | -     |   |   | $      | 88,221    |   |
| Depreciation and                    amortization      |   | 21,641           |   |   |   | 1,468         |   |   |   | 571                    |   |   |   | 37              |   |   |   | 135             |   |   |   | 23,852    |   |
| Other operating costs and                    expenses |   | 7,782            |   |   |   | 1,261         |   |   |   | -            |   |   |   | 31              |   |   |   | 40,113          |   |   |   | 49,087    |   |
| Operating income                    (loss)            | $      | 34,390           |   |   | $      | 6,853         |   |   | $      | 13,253                 |   |   | $      | 934             |   |   | $      | (40,148         | )      |   | $      | 15,282    |   |
| Interest and other expenses,                    net   |   |             |   |   |   |          |   |   |   |                   |   |   |   |            |   |   |   |            |   |   |   | 26,608    |   |
| Segment loss before income                    taxes   |   |             |   |   |   |          |   |   |   |                   |   |   |   |            |   |   |   |            |   |   |   | (11,326   | )      |
| Capital                    expenditures               | $      | 25,718           |   |   | $      | -   |   |   | $      | -            |   |   | $      | -     |   |   | $      | 609             |   |   | $      | 26,327    |   |

 

 

74

 

 

 

| December 31, 2005: |   |    |   |   |   |          |   |   |   |          |   |   |   |          |   |   |   |          |   |   |   |    |   |
|--------------------|--------|---------|--------|--------|--------|---------------|--------|--------|--------|---------------|--------|--------|--------|---------------|--------|--------|--------|---------------|--------|--------|--------|---------|--------|
| Total assets       | $      | 209,545 |   |   | $      | 26,660        |   |   | $      | 4,778         |   |   | $      | 40            |   |   | $      | 25,907        |   |   | $      | 266,930 |   |
| Goodwill           | $      | 37,936  |   |   | $      | -   |   |   | $      | -   |   |   | $      | -   |   |   | $      | -   |   |   | $      | 37,936  |   |

 

 

         

 Segment information for the twelve months ended December 31, 2006 is        as follows (in thousands):

         

|                                                  |   | **Direct**       |   |   |   |          |   |   |   |                   |   |   |   | **Equipment**   |   |   |   |            |   |   |   |      |   |
|-------------------------------------------------------|--------|------------------|--------|--------|--------|---------------|--------|--------|--------|------------------------|--------|--------|--------|-----------------|--------|--------|--------|-----------------|--------|--------|--------|-----------|--------|
|                                                  |   | **Call**         |   |   |   | **Solutions** |   |   |   | **Telecommunications** |   |   |   | **Sales &** |   |   |   | **Corporate**   |   |   |   |      |   |
|                                                  |   | **Provisioning** |   |   |   | **Services**  |   |   |   | **Services**           |   |   |   | **Other**       |   |   |   | **& Other** |   |   |   | **Total** |   |
| Revenue from external                    customers    | $      | 340,420          |   |   | $      | 45,702        |   |   | $      | 13,365                 |   |   | $      | 1,113           |   |   | $      | -     |   |   | $      | 400,600   |   |
| Segment gross margin                                  | $      | 73,032           |   |   | $      | 11,467        |   |   | $      | 6,940                  |   |   | $      | 359             |   |   | $      | -     |   |   | $      | 91,798    |   |
| Depreciation and                    amortization      |   | 26,835           |   |   |   | 1,124         |   |   |   | 2,167                  |   |   |   |            |   |   |   | 132             |   |   |   | 30,258    |   |
| Other operating costs and                    expenses |   | 7,787            |   |   |   | 407           |   |   |   | -            |   |   |   |            |   |   |   | 44,193          |   |   |   | 52,387    |   |
| Operating income                    (loss)            | $      | 38,410           |   |   | $      | 9,936         |   |   | $      | 4,773                  |   |   | $      | 359             |   |   | $      | (44,325         | )      |   | $      | 9,153     |   |
| Interest and other expenses,                    net   |   |             |   |   |   |          |   |   |   |                   |   |   |   |            |   |   |   |            |   |   |   | 27,811    |   |
| Segment loss before income                    taxes   |   |             |   |   |   |          |   |   |   |                   |   |   |   |            |   |   |   |            |   |   |   | (18,658   | )      |
| Capital                    expenditures               | $      | 27,028           |   |   | $      | -   |   |   | $      | -            |   |   | $      | -     |   |   | $      | 148             |   |   | $      | 27,176    |   |
| December 31, 2005:                                    |   |             |   |   |   |          |   |   |   |                   |   |   |   |            |   |   |   |            |   |   |   |      |   |
| Total assets                                          | $      | 218,239          |   |   | $      | 19,738        |   |   | $      | 776                    |   |   | $      | -     |   |   | $      | 20,896          |   |   | $      | 259,649   |   |
| Goodwill                                              | $      | 37,936           |   |   | $      | -   |   |   | $      | -            |   |   | $      | -     |   |   | $      | -     |   |   | $      | 37,936    |   |

         

         

 

75

 

 

Segment information for the twelve months ended December 31, 2007 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    | $      | 337,418          |   | $      | 36,496        |   | $      | 7,657                  |   | $      | 7,933          |   | $      | 456             |   | $      | -     |   | $      | 389,960   |   |
| Segment gross margin                                  | $      | 71,247           |   | $      | 11,741        |   | $      | 4,142                  |   | $      | 1,823          |   | $      | 134             |   | $      | -     |   | $      | 89,087    |   |
| Depreciation and                    amortization      |   | 33,137           |   |   | 88            |   |   | 1,792                  |   |   | 1,908          |   |   |            |   |   | 123             |   |   | 37,048    |   |
| Other operating costs and                    expenses |   | 8,768            |   |   | 420           |   |   | -            |   |   | 2,555          |   |   |            |   |   | 47,291          |   |   | 59,034    |   |
| Operating income                    (loss)            | $      | 29,342           |   | $      | 11,233        |   | $      | 2,350                  |   | $      | (2,640         | )      | $      | 134             |   | $      | (47,414         | )      |   | (6,995    | )      |
| Interest and other expenses,                    net   |   |             |   |   |          |   |   |                   |   |   |           |   |   |            |   |   | 31,487     |   |   | 31,487    |   |
| Segment loss before income                    taxes   |   |             |   |   |          |   |   |                   |   |   |           |   |   |            |   |   |            |   |   | (38,482   | )      |
| Capital                    expenditures               | $      | 21,231           |   | $      |          |   | $      | -            |   | $      | 20             |   | $      |            |   | $      | 105             |   | $      | 21,356    |   |
| December 31, 2007:                                    |   |             |   |   |          |   |   |                   |   |   |           |   |   |            |   |   |            |   |   |      |   |
|  

Total assets                                  | $      | 199,071          |   | $      | 13,524        |   | $      | 2,235                  |   | $      | 63,626         |   | $      | 8               |   | $      | 13,661          |   | $      | 292,125   |   |
| Goodwill                                              | $      | 37,936           |   | $      | -   |   | $      | -            |   | $      | 31,099         |   | $      | -     |   | $      | -     |   | $      | 69,035    |   |

         

 

**(7)** **INCOME        TAXES**

         

Income tax expense (benefit) is as follows (in thousands):

         

|                               |   |   | **Year Ended**   |   |   | **Year Ended**   |   |   | **Year Ended**   |   |
|------------------------------------|--------|--------|------------------|--------|--------|------------------|--------|--------|------------------|--------|
|                               |   |   | **December 31,** |   |   | **December 31,** |   |   | **December 31,** |   |
|                               |   |   | **2005**         |   |   | **2006**         |   |   | **2007**         |   |
| **Current**:                       |   |   |             |   |   |             |   |   |             |   |
| US Federal                         |   | $      | -      |   | $      | -      |   | $      | -                |   |
| US State                           |   |   | 194              |   |   | 337              |   |   | 965              |   |
| Foreign                            |   |   | -           |   |   | -           |   |   | 35               |   |
| Total                              |   |   | 194              |   |   | 337              |   |   | 1,000            |   |
| **Deferred**:                      |   |   |             |   |   |             |   |   |             |   |
| US Federal                         |   |   | (1,802           | )      |   | 2,080            |   |   | 2,260            |   |
| US State                           |   |   | (566             | )      |   | (956             | )      |   | (996             | )      |
| Foreign                            |   |   | -                |   |   | -                |   |   | (342             | )      |
| Total                              |   |   | (2,368           | )      |   | 1,123            |   |   | 922              |   |
| Total income tax expense (benefit) |   | $      | (2,174           | )      | $      | 1,461            |   | $      | 1,922            |   |

 

 

76

 

 

Income taxes differ from the expected statutory income tax benefit, by        applying the U.S. federal income tax rate of 35% to pretax earnings due to the following        (in thousands):

         

|                                                                                                   |   |   | **Year Ended**   |   |   | **Year Ended**   |   |   | **Year Ended**   |   |
|--------------------------------------------------------------------------------------------------------|--------|--------|------------------|--------|--------|------------------|--------|--------|------------------|--------|
|                                                                                                   |   |   | **December 31,** |   |   | **December 31,** |   |   | **December 31,** |   |
|                                                                                                   |   |   | **2005**         |   |   | **2006**         |   |   | **2007**         |   |
| Expected statutory income tax (benefit)                                                                |   | $      | (3,965           | )      |   | (6,518           | )      | $      | (13,469          | )      |
| Amounts not deductible for income tax                                                                  |   |   | 1,330            |   |   | 1,284            |   |   | 1,556            |   |
| State taxes, net of federal                    benefit                                                 |   |   | (391             | )      |   | (218             | )      |   | (171             | )      |
| Change in valuation                    allowance                                                       |   |   | 853              |   |   | 7,263            |   |   | 14,332           |   |
| Rate differences resulting from                    differing tax rates for different tax jurisdictions |   |   | -                |   |   | -                |   |   | 25               |   |
| Other                                                                                                  |   |   | (1               | )      |   | (350             | )      |   | (351             | )      |
| Total income tax expense (benefit)                                                                     |   | $      | (2,174           | )      | $      | 1,461            |   | $      | 1,922            |   |

 

The tax effects of temporary differences that give rise to significant        portions of the deferred income tax assets and deferred income tax liabilities as of        December 31, 2006 and 2007, respectively, are presented below (in        thousands):

         

|                                                                                     |   | **2006** |    |   | **2007** |   |
|------------------------------------------------------------------------------------------|--------|----------|---------|--------|----------|--------|
| **Net current deferred income                    tax assets:**                           |   |     |    |   |     |   |   |   |
| Allowance for doubtful                    accounts                                       |   | $        | 5,681   |   |     | $      | 4,418 |   |
| Accrued                    expenses                                                      |   |     | 1,990   |   |     |   | 1,334 |   |
| Other                                                                                    |   |     | 2,828   |   |     |   | 4,070 |   |
| Current deferred income                    tax assets                                    |   |     | 10,498  |   |     |   | 9,822 |   |
| Deferred income tax                    liabilities                                       |   |     |    |   |     |   |   |   |
| Other                                                                                    |   |     | (264    | )      |     |   | (1,339 | ) |
| Current deferred income                    tax liabilities                               |   |     | (264    | )      |     |   | (1,339 | ) |
| Less: Valuation                    allowance                                             |   |     | (5,079  | )      |     |   | (6,710 | ) |
| Net current deferred                    income tax asset                                 |   | $        | 5,155   |   |     | $      | 1,773 |   |
| **Net non-current deferred                    income tax assets (liabilities):**         |   |     |    |   |     |   |   |   |
| Deferred income tax                    assets:                                           |   |     |    |   |     |   |   |   |
| Net operating loss and                    tax credit carryforwards                       |   |     | 17,452  |   |     |   | 27,633 |   |
| Depreciation                                                                             |   |     | -       |   |     |   | - |   |
| Accrued                    interest                                                      |   |     | 4,288   |   |     |   | 6,855 |   |
| Other                                                                                    |   |     | (119    | )      |     |   | 93 |   |
| Non-current deferred                    income tax assets                                |   |     | 21,621  |   |     |   | 34,581 |   |
| Deferred income tax                    liabilities                                       |   |     |    |   |     |   |   |   |
| Property and equipment                    principally due to differences in depreciation |   |     | (2,475  | )      |     |   | (1,914 | ) |
| Intangible assets due to                    difference in book/tax basis                 |   |     | (16,830 | )      |     |   | (24,738 | ) |
| Non-current deferred                    income tax liabilities                           |   |     | (19,305 | )      |     |   | (26,652 | ) |
| Less: Valuation                    allowance                                             |   |     | (10,578 | )      |     |   | (23,281 | ) |
| Net non-current deferred                    income tax asset (liability)                 |   |     | (8,262  | )      |     |   | (15,352 | ) |
| Net deferred income tax                    liability                                     |   | $        | (3,107  | )      |     | $      | (13,579 | ) |

         

At December 31, 2007, the Company had U.S. federal net operating loss        carryforwards for tax purposes aggregating approximately $73.8 million which, if not        utilized to reduce taxable income in future periods, expire at various dates through the        year 2026. Approximately $7.9 million of the net operating loss carryforwards are        subject to certain rules under Internal Revenue Code Section 382 limiting their annual        usage. The Company believes these annual limitations will not ultimately affect its ability        to use substantially all of its net operating loss carry forwards for income tax purposes.        As a result of the change of control related to certain acquisitions, the use of the net        operating losses may be limited going forward under Internal Revenue Code 382. At December        31, 2007, the Company had Canadian net operating loss

 

77

 

 

carryforwards for tax purposes aggregating approximately $0.6 million which,        if not utilized to reduce taxable income in future periods, expire in 2027. At December 31,        2007, the Company had Australian net operating loss carryforwards for tax purposes        aggregating approximately $0.3 million which do not expire.

         

As of January 1, 2007, the Company adopted the provisions of Financial        Interpretation No. 48,*Accounting for Uncertainty in Income        Taxes—an Interpretation of FASB Statement No.* *109*(“FIN 48”). FIN 48 addresses        the determination of whether tax benefits claimed or expected to be claimed on a tax return        should be recorded in the financial statements. Under FIN 48, the tax benefit from an        uncertain tax position may be recognized only if it is more likely than not that the tax        position will be sustained on examination by the taxing authorities. The determination is        based on the technical merits of the position and presumes that each uncertain tax position        will be examined by the relevant taxing authority that has full knowledge of all relevant        information. The adoption of these provisions did not have any impact on our financial        condition or results of operations.

         

The Company recognized no adjustment in the liability for unrecognized tax        benefits upon the adoption of FIN 48. As a result of applying the provisions of        FIN 48, the Company recognized no increase in the liability for unrecognized tax        benefits, and no change in accumulated deficit as of January 1, 2007. The Company        unrecognized tax benefits at December 31, 2007 relate to various foreign        jurisdictions.

         

The following table summarizes the activity related to our unrecognized tax        benefits ($ in thousands):

         

|                                                  |   | **Total**     |   |
|-------------------------------------------------------|--------|---------------|--------|
| Balance at January 1, 2007                            | $      | -   |   |
| Increases related to prior year’s tax positions |   | 663           |   |
| Other                                                 |   | -   |   |
| Balance at December 31, 2007                          | $      | 663           |   |

         

Included in the unrecognized tax benefits of $0.7 million at        December 31, 2007 was $0.01 million of tax benefits that, if recognized, would        impact the annual effective tax rate. The amount of the unrecognized tax benefits that        would impact goodwill, if recognized, would be $0.6 million. The Company also accrued        potential penalties and interest of $0.0 million and $0.1 million, respectively,        related to these unrecognized tax benefits during 2007, and in total, as of        December 31, 2007, the Company has recorded a liability for potential penalties and        interest of $0.0 million and $0.1 million, respectively. The Company does not        expect our unrecognized tax benefits to change significantly over the next        12 months.

         

The Company or one of its subsidiaries file income tax returns in the U.S.        federal jurisdiction, Canada, the United Kingdom, Australia and various states. The Company        has open tax years for the U.S. federal return from 1996 forward with respect to its net        operating loss (“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.

         

A valuation allowance is provided when it is more likely than not that some        portion or the entire net deferred tax asset will not be realized. The Company calculated        the deferred tax liability, deferred tax asset, and the related valuation of net deferred        tax assets, including net operating loss carryforwards, for the taxable temporary        differences on a jurisdiction by jurisdiction basis. The valuation allowance represents the        excess deferred tax assets including the net operating loss carryforwards, over the net        deferred tax liabilities, excluding deferred liabilities that are not available to offset        deferred tax assets. The Company has offset our net deferred tax assets, including net        operating loss carryforwards, with a valuation allowance of $30.0 million at        December 31, 2007. At December 31, 2006, the Company had a valuation allowance of        $15.7 million which was applied against net deferred tax assets, including net        operating loss carryforwards. The Company increased our valuation allowance because future        taxable income may not be realized to utilize net operating losses.

         

The exercise of stock options granted under T-Netix’s 1991        Non-Qualified Stock Plan (“NSO”) stock option plan gives rise to compensation,        which is included in the taxable income of the applicable option

 

78

 

 

holder and        is deductible by T-Netix for federal and state income tax purposes. The income tax benefit        associated with the exercise of the NSO options is recorded as an adjustment to additional        paid-in capital when realized. These options expired during 2005.

         

**(8)** **REDEEMABLE        CONVERTIBLE PREFERRED STOCK**

         

On December 18, 2007, the Company issued 5,100 shares of Series A Redeemable        Convertible Preferred Stock (“Preferred Stock”). Each share of the Series A        Redeemable Convertible Preferred Stock has a stated value of $2,000 and accrues dividends        at 12.5% annually of the stated value. The Preferred Stock has a liquidation preference        equal to the greater of its per share purchase price plus any accrued but unpaid dividends        and the amount the holder would receive if such share were converted to shares of common        stock, and initially converts into one share of common stock, adjusted for certain        events.In the event that the Company does not achieve $45 million of        Credit Facility Cashflow (as defined in the Certificate of Designation for the Series A        Redeemable Convertible Preferred Stock) for the twelve months ended June 30, 2008, each        share of Preferred Stock will be convertible into 200 shares of Common Stock, as adjusted        for certain events. The Preferred Stock was issued to avoid a financial covenant default        under a certain indenture related to the 11% Second-Priority Senior Secured Notes (See Note        5).

         

The Company’s majority stockholder, H.I.G. purchased substantially all        of the shares of Preferred Stock for approximately $10.2 million. The proceeds from the        purchase were applied to our earnings in determining compliance with the covenants in the        indenture for the Company’s Second-Priority Senior Secured Notes for the year ended        December 31, 2007.

 

**(9)** **STOCKHOLDERS’ EQUITY**

         

***Common stock***

         

On December 15, 2007, in conjunction with the issuance of the Preferred        Stock (see Note 8), the Company’s shareholders approved a 1 for 1,000 reverse stock        split for the Common Stock and Class B Common Stock. Except as otherwise noted, all shares,        options and warrants have been restated to give retroactive effect to the reverse split.        All per share disclosures retroactively reflect shares outstanding or issuable as though        the split had occurred as of December 31, 2006. In connection with the reverse split,        authorized shares of common stock were reduced to 1,300,000 shares of capital stock with a        par-value of $0.001, of which 1,190,000 were designated Common Stock, 10,000 were        designated Preferred Stock and 100,000 were designated Class B Common Stock. All issued        shares of common stock are entitled to vote on a one share/one vote basis. The Company had        604,000 shares of Common Stock issued and outstanding and 73,491.22 shares of Class B        Common Stock outstanding on the date of issuance and 604 shares of common stock and 73.49        shares of Class B Common Stock, respectively, immediately following the split.

         

At December 31, 2007, 604.0 shares of Common Stock were issued and        outstanding and 73.49 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 and a $57,000 per share liquidation preference for the Common        Stock, holders of the shares of Common Stock and Class B Common Stock have identical        rights and privileges. The Company credit facilities substantially restrict the ability to        pay dividends to holders of common stock.

         

***Warrants***

         

In connection with the financing of the acquisition of Evercom on        September 9, 2004, warrants to purchase 51.01 shares of Common Stock were issued to        holders of the Senior Subordinated Notes. The warrant exercise price is $10 per share, is        immediately exercisable upon issuance, and expires 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 stock warrants at the time of        issuance.

         

 

79

 

 

In conjunction with a guarantee provided by HIG, we issued warrants to        purchase 14.54 shares of Common stock to HIG, for $0.01 per share, immediately exercisable        upon issuance. The warrants were exercised on December 18, 2007.

         

***Restricted Stock Purchase Plan***

         

The Company has a 2004 Restricted Stock Purchase Plan under which certain of        its employees may purchase shares of our Class B Common Stock. The maximum number of        authorized shares that may be delivered pursuant to awards granted under the 2004        Restricted Stock Purchase Plan was 75,000, which equaled 5.8% of our total authorized        shares of common stock. On December 15, 2007, our shareholders approved a 1 for 1,000        reverse stock split. The Company has elected to continue to authorize 75,000 shares under        the Plan.

         

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

         

As of December 31, 2007, 73.49 shares of Class B Common Stock were        issued under the 2004 Restricted Stock Purchase Plan. Of this amount, (a) 26.3 of these        shares were acquired by our Chief Executive Officer in 2004; (b) 31.82 were issued in 2005        to seven of our executives, net of forfeitures; (c) 1.330 and 2.67 shares were issued in        2005 and 2006 to two members of the Company’s Board of Directors and immediately        vested; and (d) 11.37 were issued in 2007 to certain of our executives.

These shares are subject to forfeiture pursuant to the terms of the 2004        Restricted Stock Purchase Plan and the restrictions described hereafter. As to shares        issued to the Company’s executives, with respect to 36.6% of the stock, the        restriction period ends upon the sale of the Company’s stock by certain of its other        stockholders. The restriction period for 31.7% of the stock ends upon the lapse of time,        ratably over three to four years from the date of issue. With respect to the remaining        shares, the restriction period ends upon the Company attaining certain performance measures        determined by its Board of Directors.  Upon a change of control, the restriction        period could end for all of the restricted shares that have not previously vested. The        restricted shares are entitled to dividends, if declared, which will be distributed upon        termination of the restriction period with respect to any such restricted        shares.

The Company measures compensation expense on these restricted shares        commensurate with their vesting schedules. For the portion of the restricted shares that        vest contingently with the occurrence of certain events, the Company records compensation        expense when such events become probable. The incremental compensation expense on the        restricted shares issued was determined based on the estimated fair value of the        Class B Common Stock, which resulted in $0.1 million compensation expense charged        to the consolidated statement of operations for each of the years ended December 31,        2005, 2006 and 2007, respectively.

         

The following table summarizing the status of the 2004 Restricted Stock        Purchase Plan for the periods presented:

         

|                                            | **Number of** |   | **Fair Value at** |
|-------------------------------------------------|---------------|--------|-------------------|
|                                            | **Shares**    |   | **Grant Date**    |
| Balance at December 31,                    2004 | 16.86         |   |              |   |
| Granted                                         | 36.64         |   | $                 | 5,000 |
| Expired and                    forfeited        | -   |   |              |   |
| Balance at December 31,                    2005 | 53.50         |   |              |   |
| Granted                                         | 12.15         |   | $                 | 6,000 |
| Expired and                    forfeited        | -   |   |              |   |
| Balance at December 31,                    2006 | 65.65         |   |              |   |
| Granted                                         | 11.37         |   |              | .01 |
| Expired and                    forfeited        | (3.53         | )      | $                 | 5,000 |
| Balance at December 31,                    2007 | 73.49         |   |              |   |

 

 

80

 

 

 

 

The        following is a summary of non-vested shares as of December 31, 2007 and changes during the        year.

 

|   |                                            |   | **Number of** |   |    | **Weighted Average** |
|--------|-------------------------------------------------|--------|---------------|--------|---------|----------------------|
|   |                                            |   | **Shares**    |   |    | **Fair Value**       |
|   | Balance at December 31,                    2006 |   | 40.55         |   |  $ | 9,937                |
|   | Granted during the                    year      |   | 11.37         |   |    | .01                  |
|   | Vested during the                    year       |   | (8.09         | )      |    | 8,384                |
|   | Forfeited during the                    year    |   | (3.53         | )      |    | 5,000                |
|   | Balance at December 31,                    2007 |   | 40.30         |   | $       | 8,659                |

         

In 2006, the fair value of Class B Common Stock was estimated on the grant        date using the option-pricing method, whereby the fair value of stock is modeled as a        series of call options, representing the present value of the expected future returns to        shareholders. Under this method, each class of stock is modeled with a distinct claim on        the shareholders' equity value in us, 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-Sholes option pricing model. The following assumptions were made in estimating fair        value:

         

|   | Liquidation value of Common Stock                    shares |   | $57,000 per share |   |
|--------|-------------------------------------------------------------|--------|-------------------|--------|
|   | Expected term                                               |   | 3 years           |   |
|   | Expected volatility                                         |   | 40%               |   |
|   | Risk-free interest                    rate                  |   | 4.69%             |   |
|   | Minority interest                    discount               |   | None              |   |
|   | Discount for lack of                    marketability       |   | 20%               |   |

         

In 2007, the fair value of Class B Common Stock was estimated on the grant        date using the income and market approaches.  The income approach measures the present        value of expected future cash flows and was applied using the discounted cash flow        technique in an unlevered analysis.  The market approach examines recent sales of        comparable companies or securities to determine fair value and was applied using the        precedent transactions approach and the guideline companies approach.  Each of these        three approaches was weighed equally in determining the weight adjusted fair market value        of Class B Common Stock.  The following assumptions were made in estimating fair        value:

         

| Weighted-average cost of                    capital | 14.1%                                                                    |
|-----------------------------------------------------|--------------------------------------------------------------------------|
| Forecast period                                     | 10 years                                                                 |
| Relative pricing                    multiple        | EBITDA and Enterprise                    Value/EBITDA                    |
| Comparable public                    companies:     |                                                                     |
| Revenues                                            | $100 - $800 million                                                      |
| Industries                                          | Prison service providers;                    telecommunications services |

         

As of December 31, 2007, there was $0.4 million total unrecognized        compensation cost related to the 2004 Restricted Stock Purchase Plan, of which        $0.1 million is expected to be recognized over a weighted average period of 1 year and        $0.3 million will be recognized upon the sale of the Company's stock by certain of the        Company's other shareholders.

         

**(10)** **RELATED-PARTY TRANSACTIONS**

         

The Company has a consulting services agreement with H.I.G., pursuant to        which H.I.G. receives an annual consulting services fee of $750,000 for management,        consulting and financial advisory services. In addition, H.I.G. is entitled to receive fees        equal to 2% of the consideration received by us upon a public

 

81

 

 

offering of        the Company’s capital stock or the sale of all or substantially all of its assets,        which provision survives the termination of the agreement.

         

 

82

 

 

Required minimum annual consulting fee payments for the remaining term are        as follows (in thousands):

 

|   | **Year Ended December                    31:** |   |
|--------|------------------------------------------------|--------|
|   | 2008                                           |   |   | 750 |   |
|   | 2009                                           |   |   | 563 |   |
|        |                                                |        |  |  |  |  |

         

The professional and consulting services agreement has a five-year term and        is cancelable at either party’s discretion. In connection with this agreement, the        Company paid $0.8 million, $0.8 million, and $0.8 million for the years ended        December 31, 2005, 2006, and 2007, respectively. Accrued service fees due to the        related party affiliated company was $0.2 million, and nil and nil as of December 31,        2005, 2006, and 2007, respectively.

         

The Company has a professional services agreement with H.I.G., pursuant to        which H.I.G. is paid investment banking fees equal to 2% of the value of any transaction in        which the Company (i) sells all or substantially all of its assets or a majority of        its stock, (ii) acquires any other companies or (iii) secures any debt or equity        financing. In connection with its acquisition of Syscon and the issuance of the Series A        Redeemable Convertible Preferred Stock, H.I.G. received a professional services fee equal        to 2% of each transaction value, or approximately $1.0 million and $0.2 million,        respectively.

         

On June 29, 2007, the Company acquired all of the outstanding capital stock        of Syscon from its sole stockholder. Under the Purchase Agreement, the Company paid        approximately $41 million and 45.6 shares of Common Stock, subject to a working capital        adjustment. Pursuant to the purchase agreement, the Company will pay Syscon’s former        stockholder $5.0 million as Syscon generates net cash flow (as defined in the purchase        agreement) and $7 million after each of the first three 12 month periods after the closing        date if Syscon’s revenues exceed certain thresholds and the former stockholder has        not resigned or been terminated for cause from his employment. The revenue thresholds for        the full earn-out payments are $56.5 million for the first 12 months, $61.5 million for the        second 12 months, and $63.1 million for the third 12 months. If Syscon’s revenues are        less than the aforementioned thresholds, but greater than $30 million for the first 12        months, $33.33 million for the second 12 months and $36.67 million for the third 12 months,        the seller will earn a portion of the $7 million dollar payment applicable to the given        year. Revenues, for the purposes of calculating these thresholds, is defined by the        agreement on a modified cash basis and is not based on U.S. Generally Accepted Accounting        Principles.  During the year ended December 31, 2007, the Company paid $0.2 million to        an affiliate of the former stockholder for professional software development consulting        services.

         

A former affiliated company, Accudata Technologies, provides validation        services to us and, accordingly, we paid Accudata $2.0 million, $1.3 million, and        $1.0  million for their services in 2005, 2006, and 2007, respectively. Accudata paid        dividends of $0.1 million in 2006. No dividend payments were received in 2005 or        2007.

         

On August 9, 2007, Accudata, purchased the Company’s 50% interest in        its preferred stock for $1.0 million. In connection with the sale of its stock, the Company        agreed to continue to conduct business with Accudata 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.

         

On August 17, 2007, an affiliate of H.I.G. T-Netix, Inc., the        Company’s majority stockholder, guaranteed a $5.0 million unsecured revolving credit        facility on the Company’s behalf. In connection with H.I.G. T-Netix’s        guarantee, the Company issued warrants to purchase up to 14.5 shares of Common stock. The        guarantee and the revolving credit facility were cancelled and H.I.G. T-Netix’s        exercised its warrant in connection with our issuance of Series A Redeemable Convertible        Preferred Stock. We had no borrowings under this facility.

         

 

83

 

 

**(11)** **COMMITMENTS        AND CONTINGENCIES**

         

***(a)*** ***Operating Leases***

         

The Company leases office space and certain office equipment under operating        lease agreements. Most of our lease terms have escalation clauses and renewal options,        typically equal to the lease term. The Company accounts for this on a straight-line basis        over the life of the lease. Rent expense under operating lease agreements for the year        ended December 31, 2005, 2006, and 2007 was approximately $2.3 million, $2.3        million and $2.5 million, respectively. Future minimum lease payments under these lease        agreements for each of the next five years are summarized as follows (in        thousands):

         

|   | **Year Ended December                    31:**  |   |   |   |
|--------|-------------------------------------------------|--------|--------|--------|
|   | 2008                                            |   | 2,439  |   |
|   | 2009                                            |   | 2,299  |   |
|   | 2010                                            |   | 1,889  |   |
|   | 2011                                            |   | 1,617  |   |
|   | 2012                                            |   | 1,409  |   |
|   | Thereafter                                      |   | 3,032  |   |
|   | Total minimum lease                    payments | $      | 12,685 |   |

         

***(b)*** ***Minimum payments to customers***

         

The Company is required to make the following minimum commission payments to        certain of its correctional facility customers regardless of the level of revenues        generated by the Company on those contracts as follows (in thousands):

         

|   | **Year Ended December                    31:**       |   |   |   |
|--------|------------------------------------------------------|--------|--------|--------|
|   | 2008                                                 |   | 2,497  |   |
|   | 2009                                                 |   | 3,975  |   |
|   | 2010                                                 |   | 3,064  |   |
|   | 2011                                                 |   | 1,462  |   |
|   | 2012                                                 |   | 69     |   |
|   | Thereafter                                           |   | -      |   |
|   | Total minimum                    commission payments | $      | 11,067 |   |

         

No liability has been recorded as of December 31, 2007 because the        Company expects to generate sufficient revenues from these contracts in future periods to        offset these payments consistent with contractual and historical average commission rates        and because the Company would not owe these amounts if the correctional facility customer        terminates the agreement.

         

***(c)*** ***Employment Agreements***

         

As of December 31, 2007, the Company had entered into employment        agreements with certain key management personnel, which provided for minimum compensation        levels and incentive bonuses along with provisions for termination of benefits in certain        circumstances and for certain severance payments in the event of a change in control (as        defined).

         

***(d)*** ***Litigation***

         

From time to time the Company has been, and expects to continue to be,        subject to various legal and administrative proceedings or various claims in the normal        course of business. The Company believes 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 the        Company, are parties to judicial and regulatory complaints and proceedings initiated by        inmates, consumer protection advocates or

 

84

 

 

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

         

In June 2000, T-NETIX was named, along with        AT&T**,**in a lawsuit in the Superior        Court of King County, Washington, in which two private citizens allege violations of state        rules requiring pre-connect audible disclosure of rates as required by Washington statutes        and regulations**.** T-Netix and other        defendants successfully obtained dismissal and a "primary jurisdiction" referral in        2002.  In 2005, after several years of inactivity before the Washington Utilities and        Transportation Commission -- the state telecommunications regulatory agency -- T-Netix        prevailed at the trial court in securing an Order entering summary judgment on grounds        of lack of standing, but that decision was reversed by an intermediate Washington state        appellate court in December        2006**.**  T-Netix’s        subsequentPetition for Review by the Washington Supreme Court was denied in January 2008,        entitling plaintiffs to continue to pursue their claims against T-Netix and        AT&T. Currently pending before the trial court are motions by plaintiffs to vacate        the prior summary judgment and to reinstate the primary jurisdiction referral, and a        second motion by AT&T for summary judgment. T-Netix has opposed the plaintiffs' motion        in part and intends, at the appropriate time, to oppose AT&T's motion as well.         Given the absence of any significant judicial discovery to date, however, the Company        cannotestimate the company's potential exposure or predict the outcome of this        dispute.

         

In September 2004, 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 the Company. In        TIPS, the Company, 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 the Company was dismissed on March 1,        2007, when its motion for summary judgment was granted on the issue of non-infringement.        TIPS has appealed to the U.S. Court of Appeals, and oral arguments before the Appellate        Court are set for April 9, 2008. Additionally, TIPS has filed a lawsuit in the Southern        District of Texas against the Company which alleges substantially similar allegations        concerning patent infringement claims for “cord-free” or        “hands-free” inmate phone technology. This lawsuit against the Company was        similarly dismissed on January 10, 2008, when the Company’s motion for summary        judgment was granted on the issues of non-infringement and a finding that the Company was        not a proper defendant in the lawsuit. TIPS has indicated that it plans to appeal this        Order to the U.S. Court of Appeals.

         

In October 2003, Value-Added Communications, Inc. (“VAC”) filed        suit in the District Court of Dallas County, Texas against the Company’s subsidiary        T-NETIX for alleged breach of a Patent License Agreement between VAC and T-NETIX (the        “Agreement”). VAC filed the lawsuit seeking, among other things, an        interpretation of certain provisions of the Agreement, a declaration that the Agreement        remains in effect, 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 breach of various        provisions in the contract including, but not limited to, failure to assign certain        improvements in technology that VAC has allegedly developed since 1996. Trial started on        January 15, 2008 and went through February 8, 2008. After several days of deliberation, the        jury announced that they were deadlocked, and the judge granted a mistrial on February 14,        2008. The new trial is set for August 5, 2008. T-NETIX will continue to proceed against VAC        on its affirmative claims for VAC’s failure to assign its improvements and additions        and other breaches of the Patent License Agreement and will continue to vigorously defend        against VAC’s claim for attorneys’ fees and VAC’s efforts to have the        Court declare that the Patent License Agreement remains in effect. 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

 

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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 February 2, 2009. 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, AGM Telecom Corporation, Christopher McNitt, Robert G. Sargeant,        James F. Winstead, Pablo Xiques, Henry Chang, and Mie Mie Chang, 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 requested the court compel arbitration of the matter, which request        was granted, and some defendants filed special appearances objecting to the court’s        jurisdiction. In mid January 2008, the Court granted the special appearances of Sargeant,        Winstead and Chang, due to their lack of contacts with Texas and dismissed them from the        case. The parties have since agreed to abate the state court litigation and submit all        claims between the Company and the remaining defendants to arbitration. The Company has        denied any wrongdoing with respect to the alleged counterclaims and will vigorously defend        each and every counterclaim asserted by the defendants. The Company cannot evaluate the        likelihood of any outcome at this time.

         

In October 2006, the Company 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. In November 2007, Inmate Calling        Solutions, Inc. entered into a Settlement Agreement and Mutual Release, and a Patent        License Agreement with the Company, and was dismissed from the suit. The Company cannot        evaluate the likelihood of any outcome as to the remaining defendants at this        time.

         

In May 2007, GlobalTel*Link Corporation brought a declaratory judgment        action in Montgomery County Circuit Court in Alabama, against the State of Alabama, the        Alabama Department of Finance, Isaac Kervin (Director of Purchasing), and T-NETIX,Inc        regarding the Inmate Phone Services contract award. On June 5, 2007, the Judge entered an        order that there is a valid, binding contract between the State and GTL and that the State        shall fully comply with the contract, and that the effective date of the contract shall be        June 1, 2007. On July 16, 2007, the State filed a Motion (and Amended Motion) to Stay        Execution Pending Appeal, which the court denied on July 25, 2007. The State filed a Motion        to Stay Execution Pending Appeal before the Supreme Court of Alabama on July 30, 2007.        T-Netix filed its Joinder in the State’s Motion to Stay on August 1, 2007. Appellate        briefing has been filed and the parties await the ruling of the Supreme Court of Alabama.        T-Netix has not admitted any wrongdoing and has vigorously denied each and every allegation        in the case. No evaluation of the likelihood of any outcome or reasonable estimate of range        of potential loss can be made at this time.

         

In July 2007, GlobalTel*Link Corporation filed suit in the Circuit Court of        Montgomery County against T-Netix Inc., the State of Alabama, and the Alabama Department of        Finance and Alabama Department of Corrections. This proceeding relates to the protest        matter in Alabama. The Company filed a Motion to Dismiss, which was denied; however, Global        conceded that several of its claims were not viable, and in its amended complaint included        only one count, the intentional interference with business and contractual relations claim.        Both parties agreed that the appeal of the Alabama Protest Matter could be dispositive, or        at least highly persuasive, of the outcome of this second lawsuit; therefore, the Judge        agreed to hold off on setting any scheduling deadlines and recently postponed the trial        date of August 4, 2008. The Judge also ordered the parties to mediate the case, but did not        specify a deadline. T-Netix has not admitted any wrongdoing and has vigorously denied each        and every allegation in the case. No evaluation of the likelihood of any outcome or        reasonable estimate of range of potential loss can be made at this time.

         

In March 2007, 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

 

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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 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING        AND FINANCIAL DISCLOSURE***

 

None.

         

***ITEM 9A. CONTROLS AND        PROCEDURES***

 

**1.        Disclosure Controls and Procedures**

         

We maintain disclosure controls and procedures that are designed to ensure        that information required to be disclosed in the reports that we file or submit under the        Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the        time periods specified in the Securities and Exchange Commission’s        (“SEC”) rules and forms, and that such information is accumulated and        communicated to our management, including our Chief Executive Officer and Chief Financial        Officer, as appropriate to allow timely decisions regarding required disclosure.

         

As of the end of the period covered by this report, we carried out an        evaluation, under the supervision and with the participation of our Disclosure Committee        and management, including the Chief Executive Officer and the Chief Financial Officer, of        the effectiveness of the design and operation of our disclosure controls and procedures        pursuant to Exchange Act Rule 13a-15(b). Based upon this evaluation, the Chief        Executive Officer and the Chief Financial Officer concluded that our disclosure controls        and procedures were effective as of the end of the period covered by this        report.

         

**2.        Management’s Report on Internal Control over Financial Reporting**

         

Our management is responsible for establishing and maintaining adequate        internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f)        under the Securities Exchange Act of 1934. Our internal control over financial reporting is        a process designed under the supervision of our Chief Executive Officer and Chief Financial        Officer to provide reasonable assurance regarding the reliability of financial reporting        and the preparation of financial statements for external purposes in accordance with U.S.        generally accepted accounting principles.

         

Because of its inherent limitations, internal control over financial        reporting may not prevent or detect misstatements. Also, projections of any evaluation of        effectiveness to future periods are subject to the risk that controls may become inadequate        because of changes in conditions, or that the degree of compliance with policies and        procedures may deteriorate.

         

Management assessed the effectiveness of our internal control over financial        reporting as of December 31, 2007. The assessment excluded Syscon Holdings, Ltd,        acquired during 2007, with total assets of $63.6 million and total revenues of $7.9 million        included in our consolidated financial statements as of and for the year ended December 31,        2007. In making this assessment, management used the criteria described in*Internal Control — Integrated Framework*issued by the Committee of Sponsoring Organizations of the Treadway        Commission (COSO). Based on this assessment, management concluded that we maintained        effective internal control over financial reporting as of December 31,        2007.

         

This annual report does not include an attestation report of our registered        public accounting firm regarding internal control over financial reporting.        Management’s report was not subject to attestation by our registered public        accounting firm pursuant to temporary rules of the Securities and Exchange Commission that        permit the company to provide only management’s report in this annual        report.

         

 

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**3.        Changes in Internal Control over Financial Reporting**

         

In 2005, management began a major initiative to evaluate and improve our        processes, procedures, and systems that support internal controls over financial reporting.        The objective was to (1) provide assurance that we are in compliance with the requirements        of section 404(a) of the Sarbanes-Oxley Act and (2) improve the quality of our internal        control systems. In 2006, we established a professional Internal Audit organization that        coordinates the ongoing initiative. Coordination and execution of the initiative was        conducted under the supervision and with the participation of management, including our        Chief Executive Officer, Chief Financial Officer and the Audit Committee. Consultants and        independent contractors functioned in a support role as well.

         

As a result, we have achieved our primary objective to comply with the        Sarbanes-Oxley Act by successfully implementing substantial internal control improvements        over the course of the initiative. While we have significantly improved the quality of our        internal control systems, management has not fully achieved the second objective to the        preferred level and is committed to further enhancing its internal control systems over        financial reporting. These improvement areas do not, in management’s opinion at        December 31, 2007, either individually or in the aggregate, constitute a material weakness        in our system of internal controls over our financial reporting processes.

         

***ITEM 9B. OTHER INFORMATION***

 

None.

         

 

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**PART        III**

 

***ITEM        10. MANAGEMENT***

 

The following is a list of our executive officers, other senior officers and        directors as of March 8, 2008.  

All of our directors serve until a successor is duly elected and qualified        or until the earlier of his death, resignation or removal. Our executive officers are        appointed by and serve at the discretion of our board of directors. There are no family        relationships between any of our directors or executive officers.

         

| **Name**                             |   | **Age** |   | **Position**                                                                                                                                   |
|--------------------------------------|--------|---------|--------|------------------------------------------------------------------------------------------------------------------------------------------------|
| Richard Falcone                      |   | 63      |   | Chairman, President and Chief                    Executive Officer                                                                             |
| Keith Kelson                         |   | 41      |   | Chief Financial Officer,                    Treasurer and Assistant Secretary                                                                  |
| Dennis Reinhold                      |   | 47      |   | Vice President, General Counsel                    and Secretary                                                                               |
| John Viola                           |   | 57      |   | Vice President and General                    Manager, Correctional Systems                                                                    |
| Robert Rae                           |   | 40      |   | Executive Vice President,                    Operations and Information Technology                                                             |
| Daniel Crawford                      |   | 61      |   | Senior Vice President, Corporate                    Development for Securus; and

General Manager of Syscon Justice                    Systems |
| Floyd Sully                          |   | 59      |   | Founder and Managing Director,                    Syscon Justice Systems                                                                       |
| Tony                    Tamer        |   | 47      |   | Director                                                                                                                                       |
| Brian Schwartz                       |   | 39      |   | Director                                                                                                                                       |
| Douglas Berman                       |   | 41      |   | Director                                                                                                                                       |
| Lewis Schoenwetter                   |   | 37      |   | Director                                                                                                                                       |
| Jeffery McWey                        |   | 52      |   | Director                                                                                                                                       |
| Jack                    McCarthy (1) |   | 65      |   | Director                                                                                                                                       |
| James Neal Thomas (1)                |   | 62      |   | Director                                                                                                                                       |

 

| (1) | Member of the Audit Committee |   |
|-----|-------------------------------|--------|

 

The following information summarizes the principal occupations and business        experience, during the past five years, of each of our directors and executive        officers.

         

*Richard Falcone*has served as our Chairman,        President and Chief Executive Officer since September 2004.  Mr. Falcone served        as Chief Executive Officer of Evercom from October 2000 until we acquired it in September        2004.  Prior to joining Evercom, Mr. Falcone was a Senior Vice President for        AT&T serving in a variety of capacities, including leading AT&T’s Small        Business Markets servicing organization of several thousand employees and establishing        AT&T’s national e-Servicing strategy.  Mr. Falcone received a        B.S.E.E.  from Northeastern University and has had Executive Level education at        MIT Sloan, Stanford University, Brookings Institute in Tokyo and the International        Institute for Management Development (IMD) in Lausanne, Switzerland.  Mr. Falcone        has served on the Board of the National Foundation of Women Business Owners and is a        founding father of the National Black Business Council.

         

*Keith Kelson*has served as our Chief Financial        Officer and Assistant Secretary since September 2004.  Mr. Kelson served as        Evercom’s Chief Financial Officer from March 2000 until we acquired it in September        2004.  Prior to joining Evercom, Mr. Kelson was a certified public accountant in the        accounting and auditing services division of Deloitte & Touche LLP and held        various financial positions with subsidiaries of Kaneb Services, Inc.  Mr. Kelson        has over 20 years of combined accounting experience, serving seven of those years with        Deloitte & Touche LLP and thirteen years in financial management (including ten        years with the Company and its predecessors).  Mr. Kelson has a B.B.A. in        Accounting from Texas Christian University, from which he graduated cum        laude.  Mr. Kelson is a certified public accountant, and has had Executive Level        education at IMD International in Lausanne, Switzerland.

         

 

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*Dennis Reinhold*has served as our Vice        President, General Counsel and Secretary since he joined us in August 2005. Prior to        joining us in August 2005, Mr. Reinhold served as the Associate General Counsel of        SOURCECORP, Inc. While employed at SOURCECORP, SOURCECORP was a public company (NASDAQ:        SRCP) with approximately 7,000 employees worldwide, and specialized in business process        outsourcing of critical data and documents. In that role, he was responsible for the        worldwide legal function of the Business Process Solutions Division, the Statement        Solutions Division, the Legal Claims Division and the Direct Mail Division. While at        SOURCECORP, he was the company’s Chairman of the Juvenile Diabetes Research        Foundation, and helped propel SOURCECORP to one of the largest corporate fundraisers for        Juvenile Diabetes in the DFW area. Prior to his position at SOURCECORP, Mr. Reinhold served        as Division General Counsel/ Director of International Legal Affairs and Assistant        Secretary for AAF-McQuay, Inc. Mr. Reinhold has over 20 years of legal experience, both in        law firms and in-house positions, with an emphasis in practicing in the areas of corporate        and international law. Mr. Reinhold has a J.D. from St. Louis University; a B.S. in        Marketing and Business Administration from the University of Illinois and he completed the        Advanced Management Program at The Wharton School, University of Pennsylvania. Mr. Reinhold        was one of 20 finalists in the 2006 Dallas Business Journal’s Best Corporate Counsel        Awards, and in 2006, he was awarded a National Leadership Award by the National Republican        Congressional Committee. Mr. Reinhold has served on numerous civic organizations, including        the Board of Directors for the Louisville Ballet.

         

*John Viola*has served as our Vice President and        General Manager, Correctional Systems since September 2004. Mr. Viola served as the Vice        President and General Manager of Evercom Correctional Systems from November 2000 until        weacquired it in September 2004. Prior to joining Evercom, Mr. Viola also served as General        Manager of AT&T’s small business group in the western United States during his        18-year tenure with AT&T. Mr. Viola has over 25 years of experience in senior level        sales, marketing and management. Mr. Viola holds a B.A. in Marketing and Management from        the University of Illinois, an M.B.A. from Roosevelt University in Chicago and has        Executive Level education from Texas A&M University. Mr. Viola has served on numerous        civic organizations, including the Board of Directors for the Public Education Business        Coalition and Colorado Uplift, promoting education for inner city youths.

         

*Robert Rae*has served as Executive Vice        President, Operations and Information Technology of the Company since September        2004.  Mr. Rae served as Evercom’s Executive Director of Services/        Operations from December 2002 to September 2004 and as Securus Technologies Vice President        of Enterprise Services and Operations from September 2004 to October 2006.  Prior        to joining Evercom, Mr. Rae was Vice President of Operations for EngineX Networks, an        engineering professional services firm specializing in engineering carrier        telecommunications networks.  Mr. Rae has also held leadership roles with        Fujitsu, where he led international professional services and technical support operations,        and with Bell Atlantic, where he led strategic planning of operations and engineering of        telecommunications networks.  Mr. Rae has a B.A.  in Economics and a        B.S.  in Psychology from the University of Pittsburgh and an        M.B.A.  from the Katz Graduate School of Business.  Mr. Rae has had        Executive Level education at the Wharton School of Business.

         

*Dan Crawford*is Senior Vice President,        Corporate Development for Securus Technologies, and General Manager of Syscon Justice        Systems. Mr. Crawford has enjoyed a stellar career as a senior manager (including stints as        Chairman, CEO and President) with a number of important companies in the public safety and        corrections industry. In addition, Mr. Crawford was the founder of EPIC Solutions, Inc., an        INC 500 fastest growing company. Mr. Crawford has been named Business Leader of the Month        by the national Foundation for Enterprise Development, and One of the Most Influential        Technology Leaders by the San Diego Business Journal. Mr. Crawford began his professional        career in the military as a Naval Aviator. After leaving active duty, Mr. Crawford remained        in the Naval Reserves and retired in 1996 with the rank of captain. He holds an        undergraduate degree in business administration, an MBA, and a law degree, and has served        on multiple boards of directors.

 

*Floyd Sully*has served as our Managing Director        of Syscon since June 2007. Mr. Sully founded Syscon over 25 years ago and  has played        an increasingly important leadership role in the development of correctional information        and case management best practices across North America. Mr. Sully received his        Baccalaureate degree in economics from the University of British Columbia.

 

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*Tony Tamer*has served as a member of our board        of directors since February 2004. Mr. Tamer is a cofounding Partner of H.I.G. Capital and        serves as a Managing Partner of the firm. Mr. Tamer has been an active investor in a number        of industries throughout H.I.G.’s life. Prior to founding H.I.G. in 1993, Mr. Tamer        was a partner at Bain & Company, one of the world’s leading management consulting        firms, and, through Bain Capital, one of the most successful private equity funds in the        United States. Mr. Tamer has extensive operating experience particularly in the        communications and semiconductor industries, having held marketing, engineering and        manufacturing positions at Hewlett-Packard and Embarq (formerly Sprint) Corporation. Mr.        Tamer holds an M.B.A. degree from Harvard Business School, and a Masters degree in        Electrical Engineering from Stanford University. His undergraduate degree is from Rutgers        University. He currently serves on the board of directors of several H.I.G.        companies.

 

*Brian Schwartz*has served as a member of our        board of directors since February 2004 and served as our President until September 2004.        Until December 2007, Mr. Schwartz was a Managing Director at H.I.G. Capital. Since joining        H.I.G. in 1994, Mr. Schwartz has led numerous transactions in a diverse set of industries        including business services (healthcare and IT), building products, and manufacturing.        Prior to joining H.I.G., Mr. Schwartz was a Business Manager in PepsiCo, Inc.’s        strategic planning group. Mr. Schwartz began his career with the investment banking firm of        Dillon, Read and Co. where he advised clients on transactions encompassing initial public        offerings, debt offerings and mergers and acquisitions. Mr. Schwartz earned his M.B.A. from        Harvard Business School and his B.S. with honors from the University of        Pennsylvania.

         

*Douglas Berman*has served as a member of our        board of directors since February 2004. Mr. Berman is a Managing Director at H.I.G.        Capital. He has made investments in the manufacturing, telecommunications, and business        services industries. Since joining H.I.G. in 1996, Mr. Berman has led a number of industry        consolidations, purchasing more than 30 businesses creating several industry-leading        companies. Prior to joining H.I.G., Mr. Berman was with Bain & Company, where he        managed a variety of projects for Fortune 100 clients, developing expertise in        telecommunications, financial services, and manufacturing. Mr. Berman earned his        undergraduate degree from the University of Virginia and his M.B.A. from the Wharton        School. Mr. Berman currently serves on the board of directors of several H.I.G.        companies.

         

*Lewis Schoenwetter*has served as a member of        our board of directors since February 2004 and served as our Vice President, until January        1, 2005. Mr. Schoenwetter is a Managing Director at H.I.G. Capital. With more than 10 years        of experience in private equity investing, Mr. Schoenwetter has played a significant role        in more than 30 acquisitions with an aggregate value in excess of $2 billion. Prior to        joining H.I.G. in April 2003, Mr. Schoenwetter was a director with Levine Leichtman Capital        Partners. Mr. Schoenwetter earned his undergraduate degree at Marquette University and his        M.B.A. from the University of Chicago. He currently serves on the board of directors of        several H.I.G. companies.

         

*Jeffery McWey*has served as a member of our        board of directors since August 2007. He currently serves as an operating partner of HIG        Capital. Mr. McWey has over 30 years of experience in private equity investing. He has        played a vital role in the turnaround of over 13 companies. Prior to joining H.I.G. Capital        he was the Executive Vice President at Global Payments Inc., with the responsibility for        presidents overseeing six business units and world wide marketing. Mr. McWey served on the        MasterCard International Acquirer Board and was the former Non-Executive Chairman of Damian        Services Corporation, Chicago. He currently serves on the board of directors of several        H.I.G. companies.

         

*Jack McCarthy*has served as a member of our        board of directors since May 9, 2005. Mr. McCarthy also currently serves on the board of        directors, audit committee, and compensation committee of Webco Industries, Inc. From 1986        to 2002 Mr. McCarthy held various positions at The Williams Companies, Inc., including        Senior Vice President of Finance and Chief Financial Officer. From 1983 to 1986, Mr.        McCarthy was the Executive Director of Tax at Tenneco, Inc. where he was responsible for        national and international tax planning. Prior to joining Tenneco, Inc., Mr. McCarthy was        the Vice President of Tax of The El Paso

 

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Company        from 1978 to 1983. Mr. McCarthy is a certified public accountant and was a manager in the        tax division of Arthur Young & Company. Mr. McCarthy holds a B.B.A. and an M.B.A from        University of Michigan and a J.D. from Wayne State University.

 

*James Neal Thomas*has served as a member of our        board of directors since May 9, 2005. Mr. Thomas served on the board of directors of Haggar        Corp. and chaired its audit committee until November 2005. Until 2000, Mr. Thomas was a        senior audit partner of Ernst & Young, LLP, where he began his career in 1968. While at        Ernst & Young, Mr. Thomas served mostly Fortune 500 companies including, Wal-Mart        Stores, Inc., The Williams Companies, Inc. and Tyson Foods, Inc. Mr. Thomas is a retired        certified public accountant and holds a degree in accounting from the University of        Arkansas.

         

**Board        Committees**

         

Our board of directors directs the management of our business and affairs as        provided by Delaware law and conducts its business through meetings of the full board of        directors and a standing audit committee. In addition, from time to time, other committees        may be established under the direction of the board of directors when necessary to address        specific issues.

         

Jack McCarthy and James Neal Thomas comprise our audit committee. Each of        the members of the audit committee qualify as a financial expert, as such term is defined        by SEC regulations, and are independent, as defined by the National Association of        Securities Dealers Rule 4200. The duties and responsibilities of the audit committee        include the appointment and termination of the engagement of our independent public        accountants, otherwise overseeing the independent auditor relationship, reviewing our        significant accounting policies and internal controls and reporting its findings to the        full board of directors. Mr. Thomas serves as our audit committee chair.

         

**Code of        Ethics**

         

We have adopted a written code of ethics that applies to our principal        executive officer, principal financial officer, and principal accounting officer or        controller, or persons performing similar functions. Our code of ethics, which also applies        to our directors and all of our officers and employees, is filed as an exhibit to this        report.

 

***ITEM 11. EXECUTIVE COMPENSATION***

 

**Compensation Committee Report**

         

We, the members of the Board of Directors of Securus Technologies, Inc.,        have reviewed and discussed the Compensation Discussion and Analysis with our        company’s management. Based upon this review and discussion, the Board recommends        that the Compensation Discussion and Analysis be included in this Annual Report on Form        10-K.

 

|   | **BOARD OF                    DIRECTORS** |
|--------|-------------------------------------------|
|   | Richard Falcone                           |
|   | Tony                    Tamer             |
|   | Brian                    Schwartz         |
|   | Douglas Berman                            |
|   | Lewis                    Schoenwetter     |
|   | Jeffery McWey                             |
|   | Jack                    McCarthy          |
|   | James                    Neal Thomas      |

 

 

 

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**Compensation Discussion and Analysis**

         

***Introduction***

         

We have a simple executive compensation program which is intended to provide        appropriate compensation that is strongly tied to our results. The program has only three        major components: salary, annual bonus and a restricted stock purchase plan. The program        provides executives with a significant amount of variable compensation dependent on our        performance. For example, for our chief executive officer more than half of his potential        cash compensation is variable and a significant part of his total potential compensation is        via our restricted stock purchase plan.

         

The compensation program’s overall objective is to enable us to obtain        and retain the services of highly-skilled executives. The principles of our executive        compensation program are reflected in its two variable compensation components: annual        bonus and the restricted stock purchase plan. The program seeks to enhance our        profitability and value by aligning closely the financial interests of our executives with        those of our stockholders. This alignment is created by strongly linking compensation to        the achievement of important financial goals. Our ability to reach the financial goals is        dependent on strategic activities. However, at the executive level, we measure success in        these strategic activities principally by the effect on our financial performance. The        compensation program considers the cash flow, accounting and tax aspects to support the        financial efficiency of the programs.

         

The compensation program reflects that we operate with a small team of        executives. The executives are each given significant and extensive responsibilities which        encompass both our strategic policy and direct day-to-day activities in sales and        marketing, finance, legal and regulatory, customer service, product development, and other        similar activities. The compensation program conditions significant portions of management        pay on the achievement of annual (for bonuses) and long term (for restricted stock)        financial performance goals.

         

The compensation packages for executives are designed to promote team work        by generally using the same performance goal for the annual bonus for all executives. The        individual initiative and achievement of an executive is reflected in the level of salary        and bonus, which is determined annually by our board of directors. Of course, the primary        evaluation of individual performance is made in the decision to retain the services of the        executive. If an individual executive is not performing to expectations, the executive is        not retained.

         

***Elements of Compensation***

         

Our compensation program has only three principal elements: salary, annual        bonus, and a restricted stock purchase plan. The remaining compensation paid through        employee benefits and perquisites are not significant in amount or as a percentage of any        executive’s compensation.

         

***Salary***. We recognize that paying a        reasonable cash salary is necessary to enable us to obtain and retain services of        highly-skilled executives. We believe that a reasonable salary is a component of a        well-rounded compensation program.

         

***Annual Bonus***. We believe that an annual        cash bonus provides a means to measure and, if appropriate, reward elements of corporate        performance that are closely related to the efforts of executives. Under the Summary        Compensation Table following this section, the annual bonus is reported in the column        labeled “Non-Equity Incentive Plan Compensation” rather than in the        “Bonus” column. This reporting reflects that the annual cash bonus has        pre-established and generally non-discretionary goals that determine whether any amount        will be paid. Under the Summary Compensation Table, the “Other Bonus” column is        used for discretionary payments without pre-established goals. We refer to our annual cash        incentive program as a bonus program.

         

Because salaries alone would not be sufficient to reach a reasonable level        of potential cash compensation to properly compensate key executives, we believe it is        appropriate and necessary to make

 

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bonus        payments in cash on an annual basis when earned. We choose to pay bonuses in cash rather        than stock because we anticipate that executives would use this payment to supplement their        salaries. Also, if the annual bonus were paid in stock, the total compensation package        might be overweighted in stock. Consequently, executives might discount the future value of        the benefit from the stock, which could put us at a competitive disadvantage. The annual        bonus as a percentage of an executive’s total potential cash compensation generally        increases with the level and responsibilities of the executive.

 

***Long-term Incentive******–        Restricted Stock Purchase Plan***. We provide a long-term        incentive compensation program that is based on our stock through the use of a restricted        stock purchase plan. For stockholders, the long-term value of our stock is the most        important aspect of our performance. The price of our stock is the principal factor in        stockholder value over time. The value of a restricted share is tied directly and primarily        to the ultimate fair value of our stock. Restricted stock is a means of aligning financial        interests of executives and stockholders.

         

We believe that stock-based incentives through the restricted stock purchase        plan ensure that our top officers have a continuing stake in our long term success. We        maintain the 2004 Restricted Stock Purchase Plan to provide executives with opportunities        to acquire our Class B Common Stock and our policy is to allow only executive officers and        key employees to participate.

         

***Employee Benefits***. Our executives        participate in all of the same employee benefit programs as other employees and on the same        basis. These programs are a tax-qualified retirement plan, health and dental insurance,        life insurance, and disability insurance. Our only active retirement plan is a 401(k) plan        in which executives participate on the same basis as other employees. We make a matching        contribution to the 401(k) plan. The amount of the matching contribution depends on the        percentage of their own compensation, up to IRS limits, that each executive chooses to        defer in the 401(k) plan. In 2007, the amount of our matching contributions for the named        executive officers ranged from $6,687 to $9,019 as shown in the “All Other        Compensation” column on the Summary Compensation Table following this        section.

         

***Perquisites***. We provide perquisites only        for our chief executive officer, Mr. Falcone, which consists of a car allowance of $850 per        month. Mr. Falcone is taxed on this allowance.

         

***Key Factors in Determining Compensation***

         

***Performance Measures***. The annual bonus        has been measured principally on our earnings before interest, income taxes, depreciation        and amortization (“EBITDA”). All of our executives have the same EBITDA target        for their annual bonus. EBITDA is used because we believe that it represents the best        measurement of our operating earnings. The annual bonus is intended to be paid primarily        based on actions taken and decisions made during that fiscal year. Interest, income taxes,        depreciation and amortization are excluded because those items can significantly reflect        our long-term decisions on capital structure and investments rather than annual decisions.        We believe it is appropriate to determine bonuses based on our EBITDA, which measures our        performance as an entity, particularly considering there is no public market for our stock.        Because EBITDA for performance purposes is intended to reflect operating earnings, our        Board of Directors may make adjustments in the calculation of EBITDA to reflect        extraordinary events, such as amounts we incur to comply with the Sarbanes Oxley Act of        2002.

         

The bonus based on EBITDA is measured on an annual basis. The use of annual        targets fits with our annual business plan and allows us to measure the executive        group’s performance against targets which we believe can be set in a reasonable        manner.

         

The estimated fair value of our stock is used for all long-term incentive        purposes through the restricted stock purchase plan. We often estimate the value of our        stock annually by obtaining a valuation by an accredited firm.

         

We have not had the need to establish a policy for the adjustment or        recovery of awards or payments when the relevant performance measures are restated or        adjusted in a way that would reduce the size of the

 

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award or        payment. The Board of Directors has the discretion to waive or reduce a performance goal        but this authority has been used infrequently.

 

***Individual Executive Officers***. For        compensation setting purposes, each named executive officer is considered individually,        however, the same considerations apply to all executives. In setting salary, the primary        factors are the scope of the officer’s duties and responsibilities, the        officer’s performance of those duties and responsibilities, the officer’s        tenure with us, and a general evaluation of the competitive market conditions for        executives with the officer’s experience.

         

For the named executive officers and other executives, annual bonus        potential is set as a percentage of salary. The percentage of salary amounts used for this        purpose reflects the officer’s duties and responsibilities. The same measurement,        EBITDA, is used for all officers to encourage the officers to focus on the same company        goals. In setting the salary and bonus potential, we look at total potential cash        compensation for reasonableness and for internal pay equity.

         

We have not looked specifically at amounts realizable from prior        year’s compensation in setting compensation for the current year. We believe that the        amount of compensation for each year should be reasonable for that year.

         

***Determining the Amount of Each Type of Compensation***

         

***Roles in Setting Compensation***. Mr.        Falcone, as chairman, president and chief executive officer, makes recommendations to the        Board of Directors with respect to compensation of executives (including the named        executive officers) other than himself for each of our compensation elements. The Board of        Directors reviews, and in some cases revises, the salary and bonus potential        recommendations for these executives. The Board of Directors makes the determination about        all restricted stock issuances.

         

The Board of Directors makes an independent determination with respect to        the compensation for Mr. Falcone as chairman, president, and chief executive officer. This        determination involves all elements of his compensation. Mr. Falcone has an employment        agreement that establishes minimum salary and bonus potential.

         

***Timing of Compensation Decisions***.        Compensation decisions, including decisions on restricted stock issuances, are generally        made periodically by the Board of Directors, typically in March of each year.

         

***Salary***. We intend for the salary levels        of our executives to be in the competitive market range but do not engage in a formal        market analysis. Executives are generally considered for salary adjustments        annually.

         

***Bonus***. Cash bonus opportunities are        established annually in accordance with our incentive plan. The amount of annual bonuses        earned or unearned is not a major factor in base salary decisions.

         

***Restricted Stock***. The restricted stock        purchase plan is designed primarily to provide incentives to those executives who have the        most potential to impact stockholder value. The restricted stock purchase plan gives        consideration to reasonable compensation levels. Generally, the restricted stock is set        initially and then periodically reviewed by the Board of Directors.

         

***Other Compensation***. Other types of        compensation, including employee benefits and perquisites, do not impact other compensation        decisions in any material way. The employee benefits are changed for executives at the same        time and in the same manner as for all other employees.

         

***Balancing Types of Compensation***. As        noted above, we do not maintain any supplemental retirement plans for executives or other        programs that reward tenure with us more than our actual performance. Our restricted stock        grants are our method of providing a substantial part of an executive’s retirement        and wealth creation. In contrast, we expect that most executives will use their salary and        annual cash bonus primarily for current or short-term expenses. Since the restricted stock        plan is our primary contribution to

 

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an        executive’s long-term wealth creation, we determine the size of the restricted stock        purchase plan with that consideration in mind. We intend that our executives will share in        the creation of value in the Company but will not have substantial guaranteed benefits upon        their termination if value has not been created for our stockholders.

 

***Other Matters Related to Compensation***

         

***Tax and Accounting Considerations***. We        are covered by Internal Revenue Code section 162(m) that may limit the income tax        deductibility to us of certain forms of compensation paid to our named executive officers        in excess of $1,000,000 per year. If these limits should become of broader applicability to        us, we will consider modifications to our compensation practices, to the extent        practicable, to provide appropriate deductibility for compensation payments.

         

We adopted Statement of Financial Accounting Standards No. 123 (revised        2004), “*Share-Based Payment*”        for the year ended December 31, 2006. Statement No. 123(R) is an accounting standard that        requires the fair value of all stock issued to employees to be recorded as an expense over        the related vesting period. We considered Statement No. 123(R) in our issuance of stock        under the 2004 Restricted Stock Purchase Plan, however, our financial statements were not        significantly impacted by the statement.

         

***Change of Control Triggers***. We provide a        change in control benefit under the Restricted Stock Purchase Plan, that provides for        immediate vesting upon a change in control. We believe this benefit will help protect        stockholders’ interests during any negotiations relating to a possible business        combination transaction by encouraging our top executives to remain with us through a        business combination transaction.

         

The only other termination or change in control agreements are contained in        our employment agreement between us and our chairman, president, and chief executive        officer, Mr. Falcone, and an employment letter agreement with our chief financial officer,        Mr. Kelson. Each of these officers will receive certain compensation if they are terminated        without cause.

         

***No Stock Ownership Guidelines.***We have        not adopted any stock ownership requirements or guidelines, but each holder of our        Restricted Stock is subject to the terms of his or her respective stock purchase agreement        the Restricted Stock Purchase Plan and a stockholders’ agreement. We have not adopted        any policies about hedging the economic risk of our stock. We believe that no executives        have engaged in hedging or similar activities with our stock.

         

***Compensation Information***. We have not        engaged in any formal benchmarking of any element of compensation or total compensation in        recent years. We have, however, reviewed publicly available compensation information about        other comparable companies in the telecommunications industry.

         

***Fiscal 2007 Compensation***

         

For the 2007 fiscal year, the compensation of executives was set and        administered consistent with the philosophy and polices described above. Because we did not        meet our performance objectives, we did not award annual bonuses to the named executive        officers, other than in connection the Syscon acquisition. These bonuses were paid in        recognition of the effort associated with the acquisition and integration of Syscon. The        salaries for the named executive officers are shown on the Summary Compensation Table        following this section.

         

For the named executive officers during the 2007 fiscal year, the potential        bonus as a percentage of base salary ranged from 50% to 100%.

         

On December 15, 2007, our shareholders approved a 1 for 1,000 reverse stock        split. Except as otherwise noted, all shares, options and warrants have been restated to        give retroactive effect to the reverse split. All per share disclosures retroactively        reflect shares outstanding or issuable as though the split had occurred as of December 31,        2006.

 

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Information about the restricted stock issued in fiscal 2007 is reflected in        the Summary Compensation Table. The 2007 annual expense for restricted stock as determined        under Statement No. 123(R) is shown in the “Stock Awards” column on the Summary        Compensation Table following this section. The number of shares of stock, grant date, and        grant date fair value of the stock issued in 2007 are shown on the Grants of Plan-Based        Awards table. The restricted stock issued to the named executive officers was 13.2% of the        total restricted shares issued in fiscal 2007.

         

The following table sets forth the summary compensation for each of our        named executive officers for the years ended December 31, 2005, 2006 and 2007:

         

**Summary Compensation Table**

 

| **Name and**                                                                 |     |   |       |   |          |   |   |       |   |   | **Non-Equity**     |   | **All Other**    |   |      |
|------------------------------------------------------------------------------|----------|--------|------------|--------|---------------|--------|--------|------------|--------|--------|--------------------|--------|------------------|--------|-----------|
| **Princicap**                                                                |     |   |       |   |          |   |   | **Stock**  |   |   | **Incentive Plan** |   | **Compensation** |   |      |
| **Position**                                                                 | **Year** |   | **Salary** |   | **Bonus**     |   |   | **Awards** |   |   | **Compensation**   |   | **(2)**          |   | **Total** |
| Richard Falcone -                                                            | 2007     | $      | 400,000    | $      | 100,000       | (3)    | $      | 10,434     |   | $      | -        | $      | 19,219           | $      | 529,653   |
| Principal Executive Officer,                    Chairman, President and      | 2006     | $      | 355,679    | $      | 485,500       |   | $      | 79,938     |   | $      | 420,000            | $      | 19,160           | $      | 1,360,277 |
| Chief Executive                    Officer                                   | 2005     | $      | 349,900    | $      | -   |   | $      | 86,517     |   | $      | 765,412            | $      | 8,305            | $      | 1,210,134 |
| Keith Kelson -                                                               | 2007     | $      | 209,558    | $      | 100,000       | (3)    | $      | 5,486      |   | $      | -        | $      | 6,687            | $      | 321,731   |
| Principal Financial Officer,                    Chief Financial Officer, and | 2006     | $      | 198,375    | $      | -   |   | $      | 5,486      |   | $      | 110,468            | $      | 6,641            | $      | 320,770   |
| Assistant Secretary                                                          | 2005     | $      | 182,829    | $      | -   |   | $      | 6,401      | (1)    | $      | 83,000             | $      | 6,032            | $      | 278,262   |
| John Viola -                                                                 | 2007     | $      | 202,308    | $      | 50,000        | (3)    | $      | 7,094      |   | $      | -        | $      | 8,022            | $      | 267,424   |
| Vice President and

General Manager,                                         | 2006     | $      | 179,038    | $      | -   |   | $      | 5,320      |   | $      | 94,640             | $      | 7,735            | $      | 286,733   |
| Correctional Systems                                                         | 2005     | $      | 172,526    | $      | -   |   | $      | 6,207      | (1)    | $      | 87,000             | $      | 6,178            | $      | 271,911   |
| Robert Rae -                                                                 | 2007     | $      | 201,539    | $      | 100,000       | (3)    | $      | 5,320      |   | $      | -        | $      | 6,785            | $      | 313,644   |
| Executive Vice President,                    Operations and                  | 2006     | $      | 162,191    | $      | 20,000        |   | $      | 5,320      |   | $      | 99,000             | $      | 5,034            | $      | 291,545   |
| Information Technology                                                       | 2005     | $      | 153,076    | $      | -   |   | $      | 6,207      | (1)    | $      | 70,000             | $      | 5,486            | $      | 234,769   |
| Dennis Reinhold -                                                            | 2007     | $      | 203,616    | $      | 100,000       | (3)    | $      | 5,569      |   | $      | -        | $      | 7,750            | $      | 316,935   |
| Vice President,                    General                                   | 2006     | $      | 183,115    | $      |          |   | $      | 4,073      |   | $      | 92,700             | $      | 7,500            | $      | 287,388   |
| Counsel and Secretary                                                        | 2005     | $      | 69,230     | $      | -   |   | $      | 2,885      | (1)    | $      | 82,000             | $      | -      | $      | 154,115   |

 

| (1) | In 2005, Mr. Kelson, Mr. Viola,                    Mr. Rae, and Mr. Reinhold were awarded 6.583 shares, 6.384 shares, 6.384                    shares, and 4.888 shares, respectively, of restricted stock of the Company                    pursuant to the 2004 Restricted Stock Purchase Plan. These shares were                    purchased for $10.00 per share |
|-----|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (2) | Includes the discretionary                    matching contributions by the Company for a 401(k) savings plan and, for Mr.                    Falcone, an automobile allowance of $10,200 for the year ended December 31,                    2007                                                                                                                     |
| (3) | Bonus was paid in July 2007                    related to the consummation of the Syscon acquisition in June 2007. No annual                    bonus was awarded to the executives for 2007 as the Company did not attain the                    EBITDA objectives set by the Board of Directors                                                                     |

 

 

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The following table represents the grant date fair value of stock awards for        the year ended December 31, 2007:

         

|            |           |   | **Grants of Plan-Based Awards Table** |   |           |
|-----------------|----------------|--------|---------------------------------------|--------|----------------|
|            |           |   | **Estimated Future Payouts Under**    |   | **Grant Date** |
|            |           |   | **Equity Incentive Plan Awards(1)**   |   | **Fair Value** |
| **Name**        | **Grant Date** |   | **Threshold**                         |   | **Target**     |   | **Maximum** |   | **of Stock(2)** |
| Dennis Reinhold | 2/15/2007      |   | 0.5                                   |   | 1.0            |   | 1.5 |   | $.01 |

| **(1)** | Mr. Reinhold's 2007 restricted stock grant of 1.5 shares vests                    over three separate periods. 33.34% of the award vests over a period of 3 years                    and will be fully vested by December 31, 2009. An additional 33.33% of the                    award vests in increments based upon achievement of specific performance                    criteria; the remaining 33.33% vest upon a change in control of the                    Company. |
|---------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

**(2)**   The grant date fair value        of the stock was calculated in accordance with SFAS No. 123R. See Footnote 9, Stockholders'        Equity, to our Consolidated Financial Statements for a description of the method used to        calculate fair value.

         

         

The following table represents outstanding equity awards, or restricted        stock grants that were unvested as of December 31, 2007:

|            | **Outstanding Equity Awards at December 31, 2007** |
|-----------------|----------------------------------------------------|
|            |                                               |   |   |   | **Equity Incentive Plan** |   |   |   |
|            | **Number of**                                      |   | **Market Value** |   | **Awards: Number of** |   |   | **Market or Payout** |
|            | **Shares That**                                    |   | **Of Shares That** |   | **Unearned Shares** |   |   | **Value of Unearned** |
|            | **Have Not**                                       |   | **Have Not** |   | **That Have Not** |   |   | **Shares That Have** |
|            | **Vested (1)(a)**                                  |   | **Vested(2)** |   | **Vested(1)(b)** |   |   | **Not Vested(2)** |
| Richard Falcone | 1.26                                               | $ | -   |   | 12.81 |   | $ | -   |
| Keith Kelson    | 0.37                                               |   | -   |   | 3.29 |   |   | -   |
| John Viola      | -                                                  |   | -   |   | 3.19 |   |   | -   |
| Robert Rae      | 0.35                                               |   | -   |   | 3.19 |   |   | -   |
| Dennis Reinhold | 0.84                                               |   | -   |   | 3.26 |   |   | -   |
| Totals          | 2.82                                               | $ | -   |   | 25.74 |   | $ | -   |

**(1)**   All        shares were purchased by the executives for $10.00 per share. Restricted stock vests (a)        ratably over a period or periods, or (b) based upon either a change in control of the        Company or performance criteria as provided in the related restricted stock purchase        agreement.

| **(2)**   | Assumes a market value of $.01 per share, which we estimated to                    be the fair value of the stock as of the last grant date. |
|---------------------|----------------------------------------------------------------------------------------------------------------------------------------------|

         

         

The following table details the Class B restricted stock shares awarded and        the fair value of stock-based compensation to our directors and named executive officers        for the year ended December 31, 2007:

 

|   |            | **Number of**     |   | **Value Realized** |   |
|--------|-----------------|-------------------|--------|--------------------|--------|
|   | **Name**        | **Shares Vested** |   | **On Vesting(1)**  |   |
|   | Richard Falcone | 1.26              | $      | -        |   |
|   | Keith Kelson    | .55               |   | -        |   |
|   | John Viola      | .89               |   | -        |   |
|   | Robert Rae      | 0.53              |   | -        |   |
|   | Dennis Reinhold | 0.53              |   | -        |   |
|   | Neal Thomas     | 1.00              |   | -        |   |
|   | Jack McCarthy   | 1.00              |   | -        |   |
|   | Totals          | 5.76              | $      | -        |   |

         

| (1) | The fair value is representative                    of the most recent fair value of $.01 per share times the number of shares                    vested during 2007. None of the directors or named executive officers received                    cash or other property as their restricted shares vested. Because of the                    transfer restrictions on our Class B Common Stock, the holders of such shares                    cannot freely transfer them. |
|-----|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

         

         

         

 

98

 

 

**Employment Agreements**

         

On November 13, 2006, the Company entered into a new employment contract        with Richard Falcone, the Company’s Chairman of the Board, President, and Chief        Executive Officer. The employment contract extends through January 5, 2009 and provides        that Mr. Falcone will receive (i) a minimum base salary of $400,000 per year; (ii) the        potential to earn an annual bonus at 100% of his base salary, which is earned upon        achievement of objectives mutually agreed upon by Mr. Falcone and our Board of Directors        for each year; (iii) eligibility to receive restricted shares of the Company’s Class        B common stock; (iv) an automobile allowance of $850 per month; and (v) other benefits,        such as life and health insurance, paid vacation, and reimbursement of business expenses.        Additionally, Mr. Falcone received a one-time bonus, of $485,500 when he signed the        employment agreement and will also receive a $460,000 bonus payable at the end of the        contract term.

         

Mr. Falcone reports directly to our board of directors and must secure the        board’s written consent before consulting with any other entity or gaining more than        a 5% ownership interest in any enterprise other than ours, unless such ownership interest        will not have a material adverse effect upon his ability to perform his duties under this        agreement. We may terminate Mr. Falcone’s employment for cause, in which case we will        pay him any base salary accrued or owing to him through the date of termination, less any        amounts he owes to us. We may also terminate Mr. Falcone’s employment without cause        or Mr. Falcone may terminate his own employment due to the occurrence of events        constituting constructive discharge. If Mr. Falcone is terminated without cause or is        constructively discharged, we will pay Mr. Falcone an amount equal to (i) the lesser of (1)        two times his annual base salary or (2) the amount of remaining base salary that would have        been payable to him from the date of such termination of employment through the agreement        expiry date plus an additional six months of base salary, plus (ii) the benefits which were        paid to him in the year prior to the year in which his employment was terminated, plus        (iii) a pro-rated bonus for the year in which Mr. Falcone’s employment was        terminated.

         

During Mr. Falcone’s employment and for the one-year period (or, under        certain conditions, up to the two-year period) immediately following the expiration or        earlier termination of the employment period, Mr. Falcone is prohibited from competing with        us anywhere in the United States, including locations in which we currently operate and        plan to expand, and must abide by customary covenants to safeguard our confidential        information.

         

We have an employment letter agreement with Keith Kelson, our chief        financial officer. The agreement term continues until terminated by either party. If the        agreement is terminated for any reason other than gross misconduct, Mr. Kelson is        entitled to receive a severance payment of twelve months salary. During 2007,        Mr. Kelson earned a base salary of $209,558 and a bonus of $100,000 related to the        consummation of the Syscon acquisition.

         

**2004        Restricted Stock Purchase Plan**

         

We have a 2004 Restricted Stock Purchase Plan under which our employees may        purchase shares of our Class B common stock. There are 75,000 shares of Class B common        stock authorized for issuance under the plan. On December 15, 2007, our shareholders        approved a 1 for 1,000 reverse stock split but the board of directors elected to continue        to authorize 75,000 shares under the plan. Our board of directors administers the        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 restricted stock is determined by our board of directors. Generally, restricted stock        will vest based on performance criteria, ratably over a period or periods, or upon a change        of control of the Company, as provided in the related restricted stock purchase agreements        and the plan.

         

**Compensation Committee Interlocks and Insider        Participation**

         

Our board of directors has not established a compensation committee.        Consequently, during 2007 our entire board of directors participated in the determination        of our executive officers’ compensation. Included in the 2007 compensation meetings        were Richard Falcone, our current Chairman, President, and Chief

 

99

 

 

Executive        Officer, Richard Cree, our former Chairman, Brian Schwartz, our former President and Lewis        Schoenwetter, our former Vice President and Treasurer.

 

**Indemnification Agreements**

         

We have entered into indemnification agreements with certain of our officers        and directors which provide for their indemnification and the reimbursement and advancement        to them of expenses, as applicable, in connection with actual or threatened proceedings and        claims arising out of their status as a director or officer.

 

**Director        Compensation**

         

Except for Messrs. McCarthy and Thomas, our directors receive no        compensation for serving on the board. The board members do, however, receive reimbursement        of reasonable expenses incurred in attending meetings. Each of Messrs. McCarthy and        Thomas receives $50,000 annually for serving on the board and audit committee and        Mr. Thomas receives $6,000 annually for serving as Chairman of the Audit Committee.        Additionally, Mr. Thomas and Mr. McCarthy each purchased 0.665 and 1.335 shares        of restricted stock in 2005 and 2006, respectively, for $10.00 per share. No additional        shares have been purchased as of December 31, 2007. Our outside director compensation for        the year ended December 31, 2007 is as follows:

         

|   | **Director Compensation Table(1)** |
|--------|------------------------------------|
|   |                               |   | **Fees Earned** |   |   |   |   |
|   |                               |   | **or Paid** |   | **Stock** |   | **Total** |
|   | **Name**                           |   | **In Cash** |   | **Awards** |   | **Compensation** |
|   | James Neal Thomas                  | $ | 56,000 | $ | 6,008 | $ | 62,008 |
|   | Jack McCarthy                      | $ | 50,000 | $ | 6,008 | $ | 56,008 |

 

| (1) | Our only equity compensation plan                    is our 2004 restricted stock plan which has been approved by shareholders. As                    of December 31, 2007, there were 75,000 shares authorized under the plan. On                    December 15, 2007, our shareholders approved a 1 for 1,000 reverse stock split                    but elected to continue to authorize 75,000 shares under the plan |
|-----|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

 

***ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL        OWNERS AND MANAGEMENT***

 

The following table sets forth certain information, as of March 1,        2008, with respect to the beneficial ownership of shares of our common stock by:

         

| **•** | each person who is known to us to                    beneficially own more than 5% of the outstanding shares of common                    stock;                                                                                                               |
|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|       |                                                                                                                                                                                                                                                           |
| **•** | each of our directors;                                                                                                                                                                                                                                         |
|       |                                                                                                                                                                                                                                                           |
| **•** | each of the chief executive                    officer, principal financial officer and the three other most highly                    compensated executive officers who were serving as executive officers on                    December 31, 2007; and |
|       |                                                                                                                                                                                                                                                           |
| **•** | all current directors and                    executive officers as a group.                                                                                                                                                                                    |

         

The number of shares of common stock beneficially owned by each person is        determined under rules promulgated by the SEC. Under these rules, a person is deemed to        have “beneficial ownership” of any shares over which that person has voting or        investment power, or shares such power, plus any shares that the person may acquire within        60 days, including through the exercise of stock options. Unless otherwise indicated,        each person in the table has sole voting and investment power over the shares listed. The        inclusion in the table of any shares does not constitute an admission of beneficial        ownership of those shares by the named stockholder. For each person, the “Number of        Shares Beneficially Owned” column may

 

100

 

 

include        shares of common stock attributable to the person due to that person’s voting or        investment power or other relationship.

 

On December 15, 2007, we effected a 1 for 1,000 reverse stock split for our        Common stock and Class B Common stock in connection with the issuance of 5,100 shares of        Series A Redeemable Convertible Preferred Stock. All per share disclosures retroactively        reflect shares outstanding or issuable as though the split had occurred as of December 31,        2006.

 

|                                                                                            |   | **Number of Shares**   |
|-------------------------------------------------------------------------------------------------|--------|------------------------|
|                                                                                            |   | **Beneficially Owned** |
|                                                                                            |   |                   |   |   |   |   |   | **Percentage** |
|                                                                                            |   |                   |   |   |   | **Class B** |   | **of Common** |
| **Name and Address of Beneficial Owner (1)**                                                    |   | **Preferred stock(2)** |   | **Common stock** |   | **Common stock** |   | **stock (3)** |
| **5% Stockholders**                                                                             |   |                   |   |   |   |   |   |   |   |
| H.I.G.-TNetix, Inc.(4)                                                                          |   | 5,080.62               |   | 495.33 |   |   |   | 95.7 | % |
| 1001 Brickell Bay Drive,                    27th Floor

Miami, Florida 33131                    |   |                   |   |   |   |   |   |   |   |
| AIF Investment                    Company(5)                                                    |   | 1,558.21               |   | 151.92 |   |   |   | 29.3 | % |
| 1001 Brickell Bay Drive,                    27th Floor

Miami, Florida                    33131 |   |                   |   |   |   |   |   |   |   |
| **Directors**                                                                                   |   |                   |   |   |   |   |   |   |   |
| Richard Falcone(6)                                                                              |   | 19.38                  |   | 2.49 |   | 26.34 |   | 0.8 | % |
| Tony Tamer(8)                                                                                   |   | 5,080.62               |   | 495.33 |   |   |   | 95.7 | % |
| Brian Schwartz(8)                                                                               |   | 5,080.62               |   | 495.33 |   |   |   | 95.7 | % |
| Douglas Berman(8)                                                                               |   | 5,080.62               |   | 495.33 |   |   |   | 95.7 | % |
| Lewis Schoenwetter(8)                                                                           |   | 5,080.62               |   | 495.33 |   |   |   | 95.7 | % |
| Jeffrey McWey(8)                                                                                |   | 5,080.62               |   | 495.33 |   |   |   | 95.7 | % |
| Jack McCarthy(7)                                                                                |   |                   |   |   |   | 2.00 |   | * |   |
| James Neal Thomas(7)                                                                            |   |                   |   |   |   | 2.00 |   | * |   |
| **Other Named Executive                    Officers**                                           |   |                   |   |   |   |   |   |   |   |
| Keith Kelson(7)                                                                                 |   |                   |   |   |   | 6.58 |   | * |   |
| Robert Rae(7)                                                                                   |   |                   |   |   |   | 6.38 |   | * |   |
| John Viola(7)                                                                                   |   |                   |   |   |   | 6.38 |   | * |   |
| Dennis Reinhold(7)                                                                              |   |                   |   |   |   | 6.38 |   | * |   |
| Directors and executive officers                    as a group –(16 persons) (9)     |   | 5,100                  |   | 543.43 |   | 69.27 |   | 98.01 | % |

 

| *      | Denotes less than 1%                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
| (1)    | Unless otherwise indicated, the                    address of each beneficial owner listed above is c/o Securus Technologies,                    Inc., 14651 Dallas Parkway, Suite 600, Dallas, Texas 75254-8815                                                                                                                                                                                                                                                                                                                                                                             |
| (2)    | The Series A Redeemable                    Convertible Preferred Stock initially converts into one share of Common Stock,                    adjusted for certain events. If the Company does not achieve at least $45                    million of Credit Facility Cash Flow (as defined in the certificate of                    designation for the preferred stock) for the 12 months ended June 30, 2008,                    each share of Series A Redeemable Convertible Preferred Stock will convert into                    200 shares of Common Stock, as adjusted for certain events. |
| (3)    | Represents the aggregate                    ownership of our Common stock and Class B Common stock on a fully diluted                    basis. Calculated based on 680.15 shares of Common stock and Class B                    Common stock outstanding as of March 1, 2008, giving effect to immediately                    exercisable options and warrants to purchase an aggregate of 51.011 shares of                    Common stock granted in connection with our senior subordinated debt financing                    and conversion of preferred stock.                    |
| (4)    | Includes an aggregate of 147.46                    shares of Common Stock beneficially owned by AIF Investment Company. AIF                    Investment Company is wholly-owned by H.I.G.-TNetix. Mr. Tamer currently serves                    as a director and officer of H.I.G.-TNetix, Inc.                                                                                                                                                                                                                                                                                                |
| (5)    | H.I.G.-TNetix is the majority                    stockholder of AIF Investment Company. Mr. Tamer currently serves as a director                    and officer of AIF Investment Company.                                                                                                                                                                                                                                                                                                                                                                                                        |
| (6)    | Represents 2.49 shares of Common                    stock acquired by Mr. Falcone concurrently with our acquisition of                    Evercom. Also represents 26.34 shares of Class B common stock purchased by                    Mr. Falcone pursuant to our 2004 Restricted Stock Purchase                    Plan.                                                                                                                                                                                                                                                        |
| (7)    | Represents shares of Class B                    common stock purchased in connection with our 2004 Restricted Stock Purchase                    Plan. Mr. Reinhold purchased an additional 1.49 shares of Class B common stock                    on February 14, 2007.                                                                                                                                                                                                                                                                                                                      |

 

 

101

 

 

 

| (8) | Represents shares beneficially                    owned by H.I.G.-TNetix, Inc. and AIF Investment Company. H.I.G. Capital                    Partners III, L.P. is the controlling stockholder of H.I.G.-TNetix, Inc. and                    H.I.G. — TNetix is the controlling stockholder of AIF Investment Company.                    Mr. Tamer is a member of H.I.G. Advisors III, L.L.C., the general partner of                    H.I.G. Capital Partners III, L.P., the ultimate parent entity of H.I.G.-TNetix,                    Inc. and AIF Investment Company. Messrs. McWey, Tamer, Schwartz, Berman                    and Schoenwetter may, by virtue of their respective relationships with either                    H.I.G.- TNetix, Inc., AIF Investment Company or H.I.G. Capital, L.L.C., be                    deemed to beneficially own the securities held by H.I.G.-TNetix, Inc. and AIF                    Investment Company, and to share voting and investment power with respect to                    such securities. Each of Messrs. McWey, Tamer, Schwartz, Berman and                    Schoenwetter disclaim beneficial ownership of the securities beneficially owned                    by H.I.G.-TNetix and AIF Investment Co. The address of each of                    Messrs. McWey, Tamer, Schwartz, Berman and Schoenwetter is c/o H.I.G.                    Capital, LLC, 1001 Brickell Bay Drive, 27th Floor, Miami, Florida                    33131. |
|-----|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (9) | Represents (a) 73.49 shares                    beneficially owned by Richard Falcone, Keith Kelson, Robert Rae, John Viola,                    Greg Haertling, Dan Crawford, Steve Viefaus, Dennis Reinhold, Jack McCarthy and                    Neil Thomas, and (b) 5,080.62 shares beneficially owned by H.I.G.-TNetix,                    Inc. and AIF Investment Company and attributable to each of the                    Messrs. McWey, Tamer, Schwartz, Berman and Schoenwetter.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |

 

 

***ITEM 13. CERTAIN RELATIONSHIPS AND RELATED PARTY        TRANSACTIONS***

 

**Restricted Stock Purchase Agreements**

         

We have a restricted stock purchase agreements with Mr. Falcone and        other members of our management pursuant to our 2004 Restricted Stock Plan. The maximum        number of Class B shares of common stock subject to grants under the 2004 Restricted Stock        Purchase Plan was 75,000 as of December 31, 2007, subject to adjustment. During 2007, an        aggregate of 11.37 shares were issued under the plan to executives, employees and members        of our Board of Directors. Pursuant to the terms of the plan and the applicable restricted        stock purchase agreements, shares of stock are subject to time and performance vesting        based upon the length of service such executive has with us and other vesting criteria        including obtaining a specified sales price in connection with our sale to an independent        third party. Shares of common stock issuable pursuant to restricted stock purchase        agreements are subject to certain rights of repurchase and certain restrictions on        transfer. Generally, if an executives employment is terminated, shares of restricted stock        that have not vested prior to or in connection with a sale of us to an independent third        party are forfeited to us without consideration.

         

**Equity        Investment by Richard Falcone**

         

In 2004 Richard Falcone, our Chairman, President, and Chief Executive        Officer, purchased 2.49 shares of our common stock for an aggregate purchase price of        $142,000, or a price per share of $57,028. Additionally, Mr. Falcone acquired an        aggregate of 26.34 shares of Class B restricted common stock pursuant to a restricted stock        purchase agreement, 14.1 of which were still subject to restrictions as of December 31,        2007. These restricted shares are subject to forfeiture pursuant to the terms of our 2004        Restricted Stock Purchase Plan and the restrictions described hereafter. With respect to        36.6% of the restricted stock, the restriction period ends upon the sale of our stock by        certain of our other stockholders. The restriction period for 31.7% of the restricted stock        ends upon the lapse of time, 6.3% each December 31 and June 30. With respect to        the remaining shares, the restriction period ends upon our attainment of certain        performance measures determined by our board of directors and Mr. Falcone. Further,        upon a change of control, the restriction period will end for all of        Mr. Falcone’s restricted shares that have not previously vested. The restricted        shares are entitled to dividends, if declared, which will be distributed upon termination        of the restriction period with respect to any such restricted shares.

         

During 2007, Mr. Falcone purchased 19.38 shares of Series A Redeemable        Convertible Preferred Stock. Each share of the Series A Redeemable Convertible Preferred        Stock has an initial stated value of $2,000 and accrues dividends at 12.5% annually. The        Series A Redeemable Convertible Preferred Stock initially converts into one share of Common        stock, adjusted for certain events. If we do not achieve at least $45 million of Credit        Facility Cash Flow (as defined in the certificate of designation for the preferred stock)        for the 12 months ended June 30, 2008, each share of Series A Redeemable Convertible        Preferred Stock will convert into 200 shares of Common stock, as adjusted for certain        events.

         

 

102

 

 

 

 

**Stockholders’ Agreement**

         

We and our stockholders have entered into a stockholders’ agreement to        assure continuity in our management and ownership, to limit the manner in which our        outstanding shares of capital stock may be transferred, and to provide certain registration        rights. The stockholders’ agreement provides for customary transfer restrictions,        rights of first refusal for us and our stockholders, preemptive rights, drag-along and        tag-along rights, and registration rights.  The stockholders’ agreement        also provides that as long as H.I.G.-TNetix, Inc., or its affiliates owns more than 50% of        our common stock, H.I.G.-TNetix or its affiliate may designate the majority of our board of        directors. We have also agreed to pay an aggregate of $100,000 annually on a pro rata basis        to those Evercom stockholders who invested in our company contemporaneously with the        closing of the Evercom acquisition.

         

Additionally, we have agreed to indemnify our stockholders (as sellers of        securities, not as officers or directors), their officers and directors, and each person        who controls such stockholder for losses which the indemnified person may sustain, incur or        assume as a result of our violation of the Securities Act, the Exchange Act or any state        securities law, or any untrue or alleged untrue statement of material fact contained in any        document we file with the SEC.

         

**H.I.G.        Capital, LLC Consulting Agreements**

 

***Consulting Services Agreement***

         

We have a consulting services agreement with H.I.G. pursuant to which H.I.G.        is paid an annual fee of $750,000 for management, consulting and financial advisory        services. In addition, H.I.G. is entitled to receive fees equal to 2% of the consideration        received by us upon a public offering of our capital stock or the sale of all or        substantially all of our assets, which provision survives the termination of the        agreement.

         

 

***Professional Services Agreement***

         

We also have a professional services agreement with H.I.G., pursuant to        which H.I.G. is paid investment banking fees equal to 2% of the value of any transaction in        which we (i) sell all or substantially

 

103

 

 

all of our        assets or a majority of our stock, (ii) acquire any other companies or        (iii) secure any debt or equity financing. In connection with our acquisition of        Syscon and the issuance of the Series A Redeemable Convertible Preferred Stock, H.I.G.        received a professional services fee equal to 2% of each transaction value, or        approximately $1.0 million and $200,000, respectively.

 

**Management**

         

Certain of our directors are affiliated with H.I.G. Mr. Tamer is a managing        partner of H.I.G. and Mr. Berman and Mr. Schoenwetter are managing directors of        H.I.G. Mr. McWey is an operating partner of H.I.G. and Mr. Schwartz is a former managing        director.

         

**Syscon        Acquisition**

         

On April 11, 2007 we purchased Syscon from a Canadian        company of which Mr. Floyd Sully was sole stockholder. Under        the purchase agreement, the initial purchase price for Syscon’s capital        stock was approximately $41 million and 45.6 shares of our common stock, subject to a        working capital adjustment. In addition, we will pay Mr. Sully $7 million after each of the        first three 12 month periods after the closing date if Syscon’s revenues exceed        certain thresholds and Mr. Sully has not resigned or been terminated for cause from his        employment with Syscon. The revenue thresholds for the full earn-out payments are $56.5        million for the first 12 months, $61.5 million for the second 12 months, and $63.1 million        for the third 12 months. If Syscon’s revenues are less than the aforementioned        thresholds, but greater than $30 million for the first 12 months, $33.33 million for the        second 12 months and $36.67 million for the third 12 months, Mr. Sully will earn a portion        of the $7 million dollar payment applicable to the given year.  During the year ended        December 31, 2007, we paid $0.2 million to Milotech Limited ("Milotech"), a party related        to Mr. Sully for professional software development consulting services.  We retain        Milotech's services as and when needed.

         

We have an employment agreement with Mr. Sully pursuant to which he serves        as the President of Syscon. The agreement extends through June 28, 2010. Mr. Sully receives        a minimum salary of Canadian $250,000 and expense reimbursements and is entitled to        participate in our employee benefit plans. We may terminate Mr. Sully’s employment        with or without cause. If we terminate Mr. Sully without cause, we must pay him $5,000        severance in addition to any compensation to which he is entitled under Canadian law.        During Mr. Sully’s employment and for a period of one year thereafter, Mr. Sully is        prohibited from competing with us anywhere we are doing business at the time he ceases to        be employed and must abide by customary covenants to safeguard our confidential        information.

 

***ITEM 14. PRINCIPAL ACCOUNTANT FEES AND        SERVICES***

 

The following table represents the aggregate fees paid or accrued for        services rendered by KPMG LLP, our independent registered public accounting firm, for the        years ended December 31, 2006 and December 31, 2007 (in thousands).

         

|   |               |   | **2006**      |   | **2007**      |   |
|--------|--------------------|--------|---------------|--------|---------------|--------|
|   | Audit fees         | $      | 631           | $      | 735           |   |
|   | Audit-related fees |   | -   |   | -   |   |
|   | Tax fees           |   |  -       |   | -             |   |
|   | Total fees         | $      | 631           | $      | 735           |   |

 

**Audit        Fees**

         

Audit fees consist of fees for the audit of our financial statements, the        review of the interim financial statements included in our quarterly reports on Form 10-Q,        and other professional services provided in connection with statutory and regulatory        filings or engagements.

         

**Audit-Related Fees**

 

These are fees for assurance and related services and consisted primarily of        audits of employee benefit plans, specific internal control process reviews and        consultations regarding accounting and financial reporting.

         

**Tax        Fees**

 

Tax fees consist of fees for tax compliance and tax advice services        associated with the preparation of original tax returns and requests for technical advice        from taxing authorities. All tax services are provided by an outside firm unrelated to KPMG        LLP.

         

**Audit        Committee’s Pre-approval Policy and Procedures**

 

The audit committee has adopted policies and procedures relating to the        approval of all audit and non-audit services that are to be performed by our independent        auditor. This policy generally provides that we will not engage our independent auditor to        render audit or non-audit services unless the service is specifically approved in advance        by the audit committee or the engagement is entered into pursuant to one of the        pre-approval procedures described below.

         

From time to time, the audit committee may pre-approve specified types of        services that are expected to be provided to us by our independent auditor during the next        12 months. Any such pre-approval would be detailed as to the particular service or        type of services to be provided and would be generally subject to a maximum dollar        amount.

         

 

104

 

 

De minimis non-audit services that were not recognized at the time of the        engagement to be non-audit services, may be approved by the audit committee prior to the        completion of the audit in accordance with applicable SEC rules governing de minimis        non-audit services.

         

The audit committee may delegate to one or more members of the audit        committee the authority to pre-approve audit or non-audit services to be provided by the        independent accountants, provided that any such pre-approval shall be reported to the full        audit committee at its next scheduled meeting.

         

During fiscal year 2007, no services were provided to us by KPMG LLP or any        other accounting firm other than in accordance with the pre-approval policies and        procedures described above.

 

105

 

 

**PART        IV**

 

***ITEM 15. EXHIBITS AND FINANCIAL STATEMENT        SCHEDULES***

 

| (a)    | Index to Consolidated Financial                    Statements                                                                                                                                                                                                         |
|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                                                                                  |   |
| 1.     | *Financial                    Statements:*  The following financial                    statements and schedules of Securus Technologies, Inc. are included in this                    report:                                                               |
|   | •                                                                                                                                                                                                                                                                | Consolidated Balance Sheets                    — As of December 31, 2006 and December 31, 2007. |
|   |                                                                                                                                                                                                                                                                  |   |
|   | •                                                                                                                                                                                                                                                                | Consolidated Statements of                    Operations —For the Years Ended December 31, 2005, 2006 and                    2007. |
|   |                                                                                                                                                                                                                                                                  |   |
|   | •                                                                                                                                                                                                                                                                | Consolidated Statements of                    Stockholders’ Deficit —For the Years Ended December 31, 2005,                    2006 and 2007. |
|   |                                                                                                                                                                                                                                                                  |   |
|   | •                                                                                                                                                                                                                                                                | Consolidated Statements of Cash                    Flows — For the Years Ended December 31, 2005, 2006 and                    2007. |
|   |                                                                                                                                                                                                                                                                  |   |
|   | •                                                                                                                                                                                                                                                                | Notes to Consolidated Financial                    Statements |
|   |                                                                                                                                                                                                                                                                  |   |
| 2.     | *Financial Statement                    Schedules:*  None.                                                                                                                                                                                                  |
|   |                                                                                                                                                                                                                                                                  |   |
| 3.     | *Exhibits:*  The exhibits                    which are filed with this report or which are incorporated herein by reference                    are set forth in the Exhibit Index on page 105 which is incorporated herein by                    reference. |

 

 

**Signatures**

 

Pursuant to the requirements of Section 13 or 15(d) of the Securities        Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf        by the undersigned, thereunto duly authorized, on March 28, 2008.

         

|   | SECURUS TECHNOLOGIES,                    INC. |
|--------|-----------------------------------------------|
|   |                                          |   |
|   | By:                                           |   |
|   |                                          | Richard Falcone, |
|   |                                          | *Chairman of the Board,* |
|   |                                          | *President, Chief Executive Officer* |
|   |                                          | *(Principal Executive Officer)* |

 

Pursuant to the Securities Exchange Act of 1934, this report has been signed        below by the following persons on behalf of the registrant and in the capacities below on        the dates indicated.

         

 

| **Signature**   |   | **Capacity**                                                             |   | **Date**       |
|-----------------|--------|--------------------------------------------------------------------------|--------|----------------|
|            |   |                                                                     |   |           |
|            |   | Chairman, President, Chief                    Executive Officer          |   | March 28, 2008 |
| Richard Falcone |   | and                    Director  (Principal Executive Officer) |   |           |
|            |   |                                                                     |   |           |
|            |   | Director                                                                 |   | March 28, 2008 |
| Tony Tamer      |   |                                                                     |   |           |
|            |   |                                                                     |   |           |
|            |   | Director                                                                 |   | March 28, 2008 |

 

 

106

 

 

 

| Brian Schwartz     |   |                                             |   |           |
|--------------------|--------|--------------------------------------------------|--------|----------------|
|               |   |                                             |   |           |
|               |   | Director                                         |   | March 28, 2008 |
| Douglas Berman     |   |                                             |   |           |
|               |   |                                             |   |           |
|               |   | Director                                         |   | March 28, 2008 |
| Lewis Schoenwetter |   |                                             |   |           |
|               |   |                                             |   |           |
|               |   | Director                                         |   | March 28, 2008 |
| Jeffery McWey      |   |                                             |   |           |
|               |   |                                             |   |           |
|               |   | Director                                         |   | March 28, 2008 |
| James Neal Thomas  |   |                                             |   |           |
|               |   |                                             |   |           |
|               |   | Director                                         |   | March 28, 2008 |
| Jack McCarthy      |   |                                             |   |           |
|               |   |                                             |   |           |
|               |   | Chief Financial                    Officer       |   | March 28, 2008 |
| Keith Kelson       |   | (Principal Financial                    Officer) |   |           |

 

 

107

 

 

**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    | Second Amended and Restated                    Certificate of Incorporation of Securus Technologies, Inc., incorporated by                    reference from Form 8-K filed January 3, 2008.                                                                                                                    |
|   |                                                                                                                                                                                                                                                                                                            |
| 3.1.1  | Certificate of Designation,                    Preferences, and Rights of Series A Preferred Stock of Securus Technologies,                    Inc., incorporated by reference from Form 8-K filed January 3, 2008.                                                                                             |
|   |                                                                                                                                                                                                                                                                                                            |
| 3.2    | Amended and Restated Bylaws of                    Securus Technologies, Inc., incorporated by reference from Form S-4 filed May                    16, 2005.                                                                                                                                                    |
|   |                                                                                                                                                                                                                                                                                                            |
| 3.3    | Certificate of Incorporation of                    T-Netix, Inc., filed on September 7, 2001, as amended, incorporated by                    reference from Form S-4 filed May 16, 2005.                                                                                                                        |
|   |                                                                                                                                                                                                                                                                                                            |
| 3.4    | Bylaws of T-Netix, Inc,                    incorporated by reference from Form S-4 filed May 16, 2005.                                                                                                                                                                                                          |
|   |                                                                                                                                                                                                                                                                                                            |
| 3.5    | Articles of Incorporation of                    Telequip Labs, Inc., filed on November 9, 1987, as amended, incorporated by                    reference from Form S-4 filed May 16, 2005.                                                                                                                      |
|   |                                                                                                                                                                                                                                                                                                            |
| 3.6    | Amended and Restated Bylaws of                    Telequip Labs, Inc., incorporated by reference from Form S-4 filed May 16,                    2005.                                                                                                                                                           |
|   |                                                                                                                                                                                                                                                                                                            |
| 3.7    | Articles of Incorporation of                    T-NETIX Telecommunications Services, Inc., filed on February 11, 1988, as                    amended, incorporated by reference from Form S-4 filed May 16, 2005.                                                                                               |
|   |                                                                                                                                                                                                                                                                                                            |
| 3.8    | Bylaws of T-NETIX                    Telecommunications Services, Inc., incorporated by reference from Form S-4                    filed May 16, 2005.                                                                                                                                                          |
|   |                                                                                                                                                                                                                                                                                                            |
| 3.9    | Certificate of Incorporation of                    Evercom Holdings, Inc., filed on November 25, 2002, as amended, incorporated by                    reference from Form S-4 filed May 16, 2005.                                                                                                               |
|   |                                                                                                                                                                                                                                                                                                            |
| 3.10   | Bylaws of Evercom Holdings, Inc.,                    incorporated by reference from Form S-4 filed May 16, 2005.                                                                                                                                                                                                |
|   |                                                                                                                                                                                                                                                                                                            |
| 3.11   | Amended and Restated Certificate                    of Incorporation of Evercom, Inc., filed on February 19, 2003, incorporated by                    reference from Form S-4 filed May 16, 2005.                                                                                                               |
|   |                                                                                                                                                                                                                                                                                                            |
| 3.12   | Bylaws of Evercom, Inc.,                    incorporated by reference from Form S-4 filed May 16, 2005.                                                                                                                                                                                                         |
|   |                                                                                                                                                                                                                                                                                                            |
| 3.13   | Certificate of Incorporation of                    Evercom Systems, Inc., filed on August 22, 1997, as amended, incorporated by                    reference from Form S-4 filed May 16, 2005.                                                                                                                  |
|   |                                                                                                                                                                                                                                                                                                            |
| 3.14   | Bylaws of Evercom Systems, Inc.,                    incorporated by reference from Form S-4 filed May 16, 2005.                                                                                                                                                                                                 |
|   |                                                                                                                                                                                                                                                                                                            |
| 3.15   | Certificate of Incorporation                    Syscon of Justice Systems Canada Ltd., incorporated by reference from Form S-4                    filed August 1, 2007.                                                                                                                                    |
|   |                                                                                                                                                                                                                                                                                                            |
| 3.16   | Articles of Syscon of Justice                    Systems Canada Ltd., incorporated by reference from Form S-4 filed                    August 1, 2007.                                                                                                                                                     |
|   |                                                                                                                                                                                                                                                                                                            |
| 3.17   | Articles of Incorporation of                    Syscon Justice Systems, Inc., incorporated by reference from Form S-4 filed                    August 1, 2007.                                                                                                                                             |
|   |                                                                                                                                                                                                                                                                                                            |

 

 

108

 

 

 

| 3.18   | Bylaws of Syscon Justice Systems,                    Inc., incorporated by reference from Form S-4 filed August 1,                    2007.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| 3.19   | Articles of Organization of                    Modeling Solutions LLC incorporated by reference from Form S-4 filed                    August 1, 2007.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| 3.20   | Operating Agreement of Modeling                    Solutions LLC incorporated by reference from Form S-4 filed August 1,                    2007.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| 3.21   | Articles of Organization of                    Modeling Solutions, LLC incorporated by reference from Form S-4 filed                    August 1, 2007                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| 3.22   | Operating Agreement of Modeling                    Solutions, LLC incorporated by reference from Form S-4 filed August 1,                    2007.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| 4.1    | Form of 11% Second-priority                    Senior Secured Notes due 2011, incorporated by reference from Form S-4 filed                    May 16, 2005.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| 4.2    | Indenture, dated as of September                    9, 2004, by and among Securus, 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.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |

 

 

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| 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 Copyright                    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 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.                                                                                                                                                                                                    |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 4.8    | 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.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 4.8.1  | Supplement No. 1 to Amended and                    Restated Pledge Agreement, dated June 29, 2007, incorporated by reference from                    Form S-4 filed August 1, 2007.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 4.9    | 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.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 4.9.1  | 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.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 4.9.2  | 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.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 4.9.3  | 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.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 4.9.4  | Fourth Amendment to the 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 and Administrative Agent incorporated by reference from Form 8-K filed                    July 2, 2007.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 4.9.5* | Fifth Amendment to the Credit                    Agreement, dated March 20,2008, 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.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 4.10   | 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.                                                                                                                                     |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 4.10.1 | 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.                                                                     |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 4.11   | 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.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 4.12   | 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.                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 4.12.1 | 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 Form 8-K filed July 2,                    2007. |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 4.13   | Form of 11% Second-priority                    Senior Secured Notes due 2011, incorporated by reference from Form S-4 filed                    August 1, 2007.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 4.14   | 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.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 4.15   | 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.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 4.16   | 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.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 4.17   | 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 Form 10-Q filed 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                    Form 10-Q filed 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.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 14.1*  | Securus Code of Ethics,                    incorporated by reference from 10-K filed March 30, 2007.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 21.1*  | Schedule of Subsidiaries of                    Securus, incorporated by reference from Form S-4 filed August 1,                    2007.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 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 |
|---------------|----------------|

 

 

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