T NETIX INC - 10-K Annual Report

Back to GetFilings.com

================================================================================

UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

------------------------------------------------------

FORM 10-K

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

FOR THE FISCAL YEAR ENDED DECEMBER 31, 2002
COMMISSION FILE NUMBER 0-25016

------------------------------------------------------

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

REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE:
(972) 241-1535

------------------------------------------------------

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. [ ]

Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes [ ] No [X]

State the aggregate market value of the voting and non-voting common equity
held by non-affiliates computed by reference to the price at which the common
equity was last sold, or the average bid and asked price of such common equity,
as of the last business day of the Registrant's most recently completed second
quarter: $50,425,000.

The number of shares outstanding of the Registrant's common stock as of
March 27, 2003 was 15,052,210.

The following document is incorporated herein by reference into the part of
the Form 10-K indicated: the Proxy Statement for the 2003 Annual Meeting of
Shareholders to be filed prior to April 30, 2003, 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.

================================================================================

FORM 10-K CROSS REFERENCE INDEX

2

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).

INTRODUCTORY NOTE

Subsequent to the issuance of our Annual Report for the year ended December
31, 2001, we determined that certain contract setup costs incurred by the
Company in 2001 should have been charged to operating expenses rather than
reflected on the balance sheet as an asset. As a result of changing our
accounting treatment for certain contract setup costs, the Company determined
that our financial statements as of and for the year ended December 31, 2001
should be restated. The effect of the restatement is an increase to the
previously reported net loss of $0.4 million for the twelve months ended
December 31, 2001, as a result of additional operating costs. There is no
significant impact with using this new accounting treatment on the previously
reported financial results for the years ended prior to 2001 and for the first
three quarters of 2002. Please see "Restatement of Previously Issued Financial
Statements" in Item 7 of this Annual Report and Note 11 to our Consolidated
Financial Statements filed as part of this Annual Report.

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 Part IV, Item 15 Financial Statements as "Telecommunications
Services", and revenue from direct contracts with the correctional facilities is
identified as "Direct call provisioning." As of December 31, 2002, T-NETIX
employed 456 people in 35 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.

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 2002, the Company had a single reportable business segment: the
Corrections Division. 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.

The Company formerly reported two additional business segments: the
Internet Services and SpeakEZ voice verification divisions. Through its Internet
Services Division, the Company provided interLATA Internet services to Qwest
customers through a master service agreement, the "Qwest Agreement". Effective
November 2001, substantially all services and associated revenue under this
agreement ceased due to the expiration of this contract. In August 2001, the
Company formalized its decision to offer for sale its voice verification
business unit and made the decision to curtail operations. SpeakEZ assets were
sold in July 2002 and the Company retained a license to use the technology in
its corrections business. Pursuant to this strategy and due to the subsequent
sale of the assets, related operating results of our SpeakEZ voice verification
division have been recorded as discontinued operations in the consolidated
financial statements.

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, Office of Justice Programs,
as of December 2001:

o there were 6.6 million adults under some form of correctional
supervision

3

o approximately 4.7 million adults were under parole or probation
sanction

o the U.S. incarcerated approximately 1.4 million inmates in its prison
system

o from 1995 to 2001 the number of inmates increased by an average annual
growth rate of 4 percent

o 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 to be rich, reliable and economically advantageous.

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:

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 believe that the
duration of applicable patents is adequate relative to the services and products
we offer.

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.

4

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

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 prepaid 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's 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.

T-NETIX also continues to provide paper prepaid calling cards for
facilities that desire a fast and simple calling solution for their inmates.
These are sold to the inmates 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 "Direct Call Provisioning" 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 approved. 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.

5

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. Use of PIN-LOCK(R)
can also limit the use by an inmate of another inmate's PIN. 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 license our PIN-LOCK(R) 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. We recorded 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.

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 representatives 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 35 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 and we either share the revenue with or
receive a per call prescribed fee from our telecommunications service providers
for each call completed. We receive additional fees for validating the phone
numbers dialed by inmates.

6

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.

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, 2002, 48% of our total revenue was
generated from contracts with telecommunication service providers.
Telecommunications services revenue from the following customers during 2002
accounted for the noted percentages of our total telecommunication services
provider revenue:

No other telecommunications service provider customer accounted for more
than 10% of our total telecommunications service provider 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, 2002,
41% of our total Company revenue was generated from agreements with correctional
facilities as the exclusive provider of telecommunications services to inmates
within the facility. Direct call provisioning revenue from the following
correctional facilities during 2002 accounted for the noted percentages of our
total direct call revenue:

COMPETITION

The corrections industry, which includes the inmate calling market, is and
can be expected to remain highly competitive. We estimate that we compete
directly with about ten other suppliers of inmate call processing systems and
other corrections related products (including our own telecommunications service
provider customers) 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:

7

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

INTERNET SERVICES DIVISION

In December 1999, T-NETIX entered into a master service agreement with US
WEST ENTERPRISE (now named Qwest America, Inc.) 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 and associated revenues under this agreement
had ceased due to the expiration of this contract. 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.

SPEAKER VERIFICATION DIVISION

The Company formerly reported a third business segment, the SpeakEZ Voice
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. In August 2001, management of T-NETIX made the decision to curtail
operations of this portion of the Company in order to enhance overall Company
performance by reducing the negative impact of SpeakEZ operations on both net
earnings and cash flow. SpeakEZ assets were sold in July 2002 and the Company
retained a license to use the technology in its corrections business. This
technology is currently used in the Company's PIN-LOCK(R) product. Due to the
subsequent sale of the assets, related operating results of our SpeakEZ voice
verification division have been recorded as discontinued operations in the
consolidated financial statements. See Note 5 of "Notes to Consolidated
Financial Statements".

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. We believe that the
duration of applicable patents is adequate relative to the services and products
we offer.

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

8

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. T-NETIX filed a petition with the FCC
with a request to extend the time for compliance to June 2003, which request was
granted.

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.

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, 2002, we employed 456 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, 2002, AT&T, Verizon and SBC accounted for approximately 16%, 13%,
and 7% 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

9

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 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
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:

10

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

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

o restrictive debt covenants may impair our ability to obtain additional
financing; and

o we must maintain minimum capitalization ratios and meet certain
financial ratios each quarter to maintain compliance with restrictive
debt covenants; failure to maintain compliance could cause our
indebtedness to become immediately due.

As of December 31, 2002, we had a total of $22.8 million of indebtedness.
Our ability to repay our indebtedness depends upon many factors, including
future profitability and the level of capital expenditures required for new
installations and to upgrade existing systems.

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 in March 2005. 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 in September 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, a case styled Valdez v. State of New Mexico, et al. against
Gateway and several other defendants was dismissed. The complaint, generally
alleging violations of state unfair practices, antitrust and constitutional
laws, included class action certification of all persons who had been billed for
and paid for telephone calls initiated by an inmate confined in a New Mexico
correctional facility. On appeal by plaintiffs, in August 2002 the New Mexico
State Supreme Court affirmed the District Court's dismissal of the plaintiffs'
case.

T-NETIX is a defendant in a state case brought in June, 2000 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 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, in October 1997, 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 in January, 2001 alleging constitutional violations, RICO Act
violations and violations of Federal wiretapping laws. This case was dismissed
on all counts in November 2001 and plaintiffs appealed. The dismissal was
affirmed by the Fourth Circuit in July 2002.

11

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, was dismissed by the Plaintiffs in July
2002.

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 discovery stages. In July 2002, MCI WorldCom, Inc. filed a Chapter XI
bankruptcy proceeding that automatically stayed any further proceeding against
them. On August 7, 2002, T-NETIX subsequently filed its motion to sever MCI
WorldCom from the patent litigation, which was granted on February 13, 2003.

Since September 1997 and through October 2001, pursuant to a written
agreement entered into in connection with a settlement of an arbitration
proceeding, the Company was 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 services to be provided by
Illuminet, Inc. under the contract were in the nature of the transport of
queried by Illuminet to a certain database maintained by and available to
Illuminet. In order to utilize such transport the queries were to be directed
from the Company for connection to Illuminet utilizing certain technologies.
Attempts were continually made by the Company over the time period to complete
connectivity but connectivity was never accomplished. In November 2001,
Illuminet notified the Company 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's breach and
declaratory relief that no credits are due T-NETIX. The Company has made
payments totaling approximately $2.1 million pursuant to this written agreement.
The payments (the value of which has been written down for the period ended
December 31, 2002) (See Note 1 of "Notes to the Consolidated Financial
Statements") are classified as an "Asset Held for Sale" at December 31, 2002 and
as a long-term prepayment included in Intangible and Other Assets at December
31, 2001 (See Note 2 of "Notes to Consolidated Financial Statements"). It is the
contention of the Company, in the arbitration proceeding, that the fault in the
lack of connectivity, be it the lack of proper technology, proper responsiveness
on the part of Illuminet, or otherwise, was that of Illuminet and that the
Company is still entitled to the services for which it paid. 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 balance of the
prepaid expense could be impaired. It is anticipated that the arbitration
hearing previously scheduled for December 6, 2002 will now be scheduled during
the month of July or August 2003.

In August 2001, the U.S. Bankruptcy Court for the Central District of
California approved the sale of assets of OAN Services, Inc. ("OAN"), a Chapter
11 debtor and the primary billing agent of the Company. The Company and about 20
other customers received a portion of the proceeds. The sole objecting customer
appealed to the Bankruptcy Appellate Panel but it was dismissed as moot. In
December 2001, the Bankruptcy Court granted OAN's Summary Judgment Motion and
ruled against the objecting customer. In late August 2002, the United Stated
District Court reversed the summary judgment and remanded the case to the
Bankruptcy Court. The objecting customer has notified the other customers,
including the Company, that if it ultimately prevails, it intends to pursue
available claims against the bankruptcy estate and the customers receiving the
portion of the proceeds.

Condes v. Evercom Systems, Inc., et al. is an action filed against SBC
Communications, Pacific Bell Tel. Co. and Evercom Systems, Inc. in state court
in Alameda County, California in June 2002, alleging unfair trade practices
based on asserted billing of collect calls which were not accepted or
authorized, and requesting class action certification. T-NETIX was joined as a
defendant on March 11, 2003.

In January 2003 suit was filed against T-NETIX and various state
correctional officials in the District Court of Johnson County, Nebraska styled
Dukhan Iqraa Jihad Mumin, Vicky Marie Kitt v. T-NETIX Telephone Company, et al.
The suit, brought pro se by an inmate on behalf of himself and the other
plaintiffs, alleges violations of privacy, United States and Nebraska
constitutional and civil rights. The complaint includes a demand for
compensatory damages of $500,000 and a total of $3,000,000 in treble and
compensatory damages. A Motion to Dismiss for failure to state a claim on which
relief can be granted has been filed by the Company.

Richardson v. T-NETIX Telecommunications, Inc. and Colman v. Miller , et
al., are two civil actions filed pro se on February 6, 2003 by inmates with the
state Court of Common Pleas in Somerset County, Pennsylvania. These non-class
action complaints allege inaccurate billing for pre-paid services in one
Pennsylvania Prison location and request injunctive relief, unspecified
compensatory damages and $2,500 in punitive damages.

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

12

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 sale prices of our Common Stock, all as reported on the NASDAQ
Stock Market(SM) for the two most recent fiscal years.

As of February 28, 2003, we had approximately 139 record holders of our
common stock, and we estimate that as of that date there were 2,050 beneficial
owners of our stock.

The following table summarizes securities issuable and authorized by the
stockholders under certain equity compensation plans:

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, 2002. The selected
financial data has been derived from our audited consolidated financial
statements. The consolidated financial statements as of December 31, 2002 and
2001, and for each of the years in the three-year period ended December 31,
2002, are included elsewhere in this Form 10-K.

The financial results are not necessarily indicative of our future
operations or future financial results. The data presented below should be read
in conjunction with our consolidated financial statements and the notes thereto
and "Management's Discussion and Analysis of Financial Condition and Results of
Operations." Our consolidated financial statements as of and for the year ended
December 31, 2001, have been restated. For a further discussion of the
restatement, see "Management's Discussion and Analysis of Financial Condition
and Results of Operations--Restatement of Previously Issued Financial
Statements," and our audited consolidated financial statements and notes
thereto, including Note 11.

All periods reflect the operating results of our SpeakEZ voice verification
division as discontinued operations in the consolidated financial statements.
SpeakEZ assets were sold in July 2002 and the Company retained a license to use
the technology in its corrections business. See Note 5 of "Notes to Consolidated
Financial Statements".

14

All periods reflect the merger with Gateway Technologies, Inc., which was
accounted for as a pooling of interests, and our change in year-end reporting to
a calendar year (i.e. December 31) from a July 31 fiscal year basis in 1999. 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 year ended December 31, 1998 reflects the results of
operations of T-NETIX for the year ended July 31, 1998 combined with that of
Gateway for the year ended December 31, 1998. The Balance Sheet Data as of
December 31, 1998 reflects the financial position of T-NETIX combined with that
of Gateway as of December 31, 1998. See Note 3 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 "Forward Looking Statements and Risk Factors" and 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

RESTATEMENT OF PREVIOUSLY ISSUED 2001 FINANCIAL STATEMENTS

Subsequent to the issuance of our Annual Report for the year ended December
31, 2001, we determined that certain contract setup costs incurred by the
Company should have been charged to operating costs rather than reflected on the
balance sheet as property and equipment. Such contract setup costs were incurred
by the Company subsequent to new contract consummation primarily in connection
with providing orientation and training to correctional institution employees in
the proper use and maintenance of the Company's equipment and software installed
on the correctional institution premises. While these costs were valid, direct
contract setup costs incurred by the Company subsequent to contract signing and,
as such, were within the cost deferral guidelines set forth by generally
accepted accounting principals, the Company has determined that such costs did
not meet the recoverability criteria required to defer such costs and amortize
them over the life of the respective contract.

Under generally accepted accounting principles it is only appropriate to
defer direct contract acquisition and origination costs to the extent there are
contractually committed revenues or up-front non-refundable fees. The Company's
exclusive contracts with correctional facilities to provide telecommunication
services to inmates generally have a three to five year non-cancelable term, but
do not contain any specific provisions which require the correctional facilities
to make any payments or reimbursements to the Company. Also, these contracts do
not generally contain any guarantee provisions regarding the revenue levels to
be generated through the unilateral right granted by the correctional facilities
to the Company to provide telecommunication services to the inmate. Although the
Company believes that the net margin from each contract far exceeds the contract
setup costs capitalized, it does not meet the recoverability criteria required
to initially capitalize such costs at contract inception as there is no
contractually committed revenue stream to be received over the non-cancelable
term of the agreement.

As a result of changing our accounting treatment for certain contract setup
costs, the Company determined that its financial statements as of and for the
year ended December 31, 2001 should be restated. The effect of the restatement
is a $0.4 million increase to the previously reported net loss for the year
ended December 31, 2001, as a result of the additional operating costs. There is
no significant impact with using this new accounting treatment on the previously
reported financial results for the years ended prior to 2001 and for the first
three quarters of 2002. The adjustments to the previously reported 2001 net loss
relating to the restatement are summarized in the following table:

The following balance sheet accounts as of December 31, 2001 were affected
by the restatement:

The following presents the impact of the restatement on the operating
results and cash flows for the twelve months ended December 31, 2001:

The adjustments to the previously reported net income (loss) for the three
months ended March 31, June 30 and September 30, 2001 relating to the
restatement are summarized in the following table.

The following balance sheet accounts as of March 31, June 30 and September
30, 2001 were affected by the restatement:

The following presents the impact of the restatement on the operating
results and cash flows for the three months ended March 31, June 30 and
September 30, 2001 :

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 and we either share the revenue with or
receive a per call prescribed fee from 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 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 the Company receives the entire retail value of the collect
call. Due to commissions and other operating costs, including uncollectible
revenue, the gross margin percentage from this model are lower than our
telecommunication service arrangements.

16

After the initial term of the direct call provisioning contract, the
correctional facility may choose to renew the contract with the existing
provider or initiate a formal competitive bid process. The telecommunications
industry, particularly the inmate calling market, is and can be expected to
remain highly competitive. While the Company has historically maintained a high
rate of retention of existing inmate calling service contracts, the Company may
not be able to compete effectively with our current or future competitors for
these contracts, which would have a material adverse effect on our business,
operating results, and financial condition.

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.

In 2002, we derived substantially all of our revenues from the Corrections
Division. Total revenue in 2002 in the Corrections Division increased by
approximately $25.9 million from 2001, or an increase of 28%. This increase was
primarily due to the recent awarding of several department of corrections
contracts for which the Company is provisioning direct call processing services.
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 and associated revenue under this agreement had ceased due to the
expiration of this contract.

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

The Company formerly reported a third business segment, the SpeakEZ Voice
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. In August 2001, management of T-NETIX made the decision to curtail
operations of this portion of the Company in order to enhance overall Company
performance by reducing the negative impact of SpeakEZ operations on both the
net earnings and cash flow. SpeakEZ assets were sold in July 2002 and the
Company retained a license to use the technology in its corrections business.
This technology is currently utilized in our PIN-LOCK(R) product. Due to the
subsequent sale of the assets, related operating results of our SpeakEZ voice
verification division have been recorded as discontinued operations in the
consolidated financial statements. See Note 5 of "Notes to Consolidated
Financial Statements".

RESULTS OF OPERATIONS

17

CURRENT OPERATIONS

During 2002, we achieved a net income applicable to common shareholders of
$2.1 million, compared to a net loss applicable to common shareholders of $2.0
million in 2001. This improvement was due to a $3.2 million reduction in the
loss from discontinued operations and the $1.1 million accretion of discount on
preferred stock recorded in 2001. In August 2001, the Company formalized the
decision to offer for sale its voice verification business unit, which includes
the SpeakEZ voice verification products. Accordingly, related operating results
have been reported as discontinued operations. The decreased loss in
discontinued operations during 2002 resulted in a $1.7 million improvement in
operating results, a $0.3 million gain on the sale of the SpeakEZ assets in July
2002 combined with the 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 in 2001 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 in 2001 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.

RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 2002 AND 2001 (RESTATED):

The following table sets forth certain statement of operations data as a
percentage of total revenue for the years ended December 31, 2002 and 2001.

Total Revenue. Total revenue for 2002 was $119.8 million, an increase of
$2.0 million from $117.8 million for the corresponding 2001 period. This
increase was attributable to increases in direct provisioning of $21.9 million,
and equipment sales and other of $8.9 million,

18

offset partially by decreases in Internet services of $23.9 million and
telecommunications services of $4.9 million. The decline in revenues from the
Internet services segment was the result of the expiration of the Qwest
Agreement in 2001. Effective November 2001, all services of this single purpose
division had substantially ceased, including those under the Qwest Agreement.

Telecommunications services revenue decreased 8% to $57.5 million for the
twelve months ended December 31, 2002 from $62.4 million for the corresponding
prior period. This decrease was primarily due to a decline in call volumes and
the transition of certain department of corrections contract to a direct call
provisioning basis.

Direct call provisioning revenue increased 81% to $48.8 million for the
twelve months ended December 31, 2002 from $26.9 million in the corresponding
prior period. This increase was primarily due to the awarding in 2002 of several
department of corrections contracts for which the Company is providing call
processing services. The addition of these sites is a result of our being
successful in providing competitive bidding arrangements for contracts directly
with correctional facilities.

Equipment sales and other revenue increased 194% to $13.5 million for the
twelve month period ended December 31, 2002 from $4.6 million in the
corresponding prior period. This increase was largely attributable to increased
equipment sales of TELEQUIP Labs, Inc., an inmate equipment provider. Sales of
equipment at TELEQUIP are primarily associated with a single telecommunication
service provider and revenue associated with such sales are dependent upon the
timing of sales and installations for this customer. In addition, 2002 results
include other revenue of $3.7 million related to the finalization of certain
financial aspects associated with the Qwest Agreement.

Operating costs. Total operating costs increased 9% to $72.7 million for the
twelve months ended December 31, 2002 from $66.9 million in the corresponding
prior period. The increase was primarily due to an increase in direct call
provisioning expenses of $22.8 million and the cost of equipment sold of $2.6
million, offset partially by decreases in Internet services of $15.0 million and
telecommunication services of $4.5 million. The decline in operating costs for
the Internet services segment was the result of the expiration of the Qwest
Agreement in 2001. Effective November 2001, substantially all services of this
single purpose division had substantially ceased, including those under the
Qwest Agreement.

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 also 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, 2002 and 2001.

Operating costs associated with providing telecommunications services, as a
percentage of corresponding revenue, was 37% for the twelve months ended
December 31, 2002, a decrease from 41% for the comparable 2001 period. Total
telecommunications services operating costs were $21.2 million for the twelve
months ended December 31, 2002 and $25.8 million for the corresponding prior
period. The decrease in 2002 was primarily due to reductions in personnel costs
and lower contract labor, call validation fees, travel and communications
expenses, partially offset by increased repairs and maintenance costs.

Direct call provisioning costs, as a percentage of applicable revenue, were
96% of revenue for the twelve months ended December 31, 2002 compared to 89% in
the comparable 2001 period. Due to the awarding of several department of
corrections contracts, total direct call provisioning operating costs increased
to $46.8 million for the twelve months ended December 31, 2002 from $24.0
million for the corresponding 2001 period. This increase in costs as a
percentage of applicable revenue was due primarily to a proportional increase in
bad debt expense and commission expenses associated with the increase in direct
call provisioning revenue. Bad debt expense increased primarily due to a greater
volume of calls being processed to Competitive Local Exchange Carriers ("CLEC")

19

where the Company does not have billing arrangements. The Company, beginning in
the first quarter of 2002, modified its call handling processes to block certain
of these CLEC calls, thereby reducing its unbillable call volume.

Cost of equipment sold and other as a percentage of applicable revenue
decreased to 35% of revenue for the twelve months ended December 31, 2002 from
46% for the corresponding prior period. Due to increased equipment sales of
TELEQUIP Labs, Inc., total costs of equipment sold and other were $4.7 million
for the twelve months ended December 31, 2002 compared to $2.1 million for the
corresponding 2001 period. The decrease in costs as a percentage of applicable
revenue was primarily due to the favorable impact of the settlement of certain
claims and liabilities associated with the Qwest Agreement in 2002.

Selling, General and Administrative Expenses. Selling, general and
administrative expenses were $25.6 million and $25.0 million for the twelve
months ended December 31, 2002 and 2001, respectively. This increase was
primarily due to increases in personnel costs, professional services fees and
legal fees, offset partially by a deduction of an expense associated with the
2002 executive incentive compensation plan.

Research and Development Expenses. Research and development expenses were
$3.1 million in the twelve months ended December 31, 2002 compared to $4.5
million for the corresponding prior period. This decrease was primarily due to
reductions in personnel and contract labor expense in 2002, as compared to 2001
levels.

Depreciation and Amortization Expenses. Depreciation and amortization
expense was $12.1 million for the twelve months ended December 31, 2002, a
decrease from $13.0 million for the comparable 2001 period. Depreciation expense
increased to $10.9 million in the twelve months ended December 31, 2002 compared
to $10.8 million in 2001. Amortization expense declined to $1.2 million in the
twelve months ended December 31, 2002 versus $2.2 million for the corresponding
2001 period. This decrease in amortization expense was primarily due to the
impairment charge in 2001 related to the Contain(R) and Lock&Track(TM) jail
management system products and to the adoption of SFAS 142, "Goodwill and Other
Intangible Assets" in 2002.

Interest and Other Expense, net. Interest and other expense was $2.7 million
for the twelve months ended December 31, 2002 compared to $2.4 million for the
corresponding prior period. Interest expense was $2.4 million for the twelve
months ended December 31, 2002 and December 31, 2001, respectively, as lower
applicable interest rates and average indebtedness outstanding were offset by
fees associated with the extension of the Company's Credit Facility in April and
June 2002. The average debt balance decreased primarily due to the pay down of
debt as the result of improved operating results. Other expenses for the twelve
months ended December 30, 2002 included a $0.3 million loss related to the
writedown of investments.

Impairment of Telecommunications Assets. During 2002, the Company recorded a
$1.1 million impairment charge to an asset relating to a prepaid contract for
call validation query services that is currently in legal dispute. The
impairment charge does not change the Company's belief in its rights under the
disputed contract nor does it change the Company's position to pursue its
rights. In March 2003, the Company invested in another provider of similar
services that it anticipates will significantly reduce its costs of validation
services and uncollectable accounts. As such, the Company intends to assign its
rights to third parties under the terms of the disputed contract. The $1.1
million impairment charge reduces the carrying value of the asset to $0.9
million, which is the expected value to the realized through sale, net of any
selling expenses. For the year ended December 31, 2002, the prepaid validation
asset has been classified as an "Asset Held for Sale".

During 2001, the Company 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 were offered for several years, we experienced
limited commercial success with these products and revenues 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. The assets of
Lock&Track(TM) were sold in June 2002. While we will still offer the Contain(R)
product as part of our Corrections Division product line, the Company has
determined that it is not cost justified to invest additional capital or
operating funds in these products.

RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 2001 (RESTATED) 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.

20

Total Revenue. Total revenue in 2001 was $117.8 million, an increase of 14%
over $103.2 million for the corresponding 2000 period. This revenue increase was
attributable to increases in telecommunications services revenue 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 call provisioning revenue 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 pricing. 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 or 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 continued providing services under this agreement through October
2001. Effective November 2001, operations of this segment and associated
revenues 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 and expenses. Total operating costs and expenses increased
5% to $66.9 million for the twelve months ended December 31, 2001 from $63.5
million in the corresponding prior period. The increase was primarily due to
increases in telecommunication services of $4.3 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 $0.5 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 expense. Operating costs of telecommunications services also
includes costs associated with call validation procedures, primarily network

21

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, 2001 and 2000.

Operating costs and expenses associated with providing telecommunications
services as a percentage of corresponding revenue was 41% for the twelve months
ended December 31, 2001, from 42% for the corresponding prior period. Total
telecommunications services operating costs were $25.8 million for the twelve
months ended December 31, 2001 and $21.4 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% 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 $25.0 million for the twelve months ended December
31, 2001 compared to $19.2 million for the 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
$4.5 million in the twelve months ended December 31, 2001 compared to $4.9
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 were
offered for several years, we experienced limited commercial success with these
products and revenues 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. The assets of Lock&Track(TM) were sold in June 2002. While we will
still offer the Contain(R) product as part of our Corrections Division product
line, the Company has determined that it is not cost justified to invest
additional capital or operating funds in these products.

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, net. Interest and other expense was $2.4
million for the twelve months ended December 31, 2001, a decrease from $2.8
million in the comparable 2000 period. The decrease in 2001 was attributable to
a decrease in the average amount

22

of indebtedness outstanding. The average debt balance decreased primarily due to
the pay down of debt as the result of improved operating income.

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 was $11.2 million for 2002 compared
to $19.4 million in the corresponding 2001 period. This decrease was
primarily due to a $5.7 million increase in net working capital, combined with a
$2.7 million impairment charge in 2001 and a $0.9 million decline in
depreciation and amortization expense, offset partially by the $1.1 million
impairment charge in 2002. Cash provided by continuing operations increased by
253% to $19.4 million for 2001 from $5.5 million in 2000, primarily due to a
$0.9 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.

Net cash used in investing activity of continuing operations was $5.8
million, $7.4 million and $10.7 million in 2002, 2001 and 2000, respectively.
Cash used in investing activities consisted primarily of purchases of property
and equipment of $5.9 million in 2002 compared to $5.2 million in 2001 and $11.0
million in 2000. The decrease in 2002 and 2001 spending was the result of a
lower level of new calling system installations, as compared to 2000 levels,
offset partially by an increased level of upgrades to existing systems and
infrastructure. Cash used for acquisitions totaled $0.3 million in 2002 and $1.7
million in 2001. As part of the Company's on-going effort to dispose of
underperforming assets, we completed the sale of assets associated with our Lock
& Track(TM) jail management system product and the SpeakEZ voice verification
assets for $0.7 million during 2002. Cash used in investing activities in 2000
was partially offset by the sale of surplus equipment of $0.4 million.

We anticipate that our capital expenditures in 2003 will increase over 2002
levels based on our anticipated growth in installed systems at correctional
facilities. We believe our cash flows from operations and our availability under
our new 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.

Cash provided by financing activities of continuing operations in 2002 was
$0.4 million reflecting the proceeds of the New Credit Facility obtained in
November 2002 (see "Capital Resources"). Net proceeds of the New Credit Facility
were utilized to pay in full the Company's existing Credit Facility with its
commercial bank and its Subordinated Note Payable. Due primarily to repayments
on our credit facility, cash used in financing activities of continuing
operations in 2001 was $9.3 million. 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.

CAPITAL RESOURCES

In September 1999, the Company entered into a Senior Secured Revolving
Credit Facility ("Credit Facility") with a commercial bank for working capital
and general corporate purposes. The maximum available amount of credit under the
credit facility available was dependent upon certain financial covenants and our
financial performance. Based on these financial covenants, our maximum
borrowings at December 31, 2000 were $40 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. 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 were to continue through
November 2002, when the Company obtained new financing (see below). In April
2002, the Company obtained a commitment from the bank to extend this facility to
January 2003. The Credit Facility under this commitment required interest
payments, principal and borrowing base reductions and banking fees.

23

In April 2000, the Company 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.

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
"Subordinated Note Payable"). The note, repaid when the Company obtained new
financing (see below), bore interest at prime rate plus one percent per annum
payable every six months. The lender received warrants, 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
2002, at which time the lender received additional warrants, 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. Additional
warrants to purchase 18,223 shares of common stock at an exercise price of
$2.75, on the previous terms, were issued related to this extension.

In November 2002, the Company obtained new financing (the "New Credit
Facility). Net proceeds of this New Credit Facility were utilized to repay in
full the existing Credit Facility and the Subordinated Note Payable. The New
Credit Facility provides for maximum credit availability of $31.0 million,
subject to limitations based on certain financial covenants, and consists of a
$14.0 million Senior Secured Term Loan, a $9.0 million Senior Subordinated
Promissory Note and a Revolving Credit Facility with an availability of up to
$8.0 million.

The Senior Secured Term Loan bears interest at prime plus 4.0%, with 16
equal quarterly principal installment payments thorough December 2006. The
Senior Subordinated Promissory Note is due in 2008 and bears interest at a fixed
rate of 13%, payable on a quarterly basis, with an additional 4.75% interest
payable in kind. In addition, the lender received detachable stock purchase
warrants, which are immediately exercisable, to purchase 186,792 shares of
common stock at an exercise price of $0.01 per share. The expiration date of
these warrants is November 2010. Availability under the Revolving Credit
Facility is based on the lesser of up to 85% of eligible accounts receivable or
a calculated maximum leverage ratio. Interest on the Revolving Credit Facility
is set at prime plus 3.5% with a 0.75% annual commitment fee assessed on the
unused portion of this Facility.

The New Credit Facility is collateralized by substantially all of the
assets of the Company. Under the terms of the New Credit Facility, the Company
is required to maintain certain financial ratios and other financial covenants.
These ratios include a debt to four-quarter rolling earnings before interest,
taxes and depreciation and amortization (EBITDA) ratio, a ratio of EBITDA less
capital expenditures to fixed charges (interest, taxes and scheduled debt
service payments), and a minimum capitalization ratio. The Agreement also places
limits on the amount of additional indebtedness the Company can incur.

CONTRACTUAL OBLIGATIONS AND COMMITMENTS

Set forth below is a summary of the Company's material contractual
obligations and commitments as of December 31, 2002:

Under the Company's New Credit Facility, acceleration of principal payments
would occur upon payment default, violation of debt covenants or breach of
certain other conditions set forth in the New Credit Facility not cured within
15 days. At December 31, 2002, 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.)

24

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. As the Company did not have any significant business
acquisitions, the adoption of this statement did not 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 No. 142 is effective for fiscal years
beginning after December 15, 2001. SFAS No. 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 for impairment at least annually. The Company
adopted the provisions of SFAS No. 142 on January 1, 2002. The effect of
adoption was the cessation of amortization of goodwill recorded on previous
purchase business combinations. The Company reviewed the recorded goodwill for
impairment upon adoption of SFAS No. 142. To accomplish this, we identified the
reporting units and determined the carrying value of each reporting unit. The
Company defines its reporting unit to be the same as its reportable segment
(see note 6). To the extent a reporting unit's carrying amount exceeds its fair
value, the reporting unit's cost in excess of fair value of net assets acquired
may be impaired and we must perform the second step of the transitional
impairment test. In the second step, we must compare the implied fair value of
the reporting unit's fair value to all of its assets (recognized and
unrecognized) and liabilities in a manner similar to a purchase price allocation
in accordance with SFAS No. 141, to its carrying amount, both of which would be
measured as of January 1, 2002. Any transitional impairment loss is recognized
as the cumulative effect of a change in accounting principle in our statement of
operations. The Company completed its transitional impairment tests and
determined that no impairment losses for goodwill and other intangible assets
resulted with the adoption of SFAS No. 142. The Company expects that its
depreciation and amortization expense will decrease by approximately $0.8
million annually as a result of the adoption of SFAS No. 142. If amortization of
goodwill had not been recorded, the Company's net income and income per share
for the twelve months ended December 31, 2001 and 2000 would have been as
follows:

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

25

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 adoption of this statement had no material impact upon the Company's
financial position or results of operations.

In May 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements
No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical
Corrections." Under the provisions of SFAS No. 145, gains and losses from the
early extinguishment of debt are no longer classified as an extraordinary item,
net of income taxes, but are included in the determination of pretax earnings.
The effective date for SFAS No. 145 is for fiscal years beginning after May 15,
2002, with early application encouraged.

In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities." SFAS No. 146 addresses accounting and
reporting for costs associated with exit or disposal activities by requiring
that a liability for a cost associated with an exit or disposal activity be
recognized and measured at fair value only when the liability is incurred. SFAS
No. 146 also nullifies EITF Issue 94-3, "Liability Recognition for Certain
Employee Termination Benefits and Other Costs to Exit an Activity (including
Certain Costs Incurred in a Restructuring)." The provisions of SFAS No. 146 are
effective for exit or disposal activities that are initiated after December 31,
2002.

In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure, an amendment of FASB Statement No.
123." This Statement amends No. 123, "Accounting for Stock-Based Compensation,"
to provide alternative methods of transition for a voluntary change to the fair
value method of accounting for stock-based employee compensation. In addition,
this statement amends the disclosure requirements of SFAS 123 to require
prominent disclosures in both annual and interim financial statements. Certain
of the disclosure modifications are included in the notes to these consolidated
financial statements.

In November 2002, the FASB issued FASB Interpretation No. 45 ("FIN 45"),
"Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others." FIN 45 also requires that a
liability be recorded in the guarantor's balance sheet upon issuance of certain
guarantees. FIN 45 also requires disclosure about certain guarantees that an
entity has issued. The Company has implemented the disclosure requirements
required by FIN 45, which were effective for fiscal years ending after December
15, 2002. The Company will apply the recognition provisions of FIN 45
prospectively to guarantees issued after December 31, 2002. The Company does not
expect FIN 45 to have a material effect on its financial position or results of
operations.

In January 2003, FASB issued FASB Interpretation No. 46 ("FIN 46"),
"Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51."
FIN 46 requires certain variable interest entities to be consolidated by the
primary beneficiary of the entity if the equity investors in the entity does not
have the characteristics of a controlling financial interest or do not have
sufficient equity at risk for the entity to finance its activities without
additional subordinated financial support from other parties. FIN 46 is
effective for all new variable interest entities created or acquired after
January 31, 2003. For variable interest entities created or acquired prior to
February 1, 2003, the provisions of FIN 46 must be applied for the first interim
or annual period beginning after June 15, 2003. The Company does not expect FIN
46 to have a material effect on its financial position or results of operations.

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.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

We are exposed to interest rate risk as discussed below.

INTEREST RATE RISK

As of December 31, 2002, we have debt outstanding under our New Credit
Facility of $23.0 million. The New Credit Facility provides for maximum credit
availability of $31.0 million, subject to limitations based on certain financial
covenants, and consists of a $14.0 million Senior Secured Term Loan, a $9.0
million Senior Subordinated Promissory Note and a Revolving Credit Facility with

26

an availability of up to $8.0 million. The Senior Secured Term Loan and the
Revolving Credit Facility bear interest at prime plus 4% and 3.5%, respectively.
Since the interest rate on the Senior Secured Term Loan outstanding and the
Revolving Credit Facility 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 $0.1 million based on the amount of
borrowings outstanding under our New Credit Facility at December 31, 2002.

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.

27

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 May 28, 2003. 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 May 28, 2003. 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 May 28, 2003. 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 May 28, 2003. Such information is
incorporated herein by reference.

ITEM 14. CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures. The term "disclosure
controls and procedures" is defined in Rule 13a-14(c) of the Securities Exchange
Act of 1934, or the Exchange Act. This term refers to the controls and
procedures of a company that are designed to ensure that information required to
be disclosed by a company in the reports that it files under the Exchange Act is
recorded, processed, summarized and reported within required time periods. Out
Chief Executive Officer and our Chief Financial Officer have evaluated the
effectiveness of our disclosure controls and procedures as of a date within 90
days before the filing of this annual report, and they have concluded that as of
that date, our disclosure controls and procedures were effective at ensuring
that required information will be disclosed on a timely basis in our reports
filed under the Exchange Act.

Changes in Internal Controls. We maintain a system of internal controls
that are designed to provide reasonable assurance that our books and records
accurately reflect in all material respects our transactions and that our
established policies and procedures are followed. There were no significant
changes to our internal controls or in other factors that could significantly
affect our internal controls subsequent to the date of their evaluation by our
Chief Executive Office and our Chief Financial Officer, including any corrective
actions with regard to significant deficiencies and material weaknesses.

28

PART IV

ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K

1. FINANCIAL STATEMENTS:

2. FINANCIAL STATEMENT SCHEDULES:

3. REPORTS ON FORM 8-K

On November 27, 2002, T-NETIX filed a report on Form 8-K relating to the
appointment of Thomas Larkin as Vice Chairman, Richard Cree as Chief Executive
Officer, Peter Meitzner as President and Wayne Johnson as Executive Vice
President, Business and Corporate Development, as presented in a press release
of November 26, 2002.

4. EXHIBIT INDEX:

29

- ---------------

(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.

(11) Previously filed with the Commission as an exhibit to the Company's Annual
Report on Form 10-K for the fiscal year ended 2001.

(b) Reports on Form 8-K: On November 27, 2002, T-NETIX filed a report on
Form 8-K relating to the appointment of Thomas Larkin as Vice Chairman, Richard
Cree as Chief Executive Officer, Peter Meitzner as President and Wayne Johnson
as Executive Vice President, Business and Corporate Development, as presented in
a press release of November 26, 2002.

On March 28, 2003 T-NETIX filed a report as Form 8-K reporting its
financial results for the year and fourth quarter ended December 31, 2002 and
announced that it will restate its financial statements for the year ended
December 31, 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 March 31, 2003.

T-NETIX, INC.

By: /s/ Richard E. Cree
-----------------------
Richard E. Cree,
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

CERTIFICATION

I, Richard E. Cree, certify that:

1. I have reviewed this annual report on Form 10-K of T-NETIX, Inc.

2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this annual report;

3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of and for the periods presented in this annual report;

4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we
have:

a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this annual report
is being prepared;

b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date
of this annual report (the "Evaluation Date"); and

c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;

5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of the registrant's board of directors:

a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and

b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and

6. The registrant's other certifying officer and I have indicated in this
annual report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and
material weaknesses.

Dated: March 31, 2003
By: /s/ RICHARD E. CREE
-----------------------
Richard E. Cree
Chief Executive Officer

32

CERTIFICATION

I, Henry G. Schopfer III, certify that:

1. I have reviewed this annual report on Form 10-K of T-NETIX, Inc.

2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this annual report;

3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of and for the periods presented in this annual report;

4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we
have:

a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this annual report
is being prepared;

b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date
of this annual report (the "Evaluation Date"); and

c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;

5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of the registrant's board of directors:

a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and

b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and

6. The registrant's other certifying officer and I have indicated in this
annual report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and
material weaknesses.

Dated: March 31, 2003
By: /s/ HENRY G. SCHOPFER III
-------------------------
Henry G. Schopfer III
Chief Financial Officer

33

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, 2002 and 2001, 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, 2002. 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, 2002 and 2001, and the results of their
operations and their cash flows for each of the years in the three-year period
ended December 31, 2002, in conformity with accounting principles generally
accepted in the United States of America.

As discussed in Note 1 to the accompanying consolidated financial
statements, the Company adopted the provisions of Statement of Financial
Accounting Statements No. 142, "Goodwill and Other Intangible Assets" in 2002.

As discussed in Note 11 to the accompanying consolidated financial
statements, the Company has restated the consolidated balance sheet as of
December 31, 2001 and the related consolidated statements of operations,
stockholders' equity and cash flows for the year ended.

KPMG LLP

March 26, 2003
Dallas, Texas

34

T-NETIX, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

See accompanying notes to consolidated financial statements.

35

T-NETIX, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

See accompanying notes to consolidated financial statements.

36

T-NETIX, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY

See accompanying notes to consolidated financial statements.

37

T-NETIX, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOW

See accompanying notes to consolidated financial statements.

38

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

BASIS OF PRESENTATION

T-NETIX, Inc. and subsidiaries ("T-NETIX" or the "Company") was
incorporated in Colorado in 1986. The Company currently has a single reportable
segment: the Corrections Division. 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 Company formerly reported two additional business segments: the
Internet Service and SpeakEZ speaker verification divisions. Through its
Internet Service Division, the Company provided interLATA Internet services to
Qwest customers through a master service agreement, the "Qwest Agreement".
Effective November 2001, substantially all services and associated revenue under
this agreement ceased due to the expiration of this contract. In August 2001,
the Company formalized its decision to offer for sale its voice verification
business unit and made the decision to curtail operations. SpeakEZ assets were
sold in July 2002 and the Company retained a license to use the technology in
its corrections business. Pursuant to this strategy and due to the subsequent
sale of the assets, related operating results of our SpeakEZ voice verification
division have been recorded as discontinued operations in the consolidated
financial statements.

39

T-NETIX, INC. AND SUBSIDIARIES

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

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
adversely affect operating results of the Company.

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.

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 79% and 73% of total trade
accounts receivable at December 31, 2002 and 2001 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, 2002, 2001 and 2000, 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 3 to 10 years for
office equipment. No depreciation is recorded on construction in progress until
the asset is placed in service.

40

T-NETIX, INC. AND SUBSIDIARIES

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

GOODWILL, INTANGIBLE AND OTHER ASSETS

Goodwill is the excess of the purchase price over the fair value of
identifiable net assets acquired in business combinations accounted for as
purchases. Intangible and other assets include 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. The Company adopted Statement
of Financial Accounting Standards ("SFAS") No. 142, "Goodwill and Other
Intangible Assets" ("SFAS 142") on January 1, 2002. Goodwill and certain other
intangible assets having indefinite lives, which were previously amortized on a
straight-line basis over the periods benefited, are no longer being amortized to
earnings, but instead are subject to period testing for impairment. Intangible
assets determined to have definite lives are amortized over their remaining
useful lives and reviewed for impairment in accordance with the provision of
SFAS No. 144, Accounting for Impairment or Disposal of Long-Lived Assets.

The Company reviewed the recorded goodwill for impairment upon adoption of
SFAS No. 142. To accomplish this, we identified the reporting units and
determined the carrying value of each reporting unit. The Company defines its
reporting unit to be the same as the reportable segment (see Note 6). To the
extent a reporting unit's carrying amount exceeds its fair value, the reporting
unit's cost in excess of fair value of net assets acquired may be impaired and
the Company would be required to perform the second step of the transitional
impairment tests. The Company completed its transitional impairment test and
determined that the second step was not required for the reporting unit as the
fair value of this reporting unit exceeded its carrying value. The Company also
evaluated the fair value of its goodwill for impairment as of December 31, 2002.
No impairment was required as of such date as the fair value of the goodwill
exceeded its carrying value.

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 $1.2 million, $1.8
million and $0.9 million for the years ended December 31, 2002, 2001 and 2000,
respectively.

IMPAIRMENT OF LONG-LIVED ASSETS

The Company reviews its property and equipment, goodwill and other
intangible assets for impairment whenever events or changes in circumstances
indicate that the carrying amount may not be recoverable. In reviewing for
potential impairment, the Company compares the carrying value to such assets to
the estimated future cash flows expected to result from operations. 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, 2002, the Company recorded a $1.1
million impairment charge to an asset relating to a prepaid contract for call
validation query services that is currently in legal dispute (See Note 10 of
"Notes to Consolidated Financial Statements"). The impairment charge does not
change the Company's belief in its rights under the disputed contract nor does
it change the Company's position to pursue its rights. In March 2003, the
Company invested in another provider of similar services that it anticipates
will significantly reduce its costs of validation services and uncollectable
accounts (See Note 12 of "Notes to Consolidated Financial Statements"). As such,
the Company intends to assign its rights to third parties under the terms of the
disputed contract. The $1.1 million impairment charge reduces the carrying value
of the asset to $0.9 million, which is the expected value to the realized
through sale, net of any selling expenses. For the year ended December 31, 2002,
the prepaid validation asset has been classified as an "Asset Held for Sale".

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 were offered for several years, we experienced limited commercial
success and revenues 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. The assets of Lock&Track(TM) were sold in June 2002.

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. Revenue from 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.

41

T-NETIX, INC. AND SUBSIDIARIES

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

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 and plan expenses were $0.2 million, $0.2 million and $0.1 million
for the years ended December 31, 2002, 2001 and 2000.

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.

The following is a reconciliation of the numerators and denominators of the
basic and diluted earnings per share computations:

For the year ended December 31, 2002, common stock equivalents of 1,720,000
were not included in the diluted earnings per share calculation , as their
effect would be anti-dilutive. There is no difference between basic and diluted
net loss per common share for the years ended December 31, 2001 and 2000 since
potentially dilutive securities from the conversion of redeemable convertible
preferred stock and the exercises of options and warrants are anti-dilutive. The
calculations of diluted net loss per common share for the years ended December
31, 2001 and 2000 do not include 1,648,000 and 980,000 respectively, of
potentially dilutive securities, including common stock options and warrants and
redeemable convertible preferred stock.

STOCK COMPENSATION

The Company uses the intrinsic-value method as provided by Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" in
accounting for its stock option plans and provides pro forma disclosure of the
compensation expense determined under the fair value provisions of Statement of
Financial Accounting Standards ("SFAS") No. 123, "Accounting for Stock-Based
Compensation," as amended by SFAS No. 148, "Accounting for Stock-Based
Compensation-Transition and Disclosure." Accordingly, the Company did not
recognize compensation expense upon the issuance of its stock options because
the option terms were fixed and the exercise price equaled the market price of
the Company's common stock on the date of grant.

The following table displays the effect on net earnings and earnings per
share had the fair value method been applied during each period presented (in
thousands:

The per share weighted-average fair value of stock options issued by the
Company during 2002, 2001 and 2000 was $3.00, $1.92 and $3.47, respectively,
on the dates of grant using the Black-Scholes option-pricing model. The
following weighted-average assumptions were used to determine the fair value of
stock options granted:

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.

42

T-NETIX, INC. AND SUBSIDIARIES

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

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. As the Company did not have any significant business
acquisitions, the adoption of this statement did not 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 No. 142 is effective for fiscal years
beginning after December 15, 2001. SFAS No. 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 for impairment at least annually. The Company
adopted the provisions of SFAS No. 142 on January 1, 2002. The effect of
adoption was the cessation of amortization of goodwill recorded on previous
purchase business combinations. The Company reviewed the recorded goodwill for
impairment upon adoption of SFAS No. 142. To accomplish this, we identified the
reporting units and determined the carrying value of each reporting unit. The
Company defines its reporting unit to be the same as the reportable segment
(see Note 6). To the extent a reporting unit's carrying amount exceeds its fair
value, the reporting unit's cost in excess of fair value of net assets acquired
may be impaired and we must perform the second step of the transitional
impairment test. In the second step, we must compare the implied fair value of
the reporting unit's fair value to all of its assets (recognized and
unrecognized) and liabilities in a manner similar to a purchase price allocation
in accordance with SFAS No. 141, to its carrying amount, both of which would be
measured as of January 1, 2002. Any transitional impairment loss is recognized
as the cumulative effect of a change in accounting principle in our statement of
operations.

The Company completed its transitional impairment tests and determined that
no impairment losses for goodwill and other intangible assets resulted with the
adoption of SFAS No. 142. The Company expects that its depreciation and
amortization expense will decrease by approximately $0.8 million annually as a
result of the adoption of SFAS No. 142. If amortization of goodwill had not been
recorded and if amortization of other intangible assets had been recorded using
the revised life, the Company's net loss and loss per share for the twelve
months ended December 31, 2001 and 2000 would have been as follows:

Bad debt expense was $13.5 million, $7.5 million, and $3.2 million for the
years ended December 31, 2002, 2001 and 2000, respectively.

Property and equipment consist of the following:

Intangible and other assets consist of the following:

Amortization expense related to intangible and other assets was $1.2
million, $1.8 million and $0.9 million for the years ended December 31, 2002,
2001 and 2000, respectively. Estimated amortization expense related to
intangible and other assets at December 31, 2002 for each of the years in the
five year period ended December 31, 2007 and thereafter is:

Year ending December 31:
2003............................. $ 1,370
2004............................. 1,314
2005............................. 1,087
2006............................. 924
2007............................. 618

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

45

T-NETIX, INC. AND SUBSIDIARIES

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

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.

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 as a patent license rights with an estimated
useful life of 10 years, the remaining term of the underlying patent.

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, or $0.1
million, was paid in 2002 based upon the terms of the purchase agreement
regarding certain seller representations and warranties. The excess of the
purchase price over the fair value of the net identifiable assets acquired has
been recorded as goodwill. 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.

ACT TELECOM, INC.

In June 2002, the Company purchased substantially all of the assets of ACT
Telecom, Inc., a Houston, Texas based prepaid calling platform provider and
wholly-owned subsidiary of ClearMediaOne, Inc. Assets included a
telecommunication switch, prepaid calling platform and associated software. The
purchase price was approximately $0.7 million, including $0.3 million in cash
and the issuance of a $0.4 million note due and payable on or before June 2003.
The purchase price was allocated to property and equipment ($0.6 million) and
intangibles and other assets ($0.1 million).

(4) DEBT

Debt consists of the following:

Future debt maturities for each of the next five years are summarized as
follows:

Year ending December 31:
2003............................. $ 3,500
2004............................. 3,500
2005............................. 3,500
2006............................. 3,500
2007............................. --
-------
Total debt maturities.... $14,000
=======

In September 1999, the Company entered into a Senior Secured Revolving
Credit Facility (the "Credit Facility") with its commercial bank. The Credit
Facility provided for maximum credit of $40 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. In addition,
monthly payments of $0.2 million on the term loan commenced in April 2001. In
March 2002, the maturity date of the 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 were set to continue through the maturity date. In April 2002,
the Company obtained a commitment from the bank to extend this facility to
January 2003. The Credit Facility under this commitment requires interest
payments, principal and borrowing base reductions and banking fees.

46

T-NETIX, INC. AND SUBSIDIARIES

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

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
"Subordinated Note Payable"). The note, repaid when the Company obtained new
financing (see below), bore interest at prime rate plus one percent every six
months. The lender received warrants, 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 2002 at
which time the lender received additional warrants, 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 2002.
In April 2002 this note was extended to February 2003 to facilitate the
refinancing of our overall financing structure. Additional warrants to purchase
18,223 shares of common stock at an exercise price of $2.75, on the previous
terms, have been issued related to this extension. The estimated fair value of
the stock purchase warrants, calculated using the Black-Scholes model, was
recorded as deferred financing fees and amortized over the term of the debt.

In November 2002, the Company obtained new financing (the "New Credit
Facility). Net proceeds of this New Credit Facility were utilized to repay in
full the existing Credit Facility and the Subordinated Note Payable. The New
Credit Facility provides for maximum credit availability of $31.0 million,
subject to limitations based on certain financial covenants, and consists of a
$14.0 million Senior Secured Term Loan, a $9.0 million Senior Subordinated
Promissory Note and a Revolving Credit Facility with an availability of up to
$8.0 million.

The Senior Secured Term Loan bears interest at prime plus 4.0%, with 16
equal quarterly principal installment payments thorough December 2006. Due in
2008, the Senior Subordinated Promissory Note bears interest at a fixed rate of
13%, payable on a quarterly basis, with an additional 4.75% of interest payable
in kind. In addition, the lender received detachable stock purchase warrants,
which are immediately exercisable, to purchase 186,792 shares of common stock at
an exercise price of $0.01 per share. The expiration date of these warrants is
November 2010. The estimated fair value of the stock purchase warrants,
calculated using the Black-Scholes model, was recorded as a debt discount and is
being amortized over the term of the Senior Subordinated Promissory Note.
Availability under the Revolving Credit Facility is based on the lesser of
eligible accounts receivable or a calculated maximum leverage ratio. Interest on
the Revolving Credit Facility is set at prime plus 3.5% with a 0.75% annual
commitment fee assessed on the unused portion of this Facility.

The New Credit Facility is collateralized by substantially all of the
assets of the Company. Under the terms of the New Credit Facility, the Company
is required to maintain certain financial ratios and other financial covenants.
These ratios include a debt to four-quarter rolling earnings before interest,
taxes and depreciation and amortization (EBITDA) ratio, a ratio of EBITDA less
capital expenditures to fixed charges (interest, taxes and scheduled debt
service payments), and a minimum capitalization ratio. The Agreement also places
limits on the amount of additional indebtedness the Company can incur.

(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 voice verification
products. 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.
SpeakEZ revenues have been insignificant to date and operations were
substantially curtailed in November 2001. Accordingly, related operating results
have been reported as discontinued operations. 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. As of December
31, 2001, the Company had not sold the SpeakEZ voice verification assets. For
this reason, a one-time charge of $1.1 million, net of taxes, was recognized 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

47

T-NETIX, INC. AND SUBSIDIARIES

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

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.

In July 2002, the Company completed the sale of the SpeakEZ voice
verification assets to SpeechWorks International, Inc. ("SpeechWorks") for $0.4
million cash and approximately 130,000 shares of SpeechWorks common stock valued
at $0.3 million, subject to a 10% escrow provision and recognized a gain on the
sale of discontinued operations of $0.3 million. In addition, SpeechWorks will
pay the Company an earn-out fee based on the sale over the next two years of
future SpeechWorks products incorporating the SpeakEZ technology. Payment of the
earn-out fee, if any, will be made through the issuance of additional shares of
SpeechWorks common stock. As part of the sales agreement, the Company retained
the right to utilize the speech recognition technology in the corrections
industry. SpeechWorks stock received by the Company will not be registered.

(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.

In 2002, the Company has a single reportable segment: the Corrections
Division. Through its Corrections Division, the Company provides inmate
telecommunication products and services for correctional facilities, including
security enhanced call processing, call validation and billing services for
inmate calling. Depending upon the contractual relationship at the site and the
type of customer, the Company provides these products and services through
service agreements with other telecommunications service providers, including
Verizon, AT&T, SBC Communications, Sprint and Qwest and through direct contracts
between the Company and correctional facilities. In addition, primarily through
its subsidiary TELEQUIP Labs, the Company sells inmate call processing systems
to certain telecommunication providers.

Formerly, the Company reported two additional business segments: the
Internet Services and SpeakEZ Voice Verification divisions. Through its Internet
Service Division, the Company provided interLATA Internet services to Qwest
customers through a master service agreement, the "Qwest Agreement". Effective
November 2001, substantially all services and associated revenue under this
agreement ceased due to the expiration of this contract. 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. In August 2001, the Company formalized its decision to
offer for sale its voice print business unit, which included the SpeakEZ speaker
verification products. Accordingly, related operating results of this business
unit have been reported as discontinued operations in the consolidated financial
statements. Segment reporting has been conformed to correspond to the current
presentation. As described in Note 5 of "Notes to Consolidated Financial
Statements," the Company completed the sale of SpeakEZ assets in July 2002.

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 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 ended
December 31, 2002, 2001 and 2000 is as follows:

48

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, 2002,
2001 and 2000 is as follows:

Substantially all revenue reported by our Internet Services Division for
the years ended December 31, 2001 and 2000 was attributable to our GSP agreement
with Qwest which expired in November 2001. There were no intersegment revenue
for the years ended December 31, 2002, 2001 and 2000. Consolidated total assets
included eliminations of approximately $0.7 million as of December 31, 2002.
Eliminations consist of intercompany receivables in the Corrections Division and
intercompany payables in the TELEQUIP Labs subsidiary related solely to
intercompany borrowings.

49

T-NETIX, INC. AND SUBSIDIARIES

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

(7) INCOME TAXES

Income tax expense for the years ended December 31, 2002, 2001 and 2000 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, 2002, 2001 and 2000 due to the following:

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, 2002 and 2001 are presented below:

At December 31, 2002, the Company had net operating loss carry forwards for
tax purposes aggregating approximately $15.7 million which, if not utilized to
reduce taxable income in future periods, expire at various dates through the
year 2020. Approximately $1.2 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
calculated deferred tax liability, deferred tax asset, and the related valuation
of net operating loss carryforward for the taxable temporary differences. The
valuation allowance represents excess deferred tax asset for the net operating
loss carryforward over net deferred tax liability. The Company has offset a
portion of its deferred tax 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.

50

T-NETIX, INC. AND SUBSIDIARIES

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

(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 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, 2002, is as follows:

The range of exercise prices for common stock options outstanding and
options exercisable at December 31, 2002 is as follows:

51

T-NETIX, INC. AND SUBSIDIARIES

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

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 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 $1.1 million was recognized as a
charge to income (loss) applicable to common stockholders.

In November 2002, the Company obtained new financing including a $9.0
million Senior Subordinated Promissory Note, due in 2008. Subject to the
issuance of this note, the lender received detachable stock purchase warrants,
which are immediately exercisable, to purchase 186,792 shares of common stock at
an exercise price of $0.01 per share. The estimated fair value of the stock
purchase warrants, calculated using the Black-Scholes model, was recorded as a
debt discount and is being amortized over the term of the Senior Subordinated
Promissory Note. The expiration date of these warrants is November 2010.

52

T-NETIX, INC. AND SUBSIDIARIES

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

(9) QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)

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 and certain office equipment 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, 2002, 2001 and 2000 was approximately $1.0 million,
$1.1 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:
2003................................... $1,065
2004................................... 755
2005................................... 341
2006................................... 98
2007................................... 4
-
Total minimum lease payments... $2,263
======

53

T-NETIX, INC. AND SUBSIDIARIES

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

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, a case styled Valdez v. State of New Mexico, et al. against
Gateway and several other defendants was dismissed. The complaint, generally
alleging violations of state unfair practices, antitrust and constitutional
laws, included class action certification of all persons who had been billed for
and paid for telephone calls initiated by an inmate confined in a New Mexico
correctional facility. On appeal by plaintiffs, in August 2002 the New Mexico
State Supreme Court affirmed the District Court's dismissal of the plaintiffs'
case.

T-NETIX is a defendant in a state case brought in June, 2000 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 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, in October 1997, 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 in January, 2001 alleging constitutional violations, RICO Act
violations and violations of Federal wiretapping laws. This case was dismissed
on all counts in November 2001 and plaintiffs appealed. The dismissal was
affirmed by the Fourth Circuit in July 2002.

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, was dismissed by the Plaintiffs in July
2002.

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 discovery stages. In July 2002, MCI WorldCom, Inc. filed a Chapter XI
bankruptcy proceeding that automatically stayed any further proceeding against
them. On August 7, 2002, T-NETIX subsequently filed its motion to sever MCI
WorldCom from the patent litigation, which motion was granted on February 13,
2003.

Since September 1997 and through October 2001, pursuant to a written
agreement entered into in connection with a settlement of an arbitration
proceeding, the Company was 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 services to be provided by
Illuminet, Inc. under the contract were in the nature of the transport of
queried by Illuminet to a certain database maintained by and available to
Illuminet. In order to utilize such transport the queries were to be directed
from the Company for connection to Illuminet utilizing certain

54

T-NETIX, INC. AND SUBSIDIARIES

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

technologies. Attempts were continually made by the Company over the time period
to complete connectivity but connectivity was never accomplished. In November
2001, Illuminet notified the Company 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's breach and
declaratory relief that no credits are due T-NETIX. The Company has made
payments totaling approximately $2.1 million pursuant to this written agreement.
The payments (the value of which has been written down for the period ended
December 31, 2002) are classified as an "Asset Held for Sale" at December 31,
2002 and as a long-term prepayment included in Intangible and Other Assets at
December 31, 2001 (See Note 2 of "Notes to Consolidated Financial Statements").
It is the contention of the Company, in the arbitration proceeding, that the
fault in the lack of connectivity, be it the lack of proper technology, proper
responsiveness on the part of Illuminet, or otherwise, was that of Illuminet and
that the Company is still entitled to the services for which it paid. 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 balance of the prepaid expense could be impaired. It is anticipated that the
arbitration hearing previously scheduled for December 6, 2002 will now be
scheduled during the month of July or August 2003.

In August 2001, the U.S. Bankruptcy Court for the Central District of
California approved the sale of assets of OAN Services, Inc. ("OAN"), a Chapter
11 debtor and the primary billing agent of the Company. The Company and about 20
other customers received a portion of the proceeds. The sole objecting customer
appealed to the Bankruptcy Appellate Panel but it was dismissed as moot. In
December 2001, the Bankruptcy Court granted OAN's Summary Judgment Motion and
ruled against the objecting customer. In late August 2002, the United Stated
District Court reversed the summary judgment and remanded the case to the
Bankruptcy Court. The objecting customer has notified the other customers,
including the Company, that if it ultimately prevails, it intends to pursue
available claims against the bankruptcy estate and the customers receiving the
portion of the proceeds.

Condes v. Evercom Systems, Inc., et al. is an action filed against SBC
Communications, Pacific Bell Tel. Co. and Evercom Systems, Inc. in state court
in Alameda County, California in June 2002, alleging unfair trade practices
based on asserted billing of collect calls which were not accepted or
authorized, and requesting class action certification. T-NETIX was joined as a
defendant on March 11, 2003.

In January 2003 suit was filed against T-NETIX and various state
correctional officials in the District Court of Johnson County, Nebraska styled
Dukhan Iqraa Jihad Mumin, Vicky Marie Kitt v. T-NETIX Telephone Company, et al.
The suit, brought pro se by an inmate on behalf of himself and the other
plaintiffs, alleges violations of privacy, United States and Nebraska
constitutional and civil rights. The complaint includes a demand for
compensatory damages of $500,000 and a total of $3,000,000 in treble and
compensatory damages. A Motion to Dismiss for failure to state a claim on which
relief can be granted has been filed by the Company.

Richardson v. T-NETIX Telecommunications, Inc. and Colman v. Miller, et
al., are two civil actions filed prose on February 6, 2003 by inmates with the
state Court of Common Pleas in Somerset County, Pennsylvania. These non-class
action complaints allege inaccurate billing for pre-paid services in one
Pennsylvania Prison location and request injunctive relief, unspecified
compensatory damages and $2,500 in punitive damages.

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

(11) RESTATEMENT OF PREVIOUSLY ISSUED 2001 FINANCIAL STATEMENTS

Subsequent to the issuance of our Annual Report for the year ended December
31, 2001, we determined that certain contract setup costs incurred by the
Company should have been charged to operating costs rather than reflected on the
balance sheet as property and equipment. Such contract setup costs were incurred
by the Company subsequent to new contract consummation primarily in connection
with providing orientation and training to correctional institution employees in
the proper use and maintenance of the Company's equipment and software installed
on the correctional institution premises. While these costs were valid, direct
contract setup costs incurred by the Company subsequent to contract signing and,
as such, were within the cost deferral guidelines set forth by generally
accepted accounting principals, the Company has determined that such costs did
not meet the recoverability criteria required to defer such costs and amortize
them over the life of the respective contract.

Under generally accepted accounting principles it is only appropriate
to defer direct contract acquisition and origination costs to the extent there
are contractually committed revenues or up-front non-refundable fees. The
Company's exclusive contracts with correctional facilities to provide
telecommunication services to inmates generally have a three to five year
non-cancelable term, but do not contain any specific provisions which require
the correctional facilities to make any payments or reimbursements to the
Company. Also, these contracts do not generally contain any guarantee provisions
regarding the revenue levels to be generated through the unilateral right
granted by the correctional facilities to the Company to provide
telecommunication services to the inmate. Although the Company believes that the
net margin from each contract far exceeds the contract setup costs capitalized,
it does not meet the recoverability criteria required to initially capitalize
such costs at contract inception as there is no contractually committed revenue
stream to be received over the non-cancelable term of the agreement.

As a result of changing our accounting treatment for certain contract setup
costs, the Company determined that its financial statements as of and for the
year ended December 31, 2001 should be restated. The effect of the restatement
is a $0.4 million increase to the previously reported net loss for the year
ended December 31, 2001, as a result of the additional operating costs. There is
no significant impact with using this new accounting treatment on the previously
reported financial results for years ended prior to 2001 and for the first three
quarters of 2002. The adjustments to the previously reported 2001 net loss
relating to the restatement are summarized in the following table:

The following balance sheet accounts as of December 31, 2001 were affected
by the restatement:

The following presents the impact of the restatement on the operating
results and cash flows for the twelve months ended December 31, 2001:

(12) SUBSEQUENT EVENTS

In March 2003 the Company completed an investment in a newly formed company,
Accudata Technologies, Inc. The Company acquired a 50% preferred stock
interest, combined with the right to elect a majority of the Board of
Directors. Of the $0.6 million invested in Accudata, $0.5 million went to the
purchase out of a Chapter XI bankruptcy proceeding of substantially all of the
assets (in essence the ongoing business) of Revenue Communications, Inc. With
such purchase, Accudata became one of only twelve active telephone line
information databases ("LIDB") in the United States where important customer
information is stored and maintained, including telephone number, service
provider and collect call preferences. The acquisition of Accudata will allow
the Company cost effective, flexible, high-speed access to a centralized LIDB
through sophisticated SS7 transport technology and considerably enhances our
capacity to utilize new technology for controlling bad debt and unbillables.

55

INDEPENDENT AUDITORS' REPORT ON SCHEDULE

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

Under the date of March 26, 2003, we reported on the consolidated balance
sheets of T-NETIX, Inc. and subsidiaries as of December 31, 2002 and 2001, 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,
2002. Our report dated March 26, 2003 contains an explanatory note that refers
to a restatement of the consolidated financial statements as of December 31,
2001 and for the year then ended. Our report also refers to a change in the
Company's method of accounting for intangibles. 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 31, 2003

56

SCHEDULE II

T-NETIX, INC. AND SUBSIDIARIES

VALUATION AND QUALIFYING ACCOUNTS
YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000

57

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.

(11) Previously filed with the Commission as an exhibit to the Company's Annual
Report on Form 10-K for the fiscal year ended 2001.