HISTORY OF A PROFITEER
Presented here is the history of a company that has obscenely profited off U.S. inmates and their families. Though just one aspect of the profiteering, this history of just one company (out of thousands) demonstrates the calculated mechanizations involved in making a fortune off misfortune. Once set in motion, this company of monolithic proportions, continues to grow, unchecked, with the help of tax writeoffs, bank loans, bank letters of credit and laws passed to insure inventory (inmates). They would appear to be invincible.
UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934
T-NETIX, Inc. (the "Company" or the "Registrant") provides specialized call processing and fraud control services to the telecommunications and other service industries. The Company's primary customers include AT&T, Bell Atlantic, GTE, NYNEX, SBC Communications, Inc., BellSouth and U S WEST. These customers use the Company's products and services to provide annually over 90,000,000 billable inmate collect calls in over 1,000 correctional institutions. The Company's products and services include comprehensive transaction processing, call management and identification systems for the corrections industry and special-purpose speech processing software and systems. Most of the Company's current products are based on proprietary software, the most critical of which are patented or patent pending, and a combination of proprietary and "off-the- shelf" electronic hardware. These systems are designed to be flexible delivery platforms which are easily integrated with its customer's networks and information systems. The Company's revenue stream is mostly recurring, as a result of the Company historically generally charging for its services on a fee per transaction processed basis over long term contracts.
In October 1995, the Company acquired SpeakEZ, Inc. (SpeakEZ). SpeakEZ is a wholly-owned subsidiary. The Company is engaged in the sale, marketing, and development of new fraud prevention products and services based on its SpeakEZ Voice Print(sm) speaker verification biometric technology. Developed by SpeakEZ, this technology uses "voice prints' or speech patterns as a means to verify or determine an individual's identity. The Company believes SpeakEZ Voice Print(sm) products to have a particular applicability to the fraud problems experienced by the financial services, telecommunications and network security industries. The Company's objective is to be a leading provider of innovative fraud prevention and identification products and services to the global telecommunications, financial services and network security industries. The Company believes that its expansion into these new markets will be assisted by its stategic relationships with its customers, its network ntegration expertise and its national service infrastructure. To date, substantially all the Company's revenue has been derived from its corrections industry call processing services.
INMATE CALLING SERVICES
The Company derives revenue under contracts with its customers, including AT&T, MCI, Bell Atlantic, GTE, NYNEX, SBC Communications, Inc., BellSouth and U S WEST, and other telecommunications service providers, primarily from the provisioning of specialized call processing services for correctional facilities. This revenue is generated under long-term contracts which provide for transaction fees paid on a per-call basis. The Company is paid a prescribed fee for each call completed and additional fees for validating phone numbers dialed by inmates. The Company also derives revenue as a direct provider of inmate calls, although this service is provided primarily as an accommodation to certain customers. The Company expects to derive a declining percentage of total revenue from its direct call provisioning business. However, in the event the Company is awarded contracts as a long distance provider, revenue will increase accordingly.
The Company's strategic relationships with its customers have resulted in several important benefits to the Company:
A significant portion of the Company's revenue has come from the conversion of its customers existing contracts with correctional facilities.
The Company and its customers jointly submit proposals to state departments of corrections and large correctional facilities for new business opportunities. The Company is providing its services to 25 such state departments (including the District of Columbia) as of July 31, 1997. The Company benefits from the scope of its customers' sales and marketing staffs and greater market presence.
The telecommunications services industry, especially the Public Communications sector and the inmate calling market, is and can be expected to remain highly competitive. The Company competes directly with other suppliers of inmate call processing systems that sell their products to the Company's customers, such as manufacturers of call processing equipment. These include Lucent Technologies (formerly AT&T Network Systems), Nortel (formerly Northern Telecom, Inc.), Gateway Technologies, Inc., Talton Communications, Harris Corporation, and Science Dynamics Corporation. The Company also competes with some of these same companies that are teamed with various call providers, including the Company's current customers. Finally, the Company's systems may also compete with technologies developed internally by its customers, such as those developed by AT&T Bell Labs. The Company believes that its ability to compete in the inmate calling industry depends upon the quality of the features and services it provides, its proprietary technology such as three-way call prevention, lower cost of deployment through transaction-based pricing, the availability of service administrators, the flexibility it offers through both premises-based and network-based systems and the strength of its relationships.
The Company believes it has also benefited, to a lesser extent, from the overall growth in the inmate calling market. The Company will continue to market its services to additional call providers; however, it expects growth in call processing volumes will come predominantly from adding new systems for existing customers.
The Company leases certain telecommunications and office equipment under capital leases and leases office space under operating lease agreements. Capitalized costs of the property and equipment under capital leases was $1,15O,000 at July 31, 1997, and accumulated amortization was $678,000. Rent expense under operating lease agreements for the years ended July 31, 1997 1996 and 1995 was approximately $789,000, $450,000, and $320,000 respectively. Future minimum lease payments under these lease agreements for each of the next five years are summarized as follows (amounts in thousands):
In April 1996, the Company entered into a agreement for approximately 38,000 square feet of office space. The term of the lease is for five years and commenced on November 1, 1996. The Bank has also issued a standby letter of credit on behalf of the Company for $225,000 in favor of the lessor on the new lease (note 5). The Company leases an additional 13,000 square feet of office space for its SpeakEZ operations under a five year lease, and various point of presence locations throughout the United States.
At July 31, 1997, the Company had net operating loss carryforwards for tax purposes aggregating approximately $11,200,000 which, if not utilized to reduce taxable income in future periods, expire at various dates through the year 2009. Approximately $1,300,000 of these net operating loss carryforwards are subject to certain rules limiting their annual usage. The Company believes these annual limitations will not ultimately affect the Company's ability to use substantially all of its net operating loss carryforwards for income tax purposes.
In June 1997, the Company entered into a new Loan Agreement with its current commercial bank. The Loan Agreement is for a total of $20,000,000 in committed credit. Borrowings are at the prime rate (8.5% at July July 31, 1997) and are secured by substantially all of the assets of the Company. The agreement provides for various financial covenants, including maintaining certain financial ratios and minimum net worth requirements. As of July 31, 1997, the Company has an unused amount on the committed credit of $7,294,000. All of the debt at July 31, 1997, matures within one year. The Bank has also issued a standby letter of credit for $225,000 on behalf of the Company in favor of the lessor on its new office space (note The letter of credit is for the term of the lease).
On November 8, 1994 the Company completed a public offering of 2,100,000 shares of common stock. Of the 2,100,000 shares, 1,800,000 shares were sold by the Company to the public at $9.50 per share. The proceeds to the Company, net of offering costs and underwriting discount were $15,469,000.
The number of shares outstanding of the Registrant's common stock_as of October 15, 1997, was 8,472,315.
SECURITY SERVICES - INMATE CALLING MARKET
Calls from inmates of federal, state and local correctional facilities comprise a significant segment of the Public Communications market. Inmates typically may only place calls for a limited duration, generating a high volume of calls per phone, and generally may only place collect calls, which tend to generate higher revenue per call than other types of calling. Consequently, the inmate calling market is an attractive segment to call providers.
According to the U.S. Bureau of Justice Statistics, the number of inmates in state and federal and local prisons as of June 1996 reached approximately 1.5 million. Currently, the number of inmates in federal, state and local prisons increased to an estimated 1.6 million.( Editors note: As of January, 2000 the number of inmates is 2 million.) The inmate calling market presents unique and substantial challenges to the call provider. Correctional facilities generally favor call providers who can manage the inmate phone systems themselves, maintain consistent service and easily process new inmates into the systems.
Correctional facilities generally select telephone/telecommunications service providers on the basis of services and features provided and on the level of commissions paid to the facilities. To date, intense competition among the service providers has led to commission payments to correctional facilities at levels that the Company believes only the major service providers can afford. In addition, to win new contracts and renew existing contracts, call providers must differentiate their services from the competition. They do so by offering advanced call control services as well as additional complementary services such as booking and identification processes, trust fund and commissary automation and management, investigation support and jail management support Systems.
INMATE CALLING PRODUCTS
Currently, substantially all of the Company's revenue is derived from the services it provides to its customers for use in correctional facilities. The Company's products and services for the inmate calling market include a comprehensive set of technological and administrative features which provide call control, fraud prevention and systems integration capabilities. The Company offers the following advanced features for each phase of the calling process:
Pre-connection Restriction Features. Unlimited individual number blocking capabilities; personal identification number ("PIN") operation with allowed or denied number lists; SpeakEz Voice Print(sm) speaker verification technology; restrictions based on calls per time period per inmate; restrictions on the number of call attempts versus completions; restrictions on calls to a single number; and real-time billed number validation by external database query.
Call Connection Automation. Automated operator; debit or collect calling operation; custom call announcement and identification of facility and call provider; customized introductory messages such as the possibility that the call may be recorded; PIN-based automated inmate caller identification by which the inmate is identified to the called party through a pre-recorded statement of the inmate's name in his own voice; active billing acceptance which requires the called party to respond with a key-press to accept the inmate call; and multi-lingual and international call processing.
Post-connection Services. Three-way call detection/prevention technology based on the Company's patented Strike Three!(TM) technology that prevents inmates from bypassing control features through three-way calling; "Hot Number" operation, a real-time alert feature based on inmate PINs, destination number or originating telephone number; automated attorney-client confidentiality which precludes recording or monitoring of calls between the inmate and his attorney; and comprehensive system reports for billing, administrative, law enforcement and investigative support purposes.
PIN-LOCK(sm). The Company recently announced another technological innovation- PIN-LOCK(sm), Inmate Caller Verification Service, expected to increase the competitive advantage provided by its patented Strike Three!(TM) technology, Before this innivation, inmates would use another inmate's PIN to subvert call restriction controls. PIN-LOCK(sm) prevents this practice by denying the call if there is not a match with the proper inmate's "voice print". The Company believes this technology will greatly enhance the security of its call processing systems.
Corrections Systems Integration Applications. The Company's customers offer additional services as an off-set to higher commission payments to win new and retain existing inmate calling contracts. The Company offers to its customers an expanded set of integrated automation, identification and management applications. The Company's integration design focuses on inmate identification. Identification attributes such as voice print, PIN, Video Digital Image, recorded conversations and bar codes are common to the various corrections applications. The individual applications offered by the Company include the following:
Trust Fund and Commissary. The Company's Trust Fund/Automated Commissary system ("TFC") provides for a fully-integrated, point-of-sale commissary or canteen operation including inventory management, using the inmate bar coded-ID card for transaction processing. The commissary purchases are electronically processed on a cashless, electronic funds transfer basis, through fully-integrated, point-of-sale commissary or canteen operation including inventory management, using the inmate bar coded-ID card for transaction processing. The commissary purchases are electronically processed on a cashless, electronic funds transfer basis, through the trust fund accounting system provided by the Company.
Tel-Base Investigative Services and Recording Access Management. Tel-Base provides tools to monitor inmate telephone usage for abuse and criminal conduct. The user-friendly interface permits corrections officers to sort and identify calls using a variety of search criteria including by PIN, destination number, originating telephone, etc. Through the Recording Access Management (RAM) application, officers can designate certan calls to be recorded onto magnetic digital or analog tape. Calls can be selected for playback off the recorded conversations and the officer can record notes of the conversation and append these notes as text files to the investigative file. Call detail information is provided by the inmate calling application. The integration of the call management system with the recording system is very beneficial to the corrections officer who previously had no efficient means of relating telephone calls to specific recorded conversations. By facilitating the concentration and selection of calls for recording, RAM requires much less recording capacity than the typical one-recording-channel per phone arrangement. The savings in recording capacity provides cost savings benefits to the Company's customers.
Video Imaging/Inmate Management. Video imaging is used primarily for admission and release identification purposes. Corrections officers use a Company-provided work station to take a digital image or snapshot of an inmate, input pertinent information, such as allowed/denied calling numbers, medical requirements, currency on hand, etc.. and print an identification card or wrist band which contains the bar-coded representation of the inmate identification number or other code. This data is saved in data bases, with the inmate calling application, the TFC system, and Tel-Base investigative and Recording Access Management applications. The Company's Video Imaging/Inmate Management System eliminates the costly and cumbersome manual photography process typically used today.
MACC strongly urges all concerned citizens to reprint this report on their websites.