Prison Phone Justice

Page 27 of 112

form 1O-k.htm

•

•

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;
anti-American sentiment due to the wars in Iraq and Afghanistan 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 deJays associated with any stich activities.

•

Regulatory Risks
The FCC is currently reviewing challenges and alternatives to the rates applicable 10 interstale inmate telecommunications
service that, ifimplemented, could have an adverse effect on our business.
The FCC has opened several rulemaking proceedings that question whether the current regulatory regime applicable to the
rates for interstate 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 compensation paid to correctional facilities in the form of "commissions" and that the FCC should establish rate caps,
prohibit commissions to correctional facilities and mandate the offering by inmate telecommunications service providers of
inmate debit or prepaid card alternatives to collect calling. Such a regime would require a new and complex set of federal
regulations that, if adopted, could 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 diminish the value of our intellectual property and our customer relationships and lead to a
reduction in profitability of calls originating from correctional facilities.

24

•
file:/IZ:\RFP Technician Files\Financials\2009 Financials\2009 formIO-k.htm

3/29/2010

fonnlO-k.htm

Page 28 of 112

We operate in a highly regulated industry, und UTe 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 there under. 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 andlor 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 many 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 can recording and call rate announcements, and billing, conection, customer coUection management, and
solicitation practices are all highly complex and burdensome, making it difficult to be in complete compliance. The difficulty
is sometimes exacerbated by technology issues. Although we actively seek to comply with all laws and regulations and rerriedy
areas in which we become aware of inadvertent non-compliance, we may not always be in full compliance with all regulations
applicable to us. Once non-compliance is identified, remedies are sought and implemented as quickly as possible. 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 ofthe telecommunications industry is changing rapidly, and
the regulatory environment varies substantially from state to stale. Future regulalory,judicial or legislative activities may have
an adverse effect on our operations or financial condition, and domestic or intemational regulators or third parties may raise
material issues with regard to our compliance or non-compliance with applicable regulations.

•

ITEM lB. 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 located in Carrollton,
Texas, from which we conduct our technical support operations, in-sourced call center, and warehouse operations, and our data
centers located in Allen and Dallas, Texas and Atlanta, Georgia. We have offices in Richmond, British Columbia and London,
United Kingdom. We believe that our facilities are suitable and the space contained by them adequate for their respective
operations.

•

ITEM 3. LEGAL PROCEEDINGS
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 effect 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 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. On occasion, we are also the subject of regulatory complaints
regarding our compliance with various matters including tariffing, access charges, payphone compensation requirements and
rate disclosure issues. 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 industry may charge. Similar proposals have been pending before the FCC
for more than four years without action by the agency. This newest proceeding remains under review by the FCC and has
received strong opposition from the inmate telecommunications industry. In August 200S, a group ofinmate telephone service
providers provided the FCC with an "industry wide" cost ofservice study for their consideration. That proceeding remains
ongoing and we have no information as to when, if ever, it will be resolved. We cannot predict the outcome at this time.
25

file:IIZ:\RFP Technician Files\Financials\2009 Financials\2009 fonn 1O-k.htm

3/29/2010

•

form 10-k.htm

•

Page 29 of 112

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 ("WUTC"), 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 subsequent petition 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. This
matter was referred to the WUTC on the grounds of primary jurisdiction, in order for the WUTC to determine various
regulatory issues. On May 22, 2008, AT&T filed with the trial court a cross-claim against T-Netix seeking indemnification. TNetix moved to dismiss AT&T's cross-claim, but the court denied that motion and deferred resolution of whether
AT&T's belated indemnification claim is within the statute of limitations for summary judgment. Motions by both T-Netix
and AT&T for summary determination were briefed to the WUTC in September 2009 and remain pending before an
administrative law judge. As merits and damages discovery are not completed, however, we cannot estimate the Company's
potential exposure or predict the outcome of this dispute.
In July 2009, Evercom filed a complaint against Combined Public Communications, Inc. ("CPC"), alleging tortious
interference with Evercom' s contracts for the provision of telecommunications services with correctional facilities in the
Commonwealth of Kentucky and the State of Indiana. Evercom claims CPC has misrepresented that the correctional facility
has a statutory right to terminate its contract with Evercom upon the election of a new Sheriff. Accordingly, Evercom seeks a
declaration that under Kentucky law its contracts with its customers are not personal services contracts and that under both
Indiana and Kentucky law, its contracts with correctional facilities are not void for not being terminable within thirty days, as
well as an award of compensatory and punitive damages. On July 29, 2009, CPC filed a motion to dismiss for failure to state
a claim. On August 14,2009, Evercom filed its response in opposition to dismiss, and on September 9, 2009, the court denied
CPC's motion to dismiss. On January 8, 2009, the court entered a scheduling order setting forth the pre-trial deadlines. This
matter is in its early stages and we cannot predict the outcome at this time.

•

In July 2009, the Company filed a petition with the Federal Communications Commission ("FCC") seeking affirmation of
the Company's right to block attempts by inmates to use services, which the Company calls "call diversion schemes,"
de~igned to circumvent its secure calling platforms. These illicit services are not permitted to carry calls from any correctional
faCility, and the Company has received strong support from its correctional authority clients to stop this activity. The FCC has
long-standing precedent that permits inmate telecommunications service providers to block such attempts. The FCC had asked
that interested parties file comments to the Company's petition by August 31, 2009; and thereafter, the Company filed reply
COmments. This matter is in its early stages and we cannot predict the outcome at this time.
In September 2009, T-Netix filed suit against Combined Public Communications, Inc. in the United States Federal District
Court for the Western District of Kentucky, for patent infringement of various T-Netix patents. The court has scheduled a
RUle 26(f) scheduling conference for February 10,2010 and the parties are negotiating an agreed discovery plan to present at
the hearing. This matter is in its early stages and we cannot predict the outcome at this time.
In October 2009, T-Netix filed suit in the United States Federal District Court for the Eastern District of Texas against
Pinnacle Public Services, LLC for patent infringement of various T -N etix patents. Pinnacle has served its answer and filed a
m()tion to transfer venue to the Northern District of Texas. This matter is in its early stages and we cannot predict the outcome
at this time.
In October 2009, the Company, along with Evercom and T-Netix, and one of the Company's competitors were sued in the
Federal District Court for the Southern District of Florida by Millicorp d/b/a ConsCallHome. Millicorp, a proprietor of what
the Company has described to the FCC as a call diverter, has sued these companies under the Communications Act of 1934,
alleging that the companies have no right to block attempts by inmates to use the call diversion scheme. The FCC has
pemitled inmate telecommunications service providers to bJock such attempts since 1991, and the Company had sought reaffinnance of that permission in the petition for declaratory ruling described above. All defendants have filed motions to
di~miss all claims with prejudice. Discovery has not yet commenced. This matter is in its early stages and we cannot predict
the outcome at this time.

•

In October 2009, the Company filed suit in the District Court of Dallas County, Texas, against Lattice Incorporated
("lattice", formerly known as Science Dynamics Corporation) alleging breach of contract, tortious interference, unfair
competition, damage to goodwill and injunctive relief as a result of Lattice's breach of certain provisions of a December 2003
asset purchase agreement between Evercom and Science Dynamics Corporation. On October 2, 2009, the court issued a
temporary restraining order against Lattice, and ordered Lattice to immediately cease and desist from, among other things, (1)
renewing any customer contracts in the law enforcement industry; (Ii) marketing, selling or soliciting, directly or indirectly,
any of its products andlor services to any customers in the law enforcement industry; and (iii) interfering with any ofthe

file:IIZ:\RFP Technician Files\Financials\2009 Financials\2009 formIO-k.htm

3/29/2010

fonn 10-k.htm

Page 30 of 112

Company's business relationships in the law enforcement industry in the United States. On January 4,2010, the parties
erltered into a settlement agreement and mutual release, and a patent license agreement wherein Lattice was granted a license
to use one (I) of the Company's patents.
In January 2010, T-Netix and Evercom filed suit in the United States Federal District Court for the Eastern District of
Texas against Legacy Long Distance International, Inc. dba Legacy International, Inc. and Legacy Inmate Communications for
patent infringement of various T-Neti)('s and Evercom's patents. This matter is in its early stages and we cannot predict the
outcome at this time.

•

ITEM 4. RESERVED

26

•

•
file:/IZ:\RFP Technician Files\Financials\2009 Financials\2009 fonnlO-k.httn

3/29/2010

Page 31 of 112

form lO-k.htm

•

PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER
PURCHASES OF EQUITY SECURITIES
Market In/ormation. Our common stock is not registered and there is currently no established public trading market for
our issued and outstanding equity securities.
Holders ofRecord. As of March 1,2010, we had three holders of Series A Redeemable Convertible Preferred Stock,
seven holders of Class A Common Stock and twenty-two holders of Class B Common Stock. In December 2007, we effected a
1 for] ,000 reverse stock split for our Class A 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 aC{;rues dividends at 12.5% annually. We currently intend to retain earnings, ifany, 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, opemting 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 31,2009:
Equity Compensation Plan Information

(b)

•
Plan category

Number of
securities
to be issued
upon exercise
of outstanding
options,
warrants
and rights (1)

Equity compensation plans approved by
security holders(2)
Equity compensation plans not approved by
security holders
Total

]26,660

(c)

Weightedaverage
exercise price
of outstanding
Options,
warrants
and rights

(a)

Number of
Securities
remaining available
for future issuance
under equity
compensation plans
(excluding securities
reflected in
column (a))

$

.01

126,660 =$=========,0=]

48,340
48,340

(1) Includes 126,660 shares ofrestricWd stock issued under the 2004 Restricted Stock Plan.
(2) In March 2009, thc Company filed a Fourth Amendment and Restated Certificate oflncorporation which 1,685,000 shares of stock wcre authorized, of
which IQ,OOO shares are designated Preferred Stock, $.001 par value per share (the "Preferred Stock"), 1,500,000 shares are designated Common Stock, $.OQl
par value per share (the "Common StoClk"), and 175,000 shares are designated Class B Common Stock, $.001 par value per share (the "Class B Common
Stock").

Unregistered Sales of EqUity Securities. As of December 31, 2009, we had sold to certain members of management and
our board of directors a total of ] 26,660 restricted shares of Class B Common Stock at a purchase price of $.0 1 per share
pursuant to the 2004 Restricted Stock Plan. In 2009, we issued 4,566 shares and 2,000 shares of Class B Common Stock on
February 19,2009 and March 1,2009, respectively. The shares are subject to certain contractual limitations, including
provisions regarding forfeiture and disposition, as provided in each executive's restricted stock purchase agreement 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) ofthe Securities Act of 1933 for
transactions not involving a public offering, and regulations promulgated thereunder.
27

•
file:IIZ:\RFP Technician Files\Financials\2009 Financials\2009 form 1O-k.htm

3/2912010

fonnlO-k.htm

Page 32 of 112

On March 25, 2009, the Company filed a Fourth Amended and Restated Certificate of Incorporation, which authorized
1,685,000 shares of capital stock. Additionally, the Board of Directors issued a unanimous resolution to adopt a Fourth
Amendment to the 2004 Restricted Stock Plan which increased the number of shares of Class B Common Stock authorized for
issuance thereunder from 165,000 to 175,000 shares. The Fourth Amended and Restated Certificate of Incorporation
designated 1,500,000 shares as Class A Common Stock, 10,000 shares as Preferred Stock, of which 5,100 were designated as
Series A Convertible Preferred Stock, and 175,000 shares as Class B Common Stock. All issued shares of Common Stock are
entitled to vote on a one share/one vote basis.

•

ITEM 6. SELECTED FINANCIAL DATA
The following selected consolidated historical financial 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 I O-K. The selected historical consolidated financial and other data
presented below for the fiscal years ended December 31, 2007, 2008 and 2009 have been derived from our audited
consolidated financial statements.
For the Year Ended December 31,

2005
Consolidated Statement of
OperationS
Operating revenues (I)
S
Cost of service (1)
Selling, general and
administrative expenses (1)
Depreciation and amortization
Other operating expenses (2)
Operating income (loss)
Other Income Expense:
Interest and other expenses, net
Loss befDre income taxes
Income tax expense (benefit)
Net loss
Accrued dividends on preferred
stock
Net loss available to common
$
stockholders
Other Fimmcial Data:
Direct provisioning revenues (I)
$
Wholesale services revenues (1)
Offender management software

2006

377.4
279.7

$

2007

401.9
293.1

57.9
23.9
0.6
15.3

$

391.9
286.8

2008
S

2009

388.6
271.9

$

363.4
247.2

~2.2)

(9.1)

303.3
74.1

66.1
31.4

'41.9)
(34.5)
{0.5)
(34.0)

p9.1)
(2004)
0.7
(21.1)

'1.4)

~27.8)

(18.7)
104
(20.1)

74.7
3404
0.2
7.4

,31.5)
(38.5)
1.9
(40.4)

9.1

!26.6)
(11.3)

(9.1)

7404
37.1
0.6
(7.0)

69.4
30.3

~1.5)

18.7

$

pO.I)

$

~40.4)

$

p5.4)

$

{22.6)

$

341.2
60.7

$

338.7
45.2
7.9

$

333.6
29.9
25.1

$

•

312.6
28.1
22.7

28

•
file:/IZ:\RFP Technician Files\Financials\2009 Financials\2009 form! O-k.htm

3/29/2010

. Page 33 of 112

fonnlO-k.htm

•

For the Year Ended December 31 1
Other Data:
Deficiency of earnings to fixed
charges
Consolidated Cash Flow Data:
Cash flows from operating
activities
Cash flows from investing
activities
Cash flows from financing
activities (3)
Capital Expenditures
Balance Sheet Data (End of
Period)
Cash and cash equivalents and
restricted cash
Total current assets (4)
Net property and equipment
Total assets
Totallong-tenn debt (including
current portion)
Stockholders' deficit

(I)

•

(2)
(3)
(4)

2007

2006

2005

2008

2009

$

9.1

$

20.1

$

40.4

$

35.4

S

22.6

$

29.8

$

19.1

$

20.S

$

17.4

$

26.8

(26.3)

$

(64.0)

(17.0)

(16.3)

(2.8)
26.3

$

(27.1)
6.0
27.2

46.5
21.4

1.1
17.0

( 12.3)
16.5

4.0
80.7
43.9
266.9
198.0
(31.9)

$

$

2.0
76.4
46.4
259.6
210.6
(51.9)

$

S

3.6
62.9
40.8
292.]
263.3
(88.9)

S

8.2

$

61.6
35.4
259.0

$

288.3
(128.8)

$

4.0
51.7
28.8
240.1
287.8
(148.2)

Includes reclassification of certain amounts in prior years to conform with current period presentation. No impact on operating income (loss), net loss,
cash flows or the financial position of the Company for the prior periods presented.
Includes gain on sale of assets, compensation expense on employee restricted stock. severance and restructuring costs.
The 2007 amount reflects 140 million of indebtedness incurred through the issuance of additional Secnnd·priority Seninr Secured Notes in connection
with Ollr acquisition ofSyscon.
Current assets decreased in 2007, 2008, and 2009 primarily as a result ofa decline in receivables due to a significant increase in prepaid revenues as a
percentage of total revenues, coupled with a decline in overall direct call provisioning and wholesale services revenues.

29

•
file:/IZ:\RFP Technician Files\Financials\2009 Financials\2009 fonnlO-k.htm

3/29/2010

fonn 1O-k.htm

Page 34 of 112

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 lOoK.

•

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 and
private jails in the United States and Canada. As of December 31, 2009, we provided service to approximately 2,400
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, on a limited basis we may partner with other telecommunications
companies whereby 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 faci1ity, we also sell platforms and specialized equipment and services such as law enforcement
management systems, call activity reporting and call blocking.
Our subsidiary 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.
Certain amounts in the prior periods' consolidated financial statements have been reclassified to conform to the current
period presentation. We believe this reclassification will result in a clearer presentation of our results of operations. As a
result, we have revised our Management's Discussion and Analysis of Financial Condition and Results of Operations for prior
periods to reflect this reclassification.
Revenues

•

We derived approximately 86% of our revenues for each of the years ended December 31,2008 and 2009 from our direct
operation of inmate telecommunication s),stems and the provision of related services located in correctional facilities within 43
states and the District of Columbia. We enter into multi-year agreements under direct or "prime" contracts with the
correctional facilities, pursuant to which we serve as the exclusive provider of telecommunications services to inmates within
each facility. In exchange for the exclusive service rights, we pay a commission to the correctional facility based upon inmate
telephone use. 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.
We derived approximately 6% of our revenues from our offender management software business for each of the years
ended December 31, 2008 and December 31,2009. 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. Revenue related to the offender management software business is recognized using the residual method
when the fair value of vendor specific objective evidence ("VSOE") of the undelivered element 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
re&idual method, the fair value of the undelivered elements i& 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.
30

file:IIZ:\RFP Technician Files\Financials\2009 Financials\2009 fonnl0-k.htm

•
3129/2010

Page 35 of 112

formlO-k.htm

•

We derived approximately 8% of ollr revenlles for each of the years ended December 31,2008 and 2009 from the
wholesale services business. We derive this revenue through (I) validation, uncollectible account management and billing
services (solutions services), (2) providing equipment, security enhanced call processing, call validation and service and
support through the primary inmate telecommunications providers (telecommunications services), and (3) the sale of
equipment to other telecommunications companies as customers or service partners.
In our direct call provisioning and wholesale services business, we accumulate call activity data from our various
installations and bill our revenues related to this call activity against prepaid customer accounts or through direct billing
agreements with local exchange carrier ("LEe") hilling agellts, or in some cases through bjJIjng aggregators that bilJ end users.
We receive payment on a prepaid basis for the majority 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 record 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 wholesale services business, our service partner may bill the called party and we either share the
revenues with our service partner or receive a prescribed fee for each call completed. We also charge fees for additional
services such as customer support and advanced validation,

Cost of Service
Our principal cost of service for our direct call provisioning business consists of commissions paid to correctional
facilities, which are typically expressed as a percentage of either gross or net direct call provisioning revenues and are typically
fixed for the term of the agreements, Our cost of service for direct call provisioning also includes (1) bad debt expense from
uncollectible accounts; (2) hilling and collection charges; (3) telecommunication costs such as telephone line access, long
distance and other charges; (4) call validation costs; and (5) field operations and maintenance costs for service on our installed
base of inmate telephones. We pay monthly line and usage charges to Regional Bell Operating Companies ("RBOCs") and
other LECs for interconnection to local networks to complete local calls. We also pay fees to interexchange and long distance
carriers for long distance calls completed. Third-party billing charges consist of payments to LECs and other billing service
providers for billing and collecting revenues from called parties.

•

Cost of service associated with our offender management software business primarily includes salaries and related costs of
employees and contractors that provide technological services to develop, customize or enhance the software for our clients.
Cost of service for our wholesale service business includes billing and collection, call validation, bad debt expense and
service costs for correctional facilities, including salaries and related personnel expenses, inmate calling systems repair and
maintenance expenses and the cost of equipment sold to service partners.

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.
Bad Debt. We account for bad debt as a direct cost of providing telecommunications services. We accrue the related
telecommunications cost charges along with an allowance for uncollectible calls, based on historical experience. 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.
Bad debt expense tends to rise with higher unemployment rates and as the economy worsens, and is subject to other
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.
In 2008, we tightened our credit policy to reduce our risk of loss from bad debts. Consequently, billed minutes and associated
revenues may have been negatively impacted in the latter part of 2008 and in 2009. Since our bad debt visibility is delayed an
averuge of six to nine months, risk exists that future write-ofTs may be incurred.

Field Operations and Maintenance Costs. Field operations and maintenance costs consist of service administration costs
for correctional facilities. These costs include salaries and related personnel expenses, communication costs, and inmate
calling systems repair and maintenance expenses.

•

3]

file:/IZ:\RFP Technician Files\Financials\2009 Financials\2009 formlO-khtm

3/29/2010

form 1O-k.htm

Page 36 of 112

Selling, General & Administrative Expenses
Selling, general and administrative ("SG&A") expenses consist of corporate overhead and selling expenses, including
accounting, marketing, legal, regulatory, and research and development costs.

'.

Industry Trends
The corrections industry, which includes the inmate calling and offender management software markets, is and can be
expected to remain highly competitive. We compete directly with numerous other suppliers of inmate call processing systems
and other corrections-related products (including our own wholesale service provider customers) that market their products to
our same customer base. Contracts to service correctional facilities are typically subject to competitive bidding, and as we seek
to secure inmate telecommunications contracts with larger county and state departments of corrections, we may be required to
provide surety bonds or significant up-front payments such as signing bonuses and guaranteed commissions, as well as incur
the cost of equipment and installation costs. We provide our wholesale products and services to inmate telecommunications
service providers, such as Global TeJ*Link, Embarq, AT&T, and FSH Communications.
Our offender management software business has been affected by the poor economy and government budget shortfalls. As
corrections agencies have increased the amount of time they take to evaluate proposals, process contracts and change orders,
and in some cases have deferred or cancelled orders for the purchase of technology solutions. Agencies are being extremely
careful, as all purchases are under increased scrutiny and many require additional steps before approval. The U.S. federal
government economic stimulus programs have provided some relief domestically. The glohal nature of the downturn is having
a similar impact overseas.

Results ojOperationsjor the Year Ended December31, 2009 Compared to December 31,2008
The fonowing table sets forth the primary components of revenue for 2008 and 2009.
For the Twelve Months Ended
December 31,
December 31,

2009

2008

(Dollars in thousands)
Direct call provisioning
Offender management software
Wholesale services
Total revenue

$

5

333,564
25,137
29,902
388,603

$

$

312,614 5
22,698
28,124
363 1436 $

Variance
(20,950)
(2,439)
~1,778)

1251167)

% Change

(6.3)%
(9.7)
!5.9)
!6.5)%

•

Revenues
Compared to the year ended December 31, 2008, consolidated revenues decreased for the year ended December 31,2009
by 525.2 million, or 6.5 %, to $363.4 million. The primary components of the decrease in revenues are discussed below:
Direct call provisioning revenues decreased $21,0 million, or 6.3%, to $312.6 million resulting primarily from lower call
volumes and revenues per call due primarily to the economic recession. Additionally, in 2009 we experienced a change in
revenue recognition from a partnering arrangement that reduced our revenues by approximately 5>8.2 million from the prior
year. In 2008, inmate calls were processed on our platforms and revenues and expenses were recorded on a gross basis. The
new equipment owned and managed by our partner was installed at the various sites and, accordingly. our share of revenue is
now recorded net of expenses. This change in revenue recognition from a gross to net basis will continue to affect revenues
over the term ofthe underlying facility contract.
32

•
file:IIZ:\RFP Technician Files\Financials\2009 Financials\2009 formlO-k.htm

3/29/2010

Page 37 of 112

fonn10~k.htm

•

Offender management software revenues decreased $2.4 million, or 9.7%, to $22.7 million. The majority of our offender
management revenues have been associated with the implementation of our software for Her Majesty's Prison Service in the
United Kingdom through a sub-contracting agreement with HP Enterprise Services (fonnerly EDS). The implementation phase
of this contract was successfully completed during the second quarter of 2009 causing the expected decline in
revenues. During the fourth quarter of2009, we started to generate revenues from new contracts in the United States as well
as extended our work in the United Kingdom and Australia, and we continually seek to win new contracts. We were impacted
by the global economic recession in 2009 which has affected government budgets causing corrections agencies to delay or
defer technology spending or cancel orders altogether, which, in tum, made it more difficult to generate new contracts during
this recessionary period. In connection with the acquisition of Syscon we valued the existing customer contracts and related
deferred revenues at fair value, which impacted the amount of revenue and profit recognized on the acquired contracts. Our
2008 offender management software revenues and operating profits were $3.5 million lower than what would have been
reported resulting from the amortization of acquired customer contracts, as required by purchase accounting. 2009 revenues
and operating profits were not significantly impacted by the amortization of acquired customer contracts.
Wholesale services revenues decreased by $1.8 million, or 5.9%, due to the ongoing trend of our wholesale partners, who
also compete directly with us, not renewing our services as their underlying facility contracts expire. This revenue attrition
was partially offset by a $7.1 million increase in revenues related to installation and project management services associated
with the Texas Department of Criminal Justice (TDCJ) contract. With the exception ofthe TDCJ contract, we expect our
wholesale services revenues to continue to decline in the future as wholesale contracts expire.

Cosio/Service. Total cost of service for the year ended December 31,2009 decreased by $24.7 million, qr 9.1%, from the
year ended December 31, 2008 due to lower direct call provisioning and offender management software revenues and the
implementation of direct cost reduction initiatives. A comparison of the components of our business segment gross margins is
provided below (dollars in thousands):
Year Ended December 31 2

2008

•

Direct Call Provisioning
Revenue
Cost of service
Segment gross margin
Offender Management Software
Revenue
Cost of service
Segment gross margin
Wholesale Services
Revenue
Cost of service
Segment gross margin

$
$

$
$
$

$

2009

333,564
243 1807
89,757

$
73.1%
26.9% $

312,614
221 1572
91,042

70.9%
29.1%

25,137
13,540
11,597

S
53.9%
46.1% $

22,698
9,624
13,074

42.4%
57.6%

29,902
14,543
15,359

$
48.6%
51.4% $

28,124
]6,032
12,092

57.0%
43.0%

Cost of service in our direct call provisioning segment decreased as a percentage of revenue to 70.9% from 73.1 % due to
efficiencies gained from our packet-based architecture, cost savings initiatives implemented during 2008 and 2009, as well as
our strategy to shift customers to our prepaid products, which carry a higher gross margin since bad debt risk is greatly
reduced. In 2008, approximately 46% of our direct call provisioning revenues were prepaid while 55% of our direct call
provisioning revenues were prepaid in 2009, generating an improvement in bad debt expense as a percentage of revenues even
in the current recessionary environment. Because our bad debt visibility is delayed an average of six to nine months, risk
exists that we may incur future write-offs.
Cost of service in our offender management software segment as a percentage of revenue decreased to 42.4 % from
53.9%. Excluding the impact of the amortization of acquired contracts on revenues in the prior year, cost of service as a
percentage of revenues would have been 47.3% of revenues in 2008. The cost improvement in 2009 is primarily due to more
efficient utilization of personnel coupled with the completion and delivery of several older projects that had yielded lower
margins. Cost of service for the offender software segment 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 wholesale services segment as a percentage of our revenue increased to 57.0% from 48.6% as a
result of low margins for project management and installation labor revenues associated with the IDC) contract. The
wholesale services cost structure currently includes a mix offield service costs resulting from implementation of the TDeJ
sites. Margins related to the TDC) contract are expected to improve in 2010 as we generate a higher mix ofbilIing and
collection revenues from this contract.

file:I/Z:\RFP Technician Files\Financials\2009 Financials\2009 fonnlO~k.htm

3129/2010

fonn 1O-k.htm

Page 38 of 112

•

33

•

•
file:I/Z:\RFP Technician Files\Financials\2009 Financials\2009 fonnIO-k.htm

3/29/2010

Page 39 of 112

formlO-k.htm

•

SG&A. SG&A expenses of $66.1 million were $S.6 million, or 11.5%, lower than the prior year primarily due to cost
reduction initiatives implemented beginning in the third quarter of 2008 that have allowed us to reduce our administrative
expenses by over $7.4 million in 2009. Both 200S and 2009 include non-recurring executive reorganization costs of$1.2
million and SO.5 million, respectively. Proceeds from favorable intellectual property dispute settlements were recorded against
SG&A expense in both 200S and 2009 as we had previously incurred substantial legal and other professional service fees
related to these settlements.
Depreciation and AmortiZf4tion Expenses. Depreciation and amortization expenses were $31.3 million for the year ended
December 31,2009, a decrease of$3.1 million, or 9%, from the year ended December 31, 2008. The decrease is primarily
attributable to assets that became fully depreciated or amortized as well as lower capital spending in 2008 and 2009 versus
previous years.
Interest and Other Expenses, net. Interest and other expenses, net of $39.1 million decreased by $2.8 million, or 7%,
from the prior year due to foreign exchange gains of $2.3 million in 2009 compared to foreign exchange losses of$3.8 million
in 2008. Offsetting this gain was an increase in interest expense of$3.4 million due primarily to the increasing principal on
the Senior Subordinated Notes from paid-in-kind interest accumulation.
Income Tax Expense. Income tax expense for the year ended December 31,2009 was SO.7 million compared to a benefit
of $0.5 million for the year ended December 31, 200S and principally arose from changes in valuation allowances on our
deferred tax assets. The Company's net operating losses are fully reserved by valuation allowances since the Company has a
history of generating net losses.
Results of Operations for the Year Ended December31, 2008 Compared to December 31,1007
The following table sets forth the primary components of revenue for 2007 and 2008
For the Twelve Months Ended
December 31,
December 31,
2008
2007

•

(Dollars in thousands)
Direct call provisioning
Offender management software
Wholesale services
Total revenue

S

S

338,703
7,933
45 1214
391,850

$

S

Variance

333,564 $
25,137
29,902
3S8,603 $

(5,139)
17,204
~151312)

P,247)

% Change

(1.5)%
216.9
p3.9)
0.8)%
1

Revenues
Compared to the year ended December 31, 2007, consolidated revenues decreased for the year ended December 31, 2008
by $3.2 million, or 0.8 %, to $388.6 million. The primary components of the decrease in revenues are discussed below:
Direct can provisioning revenues decreased $5.1 million, or 1.5%, to 5333.6 million. This resulted from a decrease of$20
million due primarily to the loss of direct business contracts with several departments of corrections that expired during the
second half of 2007, combined with the lower revenues due to the worsening economy, which caused us to tighten credit
controls in an effort to reduce Our bad debt exposure. In addition, in 2008 we sought to improve our margins in bidding for
new state and county contracts, which resulted in the loss of some contracts that did not meet acceptable profitability
standards. We monitor contracts coming up for renewal on the same basis. The decrease in revenue was partially offset by
$14.9 million of revenues from department of corrections and mega-county contracts won from competitors, net of accounts
not renewed. Large accounts installed in 2008 generated $7.3 million in 2008, and are expected to generate $16 million
annually over the tenn of the COntracts.

•

Offender management software revenues increased $17.2 million or 216.9% to $25.1 million primarily due to only two
quarters of operations in 2007 compared to a full year in 2008. The majority of our offender management revenues were
associated with the implementation of our software for Her Majesty's Prison Service in the United Kingdom, through a subcontracting agreement with Electronic Data Systems, Inc. In connection with the Syscon acquisition, we valued Syscon's
existing customer contracts and related deferred revenues at fair value, which impacted the amount of revenue and profit we
recognized. As a result, for the years ended December 31,2008 and 2007, respectively, our offender management software
revenues and operating profits were reduced by $3.5 million and $1.4 million related to the amortization of acquired customer
contracts, as required by purchase accounting.
Wholesale services revenUes decreased by $15.3 million, or 33.9%, primarily due to terminations of service by AT&T and
Global Tel*Link as their underlying facility contracts expire.

file:IIZ:\RFP Technician Files\Financials\2009 Financials\2009 forml0-k.htm

3/29/2010

form 1O-k.htm

Page 40 of 112

•

34

•

•
file:/IZ:\RFP Technician Files\Financials\2009 Financials\2009 formIO-k.htm

3/29/2010

Page 41 of 112

form I O-k.htm

•

Costo/Service. Total cost of service for the year ended December 31,2008 decreased by $14.9 million over cost of
service for the year endr:d December 31, 2007, or 5.2%, to $271.9 million.

Cost of service in OUr direct call provisioning segment decreased as a percentage of revenue to 73.1 % from 75.8% due to
lower bad debt, commission and field operations expenses, offset slightly by higher billing and collection fees and network
costs. Bad debt expense declined 31.5%, from 11.2 % to 7.8% as a percentage of direct call provisioning revenues, as a result
of OUr shift to selling products on our prepaid platforms, further tightening of our credit policies due to the deteriorating
economy, and the impact of a one-lime write-off of $1. 7 million in 2007 related to complications arising from our billing
system conversion. HistOrically, OUT bad debt has been highly correlated to unemployment rates; however, we have developed
stati!;tical methods to identify high risk customers who we require to prepay for services. In 2007, approximately 35% of our
direct provision revenues were prepaid, while 46% of our direct provisioning revenues were prepaid in 2008. Field operations
expense declined $0.9 million year over year due to efficiencies gained from our packet-based architecture.
Cost of service in Qur offender management software segment as a percentage of revenue decreased to 53.9 % from
77.0% mainly due to mQre efficient utilization of personnel in 2008. Cost of service for the offender software segment
primarily represents salaries and related costs of employees and contractors who provide technological services to develop,
customize or enhance the software for our clients. Time incurred for research and development or administrative activities by
these employees is claSSified as SG&A expense in 2008.
Cost of service in Out wholesale services segment as a percentage of our revenue decreased to 48.6% from 53.3% as a
result of our bad debt savings initiatives discussed above. Cost of service is a more volatile component of wholesale services
relative to our direct calI provisioning business because most of the cost is comprised of bad debt expense. Therefore, a rise in
unemployment rates may cause a significant erosion of wholesale profitability should bad debt results deteriorate.

•

SG&A. SG&A expenses of$74.7 million were SO.4 million, or 0.5%, higher than the year ended December 31, 2007. The
increase was due primm-ily to $6.3 million in additional SG&A expenses in our offender management software segment as
2007 results included only two quarters of Syscon expenses compared to a full reporting year in 2008. Additionally. we
incurred $1.2 million related to the reorganization of the executive team of the Company. These increases were offset by a
decrease of approximately $1.0 million related to one-time costs incurred in 2007 for bonuses tied to the closing of the Syscon
acquisition, severance and death benefits paid to the family of an executive and lease exit costs. Legal fees were lower in 2008
as a result of settling several intellectual property lawsuits during the third quarter of 2008. Proceeds from the intellectual
property settlements were recorded against SG&A costs, as we had incurred substantiallegal and other professional service
fees related to these settlements in SG&A expense since the fourth quarter of 2006. In the third quarter of 2008, we
implemented cost cutting initiatives which lowered administrative costs by approximately $0.7 million during the last six
months of 2008.

Restructuring Costs. During 2008, we incurred $0.2 million related to the realignment of our field service organization
because of efficiencies gained from our packet-based architecture, which we began to install in 2006 and will continue to
install as customer contracts are renewed. In 2007, restructuring charges of $0.6 million were incurred related to the
con~olidation of our customer care function into the Dallas office, comprised of $0.2 million of severance expense and $0.4
million of facility exit Costs for the Selma, Alabama location.
Depreciation and Amortization Expenses. Depreciation and amortization expenses were $34.4 million for the year ended
December 31,2008, a decrease of$2.6 million or 7.1 % over the year ended December 31,2007. The decrease was primarily
attributable to lower amortization of intangibles related to the Evereom acquisition that became fully amortized in 2007. This
was partially offset by an increase in amortization of new software development and purchases and four quarters of
depreciation and amortization related to Syscon verses two quarters in 2007.
Interest and Other Expenses, net. Interest and other expenses, net, of $41.9 million for the year ended December 31,
2008, increased by $10,4 million or 33.1 % over the year ended December 31. 2007. The increase relates primarily to the
increasing principal on the Senior Subordinated Notes due to the accumulation of interest being paid-in-kind and
additional interest expense on the $40 million 11 % Second-priority Senior Secured Notes due 2011 issued on June 29, 2007.
Additionally, we experienced a foreign exchange transaction loss of$3.8 million during the year ended December 31, 2008
compared to a gain of$1.5 million in 2007.

35

•
file:IIZ:\RFP Technician Files\Financials\2009 Financials\2009 formlO-k.htm

3/2912010

form 10-k.htm

Page 42 of 112

Income Tax Expense. We had an income tax benefit of $0.5 million for the year ended December 31, 2008 and an
expense of $1.9 million for the year ended December 31, 2007. In 2007, we generated tax expense as a result of changes in
valuation allowances on our deferred tax assets. In 2008, a tax benefit of $2.5 million was recorded related to our foreign
operations, offset by $2.0 million in expense as a result of changes in valuation allowances on deferred tax assets in the United
States.

•

Accrued Dividends on Redeemable Pre/e"ed Stock. Dividends accrue on the Series A Redeemable Preferred Stock
issued in December 2007. Each share of the preferred stock has a stated value of $2,000 and accrues dividends annually at
12.5% of the stated value. As of December 31, 2008, the Company had accrued dividends of$l.3 million for the Series A
Preferred Stock.

Liquidity and Capital Resources
General
Our principal liquidity requirements are to service and repay debt and meet our capital expenditure and operating needs.
We are significantly leveraged. Our ability to make payments on and to refinance indebtedness and to fund planned capital
expenditures will depend on our ability to generate cash in the future and our ability to maintain compliance with covenants in
our credit facilities, which, to a certain extent, is subject to general economic, financial, competitive, legislative, regulatory and
other factors that are beyond our control. 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 revolving credit facility will be adequate to make
required capital expenditures, service our indebtedness and meet our other working capital needs for at least twelve months
from our balance sheet dated December 31, 2009. However, due to the economy and other uncertainties referred to above,
there are no assurances that our available sources of cash will be sufficient to enable us to make such capital expenditures,
service our indebtedness or to fund our other working capital needs. Further, in the event we wish to make additional
acquisitions, we may need to seek additional financing. We are continuing to evaluate alternatives to refinance our existing
debt arrangements in an effort to provide greater flexibility to meet long-term capital requirements, reduce interest expense and
extend maturity dates.
As of December 31,2009, we had a total stockholders' deficit ofS148.2 million and $291.4 million in total debt
outstanding before considering $1.6 million of original issue discount on our Second-Priority Senior Secured Notes and $2.0
million of fair va1ue attributable to warrants issued in connection with our Senior Subordinated debt financing, both of which
are reflected as discounts to outstanding long-term debt in our consolidated financial statements (see additional information on
our long and short-term debt under "Debt and Other Obligations" below). As of December 31,2009, we had availability of$30
million under our working capital facility (See Note 4).

•

Cash Flows
The following table provides our cash flow data for the years ended December 31, 2007, 2008 and 2009 (in thousands):

For the Year Ended December 31,
2007
2008
2009
Net cash provided by operating activities
Net cash used in investing activities
Net cash provided by (used in) financing activities

$

$

S

20,459 $
(64,000) $
46,506 $

17,406 $
(17,046) $
1,094 $

26,752
(16,253)
(12,313)

Net cash provided by operating activities was $20.5 million, $17.4 million, and $26.8 million for the years ended
December 31, 2007, 2008 and 2009, respectively. Net cash provided by operating activities of526.8 million consisted of
operating income of $50.1 million before considering non-cash expenses, such as depreciation and amortization of $31.3
million, offset by $22.8 million of cash paid for interest and SO.5 million of working capital use. In 2008, lower wholesale
services volumes caused the payable to our partners to decline, thus using working capital. In 2009, we experienced a
reduction in receivables and accrued liabilities arising from an increased percentage of calls made on a prepaid basis, lower
call volumes and differences in the timing of cash payments made.
36

•
file:IIZ:\RFP Technician Files\Financials\2009 Financials\2009 fonnl0-k.htm

3/2912010

Page 43 of 112

fonn 1O-k.htm

•

Net cash used in investing activities was $64.0 million, $17.0 million and S 16.3 million for the years ended December
31,2007,2008 and 2009, respectively. The $16.3 million spending in 2009 was utilized primarily for investments in
infrastructure technology. equipment and intangibles to maintain and grow the direct call provisioning business. The decline in
spending from 2008 was principally due to less tangible equipment installed at customer sites and improved management
oversight of our capital spending.
Net cash provided by financing activities was $46.5 million and $1.1 million for the years ended December 31,2007
and 2008, respectively, and net cash used in financing activities was $12.3 million for the year ended December 31,2009. The
2009 use of$12.3 million primarily related to $16.5 million in net payments on the Company's revolving credit facility, offset
partially by a $4.3 million benefit from a timing difference in outstanding checks. In 2008, $11.5 million in net advances on
the revolver funded cash used to pay outstanding checks and repay a loan to Syscon's fonner stockholder. As of March 10,
2010, there were no borrowings and $30.0 million of availability under the revolving credit facility.

Debt and other Obligations
Revolving Credit Facility - On September 30, 2008, we and certain of our subsidiaries entered into a senior credit
agreement with a lending institution and the other lenders party thereto (the "Credit Agreement") to refinance our existing
revolving credit facility. The Credit Agreement provides us with a S10.0 million letter of credit facility and a revolving facility
of lip to the lesser of (I) $30.0 million and (ii) 125% of consolidated EBlTDA (as defined in the Credit Agreement) for the
preceding 12 months less the face amount of outstanding letters of credit. The Credit Agreement expires on June 9, 2011.
Advances bear interest at an annual rate of our option equal to either: (a) LIBOR plus 4.0%, or (b) a rate equal to the Base Rate
plu~ 3.0%. The Base Rate is the greater of (i) 5%, (ii) the Federal Funds rate plus 0.5%.• or (iii) the prime rate (as defined in the
Credit Agreement), which was 3.25% as of December 31, 2009. Interest is payable in arrears on the first day of each month.
Th~ unused availability under the Credit Agreement is subject to a fee based on a per annum rate of 0.3 75% due
monthly. Borrowings under the Credit Agreement are secured by a first lien on substantially all of our and certain of our
subsidiaries' assets. We draw from the available credit under the Credit Agreement to cover nonnal business cash
requirements. As of December 31, 2009, we had $30.0 million of borrowing availability under the Credit Agreement.

•

Second-priority Senior Secured Notes - We have $194.0 million of the II % Second-priority Senior Secured Notes
outstanding. These notes were issued at a discount of $4.5 million, or 97.651 % offace value. The Second-priority Senior
Secured Notes are secured by a second lien on substantially all of our and certain of the subsidiaries' assets other than accounts
receivable, inventory and real property.
All $194.0 million of principal 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 102.75% offace value through September 1,2010 and 100.00% therafter. No
eXcess cash flow payment was due for the year ended December 31,2009, because an Excess Cash Flow Amount (as defined
in the Indenture governing the terms of the Second-priority Senior Secured Notes) was not generated. In the event we
determine that the Excess Cash Flow Amount is likely to exceed $5.0 million in 2010, we may purchase Second-priority
Senior Secured Notes in the open market, by negotiated private transactions or otherwise, to reduce the aggregate Excess Cash
Flow Amount to less than $5.0 million. We and our affiliates may from time to time seek to retire or purchase our outstanding
debt, including the Notes, through cash purchases andlor exchanges, in open market purchases, privately negotiated
transactions or otherwise. Such repurchases or exchanges, if any, will depend on prevailing market conditions, our liquidity
requirements, contractual restrictions and other factors. The amounts involved may be material. Interest is payable
serniannuaIly on March 1 and September 1. The effective interest rate is 11.3% on the Second-priority Senior Secured Notes.
The fair values associated with our Senior Secured Notes were quoted as of December 31,2009, at trading prices of
$96.00 and S80.00, increases of 80.3% and 22.1%, respectively, from the quoted values at December 31,2008. We believe the
increase in fair values was due to our improved operating performance and an improvement in the credit markets in 2009.
37

•
file:IIZ:\RFP Technician Files\Financials\2009 Financials\2009 form] O-k.htm

3/29/2010

fonnIO-k.htm

Page 44 Of 112

Senior Subordinated Notes - We have outstanding $97.4 million of Senior Subordinated Notes that 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 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 al1 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 $1 0 per share to the Senior Subordinated Noteholders. As a result, we
discounted the face value ofthe Senior Subordinated Notes by $2.9 million, representing the estimated fair value of the
warrants at the time ofissuance. For the twelve months ended December 31, 2009, $14.9 million of paid-in-kind interest was
added to the principal balance of the Senior Subordinated Notes. The effective interest rate is 18.5% on the Senior
Subordinated Notes.

•

All of our domestic subsidiaries and certain of our foreign subsidiaries (the "Subsidiary Guarantors") are jointly and
severally liable for the working capital facility, Senior Subordinated Notes and Second-priority Senior Secured Notes. The
Subsidiary Guarantors are wholly-owned. We have not included separate financial statements of our subsidiaries because (a)
our 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 that require the maintenance of certain financial ratios,
including specified fixed interest coverage ratios, maintenance of minimum levels of operating cash flows and maximwn
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 ofthe long term debt and unpaid interest may be accelerated and become immediately due and payable.
As of December 31, 2009, we were in compliance with all covenants associated with our credit facilities.

Capital Requirements
As of December 31, 2009, our contractual obligations and commitments on an aggregate basis were as follows:

2010
Long-term debt (1)
Unrecognized tax benefits
Operating leases
Minimum commission payments
Minimum purchase guarantees
Other long-term liabilities
Total contractual cash obligations
and commitments
(1)

S

-

S

3,518
3,367
2,087
290

S

9,262

2011
194,000

Payments b~ Period
2012
2013
- $
48,714
$

$

2014
48,713

2,016
488

1,779
98
240

357
450

1,794

290

2,144
720

Thereafter

S

•

540

ISS
290

$

197,309

$

2,794

$

50,831

$

51,047

$

807

Docs not includ~ any amounts that may be drawn under our Credit Agreement, which expires on June 9, 2011, or accrued interest under our long-term
debt. Assumes no rcpurchases of second-priority senior secured notes or senior subordinated notes during such period whether or not mandatory.

Critical Accounting Policies
A "critical accounting policy" is one that is both important to the portrayal ofa 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 confonnity
with GAAP requires us to use estimates and assumptions to determine certain of our assets, liabilities, revenues and expenses.
We base these detenninations upon the best infonnation 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:
38

•
file:IIZ:\RFP Technician Files\Financials\2009 Financials\2009 formlO-k.htm

3/29/2010

form 1O-k.htm

•

Page 45 of 112

Revenue recognition and had debt reserve estimates;

•

goodwill and other intangible assets;
accounting for income taxes; and

•

capitalization of internally developed software costs.

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

Revenue Recognition 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 ~alls are made. In addition, during the same period, we accrue the related telecommunication
cost!,; for validating, transmitting, billing and collection, and line and long distance charges, along with commissions payable to
the facilities and allowances fot uncollectible calls, based on historical experience.
Revenues related to the wholesale services segments are recognized in the period in which the ca1ls are processed through
the billing system, or when equipment and software is sold. During the same period, we accrue the related telecommunications
cost~ for validating, transmitting, and billing and collection costs, along with allowances for uncollectible calls, as applicable,
based on historical experience.
We record call revenues related to the wholesale services segment at the net amount since we are acting as an agent on
behalf of another provider. For records processed through our billing system, this is the amount charged to the end user
customer less the amount paid to the inmate telecommunications provider.

•

Revenues associated with multiple-deliverable arrangements are recognized using the residual method when the fair value
of vendor specific objective evidence ("VSOE") of the undelivered element is determined. If the VSOE offair 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. 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 project managers and other personnel, who review each project
to assess the contract's 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
yeat.
In evaluating the collectibility of our trade receivables, we assess a number of factors including historical cash reserves
held by our LEe billing agents, 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, historical collection
experience and economic conditions including unemployment rates. Based on these assessments, we record reserves for
uncollectible receivables 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
(hrough our LEe billing agents and such agents typically do not provide us with visibility as to collection results for an
average six to nine month period, our bad debt reserves are estimated and may be subject to substantial variation.
39

file:I/Z:\RFP Technician Files\Financials\2009 Financials\2009 formlO-k.htm

3129/2010

fonn 10-k.htm

Page 46 of 112

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, 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 detennined to have an indefinite useful life are not amortized, but instead tested for impairment at least
annually. Intangible assets with estimable useful lives are amortized over their respective estimated useful lives to their
estimated residual values, and reviewed for impairment. 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 ifthe 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.
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. The goodwill test is a two-step process and requires goodwill to be allocated to our reporting units.
Reporting units are defined by us to be the same as the reportable segments (see Note 5). In the first step, the fair value of the
reporting unit is compared with the carrying value ofthe reporting unit. If the fair value ofthe 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. An impairment loss is recognized by
reducing the carrying value of the asset to its estimated fair value.
Accounting/or 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 ofthe valuation allowance.
We account for the uncertainty in income taxes on the determination of whether tax benefits claimed or expected to be
claimed on a tax return should be rewrded in the financial statements. 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.

•

Capitalization oflnterna/ly Delle/oped Software Costs

We capitalize labor associated with software developed for internal use. Software is considered for internal use if acquired,
internally developed or modified solely to meet the entity's internal needs and if during the software's development or
modification, no plan exists to market the software externally. Costs incurred during the application development stage are
capitalized. Capitalization of cost begins when the preliminary project stage is completed and management with the relevant
authority authorizes and commits to funding a computer software project and believes that it is probable that the project will be
completed and the software will be llSed to perfonn the function intended. Capitalization ceases when the project is complete
or it is no longer probable that the project will be completed.
Financial Reporting Changes
See Note I, paragraph (v) of the Consolidated Financial Statements for information about recent accounting
pronouncements.
ITEM lA. 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. Our market risks as
of December 31 , 2009 were substantially equivalent, in all material aspects, to the market risks we faced in 2008. Interest
expense on our floating rate debt will increase 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: (a) LIBOR plus 4.0%, or (b) a rate equal to the Base Rate plus 3.0%. The
Base Rate is the greater of 0) 5%, (ii) the Federal Funds rate plus 0.5%, or (iii) the prime rate (as defined in the Credit
Agreement). The effect of a 10% fluctuation in the interest rate on our revolving line of credit would have had a negligible
impact on our interest expense for the twelve months ended December 31, 2008 and 2009. There were no borrowings

file:IIZ:\RFP Technician Files\Financials\2009 Financials\2009 form! O-k.htm

3129/2010

•

fonnlO-k.htm

•

Page 47 of 112

outstanding at December 31, 2009 related to our variable rate debt.
We are exposed to foreign currency exchange rates on the earnings, cash flows and financial position of our international
operations. We are not able to project the possible effect of these fluctuations on translated amounts or future earnings due to
our constantly changing exposure to various currencies, the fact that all foreign currencies do not react in the same manner in
relation to the U.S. dollar and each other, and the number of currencies involved; however we do not believe the effect of this
eXPQsure would materially impact our financial position. Our most significant exposure is to the British pound.
40

•

•
file:IIZ:\RFP Technician Fi1es\Financials\2009 Financials\2009 formlO-k.htm

3/29/2010

form 1O-k.htm

Page 48 of 112

Report of Independent Registered Public Accounting Firm
To the Board of Directors and Stockholders
Securus Technologies, Inc.
We have audited the accompanying consolidated balance sheet ofSecurus Technologies, Inc. and Subsidiaries as of December
31,2009, and the related consolidated statements of operations, stockholders' deficit and comprehensive loss, and cash flows
for the year then ended. These financial statements are the responsibility of the Company's management. Our responsibility is
to express an opinion on these financial statements based on our audit.

•

We conducted our audit 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 audit
provides 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, 2009, and the results of their operations and their
cash flows for the year then ended, in conformity with United States generally accepted accounting principles.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States),
Securus Technologies, Inc. and Subsidiaries' internal control over financial reporting as of December 31, 2009, based on
criteria established in Internal Control- Integrated Framel-llork issued by the Committee of Sponsoring Organizations of the
Treadway Commission, and our report dated March 15, 2010 expressed an unqualified opinion on the effectiveness ofSecurus
Technologies, Inc. and Subsidiaries' internal control over financial reporting.

•

McGladrey & Pullen, LLP
Dallas, Texas
March 15,2010
41

•
file:IIZ:\RFP Technician Files\Financials\2009 Financials\2009 fonnlO-k.htm

3/29/2010

Page 49 of 112

fonnIO-k.htm

•

Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders
Securus Technologies, Inc.:
We have audited the accompanying consolidated balance sheet ofSecurus Technologies, Inc. and subsidiaries as of
December 31, 2008 and the related consolidated statements of operations, stockholders' deficit and comprehensive loss, and
cash flows for each ofthe years in the two-year period ended December 31, 2008. 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 ofSecurus Technologies, Inc. and subsidiaries as of December 31, 2008, and the results of their opemtions and their
cash flows for each ofthe years in the two-year period ended December 31,2008, in conformity with U.S. generally accepted
accounting principles.

KPMGLLP
Dallas, Texas
March 27, 2009

•

42

•
file:IIZ:\RFP Technician Files\Financials\2009 Financials\2009 formIO-k.htm

312912010

fonnl0-k.htm

Page 50 of 112

•

ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS
SECURUS TECHNOLOGIES, INC.AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Dollars in tbousands, except per sbare amounts)
December 31 z

2008
ASSETS
Cash and cash equivalents
Restricted cash
Accounts receivable, net
Prepaid expenses
C\lITent deferred income taxes
Total current assets
Property and equipment, net
Intangibles and other assets, net
Goodwill
Total assets

$

$

LIABILITIES, REDEEMABLE CONVERTIBLE PREFERRED STOCK AND
STOCKHOLDERS' DEFICIT
Accounts payable
Accrued liabilities
Deferred revenue and customer advances
Current deferred income taxes
Total current liabilities
Deferred income taxes
Long-tenn debt
Other long-tenn liabilities
Total liabilities
Commitments and contingencies

$

Series A redeemable convertible preferred stock, stated value $2,253 and $2,534 at
December 31, 2008 and December 31, 2009; total redemption value $11,489 and
$12,925 at December 31,2008 and December 31,2009; 5,100 shares authorized and
outstanding at December 31,2008 and 2009.
Stockholders' deficit:
Common stock, $0.001 stated value; 1,355,000 and 1,675,000 shares authorized at
December 31,2008 and 2009; 161,037 and 140,792 shares issued and outstanding at
December 31, 2008 and 2009, respectively.
Additional paid-in capital
Accumulated other comprehensive income (loss)
Accumulated deficit
Total stockholders' deficit
Total liabilities, redeemable convertible preferred stock and stockholders' deficit

2009

6,576
1,599
45,316
6,116
1,973
61,580
35,364
98,550
63,468
258,962

14,743
44,371
15,069
817
75,000
10,893
288,341
2,238
376,472

$

$

$

2,668
1,366
40,010
6,183
11487
51,714
28,767
92,207
67,386
240,074

19,010
38,285
14,755
893
72,943
11,306
287,802
3,357
375,408

11,321

12,820

8

8
32,806
560
(181 1528)

34,304
(2,701)
(160,442)

~148,154)

~128,831)

S

•

258,962

$

240,074

See accompanying notes to consolidated financial statements.

43

•
file:IIZ:\RFP Technician Files\Financials\2009 Financials\2009 formIO-k.htm

3/29/2010

Page 51 of 112

form 1O-k.htm

•

SECURUS TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
For the Years Ended December31, 2007, 2008 and 2009
(Dollars in thousands)
For the Year Ended December 31 2
2009
2007
2008

•

Revenue:
Direct call provisioning
Offender management software
Wholesale services
Total revenue
Cost of service (exclusive of depreciation and amortization shown
separately below):
Direc:t call provisioning, exclusive of bad debt expense
Ditect call provisioning bad debt expense
Offender management software expense
Wholesale services expense
Total cost of service
Selling, general and administrative expenses
Restructuring costs
Depreciation and amortization
Total operating costs and expenses
Operating income (1oss)
Interest and other expenses, net
Loss before income taxes
Income tax expense (benefit)
Net loss
AcclUed dividends on redeemable convertible
p~ferred stock
Net loss available to common stockholders

$

338,703
7,933
45,214
391,850

$

218,824
37,776
6,110
24,104
286,814
74,369
614
37,048
398 1845
(6,995)
31,487
(38,482)
1,922
(40,404)

$

(40,404) $

333,564
25,137
29,902
388,603

$

217,918
25,889
13,540
14,543
271,890
74,721
224
34,400
381,235
7,368
41 1896
(34,528)
~509)

(34,019)

P1

351 )
(35,370) $

312,614
22,698
28,124
363,436

197,713
23,859
9,624
161032
247,228
66,128
31,333
3441689
18,747
391114
(20,367)
719
(21,086)

1

!1 499)
(22,585)

See accompanying notes to consQlidated financial statements.

44

•
file://Z:\RFP Technician Files\Financials\2009 Financials\2009 fonn10-k.htm

312912010

form 1O-k.htm

Page 52 of 112

•

SECURUS TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' DEFICIT
AND COMPREHENSIVE LOSS
For the Years Ended December31, 2007, 2008 and 2009
(Dollars in thousands)

Common
Shares
Balance at Dcwmber 31 ,
2006
Issuance of common
stock in conjunction
with Syscon acquisition
Stock based
compensation
E1Cercise of warrants
Restricted stock grants
Forfeitures of restricted
stock
Foreign currency
translation
Net loss
Total compreqensive
loss
Balance at December 31.
2007
Stock based
compensation
Restricted stock grants
Forfeitures of restricted
steck
Purchase of common
stock
ACC1\led dividends on
preferred stock
Foreign currency
, translation
Net loss
Total comprehensive
loss
Balance at December 31,
2008
Stock based
compensation
Restricted stock grants
Forfeitures ofrcstricted
stock
Issuance of common
stock
Purchase of common
stock
ACC1\Ied dividends on
preferred stock
Foreign currency
translation
Net loss
Total comprehensive
loss
Balance at December 31,
2009

Additional
Paid-In
Caeital

Amount

610

$

6

S

Accumulated
Deficit

34,140

45

$

(86,019)

Accumulated
Other
Comprehensive
Income lLoss}
$

Total
Stockholders'
Defidt

$

(51,873)

1,413

1,414

67

67

14
II

(3)
1,935

1,935
(401
404)

(40.404)

138.469)
677

$

7

$

35,620

$

(126,423)

$

1,935

S

35

1881861)
35

160,364

I

(2)
(2)
(1,351)

(1,351)
(4,636)

(4,636)
019)
P41

(34,019)

•

1381655)
161,037

S

8

$

34,304

$

~160144Z)

$

F,701)

$

!128,831)

6,566
(40,341)
13,576
(46)
(1,499)

(1,499)
3,261

3,261
21
1 1°86)

(21,086)

!17 1825)
140,792

$

8

S

32,806

$

(181,528)

S

560

$

(148,154)

See accompanying notes to consolidated financial statements.

•

45

file:IIZ:\RFP Technician Files\Financials\2009 Financials\2009 form 1O-k.htm

3/29/2010

form 1O-k.htm

Page 53 of 112

•

•

•
file://Z:\RFP Technician Files\Financials\2009 Financials\2009 form! O-k.htm

3/29/2010

fonn 10-k.htm

Page 54 of 1] 2

•

SECURUS TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Years Ended December3l, 2007, 2008 and 2009
(Dollars in tbousands)

2007
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss
$
Adjustments to reconcile net loss to net cash provided by operating
activities:
Depreciation and amortization
Amortization of fair value of contracts acquired
Deferred income taxes
Conversion of interest paid "in kind" to secured subordinated notes
Amortization of deferred financing costs and debt discounts
Other operating activities, net
Changes in operating asst:ts and liabilities, net of effects of acquisitions:
Restricted cash
Accounts receivable
Prepaid expenses and other current assets
Other assets
Accounts payable
Accrued liabilities
$
Net cash provided by operating activities
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment and intangible assets
Cash consideration paid for acquired business
Proceeds from sale of asset
Proceeds from sale of unconsolidated affiliate
Property insurance proceeds
Nt:t cash used in investing activities

S

For tbe Year Ended
2008

(40,404) $

(34,019) $

2009
(21,086)

34,400
3,489
(2,365)
12,650
3,542
(25)

31,333

(74)
20,459
191
376
(11,251)
{I,266)
20,459 $

(68)
3,813
(862)
654
(9,057)
5,254
17,406 $

237
5,988
4
(2,885)
(210)
6,016)
1
261752

(21,356) $
(43.711)

(17,046) $

(16,453)

37,048
1,360
922
10,678
2,251
169

323
14,943
4,170
(49)

200

$

985
88
(64,OOO) $

(17,046) $

•

06,253)

See accompanying notes to consolidated financial statements.

46

•
file:IIZ:\RFP Technician Files\Financials\2009 Financials\2009 fonnlO-k.htm

3/29/2010

Page 55 of 112

form 10-k.htm

•

SECURUS TECHNOLOGIES, INC.AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS - (Continued)
For the Years Ended December 31,2007,2008 and 2009
(DollaTS in thousands)
For the Year Ended December 31.
2007
2008
2009
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of second-priOrity senior secured notes
Cash overdraft
Net advances (payments) on revolving credit facility
Debt issuance costs
Proceeds (payments) related to loan payable to related party, net
Proceeds from issuance of common stock
Proceeds from issuance of Series A preferred stock
Series A preferred stock issuance costs
Net cash provided by (used in) financing activities
Effect of exchange rates on cash and cash equivalents
Increase (decrease) in cash and equivalents
Cash and cash equivalents at beginning of year
Cash and cash equivalents at end of year

•

SUPPLEMENTAL DISCLOSURES:
Cash paid during the period for:
Interest
Income taxes

- $
39,060 $
(3,958)
(4,151)
4,275
11 ,511
1,775
(16,511)
(4,853)
(1,757)
(77)
(4,510)
4,510
1
I
10,200
_ _.......
(2;;;;2;;;.-9) _ _ _ _ ~_ __
$

1,094 .;.$_~(~12~,3~1~3)
46,506 $
(1,451)
3,050
(2,094)
$
1,514 S
4,504 $
(3,908)
_ _ _.; ; 55;;,; :8 _ _....::;2,~07:.::2
6,576
$

s
$
$

NONCASH FINANCING AND INVESTING ACTIVITIES:
Non-cash consent fee
Leasehold improvements

$
$

2,072 $

6,576

~S::::2~,6~6~8

18,715 $
239 $

22,207 $
846 $

400 $

- $
710 $

- $

22,797
1,228

155

See accompanying notes to consolidated financial statements.

47

•
file:/IZ:\RFP Technician Files\Financials\2009 Financials\2009 formlO-k.htm

312912010

fonn10-k.htm

Page 56 of 112

•

SECURUS TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Securus Technologies, Inc. and its subsidiaries ("Securus" or the "Company") provide inmate telecommunications
services and software solutions to correctional facilities operated by city, county, state and federal authorities and other types
of confinement facilities in 43 states and the District of Columbia. Securus also provides offender management and other
software solutions to U.S. and foreign correctional facilities and law enforcement agencies. The Company was incorporated in
Delaware on January 12, 2004, and on March 3, 2004 and September 9, 2004, the Company 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 Syscon Holdings, Ltd. and certain of its affiliates ("Syscon").

(a) Basis of Presentation
The Company has three reportable segments: direct call provisioning, offender management software and wholesale
services. These segments are the determinants for how management makes operating decisions, assesses performance and
allocates resources. These three segments each demonstrate similar economic characteristics and are similar in the nature, class
of customer, distribution methods, and regulatory environment for their products and services.
In the direct call provisioning segment, the Company bills call revenue to established prepaid accounts of end users, or
bills through major local exchange carriers ("LECs") or through third-party billing services for smaller volume LECs. The
Company performs ongoing customer credit evaluations and maintains allowances for uncollectible amounts based on
historical experience, changes in economic conditions including unemployment rotes and other factors. Over half of direct call
provisioning revenue is paid for on a prepaid basis. Deferred revenue is recorded for customer prepayments prior to usage.
In the offender management software 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 Company generates revenues through
license fees, software implementation and consulting fees, and software maintenance and support.
In the wholesale services segment, the Company provides both solutions and billing services (validation, fraud
management and billing and collection services) and telecommunications services (equipment, security enhanced call
processing, validation and customer service and support) to corrections facilities through contracts with other inmate
telecommunications providers.

•

(b)Reclassification
Certain amounts in the prior periods' consolidated financial statements have been reclassified to conform to the current
period presentation. This reclassification had no impact on opemting income (loss), net loss, cash flows or the financial
position ofthe Company for the prior periods presented.
(c)Principles of Consolidation
The accompanying consolidated financial statements include the accounts of Securus Technologies, Inc. and its whollyowned subsidiaries, T -Netix, Inc., Evercom Holdings, Inc., and Syscon Holdings, Ltd. An significant intercompany accounts
and transactions have been eliminated in consolidation.

48

•
file:IIZ:\RFP Technician Files\Financials\2009 Financials\2009 fonn10-k.htm

3/29/2010

Page 57 of 112

form I O-k.htm

•

(d)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 with covenants in its 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. Based on the current and
expected level of operations, management believes the Company's cash flow from operations, available cash and available
borrowings under the $30.0 million revolving credit facility will be adequate to make required capital expenditures,
service indebtedness and meet the Company's other working capital needs for at least twelve months from the balance sheet
dated December 31, 2009. However, due to the economy and other uncertainties referred to above, there are no assurances that
available sources of cash will be sufficient to enable the Company to make such capital expenditures, service indebtedness or
to fund other working capital needs. If the Company cannot meet covenants, debt service and repayment obligations, the debt
would be in default under the governing terms ofthe agreements, which would allow the lenders under the credit facilities to
declare all borrowings outstanding to be due and payable, which would in tum, trigger an event of default under the indenture
agreement and the agreement governing the Company's 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.

(e)A.ccounting Estimates
The preparation of financial statements in conformity with accounting prinCiples generally accepted in the United States
of America ("GAAP") 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 ofthe 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 recoverability of property and equipment, goodwill, intangible and other assets, and deferred income taxes.

•

Management evaluates its estimates and assumptions on an ongoing basis using historical experience and other factors,
including the current economic environment, which management believes to be reasonable under the circumstances .
Management adjust such estimates and assumptions when facts and circumstances dictate. As future events and their effects
cannot be determined with precision, actual results could differ significantly from these estimates. Changes in those estimates
resulting from continuing changes in the economic environment will be reflected in the financial statements in future periods.

(j)Risks and Uncertainties
The Company generated approximately 20% of its revenues from its five largest customers during the year ended
December 31,2009. If the Company loses one or more significant customers, revenues and our ability to comply with our debt
covenants could be adversely affected.
The majority of offender management revenues have been associated with the implementation of software for one major
customer. The implementation phase of this contract was completed during the second quarter of2009, causing a subsequent
decline in revenue. Revenues are currently being generated from new contracts with other customers; however, we will need to
continue to generate new contracts to compensate for the loss of this revenue.

(g)Cash and Cash Equivalents and Restricted Cash
Cash equivalents consist of highly liquid investments, such as certificates of deposits, money market funds and short term
treasury instruments, with original maturities of 90 days or less. Restricted cash accounts hold amounts established for the
benefit of certain customers in the event the Company does not perform under the provisions of the respective underlying
contra<:t with these customers. Restricted cash was $1.6 million and $1.4 million at December 31, 2008 and December 31,
2009, respectively.

49

•
file:IIZ:\RFP Technician Files\Financials\2009 Financials\2009 formlO-k.htm

3/29/2010

fonn 1O-k.htm

Page 58 of 112

(h) 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 the Company's 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 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
this allowance is net of amounts held by the LECs for estimated charge backs, The Company analyzes the collectibility of a
majority of its accounts receivable 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. The Company's
policy is to write-off accounts after 180 days from invoice date, or after all conection efforts have failed,

•

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

For the Year Ended December 31,
Balance beginning of period
Opening balance of acquired business
Additions charged to expense
Accounts written-off
Balance at end of period

s
$

2007

2008

15,045 S
11,506 $
115
52,062
33,094
(55,716)
(39,420)
11,506 ;;c$===::::!5,:::;18=0 $

2009
5,180

29,676
(29,115)
5,741

(i)Fair Value ofFinancial Instruments
The Company is required to include 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. Canying
amounts and estimated fair value of debt are presented in Note 4.

O)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 from two customers that, when combined,
comprised 29.7% (two telecommunications companies) of all trade accounts receivable at December 31,2009. The Company
does not require collateral on accounts receivable balances and provides allowances for potential credit losses.

•

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
an effect on the Company's financial condition and results of operations. The Company has not entered into any derivative
contracts to mitigate the impact of foreign currency fluctuations.

(k)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 of3 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.

(I)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

file:IIZ:\RFP Technician Files\Financials\2009 Financials\2009 fonnlO-k.htm

3129/,2010

•

Page 59 of 112

form I O-k.htm

•

aggregate borrowings. The Company capitalized interest in the amount of $0.2 million for each of the years ended
December 31, 2007, 2008 and 2009, respectively. The Company capitalizes contract acquisition costs representing u~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 within the balance sheet caption "Intangibles and other assets, net" and are
commonly referred to as signing bonuses in the industry.
50

•

•
file:IIZ:\RFP Technician Files\Financials\2009 Financials\2009 forml0-k.htm

3129/2010

fonnlO-k.htm

Page 60 of 112

The Company performs an annual impairment test of goodwill and other intangible assets with indefinite useful lives as of
the last day of each fiscal year. The goodwill test is a two-step process and requires goodwill to be allocated to the Company's
reporting units. Reporting units are defined by the Company to be the same as the reportable segments (see Note 5). 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 impainnent loss
is recognized to the extent that the canying value of the goodwill exceeds the impliedfair value of the goodwill. An
impairment loss is recognized by reducing the carrying value of the asset to its implied fair value.

•

Other intangible assets with indefinite useful lives are tested for impairment annually or more frequently if events or
changes in circumstances indicate that the asset may be impaired. For this impairment test, the carrying value of the intangible
asset is compared to its fair value. If the carrying value exceeds the fair value, an impairment loss is recognized by reducing
the carrying value of the intangible asset to its fair value.
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, which are subject to
amortization as of the year ended December 31, 2009, is approximately ten years. Amortization expense was $18.9 million,
S16.7 million and $17.5 million for the years ended December 31, 2007,2008 and 2009, respectively.

(m)Jmpairment ofLong.Lived Assets
Long-lived assets, such as property, equipment and purchased intangibles subject to amortization, are grouped with other
assets producing the same cash flow streams and are reviewed for impairment as a group 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 value of the assets to the estimated undiscounted future cash flows expected
to be generated by the assets. If the carrying value of the assets exceed their estimated future cash flows, an impairment charge
is recognized by the amount by which the carrying value of the assets exceed the fair value of the assets.
(n)401(k) Plan

The Company sponsors 401 (k) savings plans for the benefit of eligible full-time employees in the United States, Canada
and the United Kingdom. The U.S. plan is a qualified benefit plan in accordance with the Employee Retirement Income
Se"urity Act. Employees participating in the plans can generally make contributions to the plan of up to 15% of their
compensation, with the exception of employees in Canada, which jurisdiction does not have a maximum on the total amount of
contributions. In the U.S., the 401 (k) plan provides for the Company to make discretionary matching contributions of up to
50% of an eligible employee's contribution for up to 6% of their salary. In Canada and the United Kingdom, the Company
makes discretionary matching contributions up to 5% of an eligible employee's contributions, dependent on the employees'
tenure with the Company. Matching contributions and plan expenses were $0.6 million, $0.7 million, and $0.8 million for the
years ended December 31,2007,2008 and 2009, respectively.

•

(o)Jncome Taxes
The Company records deferred tax assets and liabilities at an amount equal to the expected future tax consequences of
transaction and events. Deferred tax assets and liabilities are determined based on the future tax consequences attributable to
the differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax. bases
and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted income tax rates
expected to apply to taxable income in the years in which those differences are expected to be recovered or settled. The effect
on deferred tax assets and liabilities of a change in income tax rates is recognized in the results of operations in the period that
includes the enactment date.

(P)Stock·Based Compensation
The Company accounts for its restricted stock plan based on the grant date estimated fair value of each award, net of
estimated forfeitures or cancellations, over the employee's requisite service period, which is generally the vesting period of the
equity grant. The Company recorded compensation expense of less than SO. 1 million for each of the years ended December 31,
2007, 2008, and 2009 related to purchases of restricted stock by certain executives and members of the board of directors (See
Note 8).

(q)Revenue Recognition
Revenues related to collect and prepaid calling services generated by the direct call provisioning segment are recognized

file:IIZ:\RFP Technician Fi1es\Financials\2009 Financials\2009 fonnlO-k.htm

3/29/2010

•

Page 61 of 112

fonn 1O-k.htm

•

during the period in which the calls are made. In addition, during the same period, the Company records 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 uncollectible calls, based on historical experience.
Revenues related to the wholesale services segment 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 records the related
telecommunications costs for validating, transmitting, and billing and collection costs, along with allowances for uncollectible
calls, as applicable, based on historical experience.
51

•

•
file:/IZ:\RFP Technician Files\Financials\2009 Financials\2009 fonnIO-k.htm

3129/2010

fonnIO-k.htm

Page 62 of 112

. The Company records can revenues related to the wholesale services segment at the net amount since the Company is
acting as an agent on behalf of another provider. For records processed through the billing system, this is the amount charged
to the end user customer less the amount paid to the inmate telecommunications provider.
Revenues related to the offender management software segment are recognized using the residual method when the fair
value of vendor specific objective evidence ("VSOE") of the undelivered elements is determined. If the VSOE of fair value
cannot be determined for any undelivered element or any undelivered element is essential to the functionality ofthe delivered
element, the arrangement fee 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. The percentage of completion is calculated using hours incurred to date compared to total estimated hours to complete
the project. The Company's estimates are based upon the knowledge and experience of its project managers and other
personnel, who review each project at each reporting date to assess the contract's 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 to revenue over the terms of the contract, typical1y one year.
The Company accounts for multiple deliverables for arrangements under which it will perfonn multiple revenuegenerating activities. In an arrangement with multiple deliverables, the delivered items are considered a separate unit of
accounting. These arrangements are eva1uated to ensure they add standalone value to the customer, there is objective and
reliable evidence of the fair value of the undelivered items, and the arrangements include only a general right ofreturn relative
to the delivered items and the delivery of the undelivered items is probable and substantially controlled by the vendor. The
arrangement considerations are then allocated to the separate units of accounting based on the relative fair value.

(r)Capitalization 0/Internal Software Development Costs
We capitalize labor associated with software developed for internal use. Software is considered for internal use if acquired,
internally developed or modified solely to meet the entity's internal needs and if during the software's development or
modification, no plan exists to market the software externally. Costs incurred during the application development stage are
capitalized. Capitalization of cost begins when the preliminary project stage is completed and management with the relevant
authority authorizes and commits to funding a computer software project and believes that it is probable that the project will be
completed and the software will be used to perform the function intended. Capitalization ceases when the project is complete
or it is no longer probable that the project will be completed.

•

(s)Foreign Currency Translation and Transaction Gains and Losses
Assets and liabilities ofa non-U.s. subsidiary whose functional currency is not the U.S. dollar are translated at 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 (loss), but are reflected in the comprehensive income (loss) component of
shareholders' deficit.
The Company has transactions in 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.
Included in "Interest and other expenses, net" on the Company's consolidated statement of operations was a $1.5 miHion
gain, $3.8 million loss and $2.3 million gain related to foreign currency transactions for the years ended December 31,2007,
2008 and 2009, respectively.

(t)Comprehensi'Ve Income/Loss
Reporting comprehensive incomenoss requires that certain items such as foreign currency translation adjustments be
presented as separate component of shareholders' equity. Total comprehensive loss for the years ended December 31, 2007,
2008 and 2009 was $38.5 million, $38.7 million, and $17.8 million, respectively. Other comprehensive income or loss
includes a $1.9 million foreign currency translation gain, $4.6 million foreign currency translation loss and $3.3 million
foreign currency translation gain in 2007,2008 and 2009, respectively.

52

file:IIZ:\RFP Technician Files\Financials\2009 Financials\2009 fonnIO-k.htm

3/29/2010

•

formlO-k.htm

Page 63 of 112

•

•

•
file:I/Z:\RFP Technician Files\Financials\2009 Financials\2009 forml0-k.htm

3129/2010

fonnlO-k.htm

Page 64 of 112

(u)Commitments and Contingencies
Liabilities for loss contingencies 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 andlor remediation can be
reasonably estimated. Legal fees related to loss contingencies are expensed as services are received.

•

(v)Recently Issued Accounting Pronouncements
In May 2009, the Financial Accounting Standards Board (''FASB'') issued guidance which established general standards
of accounting disclosures of events that occur after the balance sheet date but before financial statements are issued or are
available to be issued. The FASB requires entities to disclose the date through which subsequent events were evaluated as well
as the rationale for why that date was selected. The guidance was effective for interim and annual periods ending after June 15,
2009. Accordingly, the Company adopted the provision; however, the adoption had no material impact on the Company's
consolidated financial condition, results of operations, cash flows, or disclosures.
In July 2009, the FASB issued new guidance on the Accounting Standards Codification ("Codification"). With the
issuance of this new guidance, the FASB Codification becomes the single source of authoritative U.S. accounting and
reporting standards applicable for all nongovernmental entities, with the exception of guidance issued by the u.s. Securities
and Exchange Commission. The Codification does not change current GAAP, but changes the referencing of financial
standards, and is intended to simplify user access to authoritative GAAP by providing all the authoritative literature related to
a particular topic in one place. The Codification is effective for interim and annual periods ending after September 15, 2009.
The Company adopted the provision; however, the adoption had no material impact on the Company's consolidated financial
condition, results of operations or cash flows.
In September 2009, the FASB issued new accounting guidance related to the revenue recognition of multiple element
arrangements. The new guidance states that if vendor specific objective evidence or third party evidence for deliverables in an
arrangement cannot be determined, companies will be required to develop a best estimate of the selling price to separate
deliverables and allocate arrangement consideration using the relative selling price method. The accounting guidance will be
applied prospectively for revenue arrangements entered into or materially modified in fiscal years beginning on or after June
15,2010. Early adoption is allowed. We are currently evaluating the impact oftbis accounting guidance on our consolidated
financial statements.
In September 2009, the FASB issued new accounting guidance related to certain revenue arrangements that include
software elements. Previously, companies that sold tangible products with "more than incidental" software were required to
apply software revenue recognition guidance. This guidance often delayed revenue recognition for the delivery of the tangible
product. Under the new guidance, tangible products that have software components that are "essential to the functionality" of
the tangible product will be excluded from the software revenue recognition guidance. The new guidance will include factors
to help companies determine what is "essential to the functionality." Software-enabled products will now be subject to other
revenue guidance and will likely follow the guidance for multiple deliverable arrangements issued by the FASB in September
2009. The new guidance is to be applied on a prospective basis for revenue arrangements entered into or materially modified
in fiscal years beginning on or after June 15,2010, with earlier application permitted_ The adoption ofthis accounting
guidance will not have an impact on our consolidated financial statements.

•

(2)BALANCE SHEET COMPONENTS

Accounts receivables, net consist of the following at December 31 (in thousands);
2008

Accounts receivable, net:
Trade accounts receivable
Other receivables

2009

$

50,129 $
367
50,496
(5,180)

$

45,316

Less: Allowance for doubtful accounts

44,564
1,187
45,751
(5,741)

;:.$===4,;,;!,0,O=1=O

•

53

file:IIZ:\RFP Technician Files\Financials\2009 Financials\2009 fonn10-k.htm

3/29/2010

Page 65 of 112

fonn1 O-k.htm

•

Direct caU provisioning bad debt expense for the year ended December 31, 2007 was $37.8 million or 11.2% of direct call
provisioning revenue of $338.7 million. For the year ended December 31,2008, direct call provisioning bad debt expense was
$25.9 million or 7.8% of direct call provisioning revenue of$333.6 million. Direct call provisioning bad debt expense for the
year ended December 31, 2009 was $23.9 million or 7.6% of direct call provisioning revenue of $312.6 million.
Property and equipment, net consists of the following at December 31 (in thousands):
2009

2008
Property and equipment, net:
Teleoommunications equipment
Leasehold improvements
Construction in progress
Office equipment

$

60,291 $
3,860
3,348
19,215
86,714
~51,350)

Less: Accumulated depreciation and amortization

$

35 2364

$

59,418
4,445
1,660
23 2275
88,798
!60,031)
28,767

Intangibles and other assets, net consist of the following at December 31 (in thousands):
2008

Gross

•

Patents and trademarks
Deferred financing costs
Capitalized software development costs
Custom software development costs
Acquired contract rights
Deposits and other long-term assets
Non-compete and employment agreements

Patents and trademarks
Deferred financing costs
Capitalized software development costs
Custom software development costs
Acquired contract rights
Deposits and other long-term assets
Non-compete and employment agreements

Weighted
Average
Life
9.8
5.8
4.5
10.0
9.9

Accumulated
Carrying
Amortization
Value
24,129 $
(8,351) S
$
(5,499)
15,308
(13,495)
25,964
(1,060)
6,698
(44,645)
96,714
1,846
1,540
599)
(73,649) $
172,199 $
$

Net
15,778
9,809
12,469
5,638
52,069
1,846
941
98 2550

2009
Gross
Accumulated
Carrying
Value
Amortization
24,706 $
(10,041) $
$
15,385
(8,640)
(17,273)
32,931
7,885
(2,063)
98,312
(54,387)
4.758
1,802
Qa 168)
185,779 $
$
~93,572) S

Weighted
Average
Net
Life
9.8
14,665
6,745
5.8
4.6
15,658
10.0
5,822
9.8
43,925
4,758
4.3
634
92,207

1

4.3

At December 31, 2008 and December 31,2009, the carrying amount of trademarks assigned to patents and trademarks
that were not subject to amortization was $2.7 million.
54

•
file:IIZ:\RFP Technician Files\Financials\2009 Financials\2009 formlO-k.htm

3/2912010

formlO-k.htm

Page 66 of 112

Amortization of intangibles and other assets for the year ended December 31,2007 was $21.8 million (of which $1.5
million was included in interest expense and $1.4 million was amortized against revenue). Amortization of intangibles and
other assets for the year ended December 31,2008 was $22.7 million (of which $2.5 million was included in interest expense
and $3.5 million was amortized against revenue). Amortization of intangibles and other assets for the year ended December
31,2009 was $20.6 million (of which $3.1 million was included in interest expense). Estimated amortization expense related
to intangibles, excluding deferred financing costs and other assets, as of December 31, 2009 and for each of the next five years
through December 31,2014 and thereafter is summarized as follows (in thousands):

Year Ended December 31:
2010
2011
2012
2013
2014
Thereafter

s

$

•

18,151
15,331
13,256
8,248
7,557
l5,46l
78,004

Accrued liabilities consist of the following at December 31 (in thousands);

2008
Accrued liabilities:
Accrued expenses
Accrued compensation
Accrued severance and facility exit costs
Accrued taxes
Accrued interest and other

$

$

26,433
6,287
207
4,187
7,257
44z371

2009
$

$

21,904
4,569
150
4,512
7,150
38z
285

The Company incurred restructuring charges of $0.2 million during the first quarter of 2008 related to the realignment of
the field service organization because of efficiencies gained from our packet-based architecture. In July 2008, the Company
entered into a separation agreement with an executive and, in 2009, the Company entered into separation agreements with two
executives. For the twelve months ended December 31,2008 and 2009, the Company accrued approximately $0.2 million and
$0.4 million and paid $0.2 million and $0.3 million in severance costs, respectively.

•

(3)GOODWILL
The Company performed annua1 impairment tests as of each balance sheet date. No impairment was recorded as a result
of the testing performed at December 31,2007,2008 and 2009.
Goodwill allocated to our reportable segments is summarized as fonows (in thousands):

Dir~tCaU

Offender
Management
Software
31,099
$

$

ProvisioninG
37,936

$

37,936

$

$

Balance at December 31, 2007
Foreign currency translation
Balance at December 31, 2008
Foreign currency translation
Balance at December 31, 2009

37,936

$

$

~51567)

~5,567)

25,532
31918
29,450

Total
69,035

$
$

63,468
3,918
67,386

55

•
file:IIZ:\RFP Technician Files\Financials\2009 Financials\2009 formIO-k.htm

3/2912010

Page 67 of 112

form 1O-k.htm

•

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

2008
Revolving credit facility
Second-priority senior secured notes
Senior subordinated notes

S

Less unamortized discount on senior secured notes and senior subordinated
notes

16,511 $
194,000
82,484
292,995

1

2009
194,000
97,427
291,427

4,654)
288,341

P,625)
287,802

288,341 $

287,802

Less current portion oflong-tenn debt
$

•

Revolving Credit Facility - On September 30, 2008, the Company and certain of its subsidiaries entered into a senior
credit agreement with a lending institution and the other lenders party thereto (the "Credit Agreement") to refinance its
existing revolving credit facility. The Credit Agreement provides the Company with a $10.0 million letter of credit facility and
a revolving facility of up to the lesser of (i) $30.0 million and (ii) 125% of the Company's consolidated EBlTDA (as defined
in the Credit Agreement) for the preceding 12 months less the face amount of outstanding letters of credit. The Credit
Agreement expires on J\Jne 9, 2011. Advances bear interest at an annual rate of the Company's option equal to either: (a)
LmOR plus 4.0%, or (b) a rate equal to the Base Rate plus 3.0%. The Base Rate is the greater of (i) 5%, (ii) the Federal Funds
rate plus 0.5%, or (iii) the prime rate (as defined in the Credit Agreement), which was 3.25% as of December 31, 2009.
Interest is payable in an-earli on the first day of each month. The unused availability under the Credit Agreement is subject to a
fee based on a per annum rate of 0.375% due monthly. Borrowings under the Credit Agreement are secured by a first lien on
substantially all of the Company's and certain of the Company's subsidiaries' assets. The Company draws from the available
credit under the Credit Agreement to cover normal business cash requirements. As of December 31, 2008 and December 31,
2009, the Company had $13.5 million and $30.0 million, respectively, of borrowing availability under the Credit Agreement.
Second-Priority Senior Secured Noles - The Company has $194.0 million of 11% Second-priority Senior Secured Notes
outstanding. These note!) were issued at a discount of $4.5 million, or 97.651 % of face value. The Second-priority Senior
Secured Notes are secured by a second lien on substantially all of the Company's and certain of the Company's subsidiaries'
assets other than accounts receivable, inventory and real property.

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 ofl02.75% offace value through September 1, 2010 and
100.00% thereafter. No excess cash flow payment was due for the year ended December 31 , 2009 because an Excess Cash
Flow Amount (as defined in the Indenture governing the terms of the Second-priority Senior Secured Notes) was not
generated. In the event we detennine that the Excess Cash Flow Amount is likely to exceed $5.0 million in 2010, we may
purchase Second-priority Senior Secured Notes in the open market, by negotiated private transactions or otherwise, to reduce
the aggregate Excess Cash Flow Amount to less than $5.0 million. TIle Company and its affiliates may from time to time
seek to retire or purchase the outstanding debt, including the notes, through cash purchases andlor exchanges, in open market
purchases, privately negotiated transactions or otherwise. Such repurchases or exchanges, if any, will depend on prevailing
market conditions, our liquidity requirements, contractual restrictions and other factors. The amounts involved may be
material. Interest is payable semiannually on March I and September 1. The effective interest rate is 11.3% on the Secondpriority Senior Secured Notes.

•

Senior Subordinated Notes -The Company has outstanding $97.4 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 the 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,
20] 4 and a mandatory prepayment equal to $20.0 million plus 50% of all outstanding interest paid-in-kind is due on
September 9, 2013. In connection with the issuance of the Senior Subordinated Notes, the Company issued warrants to acquire
51.01 shares of its common stock at an exercise price of$lO per share to the Senior Subordinated Noteholders. As a result, the
Company discounted the face value ofthe Senior Subordinated Notes by $2.9 million representing the estimated fair value of
the warrants at the time of issuance. For the twelve months ended December 31, 2007,2008 and 2009 respectively, S10.7
million, $12.6 million and $14.9 million of paid-in-kind interest was added to the principal balance of the Senior Subordinated
Notes. The effective interest rate is 18.5% on the Senior Subordinated Notes.

file:I/Z:\RFP Technician Files\Financials\2009 Financials\2009 formlO-k.htm

3129/2010

Page 68 of 112

•

56

•

•
file:IIZ:\RFP Technician Files\Financials\2009 Financials\2009 formIO-k.htm

3/29/2010

Page 69 of 112

form 1O-k.htm

•

All of the Company's domestic subsidiaries and certain of its foreign subsidiaries (collectively, the "Subsidiary
Guarantors") are fully, unconditionally, and jointly and severally 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 guarantors because (a) their 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 that require the maintenance of certain financial
ratios, including specified fixed charge interest coverage ratios, maintenance of minimum levels of operating cash flows 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 these covenants and restrictions, it may be in default, at
which time payment of the long term debt and unpaid interest may be accelerated by the Company's lenders and become
immediately due and payable.
Based on the Company's current and expected levels of operations, cash flow from operations, available cash and
available borrowings under the $30.0 million revolving credit facility will be adequate to continue to operate for at least twelve
months from the Company's balance sheet dated December 31, 2009.
The fair value of our debt instruments is as follows (in thousands):
December 31,
Revolving Credit Facility
Second-priority Senior Secured Notes
Senior Subordinated Notes

December 31,

2008

2009

16,511 $
108,205
179,840
82,484
97,427
207,200 '="'$---::2~7=-7
,2~6~7

$

$

•

The fair value ofthe revolving credit facility is equal to its carrying value and is considered a Level 2 fair value
measurement (defined as inputs other than quoted prices in active markets that are either directly or indirectly observable) due
to the variable nature of its interest rate. The fair values associated with the Second-priority Senior Secured Notes were quoted
as of December 31, 2009 at trading prices of $96.00 and $80.00, increases of 80.3% and 22.1 %, respectively, from the quoted
values at December 31, 2008. The fair value of the Second-priority Senior Secured Notes is considered a Level 2 fair value
measurement (defined as inputs other than quoted prices in active markets that are either directly or indirectly observable) of
the fair value hierarchy determined on their quoted market value. The fair value of the Senior Subordinated Notes is based on
their book value since these notes are not publicly traded and it is not practical to measure their fair value. These notes would
be valued within Level 3 on the fair value hierarchy as little or no market data exists related to these notes.
Future maturities of debt for each of the following five years and thereafter are as follows (in thousands):
Year Ended December 3]:
2010
201 I
2012
2013
20\4
Thereafter

$
194,000
48,714
48,713

$

291 1427

(S)SEGMENT INFORMATION

•

The Company organizes its segments around differences in products and services and has three reportable segments:
direct call provisioning, offender management software and wholesale services. Through these segments, the Company
provides inmate telecommunications products and services for correctional facilities, including security enhanced call
processing, can validation and billing services for inmate caning, 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 primarily through direct contracts between the Company and correctional facilities. A smaller
portion of the business is provided through wholesale service agreements with other telecommunications service providers and
system sales to certain telecommunications providers. The Company's foreign operations, revenues and long-lived assets are
reported in the offender management software segment.

file:IIZ:\RFP Technician Files\Financials\2009 Financials\2009 formlO-khtm

3/29/2010

form 1O-k.htm

Page 70 of 112

•

57

•

•
file:IIZ:\RFP Technician Files\Financials\2009 Financials\2009 formlO-k.htm

3/2912010

Page 71 of 112

form 1O-k.htm

•

The Company evaluateS perfonnance of each segment based on operating results. Total assets are those owned by or
allocated to each segment. Assets included in the "Corporate & 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 estimates 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 attribute 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 infonnation for the twelve months ended December 31,2007 is as follows (in thousands):

Revenue from external customers
Segment gross margin
Depreciation and amortization
Other operating costs and e)(penses
Operating income (loss)
Interest and other expenses, net
Segment loss before income taxes
Capital expenditures
December 31, 2007:

•

Total assets
Goodwill

Direct
Call
Provisionins
$
338,703
82,103
S
33.137
19,624
$
291342

Offender
Management
Software
$
7:933
$
1,823
1,908
2,555
$
i 2z640)

$

$

$
$

21,231

199,071 $
37,936 $

Wholesale
Corporate
& Other
Total
Services
$ 391,850
S 451214 $
$
$ 105,036
21,110 $
37,048
123
1.880
741983
51513
47,291
13,717 $
i47,414) $ (6,995)
$
31,487
31,487
i38,482)
$
21,356
20 $
105 $

-

-

63:626 $
31.099 S

15,767

-

$
$

13,661

$

-

S

292,125
69,035

Segment infonnation for the twelve months ended December 31, 2008 is as follows (in thousands):

Revenue from external customers
Segment gross margin
Depreciation and amortization
Other operating costs and expenses
Operating income (loss)
Interest and other expenses, net
Segment loss before income taxes
Capital expenditures
December 31,2008:
Total assets
Goodwill

Direct
Call
Provisionins
$
333,564
$
89,757
26,736
20,617
$
42.404

Offender
Management
Software
$
25,137
$
11,597
3,679
8,820
$
(902)

$

$

$

S

15,522

187,786 $
37,936 $

Wholesale
Corporate
Total
Services
& Other
$
29,902 $
$ 388,603
$
15,359 S
- $ 116,713
34,400
3,862
123
74,945
4,109
41,399
$
7,388 $ (4],522) $
7,368
41,896
41,896
{34,528)
$
17,046
90 $
100 $
1,334

46,072 S
25,532 $

-

131338 $
$

-

11,766 $
$

-

258,962
63,468

58

•
file:IIZ:\RFP Technician Files\Financials\2009 Financia1s\2009 formlO-k.htm

3/29/2010

fonnlO-k.htm

Page 72 of 112

Segment infonnation for the twelve months ended December 31,2009 is as follows (in thousands):
Direct

Call
Revenue from external customers
Segment gross margin
Depreciation and amortization
Other operating costs and expenses
Operating income (loss)

Provisioning:
$
312,614

$

$

91,042
27,568
18 1198
45,276

$

15 a100

$

168,625

Interest and other expenses, net
Segment loss before income taxes
Capital expenditures
December 31, 2009:
Total assets
Goodwill

$

Offender
Management Wholesale
Corporate
Software
Services
& Other
Total
:) 363,436
$
22,698 $
28,124 $
$
13,074 $
12,092 $
- $ 116,208
3,482
160
123
31,333
9 1425
807
11
36,698
66,128
$
167 $
10,125 $ 136,821) $
18,747
39,114
39,114
(20,367)
$
228 $
567 $
16,453
558 S

-

S

53,015 $
29,450 S

37,936 $

10,319 $
- $

8,115

-

$
$

•

240,074
67,386

(6)INCOME TAXES
Income tax expense (benefit) is as follow!> (in thoU&ands):
Year Ended
December 31,

Year Ended
December 31,

Year Ended
December 31,

2008

2009

2007
Current:
US Federal
US State
Foreign
Total
Deferred:
US Federal
US State
Foreign
Total
Total income tax expense (benefit)

- $

$

330 $
486
848
1,664

965
35
1,000
2,260
(996)
(342)
922
1,922 S
....
$-=-==='=io==

1,696
(552)
(1 317)
~21173)

{S09) $

(88)
324
440
676

•

993
117
(11°67)
43
719

Following is a summary of the components of loss before income taxes for the years ended December 31, 2007, 2008 and
2009 (in thousands):

2007
U.S. income
Non-U.S. income:
Total

2008

2009

$

(37,125) $
(29,013) $
(21,371)
-=--_~(~1,~35:-:-7.) _ _~(,;.;:;5,_51;.;..'5) _ _......;.:1,.-004
....
S
(38,482) $
(34,528) =$=::::::::(2::::!0,=36=7)

59

•
file:IIZ;\RFP Technician Files\Financials\2009 Financials\2009 fonnl0-k.htm

3/29/2010

Page 73 of 112

formlO-k.htm

•

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
December 31.

Year Ended
December 31.

Year Ended
December 31 .•

2007

2008

2009

$

Expected statutory income tax benefit
Amounts not deductible for income tax
State taxes, net of federal benefit
Change in valuation allowance
Effect of different tax rates in various jurisdictions
Impact of changes in tax rates in foreign jurisdictions
Tax credits in foreign jurisdiction
Other
Total income tax expense (benefit)

$

(7,128)
1,529
(48)
5,738
(52)
415
(368)
633
719

(12,085) $
1,894
(66)
9,749
349
(l,841)
(188)
1,679
!509) $

(13,469) $
1,556
(171)
14,332
25

P5I)
1!922 $

The tax effects of temporary differences that give rise to significant portions ofthe deferred income tax assets and
deferred income tax liabilities as of Decem her 31,2008 and 2009, respectively, are presented below (in thousands);

2008

•

Net current deferred income tax assets:
Allowance for doubtful accounts
Accrued expenses
Deferred revenue
Other
Current deferred income tax assets

$

Deferred income tax liabilities-other
Current deferred income tax liabilities
Less: valuation allowance
Net current deferred income tax asset

1,945 $
2,055
4,354
581
8,935

2,188
845
4,295
13
7,341

(939)
(939)
(6,840)
1,156 $

1
1 ,063)

34,504
9,738
200
44,442

37,339
13,436
74
50,849

(2,716)
(5,164)

s

Net non~urrent deferred income tax assets (lIabilities):
Deferred income tax assets:
Net operating loss and tax credit carryforwards
Accrued interest
Other
Non-current deferred income tax assets
Deferred income tax liabilities;
Property and equipment principally due to differences in
depreciation
Goodwill
Intangible assets
Non-current deferred income tax liabilities
Less: valuation allowance
Net non-current deferred income tax liability
Net deferred income tax liability

2009

(2,561)
(6,402)
P3,564)
(22,527)
(39 1628)
!11,306)
{10 z712)

~14!627)

(22,507)
~321828)
~10,893)

$

!9 z737) $

(1,063)

i5,684)
594

60

•
file:/IZ:\RFP Technician Files\Financials\2009 Financials\2009 formlO-k.htm

3/29/2010

formlO-k.htm

Page 74 of 112

At December 3 1,2009, the Company had U.S. federal net operating loss carryforwards for tax purposes aggregating
approximately $109.9 million the majority of which, if not utilized to reduce taxable income in future periods, will expire from
2024 through 2029. Approximately $9.3 million of these 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 the 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 31,2009, the Company had net operating loss carry forwards for tax purposes in
Australia aggregating less than $0.1 million, which do not expire, and no operating loss carryforwards in the remaining foreign
tax jurisdictions.

•

The Company accounts for the uncertainty in income taxes on the determination of whether tax benefits claimed or
expected to be claimed on a tax return should be recorded in the financial statements. 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 Company's unrecognized tax benefits ofSO.7 million and $0.4 million at December 31, 2008 and 2009, respectively,
relate to various foreign jurisdictions.
The following table summarizes the activity related to the Company's unrecognized tax benefits ( in thousands):
Total
Balance at December 31, 2007
Increases related to prior year's tax positions
Foreign currency translation
Balance at December 31, 2008
Decreases related to prior year's tax positions
Increases related to current year's tax positions
Foreign currency translation
Balance at December 31, 2009

$

663
27
(22)
668
(316)

23
(18)

$

357

Included in the unrecognized tax benefits of $0.4 million at December 31 , 2009 was a SO.3 million tax expense that, if
recognized, would impact the annual effective tax rate. The Company also accrued potential interest of $0.1 million in 2007,
and less than $0.1 million during both 2008 and 2009, respectively, related to these unrecognized tax benefits. The Company
does not expect unrecognized tax benefits to change significantly over the next 12 months. The Company classified interest
and penalties on income tax-related balances as income tax expense.

•

The Company or one of its subsidiaries file income tax returns in the U.S. federaljurisdiction, 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 carryforwards, where the IRS may not raise tax for these years, but can reduce net operating
loss carryforwards. Otherwise, with few exceptions, the Company is no longer subject to federal, foreign, state, or local
income tax examinations for years prior to 200S.
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 the net deferred tax assets, including net operating loss carryforwards, with a valuation allowance of$39.7 million
and $45.3 million at December 31,2008 and 2009, respectively. The Company increased the valuation allowance because
future taxable income may not be realized to utilize net operating losses.
61

•
file:IIZ:\RFP Technician Files\Financials\2009 Financials\2009 form 1O~k.htm

312912010

Page 75 of 112

form lO-k.htm

•

(7)REDEEMABLE CONVERTIBLE PREFERRED STOCK
At December 31, 2009, the Company had 5,100 shares of Series A Redeemable Convertible Preferred Stock ("Preferred
Stock"), which was issued in December 2007. Each share of the Preferred Stock has a stated value of $2,534 and accrues
dividends annually at 12.5% 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. At the election ofthe Board of Directors, the Company may redeem shares of Preferred
Stock at any time on or after January 1,201 O. The redemption price is equal to the greater of the liquidation amount or the fair
market value as of the redemption date.
Each share of Preferred Stock is convertible into 200 shares of Class A Common Stock, as adjusted for certain events. The
intrinsic value of the conversion option was zero as the fair value of the Class A Common Stock was less than the conversion
price at the commitment date.
The Company accrues dividends on the Preferred Stock; however the Company's Credit Agreement contains financial and
operating covenants which limit the ability to make dividend payments to the Company's shareholders. As of December 31,
2009, the Company had accrued but unpaid dividends ofS2.7 million for the Series A Preferred Stock. The accrued but unpaid
dividends are included in the redemption amount of the Preferred Stock at December 31, 2009.

(8)STOCKHOLDERS' EQUITY
Common Stock
In 2007, in conjw1Ction with the issuance of the Preferred Stock (see Note 7), the Company's shareholders approved a I
for 1,000 reverse stock split for the Class A Common Stock and Class B Common Stock. Except as otherwise lIoted, all shares,
options and warrants have been restated to give retroactive effect to the reverse split. 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 ofSO.OOI.

•

In 2008, the Company authorized an additional 65,000 shares of Class B Common Stock and filed a Third Amended and
Restated Certificate of Incorporation, which authorized 1,365,000 shares of capital stock with a par value of $0.00 I. 1,190,000
shares were designated Class A Common Stock, 10,000 were designated Preferred Stock, of which 5, I 00 were designated as
Series A Convertible Preferred Stock, and 165,000 were designated Class B Common Stock.
On March 25, 2009, the Company filed a Fourth Amended and Restated Certificate ofIncorporation, which authorized
1,685,000 shares of capital stock with a par value ofSO.OO I. Additionally, the board of directors issued a unanimous resolution
to adopt a Fourth Amendment to the 2004 Restricted Stock Plan which increased the number of shares of Class B Common
Stock authorized for issuance thereunder from 165,000 to 175,000 shares. The Fourth Amended and Restated Certificate of
Incorporation designated 1,500,000 shares as Class A Common Stock, 10,000 shares as Preferred Stock, of which 5,100 were
designated as Series A Convertible Preferred Stock, and 175,000 shares as Class B Common Stock. All issued shares of
Common Stock are entitled to vote on a one share/one vote basis.
As of December 31, 2009, 14,132 shares of Class A Common Stock were issued and outstanding and 126,660 shares of
the Class B Common Stock were issued and 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 Class A Common Stock,
holders of the shares of Class A Common Stock and Class B Common Stock have identical rights and privileges. The
Company's Credit Agreement restricts the ability to pay dividends to holders ofthe Company's capital stock.

Warrants
The holders of the Senior Subordinated Notes hold warrants to purchase an aggregate of 51.01 shares of Class A Common
Stock. The warrant exercise price is $10 per share, is immediately exercisable upon issuance, and expires on September 9,
2014. As a result, the Company 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. The warrants had a de minimis fair value as of December 31,
2008 and 2009.
62

•
file:IIZ:\RFP Technician Files\Financials\2009 Financials\2009 formlO-k.htm

3/29/2010

fonn 1O-k.htm

Page 76 of 112

Restricted Stock Purchase Plan
The Company has a 2004 Restricted Stock Purchase Plan under which certain of its employees may purchase shares of
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 is 175,000, which equals 10.4% of the total authorized shares of common stock.

•

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 detennined 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, 2009, 126,660 shares of Class B Common Stock were issued under the 2004 Restricted Stock
Purchase Plan. Of this amount, (a) 57,072 of these shares were issued to our Chief Executive Officer; (b) 11,414 shares were
issued to our Chief Financial Officer; and (c) 58,174 shares were issued to eleven of the Company's executives and to current
or previous members of the Company's board of directors.
These shares are subject to foJfeiture pursuant to the terms of the 2004 Restricted Stock Purchase Plan and the restrictions
described hereafter. The restriction period of 33.33% of the shares issued to the majority of the Company's executives, ends
upon the sale of the Company's stock by certain of its other stockholders. The restriction period for 33.34% 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, tbe 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 less than $0.1
miHion in compensation expense charged to "Selling General and Administrative Expense" in the consolidated statement of
operations for each of the years ended December 31, 2007, 2008 and 2009.
As of December 31, 2009, there was approximately $0.1 million total unrecognized compensation cost related to the 2004
Restricted Stock Purchase Plan, of which approximately half is expected to be recognized over a weighted average period of2
years and the remaining half will be recognized upon the sale of the Company's stock by certain of the Company's other
shareholders.

•

(9)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 ofS750,OOO for management, consulting and financial advisory services. Required minimum annual consulting
fee payments for the remaining term are as follows (in thousands):

Year Ended December 31:
2010
2011
2012
2013
2014
Thereafter
Total

$

$

750
750
750
750
750
3,563
7,313

The consulting services agreement, as amended, has an eleven-year commitment period. In connection with this
agreement, the Company paid $0.8 million for each ofthe three years ended December 31, 2007, 2008, and 2009.
The Company has a professional services agreement, as amended, with H.l.G., pursuant to which H.J.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 2007, 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,

file:IIZ:\RFP Technician Files\Financials\2009 Financials\2009 fonnlO-k.htm

3129/2010

•

Page 77 of 112

formlO-k.htm

•

respectively. ]n 2008, H .lG. received a professional service fee of $0.8 million for their services related to the refinancing
of the Company's revolving credit arrangement. No transactions took place during 2009, requiring payment under the
professional services agreement.

63

•

•
file:IIZ:\RFP Technician Files\Financials\2009 Financials\2009 formlO-khtm

312912010