T NETIX INC - 10-K Annual Report

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UNITED STATES SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549
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FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE YEAR ENDED DECEMBER 31, 2001

COMMISSION FILE NUMBER 0-25016

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T-NETIX, INC.
(Exact name of registrant as specified in its charter)

DELAWARE 84-1037352
(State or Other Jurisdiction of Incorporation) (I.R.S. Employer Identification No.)
2155 CHENAULT DRIVE, SUITE 410 75006
CARROLLTON, TEXAS 75006 (Zip Code)
(Address of principal executive offices)

REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE:
(972) 241-1535
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SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE.
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
COMMON STOCK
(TITLE OF CLASS)

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

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

The aggregate market value of the voting stock held by non-affiliates of
the Registrant as of March 22, 2002, was approximately $48,103,000.

The number of shares outstanding of the Registrant's common stock as of
March 22, 2002 was 15,032,368.

The following document is incorporated herein by reference into the part of
the Form 10-K indicated: the Proxy Statement for the 2002 Annual Meeting of
Shareholders to be filed prior to April 30, 2002, pursuant to regulation 14A of
the General Rules and Regulations of the Commission, is incorporated by
reference into Part III of this Form 10-K.

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FORM 10-K CROSS REFERENCE INDEX

1

PART I

In this Annual Report on Form 10-K, "T-NETIX" refers to T-NETIX, Inc. and
the "Company", "we," "our" and "us" refer to T-NETIX and its consolidated
subsidiaries (unless the context otherwise requires).

ITEM 1. BUSINESS

GENERAL DEVELOPMENT OF THE BUSINESS

T-NETIX, headquartered in Carrollton, Texas, provides telecommunications
products and services, including security enhanced call processing, call
validation and billing, for inmate calling. The Company provides its
corrections-related products and services to more than 1,400 private, local,
county and state correctional facilities in the United States and Canada. We
deliver these products and services through contracts with some of the world's
leading telecommunications service providers, including Verizon, AT&T, SBC
Communications, Sprint and Qwest, and through direct contracts with correctional
facilities. Revenue from contracts with the telecommunications service providers
is identified in the Part IV, Item 14 Financial Statements as
"Telecommunications Services", and revenue from direct contracts with the
correctional facilities is identified as "Direct call provisioning." As of
December 31, 2001, T-NETIX employed 413 people in 37 states.

The Company was incorporated on August 21, 1986 under the name of
Tele-Matic Corporation. In 1995, the company changed its name to T-NETIX, Inc.
On June 14, 1999, T-NETIX completed a merger with Gateway Technologies, Inc.
("Gateway"), a privately held provider of inmate call processing services and
the Company's primary competitor in three-way calling detection technology.
Gateway became a wholly owned subsidiary of T-NETIX and its name was changed to
T-NETIX Telecommunications Services, Inc. On January 24, 2001, T-NETIX acquired
100% of the outstanding stock of TELEQUIP Labs, Inc., a small provider of
corrections industry telecommunications services and equipment, with principal
offices in Dallas, Texas. T-NETIX had previously owned a 20% interest in the
company.

In December 1999, we entered into a master service agreement with US WEST
ENTERPRISE (now named Qwest America, Inc.) (The "Qwest Agreement") to provide
interLATA Internet services to Qwest customers. The Qwest Agreement, which
commenced December 1, 1999, called for us to buy, resell and process billing of
Internet bandwidth to these customers. The term of the Qwest Agreement was for a
minimum of sixteen months until March 2001. Although the Qwest Agreement expired
on March 2001, we continued providing services under the Agreement through
October 2001. Effective November 2001, substantially all services under this
agreement had ceased.

FINANCIAL INFORMATION ABOUT SEGMENTS

Information relating to our revenue, operating profit or loss, and total
assets by segment, is set forth in Note 6 of "Notes to Consolidated Financial
Statements".

NARRATIVE DESCRIPTION OF BUSINESS

During 2001, the Company had two reportable business segments: the
Corrections and Internet Services divisions. Effective November 2001,
substantially all services under the Qwest Agreement ceased. Substantially all
revenue of the Internet Services division was derived through the Qwest
Agreement. The Company currently derives substantially all of its revenues from
its operation of the Corrections division, which remains and is expected to
remain the core business focus.

Formerly, the Company reported a third business segment, the SpeakEZ
Speaker Verification division. The SpeakEZ Voice Print technology is proprietary
software that compares the speech pattern of a current speaker with a stored
digital voiceprint of the authorized person to confirm or reject claimed
identity. To date, SpeakEZ revenues have been insignificant and operations have
been substantially curtailed. Management of T-NETIX believes that its decision
to curtail operations of this portion of the Company will enhance overall
Company performance by reducing the negative impact on both the net earnings and
cash flow of the Company.
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The Company has been seeking strategic alternatives for SpeakEZ, including
the sale of this division. In September 2001, the Company announced that it had
entered into an agreement to sell all of the assets of the SpeakEZ Division,
however this transaction was not completed and the agreement was terminated. We
continue to seek strategic alternatives including the sale of this division to
other interested parties. Even if the SpeakEZ division is sold, the Company
intends to retain a license for the use of this technology for corrections
applications, which currently include its Pin Lock and CONTAIN products.
Pursuant to this strategy, related operating results have been recorded as
discontinued operations in the consolidated financial statements to reflect the
results of operations of the speaker verification business. For purposes of
balance sheet presentation, the current assets and their related liabilities
have been reclassified and netted to "Net assets of discontinued operations."

CORRECTIONS DIVISION

MARKET DESCRIPTION

Calls from inmates in federal, state, and local correctional facilities
comprise a significant segment of the public communications market. Inmates
typically may only place calls for a limited duration, which generates a high
volume of calls per phone, and generally may only place collect calls, which
tend to generate higher revenue per call than other types of calling.
Consequently, the inmate calling market is an attractive segment of the
telecommunications industry.

The U.S. has one of the highest incarceration rates of any country in the
world. According to the U.S. Department of Justice Statistics and the Sourcebook
of Criminal Justice Statistics 2000, as of December 2000:

- there were 6.5 million adults under some form of correctional supervision

- approximately 4.6 million adults were under parole or probation sanction

- the U.S. incarcerated approximately 1.9 million inmates in its prison
system

- the incarceration rate has more than tripled since 1980

- from 1990 to 2000 the number of inmates increased by an average annual
growth rate of 6 percent

- there are approximately 4,500 correctional facilities in the U.S.

Primarily for security reasons, inmate calling requires advanced
technological capabilities such as (i) automated voice-processing systems rather
than a live operator; (ii) blocking mechanisms to prevent inmates from making
unauthorized calls such as direct dialed calls, 800/900 calls, or calls to
certain individuals such as judges, jurors, witnesses and victims; (iii) time
and pre-approved number limitations on calls; (iv) monitoring of phones for
activities such as frequent calls to the same numbers and schemes to evade
calling restrictions through the attempted use of call forwarding and three-way
calling; (v) periodic automated voice overlays that identify the call as
originating from a correctional facility; and (vi) listening and recording
capabilities for calls. In addition, inmate calling systems must employ
effective and flexible billing systems.

Correctional authorities generally select inmate calling providers on the
basis of call rates, services and features provided, and the level of
commissions paid to the facilities. Competition is intense among the providers
and this has led to increased commission payments to correctional facilities. In
addition, to win new contracts and renew existing contracts, inmate calling
providers must differentiate their services from those of the competition.
Correctional authorities recognize the benefits in outsourcing to providers that
provide leading edge technology that can improve the effectiveness and
reliability of their inmate calling operations.

PRINCIPAL PRODUCTS AND SERVICES

The primary focus in the design of our products and services is to provide
technologically superior solutions to special issues faced in the inmate calling
marketplace. We believe that this approach results in our customers finding our
products and services feature rich, reliable and economically advantageous.

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T-NETIX Inmate Calling System

The Inmate Calling System (ICS) is our primary product offering. The ICS is
designed and built by us expressly for the inmate calling marketplace. We
install the ICS at each correctional facility that will be utilizing our inmate
calling services. It is the ICS that provides the technological capabilities for
call processing -- the process through which a call is put through the security
features required by the facility and then validated or authorized. With the
exception of the products of TELEQUIP Labs, we typically do not charge for this
equipment, as the major portion of our revenues are derived, in essence, from
its usage in the processing of the calls that it handles. It is the ICS that
provides the technological capabilities for security enhanced inmate calling.
Over the past three years, Corrections Division revenue comprised the following
percentages of our total revenue:

Year Ended December 31, 2001................................ 76%
Year Ended December 31, 2000................................ 77%
Year Ended December 31, 1999................................ 91%

Our primary Inmate Calling System is the Digital ComBridge Platform
("ComBridge"). ComBridge is a scalable telephony system that provides call
processing which can be customized to meet varying requirements, and is
supported by applications that provide recording, monitoring, and system
administration functions.

Our Inmate Calling Systems, used to manage the inmate calling process,
contain many patented technologies. We believe that our intellectual property
portfolio gives our customers leading edge technology that is recognized as
technologically superior within the corrections industry. T-NETIX currently
holds the broadest intellectual property portfolio in the industry, with over 25
patents and applications related to our principal products.

We record all inmate calling system revenue in our financial statements
under the caption of either "Telecommunications Services" or "Direct Call
Provisioning" revenue, depending upon the contractual relationship at the site
and the type of customer. Telecommunications services revenue is derived from
our contracts with a telecommunications services provider customer such as
Verizon, AT&T and SBC Communications. These customers have the contractual
relationship with the facility. Direct call provisioning revenue is derived
through our direct contracts with the correctional facility.

Digital Recording and Monitoring

The DRS-500 Digital Recording System, or the "DRS," is a digital recording
system designed for sale and use in conjunction with one or more of our inmate
calling systems. The DRS allows for the recording of specific dialed numbers,
lines, or PINs. When the DRS detects activity based on the selected criteria,
conversations are automatically recorded. As an alternative mode of operation,
the system will simultaneously record all inmate conversations. In addition,
telephone numbers can be defined as "Record Restricted" to prevent recording of
privileged communication. Recorded conversations may be played back on demand
using the integrated playback module.

We record all DRS sales in our financial statements under the caption of
"Equipment sales and other" revenue.

Prepaid Calling

Prepaid Calling offered through T-NETIX provides flexibility in its
utilization of called party Prepaid Calling and inmate Prepaid Calling. The
T-NETIX Account Manager, or TAM system, offers a paperless, card-free prepaid
calling solution for both the called parties and the inmates. The prepaid
account is managed by either the called party's phone number or the inmate's
pin. T-NETIX' Prepaid Calling platform allows correctional facilities to offer
inmate families an alternative to collect calls, and acts as a cash management
tool to help those families budget more effectively for calls. Additionally,
because prepayment virtually eliminates bad debt, fewer calls are blocked and
correctional facilities recognize the financial benefits of higher call volumes.

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T-NETIX also continues to provide paper prepaid calling cards for
facilities that desire a fast and simple calling solution for its inmates. These
are sold to the inmates out of the facility's commissary service. These cards
come in a variety of dollar increments. The cards may be used for both domestic
and international calling.

We record all Prepaid Calling sales in our financial statements under the
caption of "Telecommunications services" revenue and such revenue has not been
significant to date.

Budget Connections

Telecommunications fraud throughout the United States is estimated at over
$4 billion. This fraud has focused telecommunication service providers on the
bad debt expense associated with calls processed by their systems. The
Corrections Division has developed a service that identifies and controls higher
risk users of inmate telecommunications services. This service, under the name
Budget Connections, combines our inmate calling system with a credit inquiry
program. Budget Connections provides daily, weekly, and monthly call limit
reporting. This service plays messages for the calling and called party advising
them of their balances and assisting them with their calling budget.

Our telecommunications service provider customers are increasingly affected
by the problem of bad debt expense allocation and are interested in a solution
that controls fraud and bad debt while encouraging the use of inmate calling
services. We believe Budget Connections is such a solution. We use a trained
staff of customer service representatives in our call center in Carrollton,
Texas to verify payment history, determine appropriate credit levels, and
monitor outstanding debt balances. The integration with our inmate calling
system allows us to take corrective action, which may include blocking calls
until credit has been improved. We anticipate using our nationwide frame-relay
network as a part of our service delivery infrastructure to help us provide
these services on a real-time basis, cost-effectively.

We record all Budget Connection sales in our financial statements under the
caption of "Telecommunications services" revenue and such revenue has not been
significant to date.

OTHER PRODUCTS AND SERVICES

PIN-LOCK(R) Speaker Verification

PIN-LOCK(R) is a method of biometric authentication of an inmate's identity
using SpeakEZ Voice Print(R) technology. PIN-LOCK(R) makes it practical for all
correctional facilities to assign PIN numbers to inmates. Currently, in high
turnover institutions such as large county jails, the cost and effort required
to assign numbers to all inmates is often prohibitive. With PIN-LOCK(R), an
inmate being booked into a facility speaks their name into a preprogrammed
phone, which enrolls them into the system. This voiceprint then becomes the
basis for the inmate's personal voice verification file, replacing the
traditional PINs requiring large amounts of data maintenance. When an inmate
places a call he keys in his PIN and speaks his name. Once approved, which may
take less than a second, the inmate can then place his call. This means of
identification may also be used to allow verified access to different areas of
the prison. We believe that PIN-LOCK(R) is a significant enhancement to the
security features of our inmate calling system.

We record all PIN-LOCK(R) sales in our financial statements under the
caption of "Telecommunications services" revenue and such revenue has not been
significant to date.

Jail Management System

Lock&Track(TM) is our jail and prison information management system. This
system assists correctional authorities in performing major data tasks within a
correctional facility. Using an applications service provider model,
Lock&Track(TM) is available to numerous correctional authorities that may have
common reporting requirements. T-NETIX also offers a scaled-down version under
the name "Inmate Management System". Management is considering selling the
Lock&Track(TM) product line while retaining the IMS system.

5

We record all Lock&Track(TM) revenue in our financial statements under the
caption of either "Equipment sales and other" or "Telecommunications services"
revenue depending upon the terms of the contracts, and such revenue has not been
significant to date.

Contain(R)

Contain is a service that uses the Company's SpeakEZ voice verification
technology and the Internet to provide officers with a quick, accurate and
easy-to-use method of verifying an offender's whereabouts. An increasing number
of offenders, adult and juvenile, serve their sentences in community-based
supervision programs. Contain is a cost-effective tool that may be used by
correctional facilities, probation and parole agencies, to monitor and
communicate with these offenders. There is no hardware or software to purchase
and install, for either an agency or a participant. A web browser is all an
officer needs to set up automated calling schedules, monitor an offender, or
view instantaneous call results and reports. With Contain(R), all calls may be
recorded and an officer can listen to the entire call over the Internet.

We record all Contain(R) sales in our financial statements under the
caption of "Telecommunications services" revenue, and such revenue has not been
significant to date.

SERVICE DELIVERY AND SUPPORT INFRASTRUCTURE

National Service Center

We operate a state-of-the-art national service center that is available 24
hours a day, seven days a week, to address the needs of our customers. Located
in Carrollton, Texas, the National Service Center ("NSC") provides a single
point of contact for all customers for remote diagnostic systems maintenance.
Once a call is placed, the NSC Customer Service Analysts perform an initial
problem diagnosis. In addition to remote repair capabilities, we also have a
network of trained and experienced field support personnel who can perform on-
site repairs and maintenance. Field personnel consist of over 200 employees
covering 36 states. We deploy our service administrators depending on several
criteria, including the size of the facility, the feature set the facility
requires (PIN versus non-PIN), the geographic proximity of our current service
administrator force, and the correctional facility contract requirements.

Also located in Carrollton, Texas is the Network Operations Center ("NOC").
Our NOC provides remote system management and real-time system diagnostics
across our wide area frame relay network. This system monitors the wide area
network that connects many of our installed systems and provides for centralized
collection of call and reporting data and real-time diagnostic information on
the status of each major system component. We also use the network to process
the on-line, real-time called number validation, process its call records and
transmit administrative data between each location and headquarters. Call data
are then formatted and provided to customers for their billing process. As part
of the system calling process, we perform real-time billed number validation by
querying an external database over the network to an on-line database. The NOC
provides 24-hour a day, seven days a week system support.

PRICING

Transaction-Based Pricing/Telecommunications Services

Telecommunications services revenue is generated under long-term contracts
(generally, three to five years) with our telecommunications service provider
customers including Verizon, AT&T, SBC Communications, Qwest and Sprint. Here,
we provide the equipment, security enhanced call processing, call validation,
and service and support through the provider, rather than directly to the
facility. The provider does the billing. We are paid a prescribed fee by our
telecommunications service providers for each call completed. We receive
additional fees for validating the phone numbers dialed by inmates.

During the second half of 2000 we entered into agreements and contract
amendments with three of our service providers to be paid a percentage of gross
revenue, subject to certain adjustments, rather than on a per-call basis. This
new pricing was an effort by us to have our pricing remain flexible and not be
affected by

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factors that affected call volumes. Pursuant to these amendments, we also
recognized certain telecommunications expenses that were previously reimbursable
charges to these customers.

Direct Call Provisioning

Our Corrections Division also provides our inmate calling services directly
as a certified telecommunications provider to correctional facilities, or
"Direct Customers". In a typical arrangement, we operate under site-specific
contracts, generally for a period of two to three years. We provide the
equipment, security enhanced call processing, validation, and customer service
and support directly to the facility. We then use the services of third parties
to bill the calls on the called party's local exchange carrier bill. Direct call
provisioning revenue is substantially higher than the percentage of revenue or
transaction based pricing compensation associated with telecommunications
services because we receive the entire retail value of the collect call. Due to
commissions and other operating costs, including uncollectible costs, the gross
margin percentages from this pricing model are lower than our telecommunications
services arrangements.

Equipment Sales and Software Licensing

Equipment sales and other revenue include the sales of our inmate calling
system (primarily the systems of our wholly owned subsidiary, TELEQUIP Labs,
Inc.), and digital recording systems. Currently, sales of inmate calling systems
are generally made by TELEQUIP to a limited number of telecommunication service
provider customers.

We license our Pin-Lock(R), Lock&Track(TM) and Contain(TM) products through
contractual relationships that also include sales of system hardware and
software, as well as transactional-based fees. The contractual arrangements
often include component pricing for hardware, software, installation and design
services, and post contract customer support.

CUSTOMERS

Telecommunications Service Providers

Our Corrections Division provides our products and services to
telecommunication service providers such as Verizon, AT&T, SBC Communications,
Qwest and Sprint, among other call providers, and directly to correctional
institutions. For the year ended December 31, 2001, 53% of our total revenue was
generated from such contracts with correctional institutions and
telecommunication service providers. Telecommunications services revenue from
the following customers accounted for the noted percentages of our total Company
revenue:

Verizon..................................................... 14%
AT&T........................................................ 12%
SBC Communications.......................................... 10%

No other telecommunications service provider customer accounted for more
than 10% of our total revenue in the same period.

Direct Customers

Our Corrections Division also has generated significant revenue from direct
call provisioning where we receive revenue through contractual relationships
directly with the correctional facility. For the year ended December 31, 2001,
23% of our total Company revenue was generated from agreements with direct
customers as the exclusive provider of telecommunications services to inmates
within the facility. No single customer accounted for more than 10% of our
direct call provisioning revenue.

COMPETITION

The corrections industry, which includes the inmate calling market, is and
can be expected to remain highly competitive. We compete directly with other
suppliers of inmate call processing systems and other

7

corrections related products that market their products to the same customers as
those of the Company. The Company believes that the principal competitive
factors in the inmate calling industry are (i) rates of commissions paid to the
correctional facilities; (ii) system features and functionality and the
technology associated therewith; (iii) system reliability and service response;
(iv) relationships with correctional facilities; and (v) calling rates.

RESEARCH AND PRODUCT DEVELOPMENT

We believe that the timely development of new products and enhancements to
existing products is essential to maintain our competitive position. We conduct
ongoing research and development for the development of new products and
enhancement of existing products that are complementary to the existing product
line. Our research and product development expenditures for the Corrections
Division were approximately as follows:

Year Ended December 31, 2001............................ $5.0 million
Year Ended December 31, 2000............................ $5.1 million
Year Ended December 31, 1999............................ $4.2 million

See "Management's Discussion and Analysis of Financial Condition and
Results of Operations".

INTERNET SERVICES DIVISION

PRODUCTS AND SERVICES

In December 1999, T-NETIX entered into a master service agreement with US
WEST ENTERPRISE (now named Qwest America, Inc.) (the "Qwest Agreement") to
provide interLATA Internet services to Qwest customers. The Qwest Agreement
called for T-NETIX to buy, resell and process billing of Internet bandwidth to
these customers. We originally established a separate Internet Services Division
in anticipation of our offering similar services to other Internet service
providers and in order to function as a Global Service Provider for our
telecommunications customers. We have since determined not to enter into such
businesses and have ceased substantially all operations of this division.

The term of the Qwest Agreement was for a minimum of sixteen months until
March 2001. Although the Qwest Agreement expired on March 2001, we continued
providing services under the Agreement through October 2001. Effective November
2001, substantially all services under this agreement had ceased. The costs
associated with this contract were primarily the costs for Internet bandwidth.
There were no capital outlays required to begin provisioning these services and
minimal SG&A during its tenure. In addition, there were no assets that were
attributable to this division and therefore a write-down of assets was not
required upon the expiration of the contract.

PATENTS AND OTHER PROPRIETARY RIGHTS

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

As it relates to our SpeakEZ Voice Print(R) technology, Rutgers University
had developed technology relating to speaker and speech recognition. Such
technology centered on the verification of a speaker by comparison of spoken
phrases to speech patterns stored on a computer. Rutgers entered into a license
agreement with SpeakEZ to develop that technology, prior to our acquisition of
SpeakEZ. We became a successor-in-interest to SpeakEZ's rights under the license
agreement when we acquired SpeakEZ. We then negotiated with Rutgers an Assumed
and Amended License Agreement in 1996. As a part of this agreement, the Company
acquired exclusive worldwide rights under existing Rutgers' patents and patent
applications, copyrights and software related to speaker and speech recognition
developed by Rutgers. Several additional Rutgers-owned patent applications are
pending. We have also filed for and received patent applications in our own name
for further developments in this field.
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REGULATION

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

The inmate calling market is regulated at the federal level by the Federal
Communications Commission ("FCC") and at the state level by the Public Utilities
Commission ("PUC") of various states. In addition, from time to time, Congress
or the various state legislatures may enact legislation that affects the
telecommunications industry. Court decisions interpreting applicable laws and
regulations may also have a significant effect on the inmate calling industry.
Changes in existing laws and regulations, as well as the adoption of new laws
and regulations applicable to our activities or other telecommunications
businesses, could have a material adverse effect on the Company.

FEDERAL REGULATION

Prior to 1996, the federal government's role in the regulation of the
inmate calling industry was limited. The enactment of the Telecommunications Act
of 1996 (the "Act"), however, marked a significant change in scope of federal
regulation of the inmate telephone service. Section 276 of the Act directed the
FCC to implement rules to overhaul the regulation of the provisioning of pay
phone service, which Congress defined to include the provisioning of inmate
telephone service in correctional institutions. The Act (i) opens local exchange
service to competition and preempts states from imposing barriers preventing
such competition, (ii) imposes new unbundling and interconnection requirements
on incumbent local exchange carrier networks, (iii) removes prohibitions on
inter-LATA services and manufacturing if certain competitive conditions are met,
(iv) transfers any remaining requirements of the consent decree (including its
nondiscrimination provisions) to the FCC's jurisdiction, (v) imposes
requirements to conduct certain competitive activities only through structurally
separate affiliates, and (vi) eliminates many of the remaining cable and
telephone company cross-ownership restrictions.

Section 276 of the Act directed the FCC to require all incumbent local
exchange carriers or "ILECs" to transfer their inmate telephone operations from
their regulated accounts to the ILEC's unregulated accounts. This legislation,
and related rulings, has significantly changed the competitive landscape of the
telecommunications industry as a whole. For example, permitting the ILECs to
provide long-distance service causes ILEC customers to become direct competitors
of AT&T, which in turn could adversely affect our relationships with all such
customers. For example, our current relationship with AT&T may foreclose
opportunities to provide long distance services to its current ILEC customers,
if and when they enter the long-distance market. As a result, a loss of
long-distance market share by AT&T could result in a corresponding loss of
market share by us.

On January 29, 1998 the FCC issued Order 98-7. This Order required that all
called parties have the opportunity to receive a maximum rate quote before
accepting a collect call. These rate quotes are necessary for all public
payphones and all inmates collect calling. Currently, our inmate calling systems
provide such a feature. On December 12, 2001 the FCC modified these rules to
require exact, rather than maximum, rate quotes on a per-minute basis. Not all
T-NETIX equipment is currently able to provide exact quotes. T-NETIX is
continuing a 4-year project to upgrade this equipment throughout its network in
order to comply with this requirement. In the meantime, T-NETIX has filed a
petition with the FCC with a request to extend the time for compliance to June
2003.

STATE REGULATION

The most significant state involvement in the regulation of inmate
telephone service is the limit on the maximum rates that can be charged for
intrastate collect calls set by most states, referred to as "rate ceilings".
Since collect calls are generally the only kind of calls that can be made by
inmates in correctional facilities, the state-imposed rate ceilings on those
calls can have a significant effect on our business.

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

EMPLOYEES

As of December 31, 2001, we employed 413 full-time equivalent employees.
None of our employees are represented by a labor union and we have experienced
no work stoppages to date.

FORWARD LOOKING STATEMENTS AND RISK FACTORS

We have included in this Annual Report on Form 10-K forward-looking
statements that state our management's intentions, beliefs, expectations, or
predictions for the future. Forward-looking statements are subject to a number
of risks, assumptions and uncertainties which could cause our actual results to
differ materially from those projected in forward looking statements. The
discussions set forth below constitute cautionary statements identifying
important factors with respect to such forward looking statements, including
risks and uncertainties, that could cause actual results to differ materially
from results referred to in the forward-looking statements.

A Small Number of Customers Accounted For a High Percentage of Our Revenue,
Therefore the Loss of a Major Customer Could Harm Our Business. In the
Corrections Division, a small number of our telecommunication service provider
customers account for a significant portion of our revenue. For the year ended
December 31, 2001, Verizon, AT&T and SBC accounted for approximately 14%, 12%,
and 10% respectively, of our total revenue. If we lose these or other providers
and do not replace them, our revenue will decrease and may not be sufficient to
cover our costs.

Changes in Government Telecommunications Regulations. In our Corrections
Division, our telecommunications service provider customers and we are subject
to varying degrees of federal, state, and local regulation. Regulatory actions
have impacted, and are likely to continue to impact our provider customers, our
competitors and us. Regulatory actions may cause changes in the manner in which
our provider customers, our competitors and we conduct business. The products
that we develop must comply with standards established by the FCC. Moreover,
regulatory actions affecting the telecommunications industry may require
significant upgrades to our current technology or may render our service
offerings obsolete or commercially unattractive. A change in these standards may
have a material adverse effect on our business, operating results, and financial
condition.

We Operate in Highly Competitive Markets and May Not Be Able to Compete
Effectively. The telecommunications industry, particularly the inmate calling
market, is and can be expected to remain highly competitive. In our Corrections
Division we compete directly against other suppliers of inmate call processing
systems, such as private pay phone operators and manufacturers of call
processing equipment. In addition, we compete against other call providers to
obtain contracts for inmate calling services. Finally, we may also compete
against our telecommunications service provider customers who choose to use
another call provider on a particular bid. Changes in regulations have affected
the competitive dynamics within our industry. Increased competition may reduce
the fees we charge, reduce margins and cause a loss of market share. As a result
of these and other factors, we may not be able to compete effectively with our
current or future competitors, which would have a material adverse effect on our
business, operating results, and financial condition.

Changes in Technology and Our Ability to Enhance Our Existing Products May
Adversely Affect Our Financial Results. The markets for our products,
especially the telecommunications industry, change rapidly because of
technological innovation, changes in customer requirements, declining prices,
and evolving industry standards, among other factors. To be competitive, we must
develop and introduce product enhancements and

10

new products that increase our customers' and our ability to increase market
share in the corrections industry. New products and new technology often render
existing information services or technology infrastructure obsolete, excessively
costly, or otherwise unmarketable. As a result, our success depends on our
ability to timely innovate and integrate new technologies into our current
products and services and to develop new products. In addition, as the
telecommunications networks are modernized and evolve from analog-based to
digital-based systems, certain features offered by us may diminish in value. We
cannot guarantee that we will have sufficient technical, managerial or financial
resources to develop or acquire new technology or to introduce new services or
products that would meet our customers' needs in a timely manner.

Our Success Depends on Our Ability to Protect Our Proprietary Technology
and Ensure That Our Systems Are Not Infringing on Other Companies. Our success
depends to a significant degree on our protection of our proprietary technology,
particularly in the area of three-way call prevention. The unauthorized
reproduction or other misappropriation or our proprietary technology could
enable third parties to benefit from our technology without paying us for it.
Although we have taken steps to protect our proprietary technology, they may be
inadequate. We rely on a combination of patent and copyright laws and non-
disclosure agreements to establish and protect our proprietary rights in our
systems. However, existing trade secret, copyright and trademark laws offer only
limited protection. Despite our efforts to protect our proprietary rights,
unauthorized parties may attempt to copy aspects of our products or obtain and
use trade secrets or other information we regard as proprietary. If we resort to
legal proceedings to enforce our intellectual property rights, the proceedings
would be burdensome and expensive and could involve a high degree of risk.

In addition, with respect to our intellectual property rights, we cannot be
sure that a third party will not accuse us of infringement. Any claim of
infringement could cause us to incur substantial costs defending against that
claim, even if the claim is not valid, and could distract our management from
our business. A party making a claim also could secure judgment that requires us
to pay substantial damages. A judgment could also include an injunction or other
court order that could prevent us from selling our products. Any of these events
could have a material adverse effect on our business, operating results and
financial condition.

Our Business Could Be Adversely Affected If Our Products and Services Fail
to Perform or Be Performed Properly. Products as complex as ours may contain
undetected errors or "bugs", which result in product failures or security
breaches or otherwise fail to perform in accordance with customer expectations.
Any failure of our systems could result in a claim for substantial damages
against us, regardless of our responsibility for the failure. Although we
maintain general liability insurance, including coverage for errors and
omissions, there can be no assurance that our existing coverage will continue to
be available on reasonable terms or will be available in amounts sufficient to
cover one or more large claims, or that the insurer will not disclaim coverage
as to any future claim. The occurrence of errors could result in loss of data to
us or our customers which could cause a loss of revenue, failure to achieve
acceptance, diversion of development resources, injury to our reputation, or
damages to our efforts to build brand awareness, any of which could have a
material adverse effect on our market share and, in turn, our operating results
and financial condition.

We Have Substantial Leverage, Which May Limit Our Ability to Comply With
the Terms of Our Indebtedness and May Restrict Our Ability to Operate. Our
significant indebtedness could adversely affect us by leaving us with
insufficient cash to fund operations and impairing our ability to obtain
additional financing. The amount of our debt could have important consequences
for our future, including, among other things:

- cash from operations may be insufficient to meet the principal and
interest on our indebtedness as it becomes due;

- payments of principal and interest on borrowings may leave us with
insufficient cash resources for our operations; and

- restrictive debt covenants may impair our ability to obtain additional
financing.

We have incurred a high level of debt. As of December 31, 2001, we had a
total of $22.4 million of total indebtedness, including approximately $18.2
million in senior indebtedness outstanding under our bank credit facility. Our
ability to repay our indebtedness depends upon many factors, including future
profitability and the
11

level of capital expenditures required for new installations and to upgrade
existing systems. Effective March 2002, our current bank credit facility was
extended to June 30, 2002 and, effective April 2002 we obtained a commitment
from the bank to extend it to January 3, 2003, at our option. The Company has
retained J.P. Morgan Securities Inc. to explore and advise us on various
financing opportunities and strategies.

If we are unable to generate sufficient cash flows to meet our debt service
requirements, we may have to renegotiate the terms of our long-term debt. We
cannot assure you that we would be able to renegotiate successfully those terms
or refinance our indebtedness when required or that satisfactory terms of any
refinancing would be available. If we were not able to refinance our
indebtedness or obtain new financing under these circumstances, we would have to
consider other options, such as:

- sale of some assets;

- sales of equity;

- negotiations with our lenders to restructure applicable indebtedness; or

- other options available to us under applicable laws.

ITEM 2. PROPERTIES

During 2001, we completed the consolidation of our headquarters and
operations in the Dallas, Texas area. Our corporate headquarters is currently
located in approximately 13,000 square feet of leased office space in
Carrollton, Texas. This lease terminates effective May 31, 2002 and the Company
plans to renew this lease. Our operations support, national call center and
network support administrative functions are located in approximately 30,000
square feet of a leased suburban Carrollton office park. This lease terminates
on September 30, 2005.

ITEM 3. LEGAL PROCEEDINGS

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

During 2000, Gateway won a dismissal of a case brought in the First
Judicial District Court of the State of New Mexico, styled Valdez v. State of
New Mexico, et al. An appeal of the case was certified and is still pending. The
case named as defendants the State of New Mexico, several political subdivisions
of the State of New Mexico, and several inmate telecommunications service
providers, including Gateway. The complaint included a request for certification
by the court of a plaintiffs' class action consisting of all persons who had
been billed for and paid for telephone calls initiated by an inmate confined in
a jail, prison, detention center or other New Mexico correctional facility. The
complaint alleged violations of New Mexico Unfair Practices Act, the New Mexico
Antitrust Act and the New Mexico Constitution, and also alleged unjust
enrichment, constructive trust, economic compulsion, constructive fraud and
illegality of contracts, all in connection with the provision of "collect only"
inmate telecommunications services. The case was never certified as a class
action suit.

T-NETIX is a defendant in a state case brought in the Superior Court of
Washington for King County, styled Sandy Judd, et al. v. American Telephone and
Telegraph Company, et al. In this case, the complaint joined several inmate
telecommunications service providers as defendants, including T-NETIX. The
complaint includes a request for certification by the court of a plaintiffs'
class action consisting of all persons who have been billed for and paid for
telephone calls initiated by an inmate confined in a jail, prison, detention
center or other Washington correctional facility. The complaint alleges
violations of the Washington Consumer Protection Act (WCPA) and requests an
injunction under the Washington Consumer Protection Act and common law to enjoin
further violations. The trial court dismissed all claims with prejudice against
all defendants except T-NETIX and AT&T. Plaintiffs have appealed the dismissal
of the other defendants and T-NETIX has crossed appealed. The T-NETIX and AT&T
claims have been referred to the Washington

12

Utilities and Transportation Commission while the trial court proceeding is in
abeyance. The Commission has not yet commenced any proceedings.

Gateway has been litigating an appeal from a favorable ruling in Kentucky
federal court in the case Gus "Skip" Daleure, Jr., et al vs. Commonwealth of
Kentucky, et al. Plaintiffs, a class of relatives of prisoners incarcerated in
Kentucky correctional facilities, sued the Commonwealth of Kentucky, the
Kentucky Department of Corrections, the state of Missouri, several Kentucky,
Missouri, Arizona and Indiana municipal entities, and various private telephone
providers alleging antitrust violations and excessive rates in connection with
the provision of telephone services to inmates. The plaintiffs alleged Sherman
Act, Robinson-Patman Act, and Equal Protection violations. The district court
held, on motions to dismiss, that Kentucky did not have personal jurisdiction
over defendants not located in or doing business in the state of Kentucky; that
telephone calls are not goods or commodities and thus are not subject to the
antitrust provisions of the Robinson-Patman Act; that Plaintiffs did not state a
claim for relief under the Equal Protection Clause of the Fourteenth Amendment;
and that Plaintiffs had not shown any harm in support of its antitrust claim
under Section 1 of the Sherman Act. The trial judge did not, however, dismiss
the plaintiff's petition for injunctive relief, despite these findings.
Recently, the appeal brought by the plaintiffs has been dismissed and no further
action has been taken.

In another case styled Robert E. Lee Jones, Jr. vs. MCI Communications, et
al, plaintiffs, 43 inmates of the Bland Correctional Center in Virginia, filed a
pro se action alleging constitutional violations, RICO Act violations and
violations of Federal wiretapping laws. This case was dismissed on all counts in
November 2001 and plaintiffs have appealed.

In October 2001, relatives of prisoners incarcerated in Oklahoma Department
of Correctional facilities filed a putative class action against T-NETIX, AT&T,
Evercom and the Oklahoma Department of Corrections for claims in anti-trust,
under due process, equal protection and the first amendment. This case, styled
Kathy Lamon, et al v. Ron Ward, et al, is in the very early stages, but T-NETIX
has filed its Motion to Dismiss, which is still pending.

In September 2001, T-NETIX filed patent litigation against MCI WorldCom,
Inc. and Global Tel*Link Corporation. The lawsuit, filed in the Eastern District
of Texas, alleges infringement of six United States patents protecting call
processing equipment and services for the inmate calling industry. The case is
in its very early discovery stages.

Since September 1997, and pursuant to a written agreement entered into in
connection with a settlement of an arbitration proceeding, the Company has been
making monthly payments to a vendor of query transport services with the
understanding that the payments were for future services to be utilized by the
Company. The vendor (Illuminet, Inc.) notified the Company in November 2001 that
no credits for such services would be honored. In January 2002 Illuminet filed a
claim before the original arbitration panel in Fairway, Kansas, requesting money
damages for T-NETIX' breach and declaratory relief that no credits are due
T-NETIX. As of December 31, 2001, the Company has made payments totaling
approximately $2.1 million pursuant to this written agreement. The payments are
classified as a long-term prepayment included in Intangible and Other Assets at
December 31, 2001 (See Note 2 of "Notes to Consolidated Financial Statements").
The Company intends to vigorously pursue its rights under the agreement. In the
event the Company is not supported in the arbitration or any related litigation,
the prepaid expense of $2.1 million could be impaired.

We believe the ultimate disposition of the forgoing matters will not have a
material affect on our financial condition, liquidity, or results of operations.

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

There were no matters submitted to a vote of shareholders during the fourth
quarter of the fiscal year on which this report is being made.

13

PART II

ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS

Our Common Stock, par value $0.01, is quoted on the NASDAQ Stock Market(SM)
under the symbol "TNTX". The following table sets forth the range of quarterly
high and low closing sale prices of our Common Stock, all as reported on the
NASDAQ Stock Market(SM) for the two most recent fiscal years.

As of March 22, 2002, we had approximately 142 record holders of our common
stock, and we estimate that as of that date there were 1,970 beneficial owners
of our stock.

We have never declared or paid any cash dividends on our capital stock. We
currently intend to retain our earnings, if any, to finance future growth and
therefore we do not anticipate paying any cash dividends in the foreseeable
future.

ITEM 6. SELECTED FINANCIAL DATA

The following selected financial data under the captions "Statement of
Operations Data" and "Consolidated Balance Sheet Data" has been presented for
each of the years in the five-year period ended December 31, 2001. The selected
financial data has been derived from our audited consolidated financial
statements. The consolidated financial statements as of December 31, 2001 and
2000, and for each of the years in the three-year period ended December 31,
2001, are included elsewhere in this Form 10-K.

14

All periods reflect the operating results of our SpeakEZ voice verification
division as discontinued operations in the consolidated financial statements.
For purposes of balance sheet presentation, the current assets and their related
liabilities have been reclassified and netted to "Net assets of discontinued
operations". See Note 5 of "Notes to Consolidated Financial Statements".

All periods reflect our merger with Gateway Technologies, Inc., which was
accounted for as a pooling of interests, and the change in our year-end to
December 31. The Selected Financial Data for the year ended December 31, 1999
reflects the combined results of T-NETIX and Gateway for that year. The
Statement of Operations Data for the years ended December 31, 1998 and 1997
reflects the results of operations of T-NETIX for the years ended July 31, 1998
and 1997, respectively, combined with that of Gateway for the years ended
December 31, 1998 and 1997. The Balance Sheet Data as of December 31, 1998 and
1997 reflects the financial position of T-NETIX as of December 31, 1998, and
July 31, 1997 combined with the financial position of Gateway as of December 31,
1998 and 1997. See Note 1 of "Notes to Consolidated Financial Statements".

As a result of T-NETIX and Gateway having different fiscal year ends prior
to 1999, the results of operations of T-NETIX for the five-month period ended
December 31, 1998 have been excluded from the reported results of operations.
The net loss for the period has been accounted for as an adjustment of the
accumulated deficit at January 1, 1999. T-NETIX had revenue, expenses, and net
loss of $15.0 million, $17.6 million, and $2.2 million, respectively, for the
five-month period ended December 31, 1998.

15

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

For a comprehensive understanding of our financial condition and
performance, this discussion should be considered in the context of the
condensed consolidated financial statements and accompanying notes and other
information contained herein.

The Private Securities Litigation Reform Act of 1995 provides a "safe
harbor" for forward-looking statements. Certain information contained in this
Management's Discussion and Analysis of Financial Condition and Results of
Operations and elsewhere in this Form 10-K includes forward-looking statements.
Important factors that could cause actual results to differ materially from
those in the forward-looking statements include, but are not limited to, those
listed under the caption "Risk Factors" which may affect the potential
technological obsolescence of existing systems, the renewal of existing site
specific Corrections Division customer contracts, the ability to retain the base
of current site specific customer contracts, the ability to perform under
contractual performance requirements, the continued relationship with existing
customers, the ability of our existing telecommunications service provider
customers such as Verizon, AT&T and SBC Communications, to win new contracts for
our products and services to maintain their market share of the inmate calling
market, the effect of economic conditions, the effect of regulation, including
the Telecommunications Act of 1996, that could affect our sales or pricing, the
impact of competitive products and pricing in the our Corrections Division, our
continuing ability to develop hardware and software products, commercialization
and technological difficulties, manufacturing capacity and product supply
constraints or difficulties, actual purchases by current and prospective
customers under existing and expected agreements, and the results of financing
efforts, along with the other risks detailed therein.

We make forward-looking statements in this report and may make such
statements in future filings with the Securities and Exchange Commission. We
also may make forward-looking statements in press releases or other public
communications. These forward-looking statements are subject to risks and
uncertainties and include information about our expectations and possible or
assumed future results of operations. When we use any of the words "believe",
"expect", "anticipate", "estimate" or similar expressions, we are making a
forward-looking statement. While we believe that forward looking statements are
reasonable, you should not place undue reliance in such forward-looking
statements, which speak only as of the date made.

Other factors not currently anticipated by management may also materially
and adversely affect our results of operations. Except as required by applicable
law, we do not undertake any obligation to publicly release any revisions which
may be made to any forward-looking statements to reflect events or circumstances
occurring after the date of this report.

OVERVIEW

ACQUISITION OF GATEWAY TECHNOLOGIES, INC.

On June 14, 1999, we completed our merger with Gateway Technologies, Inc.
or "Gateway" by exchanging 3,672,234 shares of our common stock for all of the
common stock of Gateway. Each share of Gateway was exchanged for 5.0375 shares
of our common stock. In addition, outstanding Gateway stock options were
converted at the same exchange rate into options to purchase approximately
379,000 shares of our common stock.

The merger constituted a tax-free reorganization and has been accounted for
as a pooling of interests under Accounting Principles Board Opinion No. 16.
Accordingly, all prior period information contained in this Management's
Discussion and Analysis of Financial Condition and Results of Operations has
been restated to include the combined results of operations, financial position
and cash flows of T-NETIX and Gateway as though Gateway had always been a part
of T-NETIX.

In addition, in connection with the merger transaction, T-NETIX issued
375,341 shares of common stock to certain shareholders of Gateway in exchange
for the termination of a royalty agreement with Gateway. The

16

royalty agreement related to automated call processing technology and
intellectual property rights that were assigned to Gateway by the royalty owners
in exchange for royalty payments. The termination of the royalty owners'
interests resulted in the acquisition of an intangible asset. The asset was
recorded at fair value, or $2.5 million. The fair value was based on the value
of T-NETIX common stock at February 10, 1999 (date of the Merger Agreement), or
$6.625, multiplied by the number of shares issued in exchange for termination of
the royalty owners' interests. The intangible asset has an estimated useful life
of 10 years, the remaining term of the underlying patent.

CORRECTIONS DIVISION

In the Corrections Division we derive revenue from three main sources:
telecommunications services, direct call provisioning and equipment sales. Each
form of revenue has specific and varying operating costs associated with such
revenue. Selling, general and administrative expenses, along with research and
development and depreciation and amortization are common expenses regardless of
the revenue generated.

Telecommunications services revenue is generated under long-term contracts
(generally, three to five years) with our telecommunications service provider
customers including Verizon, AT&T, SBC Communications, Qwest and Sprint. Here,
we provide the equipment, security enhanced call processing, call validation,
and service and support through the provider, rather than directly to the
facility. The provider does the billing. We are paid a prescribed fee by our
telecommunications services providers for each call completed. We receive
additional fees for validating the phone numbers dialed by inmates.

Our Corrections Division also provides our inmate calling services directly
as a certified telecommunications provider to correctional facilities, or
"Direct Customers". In a typical arrangement, we operate under site-specific
contracts, generally for a period of two to three years. We provide the
equipment, security enhanced call processing, call validation, and customer
service and support directly to the facility. We then use the services of third
parties to bill the calls on the called party's local exchange carrier bill.
Direct call provisioning revenue is substantially higher than the percentage of
revenue or transaction based pricing compensation associated with
telecommunications services because we receive the entire retail value of the
collect call. Due to commissions and other operating costs, including
uncollectible costs, the gross margin percentage from this model are lower than
our telecommunication service arrangements.

Equipment sales and other revenue include the sales of our inmate calling
system (primarily the systems of our wholly owned subsidiary, TELEQUIP Labs,
Inc.), and digital recording systems. Currently, sales of inmate calling systems
are generally made by TELEQUIP to a limited number of telecommunication service
provider customers.

We experienced an increase in total revenue in 2001 from 2000 of
approximately $14.6 million or an increase of 14%. This increase was primarily
due to new pricing agreements with four of our telecommunications services
provider customers during the second half of 2000. We will continue to market
our products and services to other telecommunication service providers; however,
we expect growth in call processing volumes and corresponding telecommunications
services revenue will come predominately from adding new systems for existing
customers and from the sale of other corrections related products and services.

INTERNET SERVICES DIVISION

In December 1999, we entered into a master service agreement with US WEST
ENTERPRISE (now named Qwest America, Inc.) (The "Qwest Agreement") to provide
interLATA Internet services to Qwest customers. The Qwest Agreement, which
commenced December 1, 1999, called for us to buy, resell and process billing of
Internet bandwidth to these customers. The initial term of the Qwest Agreement
was for a minimum of sixteen months until March 2001. Although the Qwest
Agreement expired on March 2001, we continued providing services under the
Agreement through October 2001. Effective November 2001, substantially all
services under this agreement had ceased.

17

Factors affecting margin include a negotiated base management fee and
contract incentive payments based on cost savings. The costs associated with
this contract are primarily the costs for Internet bandwidth. There were no
capital outlays required to begin provisioning these services.

SPEAKER VERIFICATION DIVISION

All periods reflect the operating results of our SpeakEZ voice verification
division as discontinued operations in the consolidated financial statements.
For purposes of balance sheet presentation, the current assets and their related
liabilities have been reclassified and netted to "Net assets of discontinued
operations". See Note 5 of "Notes to Consolidated Financial Statements".

RESULTS OF OPERATIONS

CURRENT OPERATIONS

During 2001, we experienced a net loss of $1.6 million, which was equal to
our operating results in 2000. While we achieved a $2.0 million improvement in
the operating results of continuing operations during 2001, this improvement was
offset by a $1.5 million increased loss in discontinued operations and a $0.7
million increase in income tax expense. In August 2001, the Company formalized
the decision to offer for sale it's voice verification business unit, which
includes the SpeakEZ speaker verification products. Accordingly, related
operating results have been reported as discontinued operations. The increased
loss in discontinued operations during 2001 resulted primarily from a one-time
charge of $1.1 million, net of taxes, in 2001 related to the write off of the
voice print patent and license assets related to the SpeakEZ product line. This
write-off was based on an analysis which concluded that the carrying value of
our voice print assets exceeded the present value of estimated future cash flows
given current operating results and the absence of a definitive agreement to
sell these assets.

We continue to aggressively pursue new contracts in our corrections
division through our sales and marketing efforts. Any new agreement will require
investments in new installations that, due to the long-term nature of our
contracts, do not produce immediate profitability but will contribute to future
profitability. Additionally, we have implemented a business plan that we believe
will improve operational efficiencies and will help improve overall margins.

18

RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 2001 AND 2000:

The following table sets forth certain statement of operations data as a
percentage of total revenue for the years ended December 31, 2001 and 2000.

Total Revenue. Total revenue for 2001 was $117.8 million, an increase of
14% over $103.2 million for the corresponding 2000 period. This increase was
attributable to increases in telecommunications services of $11.0 million,
internet services of $2.5 million and equipment sales and other of $2.3 million,
offset in part by decreases in direct provisioning of $1.2 million.

Telecommunications services revenue increased 21% to $62.4 million for the
twelve months ended December 31, 2001, from $51.4 million for the corresponding
prior period, due primarily to an increase in contract prices. We increased our
per call transaction fee with a major customer and we changed our pricing with
three other major customers whereby revenue is calculated as a percentage of our
customer's gross revenue versus a transaction fee per call. In addition, we
experienced an increase in revenue due to a full year of price increases in 2001
combined with an increase in call volume, primarily due to the addition of new
sites.

Direct call provisioning revenue decreased 4% to $26.9 million for the
twelve months ended December 31, 2001, from $28.1 million in the corresponding
prior period. This decrease was primarily due to the loss of sites for which we
are provisioning the long distance service. The loss of sites is a result of our
being unsuccessful in providing competitive bidding arrangements for contracts
directly with correctional institutions.

Internet services revenue increased 12% to $23.9 million for the twelve
month period ending December 31, 2001, from the $21.4 million in the
corresponding prior period. The increase was a result of an increase in the base
of Internet Services subscribers. Although the Qwest Agreement expired on March
31, 2001, we

19

continued providing services under this agreement through October 2001.
Effective November 2001, operations of this segment have substantially ceased
including those under the Qwest Agreement.

Equipment sales and other revenue increased 100% to $4.6 million for the
twelve month period ending December 31, 2001 from $2.3 million in the
corresponding prior period. This increase was largely attributable to the
acquisition of TELEQUIP Labs, Inc., an inmate equipment provider, in January
2001. The TELEQUIP sales of equipment are primarily associated with a limited
number of telecommunication service providers and revenue associated with such
sales are dependent upon the timing of sales and installations for these
customers.

Operating costs. Total operating costs increased 3% to $65.0 million for
the twelve months ended December 31, 2001 from $63.3 million in the
corresponding prior period. The increase was primarily due to increases in
telecommunication services of $2.7 million and cost of equipment sold of $1.2
million, offset partially by a reduction in internet services of $1.6 million
and the direct call provisioning expenses of $.5 million, respectively.

Operating costs of telecommunications services primarily consist of service
administration costs for correctional facilities, including salaries and related
personnel expenses, communication costs and inmate calling systems repair and
maintenance expenses. Operating costs of telecommunications services also
includes costs associated with call validation procedures, primarily network
expenses and database access charges. Operating costs associated with direct
call provisioning include the costs associated with telephone line access, long
distance charges, commissions paid to correctional facilities, costs associated
with uncollectible accounts and billing charges. Internet Services operating
costs consist of purchased internet bandwidth costs.

The following table sets forth the operating costs and expenses for each
type of revenue as a percentage of corresponding revenue for the twelve months
ended December 31, 2001 and 2000.

Operating costs associated with providing telecommunications services as a
percentage of corresponding revenue was 38% for the twelve months ended December
31, 2001, a decrease from 41% for the comparable 2000 period. Total
telecommunications services operating costs were $24.0 million for the twelve
months ended December 31, 2001 and $21.3 million for the corresponding prior
period. The increase in 2001 is due to new services being provisioned for
significant customers as part of contract amendments, increases in personnel
costs, communications expenses and repairs and maintenance.

Direct call provisioning costs as a percentage of applicable revenue
increased to 89% of revenue for the twelve months ended December 31, 2001 from
87% in for the corresponding prior period. This increase was primarily due to a
higher level of uncollectibles as a percentage of total revenue.

Internet services costs as a percentage of applicable revenue decreased to
63% of revenue for the twelve months ended December 31, 2001 from 78% for the
corresponding prior period. The decrease in costs is due to the termination of
the Qwest Agreement in October 2001, offset partially by an increased line costs
as a result of more subscribers.

Cost of equipment sold and other as a percentage of applicable revenue
increased to 46% of revenue for the twelve months ended December 31, 2001 from
40% for the corresponding prior period. This increase was primarily due to the
change in the revenue mix for equipment and other sales.

Selling, General and Administrative Expenses. Selling, general and
administrative expenses were $25.9 million for the twelve months ended December
31, 2001 compared to $19.2 million for the

20

corresponding prior period. The increase in the twelve months ended December 31,
2001 was primarily due to increases in personnel costs, severance benefits,
contract labor, travel, communications and legal fees.

Research and Development Expenses. Research and development expenses were
$5.0 million in the twelve months ended December 31, 2001 compared to $5.1
million for the corresponding prior period.

Impairment of Telecommunications Assets. During 2001, we recorded an
impairment of telecommunications assets charge of $2.7 million. This impairment
charge consisted of a reduction in the carrying value of software development
costs and the write-off of goodwill associated with our Contain(R) and
Lock&Track(TM) jail management system products. While these products have been
offered for several years, we have experienced limited commercial success with
these products and revenues to date have not been significant. Management has
been seeking strategic alternatives for these product lines, including the
possible sale, investing significantly to upgrade and enhance the current
product offering, or increase sales and marketing support to enhance sales.
While we will still offer these products as part of our Corrections Division
product line, management has determined that it is not cost justified to invest
additional capital or operating funds in these products. This impairment charge
was based upon an analysis which concluded that the carrying value of software
development costs and other intangible assets associated with these product
lines exceeded the present value of estimated future cash flows given current
sales levels.

Depreciation and Amortization Expenses. Depreciation and amortization
expense was $13.0 million for the twelve months ended December 31, 2001, an
increase from $11.6 million for the comparable 2000 period. The increase was due
primarily to the depreciation associated with new site installations.

Interest and Other Expenses. Interest and other expense was $2.4 million
for the twelve months ended December 31, 2001 and 2000. Included in interest and
other expense is other income in the twelve months ended December 31, 2000 is a
gain of approximately $0.4 million on the sale of used telecommunications
equipment. Interest expense was $2.5 million for the twelve months ended
December 31, 2001 and $2.8 million for the corresponding prior period. The
decrease in 2001 was attributable to a decrease in the average amount of
indebtedness outstanding. The average debt balance decreased primarily due to
the pay down of debt as the result of improved operating income.

21

RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 2000 AND 1999:

The following table sets forth certain statement of operations data as a
percentage of total revenue for the years ended December 31, 2000 and 1999.

Total Revenue. Total revenue in 2000 was $103.2 million, an increase of
41% over $73.1 million in 1999. This revenue increase was attributable to
increases in Internet services of $19.9 million due to the Qwest Agreement being
in effect for the entire year of 2000, increases in telecommunications services
revenue of $12.1 million and direct call provisioning revenue of $0.6 million,
partially offset by decreases in equipment sales and other of $2.5 million.

Telecommunications services revenue increased 31% to $51.4 million in 2000
from $39.3 million in 1999 due primarily to an increase in contract pricing. In
addition, we experienced an increase in revenue due to higher call volumes from
the addition of new sites.

Direct call provisioning revenue increased 2% to $28.1 million in 2000 from
$27.5 million in 1999. This 2% increase was due to the addition of sites for
which we are provisioning the long distance service. The addition of sites is
primarily the result of our being successful in competitive bidding arrangements
for contracts directly with correctional institutions.

Internet services revenue increased 1,284% to $21.4 million in 2000 from
$1.5 million in 1999. This increase was largely attributable to a full year of
operating results for this segment in 2000. The primary contract for Internet
services, the Qwest Agreement, commenced in December 1999.

Equipment sales and other revenue decreased 52% to $2.3 million for 2000
from $4.8 million in 1999. This reduction was primarily due to lower equipment
sales in 2000 to a telecommunications service provider customer.

22

Operating costs and expenses. Total operating costs and expenses were
$63.3 million in 2000, an increase of 37% from $46.3 million in 1999. The
increase in 2000 was primarily due to the commencement of the Internet services
segment combined with increases in telecommunication services and direct call
provisioning costs, offset partially by a reduction in the cost of equipment
sold and other expenses.

Operating costs of telecommunications services primarily consist of service
administration costs for correctional facilities, including salaries and related
personnel expenses, communication costs and inmate calling systems repair and
maintenance expense. Operating costs of telecommunications services also
includes costs associated with call validation procedures, primarily network
expenses and database access charges. Operating costs associated with direct
call provisioning include the costs associated with telephone line access, long
distance charges, commissions paid to correctional facilities, costs associated
with uncollectible accounts and billing charges. Internet services operating
costs consist of purchased Internet bandwidth expenses.

The following table sets forth the operating costs and expenses for each
type of revenue as a percentage of corresponding revenue for the years ended
December 31, 2000 and 1999.

Operating costs and expenses associated with providing telecommunications
services, as a percentage of corresponding revenue was 41% in 2000, a decrease
from 45% in 1999. The decrease in 2000 was primarily due to revenue increases
from renegotiated pricing agreements with our telecommunication partners.

Telecommunications services operating costs for 2000 and 1999 were $21.3
million, and $17.7 million, respectively. The increase from 1999 to 2000 was due
primarily to new services being provisioned for a significant customer as part
of a contract amendment and to an increase in personnel costs. The increase
included bonus costs associated with our line installation bonus program. The
bonus program ended June 30, 2000. Also, the addition of new personnel in the
National Service Center and other operational support functions contributed to
cost increases. To a lesser extent, increases in travel, consulting services,
repairs and maintenance contributed to the overall cost increase.

Operating costs and expenses associated with providing direct call
provisioning as a percentage of corresponding revenue was 87% in 2000 and 91% in
2001. The decrease in 2000 was primarily due to a lower level of uncollectible
expense resulting from improved collection efforts.

Operating costs and expenses associated with providing Internet services as
a percentage of corresponding revenue was 93% in 1999 and 78% in 2000. The
decrease is largely due to a full year operating results for this segment in
2000. The contract for Internet services, the Qwest Agreement, commenced in
December 1999.

Cost of equipment sold and other decreased to $0.9 million in 2000 from
$2.2 million in 1999. This decrease was largely attributable to the reduction in
equipment sales in 2000 to one telecommunication service provider customer
compared to 1999.

Selling, General and Administrative Expenses. Selling, general and
administrative expenses were $19.2 million in 2000, compared to $13.0 million in
1999. The increase in 2000 was primarily due to increases in salary and benefits
for additional personnel and the implementation of a performance bonus program.
Other expenses increased due to travel, communications, and professional fees
due to the integration of Gateway operations.

Research and Development Expenses. Research and development expenses were
$5.1 million in 2000 versus $4.2 million in 1999. The increase was primarily due
to an increase in personnel expenses and higher travel and consulting costs.

23

Impairment of Telecommunications Assets. During 1999, we recorded an
impairment of telecommunications assets of $4.6 million. Impaired
telecommunications assets consisted of software development costs, construction
in progress, and inmate calling platform assets. Two events indicated that the
carrying value of certain equipment and intangible assets might not be
recoverable. In September 1999, we completed an evaluation of the future
viability of our new inmate-calling platform ("DL Platform"), which we had been
developing over the past two years. The merger with Gateway allowed us to
consider an alternative to the DL Platform. We determined that the Gateway
ComBridge Platform ("ComBridge") would be the preferred platform to install for
both new customers and upgrades of existing customers. However, during 1999, we
had been awarded certain contracts where the DL Platform was to be deployed.
Since we believe that it would not be cost effective to maintain and support two
separate systems, we proceeded to renegotiate all existing contracts to install
ComBridge instead of the DL Platform. During the quarter ended September 30,
1999, we successfully completed these negotiations. Due to the abandonment of
the DL Platform, we no longer anticipated any cash flow to support the carrying
value of assets related to the DL Platform. Capitalized costs relating to the DL
Platform included the software development costs, components (consisting
primarily of telephony cards) and other supporting computer peripheral
equipment. As a result, software development costs at December 31, 1999 were
impaired by $2.0 million and certain components of construction in progress
relating to these products were impaired by $1.6 million. This charge was
applicable to the Corrections Division.

In addition, we had deployed a version of our old inmate-calling platform
that resides in our customers' network locations. During 1999, we experienced a
reduction in call volumes and revenues for this platform. Additionally, since
the platform was based on the predecessor to the DL Platform, it was determined
that no upgrade path would be available for the platform. Any new feature or
service offering would be evaluated based on the new ComBridge Platform. The
reduction in call volumes caused the estimated fair value of these assets to be
less than its existing book value. We estimated the fair value of these assets
based on the discounted cash flows from each location. After consideration of
minimal salvage value of these assets due to their specific use, we recorded an
impairment charge of approximately $1.0 million. This charge was applicable to
the Corrections Division.

Depreciation and Amortization Expenses. Depreciation and amortization
expenses were $11.6 million in 2000, versus $10.7 million in 1999. The increase
was due primarily to the depreciation of fixed assets placed in service in 2000.

Merger Transaction Expenses. These expenses were directly related to the
merger with Gateway and amounted to approximately $1.0 million in 1999. Merger
transaction expenses consisted primarily of fees for investment bankers,
attorneys, accountants, financial printing and other related charges.

Interest and Other Expenses. Interest and other expense was $2.4 million
in 2000, versus $2.1 million in 1999. Included in interest and other expense is
other income in 2000 and 1999 were gains of approximately $0.4 million and $0.2
million, respectively, on the sale of used telecommunications equipment.
Interest expense was $2.8 million and $2.3 million in 2000 and 1999,
respectively. The increase in 2000 was attributable to an increase in the
average amount of indebtedness outstanding and an increase in interest rates.
The average debt balance increased in 2000 primarily due to the increase in
capital expenditures.

LIQUIDITY AND CAPITAL RESOURCES

CASH FLOWS

We have historically relied upon operating cash flow, debt financing and
the sale of equity securities to fund our operations and capital needs. Our
capital needs consist primarily of additions to property and equipment for site
telecommunication equipment, upgrades to existing systems and to fund
acquisitions.

Cash provided by continuing operations increased by 262% to $19.9 million
for 2001 from $5.5 million in 2000, primarily due to a $1.3 million improvement
in net income from continuing operations combined with a $8.6 million increase
in net working capital and the $2.7 million impairment charge in 2001. Cash
provided by continuing operations declined 60% to $5.5 million for 2000 from
$13.8 million in 1999 primarily due to a

24

$15.0 million decrease in net working capital and the $4.6 million impairment
charge in 1999, offset partially by a $9.3 million improvement in net income
from continuing operations.

Net cash used in investing activity of continuing operations was $7.9
million, $10.7 million and $16.5 million in 2001, 2000 and 1999, respectively.
Cash used in investing activities consisted primarily of purchases of property
and equipment of $5.7 million in 2001 compared to $11.0 million in 2000 and
$14.6 million in 1999. The decrease in 2001 and 2000 spending was the result of
a lower level of new calling system installations and upgrades to existing
systems, as compared to 1999 levels. Cash used for acquisitions totaled $1.6
million in 2001 and $1.4 million in 1999. Cash used in investing activities was
partially offset by the sale of surplus equipment of $0.4 million in both 2000
and 1999.

We anticipate that our capital expenditures in 2002 will increase over 2001
levels based on our anticipated growth in installed systems at correctional
facilities. We believe our cash flows from operations and our availability under
our credit facility will be sufficient in order for us to meet our anticipated
cash needs for new installations of inmate call processing systems, upgrades of
existing systems, and to finance our operations for at least the next 12 months.

Due primarily to repayments on our credit facility, cash used in financing
activities of continuing operations was $9.3 million during 2001. This repayment
was largely the result of improved operating performance and lower spending on
property and equipment in 2001 than in prior years. Cash provided by financing
activities of continuing operations of $6.3 million in 2000 consisted primarily
of net proceeds from the issuance of redeemable convertible preferred stock of
$3.5 million and subordinated debt of $3.8 million, less net payments on the
credit facility and other debt of $1.0 million. Cash provided by financing
activities of continuing operations of $3.7 million in 1999 reflects the net
proceeds from debt, including the line of credit of $3.4 million.

CAPITAL RESOURCES

In September 1999, we entered into a Senior Secured Revolving Credit
Facility ("Credit Facility") with a commercial bank for working capital and
general corporate purposes. In July 2000 our lenders amended our credit
agreement to revise certain financial covenants. The maximum available amount of
credit under the credit facility available was dependent upon our financial
performance. Based on these financial covenants, our maximum borrowings at
December 31, 2000 were $40.0 million. In April 2001 our lenders extended the
Credit Facility maturity date to March 31, 2002. The maximum available borrowing
on the facility was reduced to $30 million consisting of a $10 million term
portion and a $20 million line of credit. Interest was set at prime rate plus
1.25% effective March 31, 2001, increasing by 0.25% each quarter thereafter on
June 30, September 30, and December 31, 2001 (7.50% as of December 31, 2001). In
addition, monthly payments of $0.2 million on the term loan commenced on April
30, 2001. In March 2002 the maturity date of our Credit Facility was extended to
June 30, 2002. Maximum available borrowing from the facility was reduced to
$21.8 million, consisting of a $7.8 million term portion and a $14.0 million
line of credit. Interest was set at prime plus 2.25%, effective March 31, 2002.
In addition, monthly payments of $0.2 million on the term loan will continue
through the maturity date. Further, the Company, in April 2002, obtained a
commitment from the bank to extend, at the option of T-NETIX, this facility
beyond June 30, 2002 to January 2003. The Credit Facility under this commitment
requires interest payments, principal and borrowing base reductions and banking
fees. The Company has retained J.P. Morgan Securities Inc. to explore and advise
us on various financing opportunities and strategies.

In April 2000, we raised $7.5 million of debt and equity financing. The net
proceeds of approximately $7.2 million were used to reduce the outstanding
balance on the Credit Facility. The Company issued 3,750 shares of series A
non-voting redeemable convertible preferred stock and five-year stock purchase
warrants to acquire 340,909 common shares for net proceeds of $3.5 million. In
November 2000, 500 shares of the preferred stock were converted into 250,630
shares of common stock at a conversion price of $2.09 per share. In February of
2001 the remaining 3,250 shares of preferred stock were converted into 1,770,179
shares of common stock at an average conversion price of $1.95. The unamortized
discount on the preferred stock of $1.1 million was recognized as a charge to
income (loss) applicable to common stockholders.

25

The Company also issued a subordinated note payable of $3.75 million, due
April 30, 2001, to a director and significant shareholder of the Company. The
note bears interest at prime rate plus one percent per annum (6.50% at December
31, 2001) which is payable every six months. The lender received warrants, which
are immediately exercisable, to purchase 25,000 shares of common stock at an
exercise price of $6.05 per share for a period of five years. This note was
extended in April 2001 to April 30, 2002, at which time the lender received
additional warrants, which are immediately exercisable, to purchase 25,000
shares of common stock at an exercise price of $2.75 per share for a period of
five years. In March 2002, this note was extended to July 30, 2002. In April
2002 this note was extended to February 2003 to facilitate the refinancing of
our overall financing structure. Warrants to purchase 25,000 shares of common
stock at market price, on the previous terms, have been issued to Mr. Carney but
shares will vest proportionately over the term of the note.

CONTRACTUAL OBLIGATIONS AND COMMITMENTS

Set forth below is a summary of the Company's material contractual
obligations and commitments as of December 31, 2001:

Under the Company's existing Credit Facility, acceleration of principal
payments would occur upon payment default, violation of debt covenants not cured
within 30 days or breach of certain other conditions set forth in this Credit
Facility. Subject to certain subordination terms, the subordinated note payable
is subject to the same conditions of the Company's Credit Facility through cross
default provisions. At December 31, 2001, the Company was in compliance with all
of its debt covenants. There are no provisions within the Company's leasing
arrangements that would trigger acceleration of future lease payments. (See
Notes 4 and 10 to the consolidated financial statements for additional
information regarding the obligations and commitments listed above.)

The Company does not use securitization of trade receivables, affiliation
with special purpose entities or synthetic leases to finance its operations.
Additionally, the Company has not entered into any arrangement requiring the
Company to guarantee payment of third party debt or to fund losses of an
unconsolidated special purpose entity.

RECENTLY ISSUED ACCOUNTING PRONOUNCEMENT

In July 2001, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 141, "Business
Combinations" which requires the use of the purchase method and eliminates the
option of using pooling-of-interests method of accounting for all business
combinations. The provisions in this statement apply to all business
combinations initiated after June 30, 2001, and to all business combinations
accounted for using the purchase method, for which the date of acquisition is on
or near July 1, 2001. The Company does not believe that the adoption of this
statement will have a material impact on the Company's financial position,
results of operations, or cash flows.

In July 2001, the FASB issued SFAS No. 142, "Goodwill and Other Intangible
Assets" ("SFAS 142"). In general, SFAS 142 is effective for fiscal years
beginning after December 15, 2001. SFAS 142 addresses financial accounting and
reporting for acquired goodwill and other intangible assets, and requires that
all intangible assets acquired, other than those acquired in a business
combination, be initially recognized and measured based on fair value. In
addition, the intangible assets should be amortized based on useful life. If the
intangible asset is determined to have an indefinite useful life, it should not
be amortized, but shall be tested

26

for impairment at least annually. For the years ended December 30, 2001 and
2000, amortization expense for goodwill and other intangible assets totaled $2.2
million and $1.7 million, respectively. Management has not determined the
potential impact that this statement will have on the Company's financial
position, results of operations or cash flows.

In August 2001, the FASB issued SFAS No. 143, "Accounting for Asset
Retirement Obligations". This statement addresses the financial accounting and
reporting for obligations associated with the retirement of tangible long-lived
assets and the associated asset retirement costs. SFAS 143 requires that the
fair value of a liability for an asset retirement obligation be recognized in
the period in which it is incurred if a reasonable estimate of fair value can be
made. The associated asset retirement costs are capitalized as part of the
carrying amount of the long-lived asset and reported as a liability. This
statement is effective for fiscal years beginning after June 15, 2002. The
Company is currently evaluating the impact of the adoption of SFAS 143.

In October 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets". This statement establishes a
single accounting model, based on the framework established in SFAS 121, for
long-lived assets to be disposed of by sale, whether previously held and used or
newly acquired, and broadens the presentation of discontinued operations to
include more disposal transactions. This statement is effective for fiscal years
beginning after December 15, 2001. The Company is currently evaluating the
impact of adoption of SFAS 144.

CRITICAL ACCOUNTING POLICIES

The Company prepares its consolidated financial statements in accordance
with accounting principles generally accepted in the United States. The
significant accounting policies of the Company are discussed in detail in Note 1
to the consolidated financial statements. Certain of these accounting policies
as discussed below require management to make estimates and assumptions about
future events that could materially affect the reported amounts of assets,
liabilities, revenues and expenses and disclosure of contingent assets and
liabilities.

Revenue from telecommunications services and direct call provisioning is
recognized at the time the telephone call is completed. Revenue from equipment
sales is recognized when the equipment is shipped to customers, while revenue
from Internet services is recognized when the services are provided. The Company
records deferred revenue for advance billings to customers, or prepayments by
customers prior to the completion of installation or prior to the provision of
contractual bandwidth usage.

In evaluating the collectibility of its trade receivables from
telecommunications services and direct call provisioning customers, the Company
assesses a number of factors including a specific customer's ability to meet its
financial obligations to the Company, as well as general factors, such as the
length of time the receivables are past due and historical collection
experience. Based on these assessments, the Company records both specific and
general reserves for uncollectibles to reduce the related receivables to the
amount the Company ultimately expects to collect from customers. If
circumstances related to specific customers change or economic conditions worsen
such that the Company's past collection experience is no longer relevant, the
Company's estimate of the recoverability of its trade receivables could be
further reduced from the levels provided for in the consolidated financial
statements.

The calculation of amortization expense is based on the cost and estimated
economic useful lives of the underlying intangible assets, including goodwill,
intellectual property assets, capitalized computer software, and patent defense
and applications costs. The Company reviews its 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. The
Company estimates the future cash flows expected to result from operations and
if the sum of the expected undiscounted future cash flows is less than the
carrying amount of the intangible asset, the Company recognizes an impairment
loss by reducing the unamortized cost of the long-lived asset to its estimated
fair value. Although the Company believes it is unlikely that any significant
changes in the carrying value or the estimated useful lives of its intangible
assets will occur in the near term, rapid changes in technology or changes in
market conditions could result in revisions that could materially affect the
carrying value of these assets and the Company's future consolidated operating
results.
27

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

We are exposed to interest rate risk as discussed below.

INTEREST RATE RISK

We have current debt outstanding under the credit facility of $18.2 million
at December 31, 2001. Under the terms of the debt agreement the maximum credit
available at December 31, 2001 is $28.2 million. The loan bears interest at
prime rate plus 2.0% (6.75% at December 31, 2001) with interest payable monthly.
Since the interest rate on the loan outstanding is variable and is reset
periodically, we are exposed to interest risk. An increase in interest rates of
1% would increase estimated annual interest expense by approximately $0.2
million based on the amount of borrowings outstanding under the credit facility
at December 31, 2001.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The financial statements required by Item 8 are included herein beginning
on page F-1.

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

Not Applicable.

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

Information regarding our directors and executive officers will be set
forth in our Proxy Statement for use in connection with the Annual Meeting of
Stockholders to be held on or about June 6, 2002. Such information is
incorporated herein by reference.

ITEM 11. EXECUTIVE COMPENSATION

Information regarding executive compensation will be set forth in our Proxy
Statement for use in connection with the Annual Meeting of Stockholders to be
held on or about June 6, 2002. Such information is incorporated herein by
reference.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

Information regarding security ownership of certain beneficial owners, our
directors and our executive officers, will be set forth in our Proxy Statement
for use in connection with the Annual Meeting of Stockholders to be held on or
about June 6, 2002. Such information is incorporated herein by reference.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

Information regarding certain relationships and related transactions will
be set forth in our Proxy Statement for use in connection with the Annual
Meeting of Stockholders to be held on or about June 06, 2002. Such information
is incorporated herein by reference.

28

PART IV

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K

1. FINANCIAL STATEMENTS:

Independent Auditors' Report................................ 32
Consolidated Balance Sheets as of December 31, 2001 and
2000...................................................... 33
Consolidated Statements of Operations for the Years Ended
December 31, 2001, 2000 and 1999.......................... 34
Consolidated Statements of Stockholders' Equity for the
Years Ended December 31, 2001, 2000 and 1999.............. 35
Consolidated Statements of Cash Flows for the Years Ended
December 31, 2001, 2000 and 1999.......................... 36
Notes to Consolidated Financial Statements.................. 37

2. FINANCIAL STATEMENT SCHEDULES:

Independent Auditors' Report on Financial Statement
Schedule.................................................. 53
Schedule II -- Valuation and Qualifying Accounts for the
Years Ended December 31, 2001, 2000 and 1999.............. 54

3. EXHIBIT INDEX:

- ---------------
(1) Incorporated herein by this reference from the Exhibits to the Registrant's
Registration Statement on Form S-1 filed with the Commission on September
8, 1994, SEC Registration No. 33-83844.

(2) Incorporated herein by this reference from the Exhibits to the Registrant's
Amendment No. 1 to Registration Statement on Form S-1 filed with the
Commission on October 11, 1994, SEC Registration No. 33-83844.

(3) Incorporated herein by this reference from the Exhibits to the Registrant's
Registration Statement on Form S-8 filed with the Commission on May 23,
1995, SEC Registration No. 33-92642 and amended on May 3, 1996.

(4) Previously filed with the Commission as an exhibit to the Company's Annual
Report on Form 10-K for fiscal year ended 1996.

(5) Previously filed with the Commission as an exhibit to the Company's Proxy
Statement dated May 10, 2001.

(6) Previously filed with the Commission as an exhibit to the Company's
Quarterly Report on Form 10-Q dated June 31, 2001.

(7) Previously filed with the Commission as an exhibit to the Company's Annual
Report on Form 10-K for the fiscal year ended 2000.

(8) Previously filed with the Commission as an exhibit to the Company's
Quarterly Report on Form 10-Q dated September 30, 2001.

(9) Incorporated herein by this reference from the Exhibits to the Registrant's
Registration Statement on Form S-8 filed with the Commission on August 28,
2001, SEC Registration No. 333-68482.

(10) Previously filed with the Commission as an exhibit to the Company's Current
Report on Form 8-K dated October 26, 2001.

(b) Reports on Form 8-K: Current Report on Form 8-K filed October 26, 2001.

30

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned on April xx, 2002.

T-NETIX, INC.

By: /s/ THOMAS E. LARKIN
--------------------------------------
Thomas E. Larkin,
Chief Executive Officer

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

31

INDEPENDENT AUDITORS' REPORT

The Board of Directors and Shareholders
T-NETIX, Inc.:

We have audited the accompanying consolidated balance sheets of T-NETIX,
Inc. and subsidiaries as of December 31, 2001 and 2000, and the related
consolidated statements of operations, stockholders' equity, and cash flows for
each of the years in the three-year period ended December 31, 2001. 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 auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of T-NETIX,
Inc. and subsidiaries as of December 31, 2001 and 2000, and the results of their
operations and their cash flows for each of the years in the three-year period
ended December 31, 2001, in conformity with accounting principles generally
accepted in the United States of America.

KPMG LLP

March 15, 2002, except for Note 4 which is as of April 12, 2002
Dallas, Texas

32

T-NETIX, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

See accompanying notes to consolidated financial statements.
33

T-NETIX, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

See accompanying notes to consolidated financial statements.
34

T-NETIX, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY

See accompanying notes to consolidated financial statements.
35

T-NETIX, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOW

See accompanying notes to consolidated financial statements.
36

T-NETIX, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AND SHARE AMOUNTS)

(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

GENERAL

T-NETIX, Inc. and subsidiaries ("T-NETIX" or the "Company") was
incorporated in Colorado in 1986. The Company has two reportable segments: the
Corrections Division and the Internet Services Division. In August 2001, the
Company formalized its decision to offer for sale its voice verification
business unit, which includes the SpeakEZ speaker verification products.
Accordingly, related operating results of this business unit have been reported
as discontinued operations in the consolidated financial statements.

The Corrections Division provides telecommunications products and services,
including security enhanced call processing, call validation and call billing,
for inmate calling. Products and services are provided through contracts with
telecommunications service providers, who pay the Company on either a percentage
share of revenue or a fee per call basis, and through contracts directly with
the correctional facility, in which the Company receives the retail price of the
calls. The Internet Services Division provides interLATA Internet services to
Internet subscribers and buys and resells Internet bandwidth.

BASIS OF PRESENTATION

On June 14, 1999 the Company completed a merger with Gateway Technologies,
Inc. ("Gateway"), a privately held provider of inmate calling services. As a
result of the merger, Gateway became a wholly owned subsidiary of the Company.
Prior to the merger, the Company changed its year-end from July 31 to December
31. Gateway's year-end was December 31.

The merger was accounted for as a pooling of interests. As a result, the
Company's financial statements have been restated to combine Gateway's financial
statements as if the merger had occurred at the beginning of the earliest period
presented. Information concerning common stock and per share data has been
restated on an equivalent share basis.

PRINCIPLES OF CONSOLIDATION

The consolidated financial statements include the accounts of the Company
and its subsidiaries. All significant intercompany accounts and transactions
have been eliminated in consolidation.

ACCOUNTING ESTIMATES

The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosures of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenue and expenses during the reporting
period. Actual results could differ from those estimates.

RISKS AND UNCERTAINTIES

A majority of the Company's revenue is generated from services provided to
significant telecommunications customers. The loss of a major customer could
affect operating results adversely.

CASH EQUIVALENTS

Cash equivalents consist of highly liquid investments, such as certificates
of deposit and money market funds, with original maturities of 90 days or less.

37

T-NETIX, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AND SHARE AMOUNTS)

FAIR VALUE OF FINANCIAL INSTRUMENTS

The reported amounts of the Company's financial instruments including cash
and cash equivalents, receivables, accounts payable, and accrued liabilities
approximate fair value due to their short maturities. The carrying amounts of
debt approximate fair value since the debt agreements provide for interest rates
that approximate market.

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 revenue is primarily concentrated in the
United States in the telecommunications industry. The Company had trade accounts
receivable from five customers that comprised 73% and 33% of total trade
accounts receivable at December 31, 2001 and 2000, respectively. The Company
does not require collateral on accounts receivable balances and provides
allowances for potential credit losses. An allowance for doubtful accounts has
been established based on historical experience and management's evaluation of
outstanding accounts receivable at the end of the accounting period.

INVENTORIES

Inventories are stated at the lower of cost or market. Cost is determined
using the first-in, first-out method. Provisions, when required, are made to
reduce excess and obsolete inventories to their estimated net realizable values.

PROPERTY AND EQUIPMENT

Property and equipment is stated at cost, including costs necessary to
place such property and equipment in service. Major renewals and improvements
are capitalized, while repairs and maintenance are charged to operations as
incurred.

Construction in progress represents the cost of material purchases and
construction costs, including interest capitalized during construction, for
telecommunications hardware systems in various stages of completion. During the
years ended December 31, 2001, 2000 and 1999, interest capitalized was
insignificant.

Depreciation is computed on a straight-line basis using estimated useful
lives of 3 to 7 years for telecommunications equipment and 5 to 10 years for
office equipment. No depreciation is recorded on construction in progress until
the asset is placed in service.

INTANGIBLE AND OTHER ASSETS

Other assets include intellectual property assets, capitalized computer
software, patent defense and costs of numerous patent applications, deposits and
long-term prepayments and other intangible assets. Patents and intangible assets
are stated at cost. Amortization is computed on the straight-line basis over 17
years for patent application and defense costs and periods ranging from 3 to 9
years for other intangibles. Amortization charged to expense was $1.1 million,
$0.8 million, and $1.9 million for the years ended December 31, 2001, 2000 and
1999, respectively.

GOODWILL

Goodwill, representing the excess of the cost over the net tangible and
identifiable assets of the acquired businesses, is stated at cost and is
amortized, principally on a straight-line basis, over the estimated future
periods to be benefited 5 to 10 years. On an annual basis, the Company reviews
the recoverability of goodwill

38

T-NETIX, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AND SHARE AMOUNTS)

based primarily on an analysis of undiscounted cash flows from the acquired
business. Accumulated amortization amounted to $1.8 million and $2.0 million at
December 31, 2001 and 2000, respectively.

IMPAIRMENT OF LONG-LIVED ASSETS

The Company reviews its property and equipment and unamortized intangible
assets whenever events or changes in circumstances indicate that the carrying
amount may not be recoverable. The Company estimates the future cash flows
expected to result from operations and if the sum of the expected undiscounted
future cash flows is less than the carrying amount of the long-lived asset, the
Company recognizes an impairment loss by reducing the unamortized cost of the
long-lived asset to its estimated fair value.

During the year ended December 31, 2001, we recorded an impairment of
telecommunications assets charge of $2.7 million. This impairment charge
consisted of a reduction in the carrying value of software development costs and
the write-off of goodwill and purchased intangible assets associated with our
Contain(R) and Lock&Track(TM) jail management system products. While these
products have been offered for several years, we have experienced limited
commercial success and revenues to date have not been significant. This
impairment charge was based upon an analysis, which concluded that the carrying
value of software development costs and other intangible assets associated with
these product lines exceeded the present value of estimated future cash flows
given current sales levels.

During the year ended December 31, 1999, the Company recorded an impairment
charge of telecommunications assets of $4.6 million. Impaired telecommunications
assets consisted of software development costs, construction in progress, and
inmate calling platform assets. Two events that occurred in 1999 indicated that
the carrying value of certain equipment and intangible assets may not be
recoverable. Due to the abandonment of one of the Company's operating platforms,
as a result of the Gateway merger, impairments were recorded for $2.1 million of
software development and $1.6 million relating to construction in progress. In
addition, certain assets in customer's network locations were impaired by $1.0
million due to declining call volumes.

REVENUE RECOGNITION

Revenue and expenses from telecommunications services and direct call
provisioning are recognized at the time the telephone call is completed.
Provision is made for estimated uncollectible accounts in the period direct
call-provisioning revenue is recorded. Revenue from equipment sales is
recognized when the equipment is shipped to customers. Internet services are
recognized as the services are provided. The Company records deferred revenue
for advance billings to customers, or prepayments by customers prior to the
completion of installation or prior to the provision of contractual bandwidth
usage.

RESEARCH AND DEVELOPMENT

Costs associated with the research and development of new technology or
significantly altering existing technology are charged to operations as
incurred. Capitalization of software development costs begins upon the
establishment of technological feasibility, subject to net realizable value
considerations. Capitalized software costs are amortized over the economic
useful life of the software product, which is generally estimated to be three
years.

401(k) PLAN

The Company established a 401(k) plan for all of its full time employees
effective January 1, 1994. In June 1998, the Company implemented a matching
program. The program calls for the Company to match 25% of an employee's
contribution up to 6% of the individual employee's total salary. Matching
contributions

39

T-NETIX, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AND SHARE AMOUNTS)

and plan expenses were $0.2 million, $0.1 million and $0.1 million for the years
ended December 31, 2001, 2000 and 1999.

INCOME TAXES

The Company utilizes the asset and liability method of accounting for
income taxes. Accordingly, deferred tax assets and liabilities are recognized
for the future tax consequences attributable to differences between the
financial statement carrying amounts of existing assets and liabilities and
their respective tax bases and operating loss and tax credit carry forwards.
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.

EARNINGS (LOSS) PER COMMON SHARE

Earnings (loss) per common share are presented in accordance with the
provisions of Statement of Financial Accounting Standards No. 128, "Earnings Per
Share" ("SFAS 128"). Basic earnings per share excludes dilution for common stock
equivalents and is computed by dividing income or loss available to common
shareholders by the weighted average number of common shares outstanding during
the period. Diluted earnings per share reflect the potential dilution that could
occur if securities or other contracts to issue common stock were exercised or
converted into common stock.

There is no difference between basic and diluted net loss per common share
since potentially dilutive securities from the conversion of redeemable
convertible preferred stock and the exercises of options and warrants are
anti-dilutive for the years ended December 31, 2001, 2000 and 1999. The
calculations or diluted net loss per common share for the years ended December
31, 2001, 2000 and 1999 do not include 232,000, 317,000 and 375,000
respectively, of potentially dilutive securities, including common stock options
and warrants and redeemable convertible preferred stock.

STOCK COMPENSATION

The Company accounts for employee stock options under the provisions of APB
Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB 25") and has
adopted the "disclosure only" alternative described in Statement of Financial
Accounting Standards No. 123, "Accounting for the Stock-Based Compensation"
("SFAS 123"), which requires pro forma disclosure of compensation expense using
a fair value based method of accounting for stock-based compensation plans.
Under APB 25, compensation expense is based on the difference between the
exercise price and fair value of the Company's stock on the date of grant.

RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS

In July 2001, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 141, "Business
Combinations", which requires the use of the purchase method and eliminates the
option of using pooling-of-interests method of accounting for all business
combinations. The provisions in this statement apply to all business
combinations initiated after June 30, 2001, and to all business combinations
accounted for using the purchase method for which the date of acquisition is on
or near July 1, 2001. The Company does not believe that the adoption of this
statement will have a material impact on the Company's financial position,
results of operations, or cash flows.

In July 2001, the FASB issued SFAS No. 142, "Goodwill and Other Intangible
Assets" ("SFAS 142"). In general, SFAS 142 is effective for fiscal years
beginning after December 15, 2001. SFAS 142 addresses

40

T-NETIX, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AND SHARE AMOUNTS)

financial accounting and reporting for acquired goodwill and other intangible
assets, and requires that all intangible assets acquired, other than those
acquired in a business combination, be initially recognized and measured based
on fair value. In addition, the intangible assets should be amortized based on
useful life. If the intangible asset is determined to have an indefinite useful
life, it should not be amortized, but shall be tested for impairment at least
annually. For the years ended December 31, 2001 and 2000, amortization expense
for goodwill and other intangibles totaled $2.2 million and $1.7 million,
respectively. Management has not yet determined the potential impact that this
statement will have on the Company's financial position, results of operations
or cash flows.

In August 2001, the FASB issued SFAS No. 143, "Accounting for Asset
Retirement Obligations". This statement addresses the financial accounting and
reporting for obligations associated with the retirement of tangible long-lived
assets and the associated asset retirement costs. SFAS 143 requires that the
fair value of a liability for an asset retirement obligation be recognized in
the period in which it is incurred if a reasonable estimate of fair value can be
made. The associated asset retirement costs are capitalized as part of the
carrying amount of the long-lived asset and reported as a liability. This
statement is effective for fiscal years beginning after June 15, 2002. The
Company is currently evaluating the impact of the adoption of SFAS 143.

In October 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets". This statement establishes a
single accounting model, based on the framework established in SFAS 121, for
long-lived assets to be disposed of by sale, whether previously held and used or
newly acquired, and broadens the presentation of discontinued operations to
include more disposal transactions. This statement is effective for fiscal years
beginning after December 15, 2001. The Company is currently evaluating the
impact of adoption of SFAS 144.

RECLASSIFICATION

Certain amounts in the 2000 and 1999 financial statements have been
reclassified to conform to the 2001 presentation.

(2) BALANCE SHEET COMPONENTS

Accounts receivable consist of the following:

Bad debt expense was $7.5 million, $3.2 million, and $5.0 million for the
years ended December 31, 2001, 2000 and 1999, respectively.

41

T-NETIX, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AND SHARE AMOUNTS)

Property and equipment consist of the following:

Intangible and other assets consist of the following:

Accrued liabilities consist of the following:

(3) MERGERS AND ACQUISITIONS

GATEWAY

On June 14, 1999, the Company completed a merger with Gateway, by
exchanging 3,672,234 shares of its common stock for all of the common stock of
Gateway. Each share of Gateway was exchanged for 5.0375 shares of T-NETIX common
stock. Outstanding Gateway stock options were also converted at the same
exchange factor into options to purchase approximately 379,000 shares of T-NETIX
common stock.

42

T-NETIX, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AND SHARE AMOUNTS)

In addition, in connection with the merger transaction, T-NETIX issued
375,341 shares of common stock to certain shareholders of Gateway in exchange
for terminating a royalty agreement. The royalty agreement related to automated
call processing technology and intellectual property rights that were assigned
to Gateway by the royalty owners in exchange for royalty payments. The
termination of the royalty owners' interests resulted in the acquisition of an
intangible asset. The asset has been recorded at fair value, or $2.5 million.
The fair value is based on the value of T-NETIX common stock at February 10,
1999 (date of the Merger Agreement), or $6.625, times the number of shares
issued in exchange for termination of the royalty owners' interests. The
intangible asset has been recorded in patent license rights and has an estimated
useful life of 10 years, the remaining term of the underlying patent.

In connection with the merger, the Company incurred merger transaction
expenses of $1.0 million for the year ended December 31, 1999. Merger
transaction expenses consisted primarily of fees for investment bankers,
attorneys, accountants, financial printing and other related charges.

EVANS AND RICKER ACQUISITION

Effective October 28, 1999, the Company completed the acquisition of
substantially all of the assets of Evans and Ricker ("E&R"), of Portland,
Oregon. E&R specialize in software used to control and manage information for
correctional facilities. E&R's product, Lock and Track Corrections Information
System ("Lock&Track(TM)") is a comprehensive relational database designed to
handle the operational control and reporting needs of municipal, state, federal,
and/or private correctional facilities. The purchase price was approximately
$1.4 million including acquisition costs. The acquisition has been accounted for
using the purchase method of accounting. The results of operations associated
with the assets acquired are included in the Company's financial statements
beginning November 1, 1999. Assets acquired and liabilities assumed have been
recorded at their fair values. The assets acquired were cash, accounts
receivable and intangibles. The estimated excess of cost over the estimated fair
value of the net assets acquired of approximately $1.3 million was allocated
principally to goodwill, and is being amortized on a straight line basis over
seven years. The remaining net assets acquired were primarily current assets
(cash and accounts receivable) net of current liabilities (accounts payable and
accrued liabilities). The acquisition was funded by borrowings under the
Company's line of credit.

TELEQUIP LABS, INC.

On January 19, 2001 the Company completed the purchase of all the
outstanding shares of common stock, not already owned, of TELEQUIP Labs, Inc., a
provider of inmate calling systems. The purchase price was $605 per share, of
which $573 per share was paid upon closing. The remaining $32 per share, payable
on the first anniversary of the closing date upon determination that all
representations and warranties were materially true and accurate as of the
closing date and all covenants have been substantially fulfilled, has been paid.
The excess of the purchase price over the fair value of the net identifiable
assets acquired has been recorded as goodwill and is being amortized on a
straight line basis over seven years. The total cash paid in January 2001 was
$1.5 million. The acquisition has been accounted for as a purchase and,
accordingly, the results of operations of TELEQUIP Labs, Inc. have been included
in the Company's consolidated financial statements from January 19, 2001.
Disclosure of pro forma information as if the acquisition had been completed as
of the earliest period presented has not been presented since the impact on
revenues and net income from continuing operations is not significant.

43

T-NETIX, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AND SHARE AMOUNTS)

(4) DEBT

Debt consists of the following:

In September 1999, the Company entered into a Senior Secured Revolving
Credit Facility (the "Credit Facility") with its commercial bank. The Credit
Facility provides for maximum credit of $40.0 million subject to limitations
based on certain financial covenants. In April 2001, the Company's lenders
extended the maturity date on its credit agreement to March 31, 2002. The
maximum available borrowings on the facility was reduced to $30 million and
interest was set at prime rate plus 1.25% effective March 31, 2001 increasing by
0.25% each quarter thereafter on June 30, September 30 and December 31, 2001
(6.75% at December 31, 2001). The Company also pays a fee of 0.40% per annum on
the unused portion of the line of credit. In March 2002, the maturity date of
our Credit Facility was extended to June 30, 2002. Within the terms of the March
2002 extension, maximum available borrowing from the facility was reduced to
$21.8 million, consisting of a $7.8 million term portion and a $14.0 million
line of credit. Interest was set at prime plus 2.25%, effective March 31, 2002.
In addition, monthly payments of $0.2 million on the term loan will continue
through the maturity date. Further, the Company, in April 2002, obtained a
commitment from the bank to extend, at the option of the Company, this facility
beyond June 30, 2002 to January 2003. The Credit Facility under this commitment
requires interest payments, principal and borrowing base reductions and banking
fees. The Company has retained J.P. Morgan Securities Inc. to explore and advise
us on various financing opportunities and strategies.

The Credit Facility is collateralized by substantially all of the assets of
the Company. Under the terms of the Credit Facility, the Company is required to
maintain certain financial ratios and other financial covenants. These ratios
include a debt to a four quarter rolling earnings before interest, taxes and
depreciation and amortization (EBITDA) ratio, a ratio of fixed charges (interest
and debt payments) to EBITDA, and minimum quarterly EBITDA. The Agreement also
prohibits the Company from incurring additional indebtedness.

The Company issued a subordinated note payable of $3.75 million, due April
30, 2001, to a director and significant shareholder of the Company. The note
bears interest at prime rate plus one percent per annum (6.75% at December 31,
2001) which is payable every six months. The lender received warrants, which are
immediately exercisable, to purchase 25,000 shares of common stock at an
exercise price of $6.05 per share for a period of five years. This note was
extended in April 2001 to April 30, 2002 at which time the lender received
additional warrants, which are immediately exercisable, to purchase 25,000
shares of common stock at an exercise price of $2.75 per share for a period of
five years. The estimated fair value of the stock purchase warrants, calculated
using the Black-Scholes model, has been recorded as deferred financing fees and
is being amortized over the term of the debt. In March 2002, this note was
extended to July 30, 2002. In April 2002 this note was extended to February 2003
to facilitate the refinancing of our overall financing structure.

44

T-NETIX, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AND SHARE AMOUNTS)

Warrants to purchase 25,000 shares of common stock at market price, on the
previous terms, have been issued to Mr. Carney but shares will vest
proportionately over the term of the note.

(5) DISCONTINUED OPERATIONS AND NET ASSETS FOR SALE

In August 2001, the Company formalized the decision to offer for sale its
voice verification business unit, which includes the SpeakEZ speaker
verification products. Accordingly, related operating results have been reported
as discontinued operations. For purposes of the balance sheet presentation, the
current assets and liabilities of discontinued operations have been netted. The
financial information for the discontinued speaker verification operations is as
follows:

In September 2001, the Company announced that it had entered into an
agreement to sell all of the assets of the SpeakEZ division; however, the
transaction was not completed and the agreement was terminated. We are actively
seeking strategic alternatives including the sale of these assets to other
interested parties. As of December 31, 2001, the Company has been unsuccessful
in its attempt to sell the SpeakEZ speaker verification assets. For this reason,
we recorded a one-time charge of $1.1 million, net of taxes, in 2001 related to
the write off of the voice print patent and license assets related to the
SpeakEZ product line. This write-off was based on an analysis which concluded
that the carrying value of our voice print assets exceeded the present value of
estimated future cash flows given current operating results and the absence of a
definitive agreement to sell these assets.

(6) SEGMENT INFORMATION -- CONTINUING OPERATIONS

Statement of Financial Accounting Standards No. 131, "Disclosures About
Segments of an Enterprise and Related Information," ("SFAS 131"), establishes
standards for reporting operating segments in annual financial statements. SFAS
131 also establishes standards for disclosures about products and services,
geographic areas and major customers.

The Company has two reportable segments: the Corrections and Internet
Services Divisions. Segment reporting has been conformed to correspond to the
current presentation. In August 2001, the Company formalized its decision to
offer for sale its voice print business unit, which includes the SpeakEZ speaker
verification products. Accordingly, related operating results of this business
unit have been reported as discontinued operations in the consolidated financial
statements.

The Company evaluates performance based on earnings (loss) before income
taxes. Additional measures include operating income, depreciation and
amortization, and interest expense. There are no intersegment

45

T-NETIX, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AND SHARE AMOUNTS)

sales. The Company's reportable segments are specific business units that offer
different products and services. They are managed separately because each
business requires different technology and marketing strategies. The accounting
policies of the reportable segments are the same as those described in the
summary of significant accounting policies. Segment information for the years
ending December 31, 2001, 2000 and 1999 are as follows:

46

T-NETIX, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AND SHARE AMOUNTS)

Substantially all of the Company's reportable segment revenue is derived
from within the United States. Revenue as a percentage of total revenue
attributable to significant customers for the years ended December 31, 2001,
2000 and 1999 is as follows:

Substantially all revenue reported by our Internet Services Division for
the years ended December 31, 2001, 2000 and 1999 was attributable to our GSP
agreement with Qwest. There was no intersegment revenue for the years ended
December 31, 2001, 2000 and 1999. Consolidated total assets included
eliminations of approximately $0.7 million as of December 31, 2001. Eliminations
consist of intercompany receivables in the Corrections Division and intercompany
payables in the TELEQUIP Labs subsidiary related solely to intercompany
borrowings.

(7) INCOME TAXES

Income tax expense for the years ended December 31, 2001, 2000 and 1999 is
as follows:

Income taxes differ from the expected statutory income tax benefit, by
applying the US federal income tax rate of 34% to pretax earnings for the years
ended December 31, 2001, 2000 and 1999 due to the following:

47

T-NETIX, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AND SHARE AMOUNTS)

The tax effects of temporary differences that give rise to significant
portions of the deferred income tax assets and deferred income tax liabilities
as of December 31, 2001 and 2000 are presented below:

At December 31, 2001, the Company had net operating loss carry forwards for
tax purposes aggregating approximately $14.4 million which, if not utilized to
reduce taxable income in future periods, expire at various dates through the
year 2020. Approximately $1.3 million of the net operating loss carry forwards
are subject to certain rules limiting their annual usage. The Company believes
these annual limitations will not ultimately affect the Company's ability to use
substantially all of its net operating loss carry forwards for income tax
purposes.

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
has offset a portion of its deferred tax assets with a valuation allowance. The
valuation allowance will be adjusted in the future based on the Company's
projected taxable income.

The exercise of stock options, which have been granted under the Company's
1991 NSO stock option plan gives rise to compensation which is included in the
taxable income of the applicable option holder and is deductible by the Company
for federal and state income tax purposes. The income tax benefit associated
with the exercise of the NSO options is recorded as an adjustment to additional
paid-in capital when realized.

(8) STOCKHOLDERS' EQUITY

STOCK OPTION PLANS

The Company has reserved 5,850,000 shares of common stock for employees and
non-employee directors under various stock option plans (collectively the
"Plans"): the 1991 Incentive Stock Option Plan (the "1991 ISO Plan"); the 1991
Non-Qualified Stock Option Plan ("the 1991 NSO Plan"); the 1993 Incentive Stock
Option Plan (the "1993 ISO Plan") and the 2001 Stock Option Plan (the "2001
Plan"). The Plans provide for issuing both incentive and non-qualified stock
options, which must be granted at not less than 100% of the fair market value of
the stock on the date of grant. All options to date have been granted at the
fair market value of the stock as determined by the Board of Directors. Options
issued prior to 1994 had vesting terms of

48

T-NETIX, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AND SHARE AMOUNTS)

one to three years from the date of grant. Substantially all of the Incentive
Stock Options issued after 1993 vest over four years from the date of grant. The
options expire ten years from the date of grant.

A summary of the Company's stock option activity, and related information
through December 31, 2001, is as follows:

The range of exercise prices for common stock options outstanding and
options exercisable at December 31, 2001 is as follows:

49

T-NETIX, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AND SHARE AMOUNTS)

The Company has not recorded compensation expense for stock options
granted. The Company has computed the pro forma disclosures required under SFAS
123 for stock options granted using the Black-Scholes option-pricing model. The
assumptions are as follows:

The pro forma effects of applying SFAS 123 for the years ended December 31,
2001, 2000, and 1999 are as follows:

The Black-Scholes option-pricing model was developed for use in estimating
the fair value of traded options that have no vesting restrictions and are fully
transferable. In addition, option-pricing models require the input of highly
subjective assumptions, including expected stock price volatility. Because the
Company's employee stock options have characteristics significantly different
from those of traded options, and because changes in subjective input
assumptions can materially affect the fair value estimate, in management's
opinion, the existing models do not necessarily provide a reliable single
measure of the fair value of its employee stock options.

REDEEMABLE CONVERTIBLE PREFERRED STOCK

In April 2000, the Company issued 3,750 shares of Series A Non-Voting
Redeemable Convertible Preferred Stock and five-year stock purchase warrants to
acquire 340,909 common shares for net proceeds of $3.5 million. The Company
accounted for the transaction in accordance with EITF 98-5, "Accounting for
Convertible Securities with Beneficial Conversion Features or Contingently
Adjustable Conversion Ratios" and EITF 00-27 "Application of EITF Issue No. 98-5
to Certain Convertible Securities". The Company recognized an increase in
additional paid in capital in the amount of $1.1 million for the value of
warrants and $0.8 million for the value of the beneficial conversion feature.
The Company is accreting the resulting discount to income (loss) applicable to
common stockholders over a three-year period to the mandatory redemption

50

T-NETIX, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AND SHARE AMOUNTS)

date. The discount from the beneficial conversion feature was accreted over a
six-month period to the date when the stock was first convertible into common
stock. The Series A preferred stock does not bear dividends.

In November 2000, the holders of the preferred stock converted 500 shares
of the Series A Preferred Stock into 250,630 shares of common stock at a
conversion price of $2.09 per share. As a result of this transaction, the
Company recognized a charge of $0.2 million to income (loss) applicable to
common stockholders, representing the pro-rata share of the remaining
unamortized discount on the preferred stock.

In February of 2001 the remaining 3,250 shares of preferred stock were
converted into 1,770,179 shares of common stock at an average conversion price
of $1.95. The remaining unamortized discount on the Series A preferred stock of
$1.0 million was recognized as a charge to income (loss) applicable to common
stockholders.

(9) QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)

51

T-NETIX, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AND SHARE AMOUNTS)

Certain amounts for the three months ended September 30, 2001, June 30,
2001 and March 31, 2001 have been reclassified to conform to the presentation
for the fourth quarter of 2001.

The Internet services contract, the "Qwest Agreement," began in December,
1999. Revenue and expenses have increased significantly as a result of entering
into this contract. Effective November 2001, operations of this segment have
substantially ceased, including those under the Qwest Agreement.

(10) COMMITMENTS AND CONTINGENCIES

The Company leases office space under operating lease agreements and
certain computer and office equipment under capital lease agreements. Rent
expense under operating lease agreements for the years ended December 31, 2001,
2000 and 1999 was approximately $1.1 million, $1.0 million, and $1.0 million,
respectively. Future minimum lease payments under these lease agreements for
each of the next five years are summarized as follows:

Year ending December 31:
2002...................................................... $ 922
2003...................................................... 717
2004...................................................... 289
2005...................................................... 209
2006...................................................... 94
------
Total minimum lease payments...................... $2,231
======

The Company is involved in various legal proceedings of a nature considered
normal to its business. It is the Company's policy to accrue amounts related to
these legal matters if it is probable that a liability has been incurred in an
amount that is reasonably estimable. In the opinion of management, all matters
are of such a nature as would not have a material affect on the Company's
financial position, results of operations and cash flows of the Company if
resolved unfavorably.

52

INDEPENDENT AUDITORS' REPORT ON SCHEDULE

The Board of Directors and Shareholders
T-NETIX, Inc.:

Under the date of March 15, 2002 except for Note 4 which is as of April 12,
2002, we reported on the consolidated balance sheets of T-NETIX, Inc. and
subsidiaries as of December 31, 2001 and 2000, and the related consolidated
statements of operations, stockholders' equity, and cash flows for each of the
years in the three-year period ended December 31, 2001. In connection with our
audits of the aforementioned consolidated financial statements, we also audited
the related consolidated financial statement Schedule II. This financial
statement schedule is the responsibility of the Company's management. Our
responsibility is to express an opinion on this financial statement schedule
based on our audits.

In our opinion, such consolidated financial statement schedule, when
considered in relation to the basic consolidated financial statements taken as
whole, presents fairly, in all material respects, the information set forth
therein.

KPMG LLP

Dallas, Texas
March 15, 2002

53

SCHEDULE II

T-NETIX, INC. AND SUBSIDIARIES

VALUATION AND QUALIFYING ACCOUNTS
YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999

54

EXHIBIT INDEX

- ---------------
(1) Incorporated herein by this reference from the Exhibits to the Registrant's
Registration Statement on Form S-1 filed with the Commission on September 8,
1994, SEC Registration No. 33-83844.

(2) Incorporated herein by this reference from the Exhibits to the Registrant's
Amendment No. 1 to Registration Statement on Form S-1 filed with the Commission
on October 11, 1994, SEC Registration No. 33-83844.

(3) Incorporated herein by this reference from the Exhibits to the Registrant's
Registration Statement on Form S-8 filed with the Commission on May 23, 1995,
SEC Registration No. 33-92642 and amended on May 3, 1996.

(4) Previously filed with the Commission as an exhibit to the Company's Annual
Report on Form 10-K for fiscal year ended 1996.

(5) Previously filed with the Commission as an exhibit to the Company's Proxy
Statement dated May 10, 2001.

55

(6) Previously filed with the Commission as an exhibit to the Company's
Quarterly Report on Form 10-Q dated June 31, 2001.

(7) Previously filed with the Commission as an exhibit to the Company's Annual
Report on Form 10-K for the fiscal year ended 2000.

(8) Previously filed with the Commission as an exhibit to the Company's
Quarterly Report on Form 10-Q dated September 30, 2001.

(9) Incorporated herein by this reference from the Exhibits to the Registrant's
Registration Statement on Form S-8 filed with the Commission on August 28,
2001, SEC Registration No. 333-68482.

(10) Previously filed with the Commission as an exhibit to the Company's Current
Report on Form 8-K dated October 26, 2001.

56