T-Netix, Inc.

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T-Netix, Inc.

67 Inverness Drive East
Englewood, Colorado 80112
U.S.A.
Telephone: (303) 790-9111
Toll Free: (800) 531-4245
Fax: (303) 790-9540
Web site: http://www.t-netix.com

Public Company
Incorporated: 1986 in Colorado as Tele-Matic Corp.
Employees: 441
Sales: $103.3 million (2000)
Stock Exchanges: NASDAQ
Ticker Symbol: TNTX
NAIC: 4813 Telephone Communications

T-Netix, Inc. is a leading provider of specialized call processing, billing, and other services primarily to the corrections industry. The company delivers these services through direct contacts with correctional facilities and through relationships with leading telecommunications companies, including AT&T, Verizon, Quest, and SBC Communications. T-Netix operates two principal units: the Corrections Division and the Internet Services Division. The Corrections Division primarily processes telephone calls for prison inmates. The company provides customized call processing services to telephone companies that serve more than 1,600 correctional facilities in 43 states. T-Netix employs specialized software and systems that allow telecommunications providers and prison operators to control telephone use by restricting the length of an inmate’s call, blocking unauthorized or fraudulent calls, and monitoring and recording calls. T-Netix’s advanced call control software and services also enable correctional facilities to control calls by facility, cellblock, telephone, and in some cases, each inmate. The Corrections Division primarily manages its specialized telecommunications hardware and software systems for long distance and local exchange carriers on a contractual basis and sells inmate calling systems. In addition, the Corrections Division provides other inmate-related products, including an electronic monitoring system for low-risk offenders, a prison information management system, and software for inmate accounting, product inventory, and commissary management. The Internet Services Division provides interLATA Internet services to internet subscribers and buys and resells Internet bandwidth.

The Mid-1980s: Company Beginnings

Terry Johnson founded Tele-Matic in 1986 after the federal government dismantled AT&T’s telephone monopoly and deregulated the communications industry. The company primarily made pay telephones until 1991 when it released Strike Three!, a three-way call detection technology that prevented inmates from making fraudulent calls. Due to Strike Three!’s success, in 1992 president and chief operating officer Tom Huzjak changed Tele-Matic’s marketing strategy by focusing on processing calls for the corrections industry. As a result, Tele-Matic bought eight inmate-focused telephone companies and acquired approximately 33 percent of Tele-Matic UK, purchasing the rest in 1994 for 40,000 shares of common stock. The acquisitions enabled Tele-Matics to provide call and processing services to inmates at 368 correctional facilities in 34 states. To service this many correctional facilities, by 1995 the company installed more than 10,500 phone lines and planned to install additional lines in the future. Although inmate calling represented more than a billion dollar opportunity, it also was fraught with credit card fraud and running scams over the network. Nevertheless, the company entered the inmate calling business with the aim of providing specialized call processing and monitoring services to jails and prison systems throughout the country. The rapidly growing prison population, which tripled between 1980 and the mid-1990s, spawned the company’s growth. Tele-Matic’s growth also stemmed from allowing inmates greater access to telephones by jails and prisons, which received commissions from the calls.

The Mid-1990s: Expansion into Voice Verification

In 1994, Thomas Huzjak became Tele-Matic’s president and chief executive officer. In 1995, the company changed its name to T-Netix, and in October of that same year acquired all of the outstanding stock of SpeakEZ, Inc., a privately held development-stage company. T-Netix bought the SpeakEZ for $3 million in company stock, cash, and notes payable, and thereafter operated it as a wholly owned subsidiary. The acquisition of SpeakEZ led the company to an increased focus on new technology, specifically biometrie identification or speaker verification technologies. This technology used voiceprints or speech patterns as a way of verifying an individual’s identity. T-Netix believed that this technology had particular applicability in curbing fraud in the financial services, telecommunications, and security industries. The company’s main objective was to be a leading provider of innovative fraud prevention and identification products and services to these specific industries in the international arena. Thus, virtually all of the company’s revenue stemmed from its corrections industry call processing services.

The company anticipated that the emerging market for voice verification offered significant growth opportunities. T-Netix CEO, Thomas Huzjak, believed that such security technologies as data encryption, digital certificates, server firewalls, and certificates of authority helped to secure networks, but fell short of true identification of the person making a transaction. The company’s voice print technology addressed the weak link in the secured system chain. As a result, by 1998 the SpeakEZ division had developed a suite of products and several strategic relationships to address the voice verification market. T-Netix introduced several verification products to protect Web sites, LANs, and personal computers. The company introduced its VoicEntry product as a biometrics-based alternative to typed password protection for individual and shared computer users. T-Netix’s VeriNet product provided network security for web and internet-based applications through the use of speaker verification technology. The company sought the rapid introduction of VeriNet by entering into a distribution relationship with and investing in a start-up venture called Sentry Systems, Inc., which was developing a turnkey security system for e-commerce transactions. T-Netix also established distribution relationships with network security technology companies, including several facial imaging firms, such as Miros and Visionics, and the fingerprint company BioNetrix. For the financial services industry, the company introduced its Customer Verification Service (CVS), designed for use by banks, brokerage houses, insurance companies, and other financial institutions to authenticate customer transactions through a voice recognition system. The company also developed and installed for GTE Telecommunications System, Inc., its Verifi-Air product to address wireless telecommunications fraud. This product compared a cellular caller’s password voice with the stored voice print of the authorized caller.

In 1998, the company also purchased a 15 percent stake in Cell-Tel Monitoring, Inc. (Cell-Tel), a provider of software for offender caseload management by community corrections, probation, and parole agencies. Cell-Tel’s product, Contain, utilized SpeakEZ’s voice print speaker verification technology for the community or home-based corrections market. Management of parole and probation programs had been a growing concern among local, county, state, and federal criminal justice agencies. During 1995, five states had reported increases of more than 10 percent in their probation populations and 10 states had reported similar increases in their parole populations. With the increase of this population, the corresponding national average caseload per probation/parole officer had risen to about 117 offenders. Because of these burdensome case loads, the company marketed Contain as a cost effective and efficient means of monitoring people on probation and parole. The product worked by calling the subject’s home, or other agency approved locations, and prompting the individual via automated speech to say a password. SpeakEZ’s voice print technology then verified the speaker’s identity by comparing the voice prints of the speaker with the subject’s. If the speaker failed to be verified, Contain automatically notified the corrections officer by telephone, fax, or email. The Contain system also enabled officers to confirm failed verifications and to send voice mail to individuals on parole or probation. As a result, the system allowed officers to detect parole and probation violations faster and with more accuracy than more traditional methods and at lower cost.

Company Perspectives:

T-Netix, Inc. provides specialized call processing and bill services for correctional institutions to the telecommunications industry, direct local and long-distance call processing for correctional facilities, value-added telecommunications services such as pre-connection restrictions, digital recording, jail and inmate management systems, video booking, and sales to call-processing systems hardware. Through its Contain product, T-Netix provides parolee and home detention monitoring services using the Internet and SpeakEZ, its patented voice verification technology. The company services more than 1,600 corrections facilities and justice departments nationwide.

The Late 1990s: Corporate Changes and Acquisitions

In 1998, Thomas Huzjak resigned as chief executive officer and chairman of the board of directors. Alvyn Schoop, the company’s chief financial officer, was named the new chief executive officer and continued as president of the company’s T-Netix Inmate Calling Services Division. Daniel Carney, co-founder and former chairman of Pizza Hut, and a member of T-Netix’s board since 1991, accepted the chairmanship of the company’s executive board. Huzjak’s departure stemmed from differences over strategic and operating philosophies, particularly over the need to refocus operations with an emphasis on core capabilities. As the new CEO, one of Schoop’s first major moves was to streamline the SpeakEZ Division to bring operating expenses more in line with revenue opportunities. Schoop consolidated the division’s Piscataway, New Jersey operations into the company’s Englewood, Colorado headquarters location. The major problem stemmed from the lack of significant sales of its SpeakEZ products, despite the company’s sales and distribution agreements with such corporations as Lucent, IBM, and OTG. The absence of broad based sales also derived from the market for speaker verification technology still being in its infancy. Nevertheless, Schoop moved to reposition T-Netix to focus on its core inmate calling services business, and on reducing non-core operating expenses that had adversely affected earnings for the past several years. In addition, he attempted to address the research and development costs associated with the SpeakEZ Division by curtailing development costs and operating losses. To accomplish this aim, the company shifted marketing away from a direct customer sales strategy to licensing its voice print technology to other companies.

In January 1999, the company announced that it was acquiring main rival Dallas-based Gateway Technologies, Inc., a privately held provider of inmate telecommunications services, for $35.2 million in stock and debt. The acquisition, completed in June, made T-Netix the largest inmate calling services provider in the country. The agreement included the issuance of approximately 4.05 million shares of T-Netix common stock to Gateway shareholders, plus options and T-Netix’s assumption of $10 million in Gateway debt. Although the two companies had been main competitors, each had developed a specialty in the inmate calling services market. T-Netix had primarily served larger facilities with 50 or more phone lines, while Gateway had specialized in facilities with 75 or fewer phone lines. The merger enabled T-Netix to serve the entire corrections facilities market, and provided the company with Gateway’s established billing services, managers, and a sales force.

On August 25, 2000, Alvyn Schoop resigned after two years as CEO and director. Daniel Carney, chair of the board, was appointed interim CEO until a new chief executive officer could be appointed. Under Schoop’s direction, T-Netix had become the leading provider of inmate telecommunications and other services in the country. Schoop also had put the company on solid financial ground with year end 2000 results showing total revenues of $103.3 million, an increase of 41 percent compared with $73.2 million in 1999. On November 16, 2000, the company announced that Tom Larkin would assume the additional title of chief executive officer in addition to his responsibilities as company president. Larkin had joined the company in 1999 as executive vice-president of sales and had been serving as president since March 2000.

On January 19, 2001, the company completed the purchase of 100 percent of the outstanding stock of Telequip Labs, Inc., a small, strategically based provider of inmate telecommunications calling services with headquarters in Dallas. The company anticipated that the acquisition would enable it to expand services to smaller corrections facilities with 20 or fewer phone lines. At the same time, T-Netix entered into an agreement with Telus Corporation, allowing Telus to become the exclusive provider of T-Netix inmate call processing services in Canada. T-Netix expected the agreement to generate revenues from $18 million to $40 million over the life of the six-year contract. Under the terms of the agreement, T-Netix would extend services to Telus’s long distance correctional facilities customers. In return, T-Netix would receive a percentage of the billed monthly revenues for Telus’s accounts.

In December 1999, the company had announced that its wholly owned subsidiary T-Netix Internet Services, Inc. executed a master service agreement with US West (now called Quest America, Inc.) to provide interLATA internet services to Quest customers. The agreement, which commenced December 1, 1999, called for T-Netix to serve as a middleman in buying, reselling, and processing billing of Internet bandwidth to these customers. The contract stipulated an initial minimum term of sixteen months until March 2001. The company’s Internet Services Division accounted for about 25 percent of T-Netix’s total revenue for the year 2000. Based on this agreement, T-Netix anticipated that the opportunities presented by its procurement and management of ISP bandwidth offered far-reaching positive implications for future business growth. Nevertheless, by the end of 2001 this initial enthusiasm gave way to disappointment as all operations under the contract with Quest ceased in November 2001 and the company failed to make substantial headway in the Internet services market.

2000 and Beyond: Corporate Restructuring

The poor performance of the Internet Services Division and other business inefficiencies and redundancies led the company to realign its organizational structure. Despite its 1999 merger with Gateway, the company determined that duplication remained in the organization after the two firms joined forces. The company therefore sought to cut costs by reducing its workforce, eliminating inefficient business segments, and consolidating its operations and closing excess facilities. Pursuant to this restructuring strategy, the company announced plans to discontinue its internet service unit and to sell the SpeakEZ Division, both money losing divisions. As a result, T-Netix entered into a definitive agreement on September 27, 2001 to sell all of the assets of the SpeakEZ Division for approximately $3 million in cash and other considerations. Also in 2001, the company opened a national service center in Carollton, Texas to consolidate most of its support centers into one operation near Dallas. The new center was designed to handle nationwide service and support for the company’s 1,600-plus customer facilities and the more than 20,000 calls from inmate families that the company processed each month. With these changes aimed at re-focusing and enhancing its core businesses, the company appeared to have repositioned itself for future growth.

Principal Divisions

Corrections Division; Internet Services Division.

Key Dates:

1986:: Company is incorporated in Colorado as Tele-Matic Corp.
1992:: The company acquires eight inmate-focused telephone companies and purchases a 33 percent stake in Tele-Matic U.K.
1994:: Remaining shares of outstanding common stock of Tele-Matic Corp. are purchased.
1995:: The company acquires SpeakEZ, Inc. for $3 million; changes name to T-Netix, Inc.
1999:: The company acquires chief rival Gateway Technologies, Inc.
2001:: T-Netix acquires Telequip Labs. Inc. and realigns corporate organization to focus on core business.