Back to GetFilings.com

SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-K

Commission file number 000-29335

WITNESS SYSTEMS, INC.
(Exact Name of Registrant as Specified in Its Charter)

770-754-1900
(Registrant's telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to Section 12(g) of the Act:

        Indicate by check mark whether the registrant (1) has filed all reports required 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 ý    No o

        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 the 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. o

        Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). Yes o    No ý

        At February 28, 2003, the registrant had 21,881,536 shares of common stock, par value $.01 per share, outstanding, and the aggregate market value of the outstanding shares of voting stock held by non-affiliates of the registrant on such date was approximately $32.8 million based on the closing price of $3.09 per share of such common stock on such date.

DOCUMENTS INCORPORATED BY REFERENCE

        Portions of the registrant's definitive proxy statement for its annual meeting of stockholders, currently scheduled for May 29, 2003, are incorporated by reference in Part III of this report.

PART I

Item 1.    Business

        This annual report on Form 10-K contains forward-looking statements that are not historical facts but rather are based on current expectations, estimates and projections about our business and industry, our beliefs and assumptions. Words such as "anticipates", "expects", "intends", "plans", "believes", "seeks", "estimates" and variations of these words and similar expressions are intended to identify forward-looking statements. These statements are not guarantees of future performance and are subject to risks, uncertainties and other factors, some of which are beyond our control, are difficult to predict and could cause actual results to differ materially from those expressed or forecasted in the forward-looking statements. Forward-looking statements that were true at the time made may ultimately prove to be incorrect or false. Readers are cautioned not to place undue reliance on forward-looking statements, which reflect our management's view only as of the date of this report. Except as required by law, we undertake no obligation to update any forward-looking statement, whether as a result of new information, future events or otherwise.

        The following should be read in conjunction with Management's Discussion and Analysis of Financial Condition and Results of Operations and the Consolidated Financial Statements and Notes thereto included elsewhere in this report. Investors should carefully review the information contained in this report under the caption "Factors That May Affect Our Future Results and Market Price of Our Stock" beginning on page 28.

Overview

        We provide the contact center market an integrated performance optimization software suite that enables global enterprises to capture customer intelligence and optimize workforce performance. Our solution is comprised of business-driven multimedia recording, performance analysis and e-learning management applications that are designed to enhance the quality of customer interactions across multiple communications media, including the telephone, e-mail and the Internet. Our enterprise collaboration architecture allows contact center management to share information gathered in the contact center with departments that touch the customer, as well as executives throughout the organization. The result is a proactive management tool for optimizing their customer relationship management ("CRM"), improving communication among departments, fine-tuning workflow, processes and quality of service from within the contact center and throughout the enterprise. As a result, we believe our customers are able to generate additional revenue opportunities, improve profitability, enhance customer retention, reduce employee turnover and improve their overall customer service.

        Our eQuality® software suite is designed to enable customer contact centers within a company to capture, evaluate and analyze complete customer interactions through multiple media, such as telephone, e-mail and the Internet, identify performance gaps and then apply targeted electronic learning for continuous performance improvement. The eQuality software records a customer sales/service representative's ("CSR"s) voice interactions with a customer as well as the CSR's corresponding computer desktop activities, such as data entry, screen navigation and data retrieval. By capturing both voice and computer desktop activity and synchronizing them during replay, a company can observe and analyze complete customer interactions as they actually occurred. Supporting the need for Web-based customer interactions driven by the growth of the Internet and e-commerce, the eQuality software suite also enables companies to capture, evaluate and analyze e-mail, Web interactions and guided browser sessions. In addition, the eQuality software suite allows companies to selectively capture, evaluate and analyze customer interactions on any of these mediums based on business criteria that they define, such as key customers, important marketing campaigns and new product introductions.

2

        We currently provide software to an extensive base of large companies with multiple contact centers, including American Airlines, AT&T, Compaq Computer Corporation, Continental Airlines, EDS, Federal Express, Pitney Bowes, Starwood Hotels & Resorts Worldwide, Target Corporation, Verizon, Visa, Wells Fargo Bank and Xerox Corporation. As of December 31, 2002, we had licensed our software to 418 customers at 1,177 sites.

Industry Background

        Developing and maintaining long-term customer relationships is critical to the success of a business operating in the competitive global marketplace. The rapid growth of the Internet and e-commerce has increased the importance companies place on their customer relationships. Because the Internet enables consumers to easily evaluate products and prices from a wide range of geographically dispersed vendors and quickly change vendors at relatively low cost, it is becoming more difficult for businesses to develop long-term relationships with their customers. As the use of the Internet expands as a business platform, the need for personal contact is essential to enabling a higher quality customer experience. The integration and optimization of customer contacts across all channels of communication is becoming both a strategic and tactical business requirement. In response to these trends, companies adopted CRM initiatives to increase the longevity and profitability of their customer relationships, and developed software applications to automate and evaluate key sales, marketing and customer service processes and improve the effectiveness of their customer interactions. According to AMR Research, CRM remains one of the highest spending priorities in the near-term.

        Historically, the focus of CRM applications has been on improving the companies' internal sales, marketing and customer service processes. Competitive pressures resulting from the emergence of the Internet and e-commerce have required companies to shift the focus of their CRM initiatives from improving their internal operations to meeting the needs of their customers. Companies are developing a new set of business principles that place a greater value on improving customer satisfaction and enhancing employee skills to foster customer relationships and increase customer intimacy. We believe that companies, with a better understanding of the characteristics and preferences of their customers, will be able to customize product and service offerings more effectively, which can result in increased customer retention. In addition, these companies will be able to better identify opportunities to sell complementary or higher-end products and to more accurately forecast customer demand.

        To understand and improve customer relationships, a company must first improve its specific business processes that involve a high degree of direct customer interaction. Today, many of a company's direct customer interactions occur through call centers. These call centers are generally staffed by telephone operators, often referred to as CSRs, who process a steady flow of outbound or inbound telephone calls relating to the company's products and services. Call centers generally consist of supervisor and agent workstations linked to a central telephone switch and a common computer system. Companies have increased their focus on developing and improving the efficiency of their call center operations.

        Historically, call centers have had the ability to handle only telephone and other voice interactions. These call centers have generally focused on either conducting outbound calls, for functions such as collections and product sales, or on managing inbound calls, for purposes such as product support, order processing or customer service. The growth of the Internet and the increased focus of businesses on optimizing customer relationships have contributed to the evolution of traditional single-function, telephone-based call centers into multi-functional, multi-channel customer interaction centers, or contact centers. The emergence of multi-channel customer contact centers has generally increased the volume and complexity of tasks that CSRs are required to perform. As a result, traditional single-function CSRs must now assume more valuable, multi-function customer service responsibilities. CSRs are now required to handle multiple tasks effectively that involve interaction across a growing number of customer touch points, including telephone, e-mail and the Web. Survey results from the Yankee Group indicate that companies still consider the deployment of Web-based self-service options a crucial priority in their future customer care plans.

3

        A number of applications have emerged to attempt to address the need to better manage these interactions. However, we believe that most solutions currently available do not adequately address the importance of optimizing customer interactions through recording at the point of contact, evaluating the complete customer interaction, analyzing the CSR's performance, and applying organizational learning through an integrated electronic learning management software solution. For example, without an integrated electronic learning solution, other programs cannot effectively train and develop the CSRs who serve a company's customers. As a result, we believe that there is a significant opportunity in the marketplace for a comprehensive, integrated multimedia solution, which optimizes a company's customer interactions.

The eQuality Solution

        We provide business-driven multimedia recording, performance analysis and e-learning management applications that are designed to enhance the quality of customer interactions across multiple communications media. As a result, we believe our customers are able to generate additional revenue opportunities, improve profitability, reduce employee turnover, enhance customer retention and improve overall customer satisfaction. We believe our eQuality suite of software and services provide the following key business benefits:

•

Increases revenue opportunities.    The eQuality solution enables companies to analyze complete customer interactions, incorporating data from their existing databases and systems. As a result, companies are able to customize their sales and marketing efforts to individual customer preferences or tendencies, improve the selling techniques of their CSRs and sell additional complementary or higher-end products and services to their existing customers. Consequently, we believe companies deploying our solution can generate additional revenue opportunities.



•

Improves profitability.    The eQuality solution improves the overall quality of companies' interactions with their customers, which reduces the costs associated with customer turnover. By providing CSRs with better training, companies can improve the efficiency of CSRs by reducing their average "talk time," which results in decreased telephone charges and reduced total number of CSRs needed to handle the same volume of customer interactions. As a result, we believe companies are able to improve profitability by deploying the eQuality solution to reduce customer turnover and CSR costs.



•

Reduces employee turnover.    The eQuality solution enables the evaluation and analysis of an individual CSR's performance, which companies can use to customize incentives for rewarding CSRs. We believe these customized incentives, together with effective feedback and training, leads to increased CSR job satisfaction, retention of high quality CSRs and reduced costs related to CSR turnover. According to Giga Information Group, the contact center average turnover rate ranges from 20% to 30% annually, and the costs to recruit, interview and train new CSRs are often as high as $10,000 per agent, depending on the level of skills required.



•

Enhances customer retention.    The eQuality solution helps companies to develop more intimate knowledge of their customers, which should improve the overall quality of products and services being delivered to customers. We believe that the growth in the Internet and e-commerce will increase the importance customers place on high-quality and consistent customer service. It is imperative that companies retain these costly new customers to capitalize on their investment. As a result, we believe that companies who deliver excellent service to their customers will develop longer-term, more profitable customer relationships.

4

        We believe that we are able to provide these key business benefits through the innovative features of our eQuality solution, which include the following:

•

Enables synchronized replay of voice and computer desktop data.    The eQuality software records a CSR's voice interaction with a customer, as well as the CSR's corresponding computer desktop activities, such as data entry, screen navigation and data retrieval. By capturing both voice and computer desktop activity and synchronizing them during replay, companies can observe and analyze complete customer interactions as they actually occurred. This enables companies not only to evaluate the behavior of their CSRs, but also to determine whether the necessary technology resources for customer support are readily available to them and whether they are making effective and efficient use of available technology resources.



•

Captures customer interactions across multiple communications media.    The eQuality software captures customer interactions from a variety of communications media, including telephone, e-mail and the Internet. This multimedia capability allows companies to deliver consistent, high quality customer service regardless of the communication channel.



•

Records based on company-selected criteria.    Companies using the eQuality software can record customer interactions based on selected criteria, which we refer to as business-driven recording. This enables companies to define specific business criteria to trigger recording and analysis of information, such as key customers, important marketing campaigns, new product introductions and selected CSRs. Further, companies can define critical business events to trigger the capture of the interaction, such as customer problems that have reached a certain severity level. Companies can then use this information to quickly evaluate the performance of targeted business initiatives and to adjust those initiatives for higher market impact.



•

Enables information obtained in the contact center to be shared across the enterprise.    The eQuality enterprise collaboration recording architecture enables contact center management to share interactions from the contact center with departments that touch the customer, as well as executives throughout the organization, by notifying them when a business-critical customer event occurs. The result is a proactive management tool for optimizing customer relationships and improving communications among departments, as well as fine-tuning workflow, processes and quality of service from within the contact center and throughout the enterprise.



•

Provides performance analysis and feedback.    The eQuality Evaluation software facilitates the review, evaluation and scoring of CSRs, providing an immediate performance summary. Using the eQuality Analysis software, a user can combine important data derived from eQuality Evaluation with data derived from many other business applications, such as CRM and enterprise resource planning software and integrated telephony applications. For instance, a company can evaluate quality scores obtained from eQuality Evaluation with sales achievement data received from a sales tracking system to ensure CSRs are not compromising the quality of their customer interactions to sell new products. The resulting information, which is presented in easy-to-use formats, such as reports, graphs and tables, allows companies to provide more meaningful feedback to CSRs on their performance and better analyze the overall operation of the contact center.



•

Provides an integrated, closed-loop environment for applying organizational learning.    eQuality Now™ delivers ongoing training tailored to CSR competencies, which helps companies build customer loyalty though a more highly-skilled and motivated workforce. Underscoring the importance of staff development, research from the Yankee Group indicated that contact center managers ranked agent training as their number one budget priority. Companies are turning to electronic learning in response to the urgency of delivering and reinforcing training to improve CSRs' skills, as well as to provide a means to support their career paths. Our eQuality Now product addresses this market trend by focusing on electronic learning opportunities in the contact center, such as new product and service introductions; up-selling and cross-selling techniques; and tips for managing customer communications through newer communications channels, such as e-mail and collaborative Web chat.

5

•

Integrates with third-party software and hardware.    The eQuality software is designed to integrate with a variety of third-party software, such as CRM and enterprise resource planning applications. The eQuality solution is also designed to integrate or be compatible with a company's existing telephony and computer network hardware and software such as telephone switches, automated telephone dialers and computer-telephony integration systems. This allows companies to capitalize on their existing infrastructure and gain the benefits of our software with minimal additional investment.



•

Provides an open architecture that scales to support small to large installations.    The eQuality software operates on the Windows NT platform and is compatible with standard voice cards and databases. Also, the software can capture and record computer screen activity from CSR workstations that are running any of a variety of operating systems. By utilizing off-the-shelf hardware and software, our customers are able to implement and support our products at a relatively low cost. Because the software is scalable, it can support the needs of a small single site as well as large multi-site installations. The eQuality software's high volume recording architecture interfaces on either the network or agent side of the PBX/ACD switch and enables companies to record zero to 100% of any type of contact that comes into their center based on "business rules" that they define.



•

Enables rapid deployment.    Because of the software's features, extensive third-party integration, open architecture and implementation process, we can typically implement our software at a customer's initial site within 30 to 60 days from the date the software agreement is signed by a new customer. Since the detailed project planning occurs during installation at the first site, we can typically implement our software at additional sites in five to seven days. Most of our target market consists of large corporations with many customer contact centers, and we have significant experience with customers purchasing our software for multiple sites. As a result, rapid deployment is important in that it allows those customers to quickly implement and begin realizing the benefits of the eQuality solution.

Strategy

        Our objective is to be a leading provider of software and services to the contact center market that enable global organizations to optimize their workforce performance and capture customer intelligence by recording and analyzing customer interactions across multiple communications media, including telephone, e-mail and the Internet. Key elements of our strategy include the following:

•

Extend the breadth and depth of product offerings.    We intend to continue to invest in research and development to enhance our current software suite and build or purchase new software to address the growing needs of companies that seek to better manage their customer relationships across multiple communications media. We also intend to extend our Web-based capabilities, such as the recording and analyzing of integrated e-commerce, e-mail and voice interactions. Additionally, we plan to expand the number of third-party applications with which our software can integrate.



•

Increase sales to new and existing customers.    A majority of our existing customers are large companies that have multiple contact centers. While we have been successful in penetrating these customers and installing our software at more than one contact center, we have many customers where we have not yet installed our software at all of their contact centers. We intend to capitalize on the success of our initial installations by emphasizing the scalability and rapid deployment of our software to increase the number of installations at existing customer sites that have not yet installed our software. We also plan to continue pursuing new customer accounts with multiple contact centers through our existing sales force and our network of strategic relationships.

6

•

Expand international presence.    We currently maintain sales forces in Australia, Brazil, Canada, India, Japan, Mexico, the Netherlands, Singapore and the United Kingdom as well as in the United States. We plan to expand our direct and indirect sales channels in these regions, with particular attention to areas that are actively adopting CRM and contact center software solutions.



•

Expand network of business alliances.    We intend to expand our network of business alliances with complementary application software and Internet infrastructure providers to increase the number of products with which our software is compatible. We believe the demand for our software will increase as it becomes compatible with an increasing number of CRM, enterprise resource planning and Internet infrastructure applications. In addition, expanding this network of business alliances will enable us to generate new sales leads as our business alliances recommend our products to their customers.

Products

        The eQuality software initiates recording of customer interactions based on criteria selected by companies and facilitates retrieval and analysis of the recorded information, as well as targeted electronic learning events based on skill gaps identified using the evaluation software. With eQuality's enterprise collaboration recording architecture, organizations can create advanced business rules for random, selective or 100% recording of the specific types of telephone, e-mail and Web customer interactions that drive their businesses. Additionally, contact center management is able to share these interactions with departments that touch the customer, as well as executives, by notifying them when a business-critical customer event occurs. The result is a proactive management tool for optimizing customer relationships and improving communications among departments, as well as fine-tuning workflow, processes and quality of service from within the contact center and throughout the enterprise.

        The foundation of the eQuality software records a CSR's voice interaction with a customer as well as the CSR's corresponding computer desktop activities, such as data entry, screen navigation and data retrieval. The voice and data are captured and stored on a computer disk for synchronized evaluation and analysis. By capturing both voice and desktop activity and synchronizing them during replay, a company can observe and analyze complete customer interactions as they actually occurred. The captured interactions can then be selectively retrieved, combined with information from a company's other business systems, such as CRM and enterprise resource planning software, analyzed and presented in a number of summary and detailed formats. The eQuality software thus enables companies to evaluate the effectiveness of its CSRs, improve contact center performance and profile their customers' characteristics and preferences to create customized product and service offerings. By recording customer interactions, evaluating and analyzing CSRs performance, and then using eQuality Now to prioritize training, companies have an integrated, closed-loop solution for applying organizational learning. The result is an effective environment for continuous performance improvement that helps companies ensure their customers receive consistent service across all touch points.

        An integral feature of the eQuality solution is business-driven recording, which allows a company to record specific customer interactions based on criteria that it selects. Using the eQuality solution, a company can define business rules that trigger recording of selective customer interactions that are particularly critical to its operating performance. For example, a company may use eQuality software to record customer interactions based on a number of criteria, including:

•

Key customers.    The eQuality software can selectively record all calls from specific classes or groups of customers having common traits or characteristics. Examples include customers with certain sales or asset levels or customers having a particular importance to the company.



•

Important marketing campaigns.    All calls associated with particular marketing campaigns can be recorded so that the effectiveness of the campaign can be evaluated while the initiative is in process. Consequently, adjustments can be made proactively to optimize performance of the campaign.

7

•

Target products.    Interactions that relate to targeted products can be identified and recorded to allow businesses to evaluate product design, installation and service issues. Examples include selected calls related to new product introductions, key revenue-producing products and higher margin products.



•

Selected CSR considerations.    Calls that are handled by specific CSRs can be sampled so that supervisors can more effectively monitor and train CSRs. Examples include newly hired CSRs, CSRs that are not achieving desired performance levels and CSRs working with a new medium, such as e-mail or Web chat.

        By recording only critical customer interactions based on business rules, companies have fewer interactions to store and therefore significantly lower storage requirements. Further, the eQuality software's data capture technique allows companies to utilize minimal network bandwidth by sending across the network only the changed areas of a CSR's computer desktop screen. In addition, the eQuality software is designed to integrate or be compatible with a company's existing telephony and computer network hardware and software. The result is a lower total cost of ownership.

        The eQuality suite of products is comprised of the following modules:

        eQuality Balance™.    eQuality Balance records a CSR's voice interaction with a customer and the CSR's corresponding computer desktop activities, such as data entry, screen navigation and data retrieval. The captured voice and desktop activity can then be synchronized during replay, allowing companies to observe and analyze complete customer interactions as they actually occurred. This enables companies to evaluate the performance of CSRs, determine whether the necessary technology resources for customer support are available to the CSRs and ascertain whether the CSRs are making effective and efficient use of these resources. Supervisors can use this information to train CSRs, improve company systems and resources designed to support CSRs and enhance the quality of the services being delivered to customers.

        eQuality Evaluation™.    The eQuality Evaluation application facilitates the review, evaluation and scoring of CSRs, providing an immediate summary of a CSR's performance. Using eQuality Evaluation, CSR supervisors can build custom evaluation forms that are designed to collect information about aspects of a CSR's performance that are most important to them. Supervisors and others can input information regarding a CSR's performance into the form, which is then collected in a database. The collected information can be retrieved, presented in a summary format, analyzed and ultimately used to measure and improve a CSR's performance. eQuality Evaluation can reveal problem areas, issues, trends and opportunities. Supervisors and others with access to eQuality Evaluation can review CSRs' performance and determine opportunities to increase their skill levels through training. Supervisors can compare CSRs' performance to current goals and provide more realistic future goals.

        eQuality Analysis™.    The eQuality Analysis application provides a more comprehensive analysis of customer interaction and CSR performance by bridging the disparate information systems of a company. Using eQuality Analysis, a company can combine data derived from eQuality Evaluation with data derived from information obtained from a company's other business systems, such as CRM and enterprise resource planning software and integrated telephony applications. Combining multiple sources of data from within the company into a common analysis and reporting system allows for a more thorough evaluation of CSR and overall contact center performance. Recognizing the importance of multi-channel contact centers, we have designed eQuality Analysis to integrate with business systems that collect data from a broad range of communications media. With its performance scorecard, contact center managers can attain a quick, streamlined view of performance relative to strategic organizational objectives. The software leverages a variety of industry-accepted, best-practice key performance indicators (KPIs) contained in eQuality Analysis and includes pre-defined KPIs as a foundation to build customized measures. Users can view data and drill up and down into an area of interest. eQuality Analysis produces a wide array of user-defined summary (historical and trend) and detailed analysis (adherence, productivity, quality and others) in a

8

report, graph or exported medium. The solution's reporting, dynamic analysis and performance scorecard capabilities provide organizations with business intelligence that can lead to increased revenue, heightened service quality and improved operational efficiencies.

        eQuality Now™.    The eQuality Now application delivers ongoing training tailored to CSR competencies, which helps companies build customer loyalty through a more highly skilled and motivated workforce. The electronic learning management software integrates with leading on-line learning products focused on CSR soft and hard skills. By recording customer interactions, evaluating CSR performance, and then using eQuality Now to prioritize training, contact centers have an integrated, closed-loop solution for applying organizational learning. The result is an effective environment for continuous performance improvement that helps companies ensure their customers receive consistent service across all touch-points.

        eQuality Interactive™ and eQuality Response™.    The eQuality Interactive and eQuality Response applications allow a company to record Internet interactions, including Web chat, instant messaging, guided browser sessions and e-mail, based on user-defined business rules. These applications enable companies to gauge the effectiveness of their CSRs' Internet skills, refine newly implemented Internet processes and optimize the effectiveness of their Web technology deployments. In combination with eQuality Balance, companies are able to deliver consistently high standards of service regardless of the medium.

        eQuality Discover™.    The eQuality Discover application enables companies to record and graphically view actual customer experiences on their Web sites so they can identify clear steps for improving online customer service. With these captured samples, companies will have the insight they need to determine how consumers interact with their Web sites, which in turn helps them increase the profitability of on-line relationships while at the same time reducing customer service costs. Using eQuality Discover, companies can determine why a visitor placed a call to the contact center or abandoned their Web site. When brought together with recorded customer interactions from other touch-points, captured self-service interactions can help companies achieve a single view of customers and the way they are serviced across many channels.

        eQuality Connect™.    The eQuality Connect application serves as the foundation to integrate eQuality with Web-enabled contact center and CRM applications, including e-mail response management, collaborative Web chat and customer information systems. As the underlying integration component of the eQuality suite, eQuality Connect is an open, scalable software solution that leverages strategic events and data gathered from external solutions to initiate recordings. Companies can implement eQuality Connect as the integration layer within their eQuality multimedia recording and analysis software, or as a standalone solution that integrates eQuality with other applications, such as internally developed customer information systems.

        eQuality Balance has historically and will continue to be licensed together with the eQuality Evaluation application. Through December 31, 2002, we had derived the majority of our license revenue from the sale of these two products. During 2002, approximately 28% of our orders included an additional module of our eQuality application suite, including eQuality Analysis, Now, Interactive, Response, Discover and Connect.

Professional Services

        Our professional services organization provides an integrated implementation, training and business consulting methodology that supports an effective and rapid deployment of the eQuality suite enabling organizations to more quickly realize the benefits of our solution. Our implementation professionals work with the customer to build a solid technical infrastructure that supports the eQuality suite of applications. An initial implementation engagement is typically completed within 30 to 60 days from the date the software agreement is signed by a new customer, and involves the planning, configuration, testing and

9

implementation of our software. Since the detailed project planning occurs during installation at the first site, we can typically implement our software at additional sites in five to seven days. Generally, the actual software installation takes three to five days. We provide end-user training both on-site at the customer location and at a centralized training facility. Training services include coach training and system administration. We also offer business consulting services that enable our customers to identify and link key business drivers with CSR skills and behaviors, providing a blueprint for implementing a successful performance optimization strategy.

Customers

        Our customers include large and small companies with a varying number of contact center sites. Our customers come from the banking and finance, general business, insurance, outsourcing, technology, travel and hospitality and utility industries. As of December 31, 2002, we had licensed our software to 418 customers at 1,177 sites. To date, customer installations have ranged from as small as one contact center having 25 CSRs, to customers with 32 contact centers having an aggregate of approximately 16,000 CSRs. No customer accounted for 10% or more of our revenue in 2002, 2001 and 2000.

Sales and Marketing

        We sell our software primarily through a combination of a direct sales force and resellers. As of December 31, 2002, our sales organization consisted of 79 sales professionals in 26 offices throughout the United States and offices in Australia, Brazil, Canada, Japan, Mexico, the Netherlands, Singapore and the United Kingdom.

        Our direct sales force is responsible for pursuing qualified leads generated internally and also qualified leads provided by companies with whom we have formal or informal referral agreements. To expand the coverage and support of our direct sales force, we develop strategic marketing alliances with leading companies in our industry. These relationships may include joint marketing campaigns and selling strategies. In addition to the direct sales force, we have agreements with a variety of companies that resell our software. To support this indirect sales channel, our business development personnel provide training and support to the sales personnel of these companies so they can more effectively educate potential customers about the benefits of our solution. Our agreements with the resellers are not exclusive and may be terminated by either party.

        Our direct sales cycle typically begins with the qualification of a sales lead or the request for a proposal from a prospective customer. The sales lead, or request for a proposal, is followed by the qualification of the lead or prospect, an assessment of the customer's requirements, a formal proposal, presentations and product demonstrations, site visits to an existing customer using the software and contract negotiation. The sales cycle can vary substantially from customer to customer but typically lasts six months, and is considered completed with the signing of the contract. Historically, most of our customers have increased their use of the software to expand the number of CSRs and applications at existing sites and to license additional contact centers, with a minimal incremental sales effort on our behalf.

        We use a variety of marketing programs to build brand name awareness, as well as to attract potential customers. These programs include market research, product and strategy updates with industry analysts, public relations activities, direct mail and relationship marketing programs, seminars, trade shows, speaking engagements and Web site marketing. To support sales efforts, the marketing organization also produces marketing materials, including brochures, data sheets and other technical descriptions, presentations and demonstrations. As of December 31, 2002, we had 101 employees in our sales and marketing organization.

10

Research and Development

        We believe our software development capabilities are essential to our strategy of enhancing our core technology, developing additional applications, incorporating that technology and maintaining the competitiveness of our software. We devote a substantial portion of our resources to developing new software and features, extending and improving our software technology, debugging and quality testing our products and researching new technological initiatives in our market. We believe that our future success depends in part upon our ability to continue to enhance existing software, respond to changing customer requirements and develop and introduce new or enhanced software that incorporates new technological developments and emerging industry standards.

        Research and development expenditures for the years ended December 31, 2002, 2001, and 2000 were $15.1 million, $13.6 million and $10.4 million, respectively. We intend to continue to increase our investment in research and development. As of December 31, 2002, we had 91 employees engaged in research and development activities.

Competition

        Our software and services compete in the emerging market for products that record and analyze customer interactions and provide electronic learning applications. This market is intensely competitive and experiences rapid changes in technology. We believe that we compete effectively and that we enjoy a competitive advantage based upon (1) the functionality and quality of our products, (2) the ease of use and ability of our products to operate with a variety of hardware and software products, (3) our ability as a single vendor to offer a full suite of applications, (4) our ability to implement our products quickly, (5) the responsiveness of our customer support, and (6) our competitive pricing. However, many current and potential competitors may have longer operating histories, more established business relationships, larger customer bases, a broader range of products and services, greater name recognition and substantially greater financial, technical, marketing, personnel, management, service, support and other resources. This could allow our current and potential competitors to respond more quickly than we can to new or emerging technologies and changes in customer requirements, to more effectively take advantage of acquisition and other opportunities, to devote greater resources to the sales and marketing of their products and services, and to adopt more aggressive pricing policies. In addition, many competitors market their products through resellers and companies that integrate their technology and products with those of the competitor. These resellers and technology partners of competitors often have strong business relationships with our customers and potential customers. Our competitors may use these business relationships to market and sell their products and compete for customers. We cannot assure that our competitors will not offer or develop products and services that are superior to ours, or that achieve greater market acceptance. Our competitors include:

•

quality monitoring suppliers to the call and contact center industry, which historically have been companies that develop voice-only recording software;



•

traditional call logging vendors that have historically focused on providing products that record all phone conversations made by or to the user, including emergency services, such as 911, and verification and liability users, such as trading floors and stockbrokers;



•

electronic learning vendors that have historically provided a point solution that delivers training to customer service representatives;



•

reporting vendors that have historically provided a point solution focused on providing contact center performance reports to management;



•

systems integrators and consulting firms which design and develop custom systems and perform custom integration; and



•

new, larger and more established entities that may acquire, invest in or form joint ventures with providers of recording or performance enhancing software solutions, such as vendors of CRM products, computer telephony companies and computer hardware, software and networking companies.

11

        In addition, we have developed, and intend to continue to develop, relationships with companies that resell our software, companies that integrate the software with their technology and products and companies that provide us with customer referrals or leads. Some of these companies have similar, and often more established, relationships with our competitors, and may recommend the products and services of competitors to customers instead of our software and services. In addition, through their relationships with us, these companies could learn about our software and the market for our software and services and could develop and sell competing products and services.

        The principal competitive factors in our market include:

•

product performance, reliability and features;



•

user scalability and open architecture;



•

third-party integration;



•

quality and speed of product implementation;



•

ease-of-use for customers;



•

analytic capabilities of the product;



•

how quickly new products and product enhancements can be brought to market;



•

customer support; and



•

pricing of products and services.

        Our success will depend on our ability to compete effectively based on these factors. Further, we expect that competition will increase as other established and emerging companies enter our market and as new products, services and technologies are introduced. Increased competition may result in price reductions, lower gross margins and loss of market share. This could materially and adversely affect our business, financial condition and results of operations.

Proprietary Rights

        General.    Our success depends to a significant degree on the legal protection of our software and other proprietary technology rights. We rely on a combination of patent, trade secret, copyright and trademark laws and confidentiality and non-disclosure agreements with employees and third parties to establish and protect our proprietary rights. These measures may not be sufficient to protect proprietary rights, and we cannot be certain that third parties will not misappropriate our technology and use it for their own benefit. Also, most of these protections do not preclude our competitors from independently developing products with functionality or features substantially equivalent or superior to our software. Any failure to protect our intellectual property could have a material adverse effect on our business.

        Licenses.    Our licenses are designed to prohibit unauthorized use, copying and disclosure of our software technology. When we license our software to customers, we require license agreements containing confidentiality terms customary in the industry in order to protect our proprietary rights in the software. These agreements generally warrant that the software will materially comply with written documentation. We assert that we own the software we distribute and have not violated the intellectual property rights of others. We license our products in a format that does not permit the users to change the software code. In addition, because we treat the source code for our products as a trade secret, all employees and third parties who require access to the source code are first required to sign non-disclosure agreements.

12

        Patents.    We have received two patents generally relating to our voice and data synchronization technology and data capture. We also have 13 patent applications pending with the U.S. Patent and Trademark Office. There is no guarantee that the pending applications will result in issued patents or, if issued, will provide us with any competitive advantages. We cannot assure you that we will file further patent, trademark or copyright applications, that any future applications will be approved, that any existing or future patents, trademarks or copyrights will adequately protect our intellectual property or that any existing or future patents, trademarks or copyrights will not be challenged by third parties.

        Trademarks and service marks.    We have five U.S. registered trademarks. We also claim common law protections for other marks we use in our business. Competitors and other companies could adopt similar marks, or try to prevent us from using our marks, consequently impeding our ability to build brand identity and possibly leading to customer confusion. We are aware of certain uses, U.S. trademark registrations, and U.S. trademark applications for our "eQuality" trademark and its variations that predate our use, and the April 30, 2002 issuance, of the U.S. registration for our trademark eQuality®. It is possible that the owner of legal rights resulting from one or more of these prior uses, U.S. trademark registrations, or U.S. trademark applications will bring legal action to challenge our registration of and/or our continued use of the trademark eQuality®, and may also seek compensation for damages resulting from our use of our registered trademark if such challenging party prevails on such a claim. As a result, we cannot assure you that our registration of this trademark will be undisturbed, or that this use will not result in liability for trademark infringement, trademark dilution, and/or unfair competition.

        Copyrights.    We have six copyright registrations covering our eQuality software.

Item 2.    Properties

        Our principal administrative, marketing, product development and support facilities are located in Roswell, Georgia, a suburb of Atlanta, where we lease approximately 96,400 square feet under a lease that expires in 2007. In addition, we lease a total of 17 sales and marketing offices in the United States, and offices in Australia, Brazil, Canada, Japan, Mexico, the Netherlands, Singapore and the United Kingdom. We believe our facilities are adequate for our current and expected near-term requirements.

Item 3.    Legal Proceedings

        From time to time we may be involved in legal proceedings and/or litigation arising in the ordinary course of our business.

        On December 11, 2002, we filed in the United States District Court for the Northern District of Georgia, Atlanta Division, a lawsuit against Knowlagent, Inc. ("Knowlagent"), which is the assignee of the United States Patent Nos. 6,324,282 B1 and 6,459,787 B2. Knowlagent has accused our eQuality Now software suite of infringing the above patents. We filed suit seeking a declaration that we did not and do not infringe either of the two patents listed above, as well as a declaration that the above patents are invalid and unenforceable. We also filed a claim requesting that if the patents are found to be valid, that one of our own employees be named the rightful inventor of the patents. We also requested that monetary damages in an amount equal to the amount that Knowlagent has received from its use of the above patents. On December 31, 2002, Knowlagent filed its answer to our complaint as well as two counterclaims, alleging that we infringe and contribute to the infringement by others of the above patents; Knowlagent seeks both monetary damages and an injunction in connection with its counterclaim. We are currently in the discovery phase of the lawsuit.

        We are not party to any other litigation or other legal proceedings that we believe could have a material adverse effect on our business, operating results or financial condition.

Item 4.    Submission of Matters to a Vote of Security Holders

        No matters were submitted to a vote of security holders during the fourth quarter ended December 31, 2002.

13

PART II

Item 5.    Market for Our Common Equity and Related Stockholder Matters

Common Stock

        Our common stock trades on the Nasdaq Stock Market under the symbol "WITS". The following table sets forth, for the periods indicated, the high and low sale price per share of the common stock on the Nasdaq Stock Market in each of the last eight quarters.

        The closing sale price of our common stock as reported by the Nasdaq Stock Market on February 28, 2003 was $3.09.

        Dividend Policy.    We have not paid any cash dividends on our common stock to date. Our Board of Directors determines whether or not we will pay dividends. The Board of Directors considers a number of factors in deciding whether or not to pay dividends, including our earnings, our capital requirements and our financial condition. Currently, the Board of Directors intends to retain all earnings, if any, for use in our business operations and, accordingly, does not expect to declare or pay any dividends in the foreseeable future.

        Rule 10b5-1—Trading Plans.    Our Board of Directors approved an amendment to our insider trading policy to permit our officers, directors and other insiders to enter into trading plans or arrangements to sell shares of our common stock complying with Rule 10b5-1 of the Securities Exchange Act of 1934, as amended. Trading plans provide for sales, subject to price restrictions, daily limits and other contingencies, of shares of our common stock

        Holders.    As of February 28, 2003, we had approximately 248 holders of record of our common stock. We believe that we have more than 2,500 beneficial owners.

14

Item 6.    Selected Financial Data

        The following selected consolidated financial data should be read in conjunction with the Consolidated Financial Statements and Notes thereto and with "Management's Discussion and Analysis of Financial Condition and Results of Operations" included elsewhere in this report.

15

Item 7.    Management's Discussion and Analysis of Financial Condition and Results of Operations

        This annual report on Form 10-K contains forward-looking statements that are not historical facts but rather are based on current expectations, estimates and projections about our business and industry, our beliefs and assumptions. Words such as "anticipates", "expects", "intends", "plans", "believes", "seeks", "estimates" and variations of these words and similar expressions are intended to identify forward-looking statements. These statements are not guarantees of future performance and are subject to risks, uncertainties and other factors, some of which are beyond our control, are difficult to predict and could cause actual results to differ materially from those expressed or forecasted in the forward-looking statements. Forward-looking statements that were true at the time made may ultimately prove to be incorrect or false. Readers are cautioned not to place undue reliance on forward-looking statements, which reflect our management's view only as of the date of this report. Except as required by law, we undertake no obligation to update any forward-looking statement, whether as a result of new information, future events or otherwise.

        The following Management's Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with the Consolidated Financial Statements and Notes thereto included elsewhere in this report. Investors should carefully review the information contained in this report under the caption "Factors That May Affect Our Future Results and Market Price of Our Stock" beginning on page 28.

Overview

        We provide the contact center market an integrated performance optimization software suite that enables global enterprises to capture customer intelligence and optimize workforce performance. Our solution is comprised of business-driven multimedia recording, performance analysis and e-learning management applications that are designed to enhance the quality of customer interactions across multiple communications media, including the telephone, e-mail and the Internet. Our enterprise collaboration architecture allows contact center management to share information gathered in the contact center with departments that touch the customer, as well as executives throughout the organization. An integrated business consulting, installation and training methodology provides services to support an effective, rapid deployment of our software that enables organizations to maximize their return on investment. Our software is designed to integrate with a variety of third-party software applications, such as customer relationship management ("CRM") and enterprise resource planning applications, and with existing telephony and computer network hardware and software. The majority of our customers are companies with one or more contact centers that handle voice and data customer interactions for outbound sales and marketing operations, inbound service/support lines, or both.

        During 2002, many of our prospects and customers continued to defer projects and/or extended their software purchasing processes, resulting in our license revenue being less than our license revenue in 2001. Although services revenue for 2002 increased compared to the prior year, services revenue was impacted by customers deferring installations due to their own lack of resources and budget uncertainties, as well as increased pricing pressures for maintenance renewals. The length of our collections cycle has been adversely impacted by the increase in international revenues and by the weakened economy, resulting in our customers deferring payments to us or requiring payment terms longer than those normally provided by us. As a result of these economic conditions, our ability to forecast future license and services revenues has become more difficult. If the economy continues to deteriorate, the level of corporate spending for information technology and CRM applications may further decline. Such declines could have an adverse effect on our financial condition and results of operations.

16

Sources of Revenue and Revenue Recognition Policy

        We derive our revenue from licensing our software and providing related services. We primarily utilize a direct sales organization and an indirect sales channel that consists of select resellers and a variety of strategic marketing alliances to reach our target customer base. Prior to 2002, less than 10% of our license revenue had been derived from our indirect sales channel rather than from our direct sales force. For the year ended December 31, 2002, 23% of our license revenue was derived from our indirect sales channel. We expect the proportion of license revenue derived from our indirect sales channel to continue to increase in the future as we expand internationally, where we derive a greater portion of our revenue through our indirect sales channel.

        During 2002, 2001 and 2000, approximately 15%, 9% and 6%, respectively, of our revenue was derived from customers outside the United States and Canada. We expect the proportion of future revenue derived from international markets to continue to increase and may be denominated in the currency of the applicable market.

        License revenue is recognized when persuasive evidence of an agreement exists, delivery of the product has occurred, the fee is fixed or determinable and collection is probable. We recognize license revenue using the residual method whereby revenue is recognized in a multiple element arrangement when vendor specific objective evidence of fair value exists for all of the undelivered elements in the arrangement, but does not for one of the delivered elements in the arrangement. We defer revenue for the fair value of its undelivered elements, normally services and maintenance, and recognize license revenue for the remainder of the total arrangement fee. Our license agreements generally provide that customers pay a software license fee for one or more software products for a specified number of users. The amount of the license fee varies based on which product is licensed, the number of software products licensed, the number of installation sites and the number of users licensed. Customers can subsequently pay additional license fees to allow additional users to use previously licensed software products or to license additional software products. Each software product contains common components, allowing for easy integration of additional software products as they are licensed from us. Customers that license our software products usually receive the software on compact disc.

        Services revenue includes installation, training, consulting, maintenance and reimbursable travel expenses. Revenue from installation, training and consulting services is recognized upon performance of the related services. Revenue from reimbursable travel expenses is recognized upon incurrence of the related expenses. Services are traditionally offered and billed as separate elements of contracts on either a fixed service fee plus travel expenses or on a time-and-materials basis. The functionality of the software is not dependent on these services. Maintenance is offered as a separate element and includes the right to unspecified upgrades on a when-and-if available basis. Maintenance revenue, which is generally billed annually in advance, is deferred and recognized ratably over the term of the related contract. Specified upgrades are not typically offered to customers. Historically, all customers have purchased an initial maintenance contract for each newly licensed site. During 2002, 2001 and 2000, approximately 98% of active customer installation sites renewed their annual maintenance contracts.

        Effective January 1, 2002, we adopted the Emerging Issues Task Force's ("EITF") No. 01-14, Income Statement Characterization of Reimbursements Received for 'Out-of-Pocket' Expenses Incurred, which requires companies to characterize reimbursements received for travel expenses incurred as revenue in the statement of operations. We had historically recorded reimbursements as a reduction of services cost of revenue. In accordance with EITF No. 01-14, we reclassified $744,000 and $834,000 of reimbursable travel expenses to services revenue from cost of services revenue resulting in no change to gross profit for the years ended December 31, 2001 and 2000, respectively. Gross profit margins decreased to 82% and 80% in 2001 and 2000, respectively, from 83% and 82%, respectively, after the effect of EITF No. 01-14.

17

Cost of Revenue and Operating Expenses

        Cost of license revenue primarily consists of royalties due to third parties and packaging costs. Cost of services revenue for installation, training, consulting and maintenance services includes personnel costs and related expenses and allocated overhead. Personnel costs include salaries, bonuses and benefits. We classify all charges to the operating expense categories based on the nature of the expenditures. Allocated overhead include rent for corporate offices and furniture, communication charges and depreciation and amortization expenses for office equipment and leasehold improvements. We allocate these costs to each of the functional areas based on use.

        Operating expenses are classified into three general categories: sales and marketing, research and development and general and administrative. Sales and marketing expenses consist primarily of personnel costs, sales commissions, promotional expenses, public relations, tradeshows, travel expenses and allocated overhead. Research and development expenses consist primarily of personnel and consulting costs to support product development, and allocated overhead. Research and development costs are expensed as incurred. Costs incurred subsequent to establishing technological feasibility are capitalized and amortized over their estimated useful lives. Historically, software development costs incurred after technological feasibility has been established have not been material and, therefore, have been charged to expense. General and administrative expenses consist primarily of personnel costs for accounting and finance, information technology, human resources and legal, as well as provisions for allowance for doubtful accounts and allocated overhead.

        We had 309 full-time employees at December 31, 2002, compared to 327 at December 31, 2001 and 275 at December 31, 2000. We anticipate that total operating expenses will increase over time as we globally expand our sales and marketing operations, develop new distribution channels, fund ongoing research and development, broaden professional services offerings, improve operational and financial systems and support our growth internationally.

Critical Accounting Policies and Estimates

        The discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect our reported assets, liabilities, revenues and expenses, and our related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our estimates, including those related to revenue recognition, allowance for doubtful accounts, research and development and software development costs, allowance for deferred tax assets and stock-based compensation. We base our estimates on historical experience and on various assumptions that we believe to be reasonable under the circumstances. This forms the basis of judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

        Factors that could affect our future operating results and cause actual results to vary materially from expectations include, but are not limited to, lower than anticipated growth from existing customers, our ability to attract new customers and grow internationally, our ability to grow through acquisitions and to successfully integrate acquisitions, the availability and cost of debt and equity financing, technology changes, or a decline in the financial stability of our customers. Negative developments in these or other risk factors could have a material adverse effect on our financial position and results of operations. A summary of our critical accounting policies follows.

        Revenue Recognition.    Our revenue recognition policy is significant because our revenues are a key component of our results of operations. We follow very specific and detailed guidelines, discussed above, in measuring revenues; however, certain judgments affect the application of our revenue policy. Further, assessment of collectibility is particularly critical in determining whether or not revenues should be

18

recognized in the current market environment. We also record provisions for estimated sales allowances on product and service related revenues in the same period as the related revenues are recorded. These estimates are based on historical sales and services allowances, analysis of credit memo data and other known factors. If future sales credits prove to be greater than the historical data and management estimates we used to calculate these estimates, revenues could be overstated.

        Allowance for Doubtful Accounts.    We perform ongoing evaluations of our customers and continuously monitor collections and payments and estimate an allowance for doubtful accounts based on a percentage of our accounts receivable, our historical experience and any specific customer collection issues that we have identified. While such credit losses have historically been within our expectations and we believe appropriate reserves have been established, we cannot assure that we will continue to experience the same credit loss rates that we have experienced in the past or adequately predict future credit losses. If the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required which would result in an additional general and administrative expense in the period such determination is made.

        Research and Development and Software Development Costs.    We evaluate the establishment of technological feasibility of our products in accordance with Statement of Financial Accounting Standards ("SFAS") No. 86, Accounting for the Costs of Computer Software to Be Sold, Leased or Otherwise Marketed. We sell products in a market that is subject to rapid technological change, new product development and changing customer needs; accordingly, we have concluded that technological feasibility is not established until the completion of a working model. Historically, software development costs incurred after technological feasibility has been established have not been material. Therefore, we charge all such costs to research and development expense in the period incurred.

        Allowance for Deferred Tax Assets.    We record a valuation allowance to reduce our deferred tax assets to an amount that is more likely than not to be realized. To the extent that future taxable income is generated and considered more likely than not to continue in the future an adjustment to reduce the valuation allowance would be made, increasing net income in the period in which such determination was made.

        Stock-Based Compensation.    With the exception of the deferred stock compensation that we recorded at our initial public offering ("IPO"), we generally do not record compensation expense for options granted to our employees because all options granted under our stock option plans have an exercise price equal to the market value of the underlying common stock on the date of grant. As permitted under SFAS No. 148, Accounting for Stock-Based Compensation—Transition and Disclosure and SFAS No. 123, Accounting for Stock-Based Compensation, we have elected to continue to apply the provisions of Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees and have adopted only the disclosure requirements of SFAS No. 123. Had we determined compensation cost based on the fair value at the grant date for our stock options and purchase rights under SFAS No. 123, our net income (loss) would have been the pro forma amounts indicated below (in thousands, except per share data):

19

Results of Operations

        The table below shows operating data as a percentage of total revenue for the periods indicated:

Revenue

        Total revenue increased 8% in 2002 to $67.7 million due to an increase in services revenue. The number of installed customer sites grew to 1,177 sites at the end of 2002 from 885 sites at the end of 2001. Total revenue increased 40% in 2001 to $62.5 million from $44.7 million in 2000 due to an increase in license and services revenue. This revenue growth was attributable to increases in international revenue, the addition of new products and services, and the increasing recurring maintenance revenue stream. The number of installed customer sites grew to 885 sites at the end of 2001 from 593 sites at the end of 2000.

        License revenue decreased 16% in 2002 to $33.4 million due to fewer contracts signed by customers during 2002, which we believe was attributable to a reduction in the level of corporate spending for information technology partially offset by an increase in the number of products licensed within our software product suite. The decrease in license revenue as a percentage of total revenue was also a result of increased services revenue, as discussed below. License revenue increased 32% in 2001 to $39.9 million from $30.3 million in 2000 due to an increase in the number contracts signed by customers during 2001. During 2002, 2001 and 2000, 46%, 47% and 57%, respectively, of license revenue was attributable to new customers compared to follow-on revenue from our existing customer base. We receive follow-on revenue from our customers when they purchase additional user licenses or license additional applications at existing sites and when they license our products at new sites.

20

        Services revenue, consisting of installation, training, consulting, maintenance revenue and reimbursable travel expenses, increased 52% to $34.3 million in 2002 and 57% in 2001 to $22.6 million from $14.4 million in 2000. These increases were attributable to increases in maintenance and professional services revenue. The growth in maintenance revenue resulted from the growth in our customer base as well as increased renewal amounts charged for annual maintenance contracts from existing customer sites. Although maintenance revenue increased in 2002, some customers resisted price increases for maintenance renewal amounts due to a weakened economy. Installation, training and consulting revenue increased in 2002 and in 2001 due to overall increased services revenue per customer site and the addition of new consulting services offerings. Services revenue as a percentage of total revenue increased due to the compounding effect of maintenance revenue from both new customer sites and renewals of maintenance contracts from existing customer sites and, to a lesser extent, from the decrease in license revenue from 2001 to 2002. We expect services revenue in absolute dollars and as a percentage of total revenue to continue to increase over time due to the compounding effect of renewals of annual maintenance contracts from existing customer sites and increased business consulting services offered around our expanded product suite.

Cost of Revenue

        Total cost of revenue increased 21% to $13.4 million in 2002 and 23% in 2001 to $11.1 million from $9.0 million in 2000. Gross profit margins decreased or remained constant at 80% in 2002 from 82% in 2001 and 80% in 2000. The decrease in gross profit margin was attributable to a greater percentage of revenue in 2002 generated from services, which has a lower margin than license revenue. The increased gross profit margins in 2001 were driven by improved services margins that resulted primarily from the increase in maintenance services revenue. We expect gross profit margins to decrease slightly over time as a greater percentage of our revenue is generated from services revenue, which has a lower gross margin than license revenue.

        Cost of license revenue increased 88% to $1.1 million in 2002 and 38% in 2001 to $602,000 from $436,000 in 2000. These increases were primarily attributable to license fees associated with third-party software components that are embedded in our software applications. As we develop upgrades of our existing products and add new offerings to our product suite we often embed third-party technology into our software. As a result, we expect cost of license revenue as a percentage of total revenue to increase over time as a greater proportion of revenue is derived from software applications containing embedded technologies.

        Cost of services revenue increased 18% to $12.3 million in 2002 and 23% in 2001 to $10.4 million from $8.5 million in 2000. These increases were primarily a result of an increase in the number of employees and contractors engaged in consulting and customer maintenance services. Cost of services revenue as a percentage of services revenue decreased to 36% in 2002 from 46% in 2001 and from 59% in 2000. These improvements were due primarily to the increased services revenue per customer site as well as improved profit margins in the consulting and maintenance services group due to the increase in consulting and maintenance revenue. We anticipate that the cost of services revenue as a percentage of services revenue will decrease over time as we increase our business consulting service offerings and increase our maintenance customer base.

Operating Expenses

        Sales and Marketing.    Sales and marketing expenses remained fairly constant in 2002 at $29.5 million from $29.3 million in 2001. However, as a percentage of total revenue, sales and marketing expenses decreased due to a redirection of certain discretionary marketing spending in 2002. Sales and marketing expenses increased 30% in 2001 to $29.3 million from $22.6 million in 2000. The 2001 increase was primarily due to an increase in sales and marketing personnel costs, marketing programs, facilities expenses and the establishment of additional sales offices in Europe, Asia Pacific and Latin America. We expect sales and marketing expenses to decrease slightly as a percentage of total revenue over time in conjunction with anticipated revenue growth.

21

        Research and Development.    Research and development expenses increased 11% to $15.1 million in 2002 and 31% in 2001 to $13.6 million from $10.4 million in 2000. These increases were due primarily to an increased number of employees and consultants engaged in research and development activities. As a percentage of total revenue, we expect research and development expenses to remain fairly constant in the near future.

        General and Administrative.    General and administrative expenses decreased 6% to $10.9 million in 2002 due to cost saving measures implemented during the year as well as a decrease in the provision for bad debt expense in 2002 resulting from collections in 2002 that were significantly reserved for during the latter part of 2001. As a percentage of total revenue, general and administrative expenses decreased during 2002. General and administrative expenses increased 33% in 2001 to $11.6 million from $8.8 million in 2000 primarily due to an increased provision for bad debt expense, increased corporate expenses in the executive, finance and administrative functions to support a larger organization, and increased facilities expense due to a larger headquarters facility. We expect general and administrative expenses overall and as a percentage of total revenue to increase slightly in the near future due to increased legal, professional and insurance costs associated with the implementation of the Sarbanes-Oxley Act.

        During 2000, we adopted a plan to relocate our corporate headquarters to a larger facility within the Atlanta metropolitan area. In accordance with the EITF No. 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring), we estimated that the net costs associated with our then existing facilities, which were under noncancellable leases expiring on June 30, 2002, would be approximately $525,000. We recorded this obligation during the second quarter of 2000. During 2001, two of the sublessees were unable to fulfill their obligations and the subleases were terminated. As a result, we recorded an additional obligation of $155,000 in 2001 for the additional estimated loss. As of December 31, 2002, there were no remaining obligations.

        During 1999, we incurred a deferred stock compensation charge of $1.0 million for the difference between the exercise price and the deemed fair value of certain stock option grants. This charge is being amortized over the vesting period of the underlying options, generally four years. Deferred stock compensation was $115,000, $171,000 and $271,000 in 2002, 2001 and 2000, respectively, and has been classified into the respective department functional areas.

        In-Process Research and Development and Related Charges.    During 2000, we entered into an option agreement to purchase in-process research and development ("IPR&D") technology which had a carrying value of $650,000. In March 2001, we paid $2.0 million to exercise this option to purchase the underlying technology. Also, during the first quarter of 2001, we purchased additional IPR&D technology for $1.1 million relating to similar development projects. These projects were successfully completed by the end of 2001.

        During the second quarter of 2001, we purchased software-based IPR&D technology relating to the development of on-line analytical processing and multi-dimensional analysis capabilities for $1.1 million. This project was successfully completed by June 30, 2002.

        At the date of the aforementioned transactions, the acquired IPR&D technologies had not progressed to a stage where they met technological feasibility as defined by SFAS No. 86. At the time of each transaction, we estimated the stage of completion of the project and the time and resources required to complete the project by creating a product design plan and evaluating the progress of the acquired technology towards this plan. A significant amount of uncertainty existed as to our ability to complete the development projects within a timeframe acceptable to the market, and failure to do so would have caused our competitive position in the market to erode. Additionally, the amount of development required to enable the acquired technology to integrate with our primary product was estimated to be significant, which increased the uncertainty surrounding its successful development. The acquired technologies did not have alternative future uses. As a result of the above, we recorded charges totaling $4.8 million in 2001 for acquired IPR&D.

22

Interest and Other Income, Net

        Interest and other income, net consists primarily of interest earned on funds available for investment, net of foreign currency exchange gains and losses. Interest and other income, net decreased 45% to $1.6 million in 2002 due to lower yields. Interest and other income, net decreased 28% in 2001 to $2.9 million from $4.0 million in 2000 due to lower yields and lower investment balances.

Provision for Income Taxes

        We recorded a provision for federal alternative minimum tax and foreign income tax in 2002 and a provision for state income tax, federal alternative minimum tax and foreign income tax in 2001. Prior to 2001, no provision for federal, state or foreign income taxes was recorded, primarily due to net operating loss carryforwards. Deferred tax assets are normally recognized for deductible temporary differences and net operating loss and tax credit carryforwards. We have recorded a full valuation allowance against deferred tax assets generated as a result of net operating loss carryforwards aggregating $8.1 million for U.S. tax purposes and $5.9 million for foreign tax purposes at December 31, 2002, as the future realization of the tax benefits is not currently considered more likely than not.

Quarterly Results of Operations

        The following tables present unaudited quarterly statements of operations data for each of the last eight quarters in the period ended December 31, 2002, as well as the percentage of total revenue represented by each item. The information has been derived from our unaudited consolidated financial statements, which have been prepared on substantially the same basis as the audited consolidated financial statements contained in this report. The unaudited consolidated financial statements contain all adjustments, consisting only of normal recurring adjustments that we consider to be necessary to present fairly this information when read in conjunction with the consolidated financial statements and notes thereto appearing elsewhere in this report. The results of operations for any quarter are not necessarily indicative of the results to be expected for any future period.

23

        During 2001 and 2002, license revenue as a percentage of total revenue generally decreased from quarter to quarter due to fewer contracts signed by customers, which we believe was attributable to a reduction in the level of corporate spending for information technology, and the significant growth in services revenues. Services revenue as a percentage of total revenue generally increased during 2001 and 2002 due to the increased maintenance customer base and the expansion of our service offerings. We expect that services revenue will continue to grow relative to license revenue throughout 2003. Gross profit margins decreased from quarter to quarter during 2002 due to license fees associated with third-party software components that are embedded in our software applications sold in 2002 and the increased percentage of revenue from services. We expect gross profit margins to decrease slightly over time as a greater percentage of our revenue is generated from services revenue, which has a lower margin than license revenue.

        Total operating expenses in 2001 and 2002, excluding the acquired IPR&D, have been relatively stable, varying largely with quarterly license revenue, as we attempted to control our cost structure in light of the economic uncertainty and continued deterioration in the economy.

        Our quarterly operating results, particularly license revenue, have experienced significant fluctuations in the past and we expect that this pattern will continue in the future. For instance, quarterly results may fluctuate based on the timing of sales due to customer calendar-year budgeting cycles, slow summer purchasing patterns and compensation policies that tend to compensate sales personnel, typically in the latter half of the year, for achieving annual quotas.

        As a result of the foregoing and other factors, we believe that quarter to quarter comparisons of results are not necessarily meaningful, and such comparisons should not be relied upon as indications of future performance.

24

Liquidity and Capital Resources

        We generated $8.9 million in cash flows from operating activities in 2002 compared to cash used in operating activities of ($5.3) million in 2001 and ($4.7) million in 2000. This increase in cash flow from operations was due primarily to the $4.0 million cash paid for IPR&D during 2001 and the reduction in operating expenses as a percentage of total revenue during 2002. Net cash flows provided by investing activities was $5.5 million in 2002 compared to cash used in investing activities of ($2.6) million in 2001 and ($40.6) million in 2000. These variances were primarily due to the release of our restricted cash in 2002 and the investment of the net proceeds received from our IPO in 2000. Capital expenditures of $3.2 million, $3.3 million and $5.5 million in 2002, 2001 and 2000, respectively, were primarily for computer equipment and leasehold improvements. Net cash flows used in financing activities in 2002 were ($1.1) million compared to cash flows provided by financing activities of $1.6 million in 2001 and $72.3 million in 2000. The use of cash from financing activities in 2002 was due to our stock repurchases which began in the fourth quarter of 2002, which more than offset the proceeds received from the exercise of stock options and employee stock purchases. Overall, up to $10 million of stock repurchases have been authorized. The decrease in cash flows from financing activities in 2001 was due to the receipt in 2000 of the net proceeds received from our IPO.

        At December 31, 2002, we had $59.4 million in working capital, which included $65.3 million in cash and cash equivalents and investments. In 2002, we increased our existing line of credit to $15.0 million and extended its maturity date to November 2003. At our discretion, borrowings under the line of credit bear interest at the bank's prime rate, which was 4.25% on December 31, 2002, or LIBOR plus 300 basis points. The revolving line of credit is secured by all of our assets and requires compliance with various covenants, including liquidity ratios and tangible net worth requirements, among others. Borrowings under the revolving line of credit are limited to 85% of eligible accounts receivable, as defined by the agreement. In 2002, we also caused our bank to issue irrevocable standby letters of credit under this facility to secure the lease on the corporate headquarters facility which relieved our restricted cash. The letter of credit requirements of the leases have decreasing schedules that ultimately expire in 2007. The amount available under the line of credit at December 31, 2002 was $11.2 million, which was net of the outstanding letters of credit of $3.8 million. As of December 31, 2002, we had not borrowed any funds under the line of credit.

        In February 2003, we entered into a cash purchase agreement with Eyretel plc ("Eyretel") for $59.9 million (see Subsequent Event). In February 2003, we borrowed $5 million under the line of credit at the bank's prime rate of 4.25% for short-term working capital purposes as we pursue the Eyretel acquisition.

        We anticipate that our capital expenditures will increase over the next several years as we acquire equipment to support the expansion of our research and development activities and internal management information systems. We expect to continue to experience growth in our operating expenses. We anticipate that operating expenses and planned capital expenditures will continue to be a material use of our cash resources. We believe that our existing cash, cash equivalents and investments and our line of credit will be more than sufficient to meet our anticipated cash needs for working capital and capital expenditures for the next 12 months. If cash generated from operations is insufficient to satisfy our liquidity requirements, we may seek to sell additional equity or debt securities or establish new financing arrangements. The sale of additional equity or convertible debt securities could result in additional dilution to our stockholders. We cannot assure that any financing arrangements will be available in sufficient amounts or on acceptable terms.

        Our accounts receivable days sales outstanding decreased to 70 days for the fourth quarter of 2002 from 72 days for the fourth quarter of 2001. We expect our days sales outstanding to increase as we derive a greater proportion of our revenue from international operations where payment is typically slower than in the United States; and due to an increase in the number of customers with extended payment terms or deferring payments, which we believe can be attributed to a weakened economy. We expect our days sales outstanding to be in the high-70s range in the future.

25

        Our interest income is sensitive to changes in interest rates of investment grade securities. To reduce our balance sheet exposure to variations in asset values, our investment policy guidelines specify that we invest in the highest investment grade securities and maintain a weighted average maturity of nine months for our entire portfolio. Our investment portfolio may contain securities with maturities of up to three years. While this minimizes our interest rate risk to asset values, our results are exposed to fluctuations in interest income due to changes in market rates.

        The majority of our operations are based in the United States and, accordingly, the majority of our transactions are denominated in U.S. dollars. However, we do have foreign-based operations where transactions are denominated in foreign currencies and are subject to market risk with respect to fluctuations in the relative value of currencies. Currently, we have offices in Australia, Brazil, Canada, India, Japan, Mexico, the Netherlands, Singapore and the United Kingdom and conduct transactions in either the local currency of the location or in U.S. dollars. To date, the impact of fluctuations in the relative value of other currencies has not been material. Net foreign exchange gains and (losses) were $17,000, ($53,000) and ($17,000) in 2002, 2001 and 2000, respectively.

        Our future contractual obligations include minimum lease payments under operating leases at December 31, 2002, and are as follows (in thousands):

        As of December 31, 2002, we did not have any other contractual commitments or off-balance sheet arrangements.

Transactions with Management

        During 2002, notes receivable due from certain officers totaling $455,000 were satisfied by delivering, at current fair market value, shares of our common stock, which such employees had held for longer than six months. In February 2002, the notes receivable from our Chief Executive Officer ("CEO") totaling $1.8 million were refinanced in part with a full recourse note (the "2002 Note") for approximately $1.5 million with floating monthly interest of 325 basis points over the Federal Funds Rate. The 2002 Note is payable in three equal payments of principal and interest due annually through February 2005. The remaining balance was satisfied by the CEO delivering, at current fair market value, shares of our common stock, which he had held for more than six months. During the fourth quarter of 2002, the value of the underlying shares of our common stock held as collateral did not meet the collateral maintenance requirements of the 2002 Note. Our Board of Directors delivered to the CEO a notice of forbearance, advising the CEO that, for the time being, Witness will forbear pursuit of its rights to demand additional collateral or prepayment of the 2002 Note. However, Witness did not waive, release or relinquish its right to exercise any and all of its rights or remedies at that time or in the future. This action is not expected to affect our results of operations or financial position. The CEO paid the first of the three installments in February 2003.

26

Recent Accounting Pronouncements

        In December 2002, the Financial Accounting Standards Board ("FASB") issued SFAS No. 148, Accounting for Stock-Based Compensation—Transition and Disclosure, which amends SFAS No. 123, Accounting for Stock-Based Compensation, to provide alternative methods of transition to SFAS No. 123's fair value method of accounting for stock-based employee compensation. SFAS No. 148 does not require companies to account for employee stock options using the fair value method but does amend the disclosure requirements of SFAS No. 123 to require prominent disclosure in both the annual and interim financial statements. Certain of the disclosure modifications are required for fiscal years ending after December 15, 2002. We do not intend to adopt SFAS No. 123's fair value method of accounting for stock-based employee compensation but have included the disclosures required by SFAS No. 148 in the notes to our consolidated financial statements.

        In November 2002, the FASB issued FASB Interpretation No. 45, Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others, which clarifies disclosure and recognition/measurement requirements related to certain guarantees. The disclosure requirements are effective for financial statements issued after December 15, 2002 and the recognition/measurement requirements are effective on a prospective basis for guarantees issued or modified after December 31, 2002. We typically grant our customers a standard warranty term which guarantees that our products will substantially conform to our current specifications. We may also indemnify our customers from third-party claims of intellectual property infringement relating to the use of our products. Costs related to these guarantees have not been significant and we do not believe that these guarantees will have a material impact on our financial statements.

        In June 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities. Under the new rules, a liability for a cost associated with an exit or disposal activity must only be recognized when the liability is incurred. Under the previous guidance of EITF No. 94-3, a liability for an exit cost was recognized at the date of an entity's commitment to an exit plan. This SFAS is effective for fiscal years beginning after December 15, 2002. We do not anticipate that the adoption of this SFAS will have a material impact on our financial statements.

        In April 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. Prior to the issuance of SFAS No. 145, SFAS No. 4 had required that all gains and losses from extinguishment of debt were to be aggregated and, if material, classified as an extraordinary item, net of related income tax effect. SFAS No. 145 rescinds SFAS No. 4 and the related required classification of extraordinary items. This SFAS is effective for fiscal years beginning after May 15, 2002. We do not anticipate that the adoption of this SFAS will have a material impact on our financial statements.

        In August 2001, the FASB issued SFAS No. 143, Accounting for Asset Retirement Obligations, which addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. This SFAS is effective for fiscal years beginning after June 15, 2002. We do not anticipate that the adoption of this SFAS will have a material impact on our financial statements.

Subsequent Event

        On February 26, 2003, we announced that we had reached an agreement with Eyretel, a U.K.-based provider of compliance and recording solutions for customer contact centers, on the terms of a recommended cash offer for all of the shares of Eyretel. The offer was for 25 pence in cash for each Eyretel share and values the company's entire issued share capital at approximately £37.4 million or $59.9 million. We purchased 28% of Eyretel on February 26, 2003 and we commenced the recommended cash offer for all of the shares of Eyretel on February 28, 2003 by publishing the U.K. Offer Document and a Form of Election and Authority in accordance with the requirements of Eyretel's home jurisdiction. The total cash consideration for the offer will be financed from our existing cash and investments.

27

        The acquisition is intended to extend our leadership in the global contact center performance optimization market, offering customers a comprehensive range of software and services. The acquisition has been recommended by the board of directors of Eyretel and is subject to the successful closing of the offer and to customary conditions, including regulatory and other standard approvals. The acquisition is expected to be completed in March or April of 2003.

Factors That May Affect Our Future Results and Market Price of Our Stock

        Our future operating results may vary substantially from period to period. The price of our common stock will fluctuate in the future, and an investment in our common stock is subject to a variety of risks, including but not limited to the specific risks identified below. Inevitably, some investors in our securities will experience gains while others will experience losses depending on the prices at which they purchase and sell securities. Prospective and existing investors are strongly urged to carefully consider the various cautionary statements and risks set forth in this report and the other documents we file with the SEC.

        Important factors currently known to our management that could cause actual results to differ materially from those in forward-looking statements include the disclosures contained in this report and the other documents we file with the SEC, as well as the following risks:

Our software has a long sales cycle that makes it difficult to plan our expenses and forecast our results

        Although it typically takes three to six months from the time we qualify a sales lead until we sign a contract with the customer, we occasionally experience a longer sales cycle. This was the case in 2002, and may be the case in future periods. It is therefore difficult to predict the quarter in which a particular sale will occur. If our sales cycle unexpectedly lengthens for one or more large orders or a significant number of small orders, it would adversely affect the timing of our revenue and the timing of our corresponding expenditures. This could harm our ability to meet our financial forecasts for a given quarter. Our customers' decisions regarding their purchase of our software and services is relatively long due to several factors, including:

•

the complex nature of our software;



•

our need to educate potential customers about the uses and benefits of our software;



•

competition for a shrinking amount of corporate resources because of a slowing economy;



•

the investment of money and other resources required by customers to purchase and implement our software;



•

customers' budget cycles and operating activities, which affect the timing of their purchases;



•

the competitive evaluation and internal approval process many of our customers undertake before purchasing our software and services;



•

delayed purchases due to announcements or planned introductions of new software or software enhancements by us or our competitors; and



•

the length of time some of our larger customers require to make a decision to purchase our software and services.

28

If the market in which we sell our software and services deteriorates further as a result of declining economic conditions and/or consolidations, it will have a material adverse effect on our business and results of operations

        The market for customer relationship management software, including software that records and analyzes customer interactions, is still emerging. However, recent economic conditions and uncertainties have caused many of our customers and prospective customers to postpone capital expenditures and many have experienced severe financial difficulties. Some examples include WorldCom, Adelphia and USAir. Consequently, this has caused an adverse effect on our business and results of operations during 2002 and it is expected that these financial difficulties and consolidations experienced by our customers might adversely affect our business and results of operations during 2003. In addition, since our customers control the timing of our installation and training services, our services revenues have been, and may continue to be, adversely impacted as customers delay the scheduling of services. In addition to the aforementioned, demand for our software remains uncertain because our existing and potential customers may:

•

not understand the benefits of using customer relationship management software generally or, more specifically, software which records and analyzes the interactions between a business and its customers;



•

not achieve favorable results using this software;



•

experience technical difficulty in implementing this software;



•

use alternative methods such as online self-help to solve the same business problems this software is intended to address; or



•

close contact centers.

        If the market for our software declines, it will have a material adverse effect on our business and results of operations.

Although we achieved a quarterly operating profit earlier in 2002, we may continue to experience quarterly losses from operations in the future

        We achieved a quarterly operating profit in the first and second quarters of 2002. We incurred losses in the third and fourth quarters of 2002 and substantial losses before 2002. We may continue to suffer losses in the future. As a result of our operating losses, we had an accumulated deficit of $27.9 million as of December 31, 2002. In addition, we expect to continue to devote substantial resources to research and development, professional services, and sales and marketing activities. As a result, we will need to generate significant revenue to sustain profitability in any future period. If we do not achieve profitability from operations, or if we do not remain profitable on a net basis, we may need to obtain additional financing. The financing from other sources upon which we have historically relied may not be available to us on acceptable terms. If we fail to remain profitable, it will materially and adversely affect the market price of our stock.

Our quarterly revenue, expenses and operating results have fluctuated and are likely to continue to fluctuate, which may cause our stock price to decline

        Our quarterly revenue, expenses and operating results could vary significantly from period to period. With respect to the current fiscal year, this is discussed above under the heading "Overview." In particular, we derive a significant portion of our software license revenue in each quarter from a small number of relatively large orders. A delay in the recognition of revenue from one of these orders may cause our results of operations during a quarter to be lower than we expect. The delay or failure to close anticipated sales in a particular quarter could reduce our revenue in that quarter and subsequent quarters over which

29

revenue for the sale could be recognized. In addition, because our revenue from installation, maintenance and training services largely correlates with our license revenue, a decline in license revenue could also cause a decline in our services revenue in the same quarter or in subsequent quarters. Our revenue, expenses and operating results may vary significantly in response to the risk factors described in this section, as well as the following factors, some of which are beyond our control:

•

a decrease in demand for our software or, more generally, for products that record and analyze the interactions between a business and its customers and/or provide electronic learning, due to either purchasing trends or general economic conditions;



•

announcements or introductions of new products and services by our competitors;



•

pricing for competitive products;



•

the timely payment of fees due to us by our customers;



•

our ability to develop, market and manage new software, software enhancements and services;



•

the deferral of orders for our software or delays in the installation of our software from one quarter to a later quarter;



•

how quickly we are able to develop new software, software enhancements and services that our customers require;



•

how much money we have to spend to improve our software, services and operations;



•

delays in installations of our software;



•

the increasing length of sales cycles for our software;



•

the mix of revenue generated by software licenses and related services;



•

spending limitations imposed on our customers or potential customers because of economic factors and decreased capital spending budgets, including limitations imposed after the sales cycle has begun but before a sale is consummated;



•

the timing and size of our capital expenditures and changes in our working capital;



•

the failure of our customers to renew their annual maintenance, either because they consolidate their contact centers or they stop using our product company-wide;



•

the economic conditions of the companies within the financial services and telecommunications industry verticals into which we have historically sold and expect to sell our software;



•

how successfully our reseller partners are able to resell our software; and



•

how successful we are in selling our products in new geographic markets.

        Due to the foregoing factors, we believe that quarter-to-quarter comparisons of our operating results may not be a good indication of our future performance, and you should not rely on them to predict our future performance or the future performance of our stock price. Historically, our quarterly revenue variations have fluctuated from as low as an 11% decline to as high as a 58% growth from one quarter to the next. If our future revenue or operating results fall below the expectations of investors or securities analysts, the price of our common stock would likely decline.

Seasonal trends in sales of business software or customer interaction levels may affect our quarterly revenue

        The market for business software has experienced seasonal fluctuations in demand. The first and third quarters of the year have been typically characterized by slightly longer sales cycles related to holiday and vacation schedules. We believe that these fluctuations are caused in part by customer buying patterns,

30

which are influenced by year-end budgetary pressures and by sales force commission structures. Customer interaction centers typically experience much higher volumes of customer contact during and immediately following the year-end holiday season. As a result, many customers may elect to defer installation of our software during this time. This has caused us to experience, and we expect to continue to experience, seasonal fluctuations in our revenue.

If we fail to expand and manage our international operations, we may be unable to reach or maintain our desired levels of revenue or profitability

        Revenue from customers located outside of North America, including the United States and Canada, accounted for approximately 15% and 9% of our total revenue for years ended December 31, 2002 and 2001, respectively. We intend to continue to expand our international operations through acquisitions, internal business expansion and strategic business relationships. Our operations outside of North America at December 31, 2002 consisted of 35 dedicated employees located in Australia, Japan, Mexico, the Netherlands, Singapore and the United Kingdom. We have also established relationships with a small number of international resellers. On February 26, 2003, we announced a recommended offer to purchase all of the outstanding shares of Eyretel, a company located in the United Kingdom. If we successfully complete this pending acquisition, we expect that we will expand our international operations significantly.

        In addition to general risks associated with international expansion, such as foreign currency fluctuations and political and economic instability, our plans to expand internationally may be adversely affected by a number of risks, including:

•

limited development of an international market for our software and services;



•

the challenges we face in expanding and training our international sales force and support operations;



•

expenses associated with customizing products for multiple countries;



•

longer payment cycles, different accounting procedures and difficulties in collecting accounts receivable; and



•

multiple, conflicting and changing governmental laws and regulations governing intellectual property, call monitoring and the recording of employees.

        As we further expand our operations outside the United States, we will face new competitors and competitive environments. In addition to the risks associated with our domestic competitors, foreign competitors may pose an even greater risk, as they may possess a better understanding of their local markets and better working relationships with local infrastructure providers and others. In particular, because telephone protocols and standards are unique to each country, local competitors will have more experience with, and may have a competitive advantage in, these markets. We may not be able to obtain similar levels of local knowledge or similar relationships in foreign markets, which could place us at a significant competitive disadvantage. In addition, we have limited experience in developing local language versions of our products or in marketing our products to international customers. We may not be able to successfully translate, market, sell, and deliver our products internationally.

Conducting business internationally poses risks that could affect our financial results

        Conducting business outside North America poses many risks that could adversely affect our operating results. In particular, we may experience gains and losses resulting from fluctuations in currency exchange rates, for which hedging activities may not adequately protect us. Moreover, exchange rate risks can have an adverse effect on our ability to sell our products in foreign markets. Where we sell our products in U.S. dollars, our sales could be adversely affected by declines in foreign currencies relative to the dollar, thereby making our products more expensive in local currencies. Where we sell our products in

31

local currencies, we could be competitively unable to increase our prices to reflect fluctuations in the exchange rate. Additional risks we face in conducting business internationally include the following: longer payment cycles; difficulties in staffing and managing international operations; problems in collecting accounts receivable; and the adverse effects of tariffs, duties, price controls or other restrictions that impair trade.

We face intense competition that could adversely affect our revenue, profitability and market share

        The market for products that record customer interactions, analyze performance and/or provide electronic learning is intensely competitive, evolving and experiences rapid changes in technology. We believe our principal competitors include, but are not limited to:

•

quality monitoring suppliers to the contact center industry;



•

traditional call-logging vendors;



•

electronic learning vendors;



•

business analytics vendors;



•

systems integrators and consulting firms; and



•

new, larger and more established entities that may acquire, invest in or form joint ventures with providers of recording or performance enhancing software solutions.

        Many of our current and potential competitors have longer operating histories, more established business relationships, larger customer bases, a broader range of products and services, greater name recognition and substantially greater financial, technical, marketing, personnel, management, service, support and other resources than we do. This could allow our current and potential competitors to respond more quickly than we can to new or emerging technologies and changes in customer requirements, take better advantage of acquisitions and other opportunities, devote greater resources to the marketing and sale of their products and services and adopt more aggressive pricing policies. These competitors may distinguish themselves from us on the basis of their longer operating histories and ability to withstand difficult economic conditions. Our competitors may also be able to offer products at lower prices or with other incentives that we cannot match. Additionally, the scope of our products and services may be viewed as too narrow because some of our competitors offer a broader range of products and services.

        In addition, many of our competitors market their products through resellers and companies that integrate their technology and products with those of the competitor. These resellers and technology partners of our competitors often have strong business relationships with our customers and potential customers. For example, some of our competitors have a better and more long standing relationship with telephone switch vendors. Our competitors may use these business relationships to market and sell their products and compete for customers with us. We cannot assure you that our competitors will not offer or develop products and services that are superior to ours. In addition, it is possible that resellers or technology partners, such as certain telephone switch vendors, may acquire one or more of our competitors, which would further solidify their business relationships.

        We have developed, and intend to continue to develop, relationships with companies that resell our software and companies that provide us with customer referrals or leads, some of which may become competitors. License revenue from our indirect sales channel, which consists of select resellers and a variety of strategic marketing alliances, accounted for approximately 23% and 2% of our license revenue for the years ended December 31, 2002 and 2001, respectively. We expect revenue from our indirect sales channel, and accordingly our dependence on resellers, to continue to increase as we establish more relationships with companies to resell our software worldwide. We engage in joint marketing and sales efforts with our resellers, and rely on them for recommendations of our software during the evaluation stage of the purchase process. When we enter into agreements with these companies, the agreements are

32

not exclusive and may ordinarily be terminated by either party. Some of these companies have similar, and often more established, relationships with our competitors, and may recommend the products and services of our competitors to customers instead of our software and services. In addition, through their relationships with us, these companies could learn about our software and the market for our software and services and could develop and sell competing products and services. As a result, our relationships with these companies could lead to increased competition for us.

        We expect that competition will increase as other established and emerging companies enter our market and as new products, services and technologies are introduced. Increased competition may result in price reductions, lower gross margins and loss of our market share. This could materially and adversely affect our business, financial condition and results of operations.

We rely heavily on sales of our eQuality Balance and eQuality Evaluation software

        Our financial performance has depended, and will continue to depend, on our ability to develop and maintain market acceptance of our eQuality Balance software and new and enhanced versions of it. Historically, nearly all of our license revenue has been derived from the sale of our eQuality Balance and eQuality Evaluation software, and we expect revenue from these two products to continue to account for most of our revenue for the foreseeable future. Through December 31, 2002, we have recognized less than 15% of our license revenue from products other than eQuality Balance and eQuality Evaluation. As a result, factors which adversely affect the pricing or demand for our eQuality Balance and eQuality Evaluation software, such as competitive pressures, technological change or evolution in customer preferences, could materially and adversely affect our business, financial condition and results of operations. Many of these factors are beyond our control and difficult to predict.

If we fail to develop new software or improve our existing software to meet or adapt to the changing needs and standards of our target market, sales of our software and services may decline

        Our future success depends upon our ability to develop and introduce new software and software enhancements which meet the needs of companies seeking to record and analyze their interactions with customers and/or deliver electronic learning to their employees. To achieve increased market acceptance of our software and services, we must, among other things, continue to:

•

improve our existing software and introduce new software solutions;



•

incorporate new technology into our software and services on a timely and cost-effective basis;



•

keep pace with the products and services of our competitors;



•

satisfy the changing requirements of our current and potential customers;



•

improve the effectiveness of our software, particularly in installations involving very large databases and large numbers of simultaneous users;



•

enhance our software's ease of administration;



•

improve our software's ability to extract data from existing software systems; and



•

adapt to rapidly changing computer operating system, database and software platform standards and Internet technology.

        We may require substantial product development expenditures and lead-time to keep pace and ensure compatibility with new technology in our industry. If we fail to develop and introduce new software and enhancements for our existing software, our software and services may not achieve market acceptance and we may be unable to attract new customers.

33

Our products may fail to perform properly, which may cause us to incur additional expenses or lose sales

        Our software is used in a complex operating environment that requires its integration with computer and telephone networks and other business software applications. Furthermore, the hardware, software and network systems generally used in conjunction with our software, particularly telephone standards and protocols, change rapidly. The evolution of these standards may cause our products to function slowly or improperly. Poor product performance may necessitate redevelopment of our product or other costly reengineering measures which may divert our management and product development resources and funds. Due to the large number of, and variations in, computer and telephone network systems and applications, as well as the rapid changes in these products, our testing process may be unable to duplicate all possible environments in which our software is expected to perform. Any errors or defects that are discovered after we release new or enhanced software could cause us to lose revenue, cause a delay in the market acceptance of our software, damage our customer relationships and reputation and increase our service and warranty costs. All of these problems could be exacerbated as we move our product to the latest software technologies and platforms.

Our failure to protect our intellectual property may lead to third parties using our technology for their own benefit

        Our success depends to a significant degree upon the legal protection of our software and other proprietary technology rights. We rely on a combination of patent, trade secret, copyright and trademark laws and confidentiality and non-disclosure agreements with employees and third parties to establish and protect our proprietary rights. These measures may not be sufficient to protect our proprietary rights, and we cannot be certain that third parties will not misappropriate our technology and use it for their own benefit. Also, most of these protections do not preclude our competitors from independently developing products with functionality or features substantially equivalent or superior to our software. Any failure to protect our intellectual property could have a material adverse effect on our business.

        As of December 31, 2002, we had five U.S. registered trademarks, two patents generally relating to our voice/data synchronization technology and data capture technique and 13 patent applications pending. There is no guarantee that our pending applications will result in issued patents or, if issued, that they will provide us with any competitive advantages. We cannot assure you that we will file further patent, trademark or copyright applications, that any future applications will be approved, that any existing or future patents, trademarks or copyrights will adequately protect our intellectual property or that any existing or future patents, trademarks or copyrights will not be challenged by third parties. Furthermore, one or more of our existing or future patents, trademarks or copyrights may be found to be invalid or unenforceable.

        We are aware of certain uses, U.S. trademark registrations, and U.S. trademark applications for our "eQuality" trademark and its variations that predate our use, and the April 30, 2002 issuance, of the U.S. registration for our trademark eQuality®. It is possible that the owner of legal rights resulting from one or more of these prior uses, U.S. trademark registrations, or U.S. trademark applications will bring legal action to challenge our registration of and/or our continued use of the trademark eQuality®, and may also seek compensation for damages resulting from our use of our registered trademark if such challenging party prevails on such a claim. As a result, we cannot assure you that our registration of this trademark will be undisturbed, or that this use will not result in liability for trademark infringement, trademark dilution, and/or unfair competition.

        Moreover, the laws of other countries in which we market our products may afford little or no effective protection of our proprietary technology. If we resort to litigation to enforce our intellectual property rights, the proceedings could be burdensome and expensive, would likely divert valuable management and product development resources and could involve a high degree of risk, regardless of whether we win or lose the litigation.

34

Claims by other companies that our software infringes their intellectual property could require us to incur substantial expenses or prevent us from selling our software or services

        If any of our software violates the intellectual property rights of others, we may be required to reengineer or redevelop our software, seek to obtain licenses from third parties to continue offering our software without substantial reengineering, or conduct studies of such intellectual property rights so as to evaluate whether such intellectual property rights are valid or enforceable. Any efforts to reengineer our software or obtain licenses from third parties may not be successful, could be extremely costly and would likely divert valuable management and product development resources. Our efforts to study the intellectual property rights of third parties may not be successful and could reveal that such intellectual property rights are valid and enforceable, could be extremely costly and would likely divert valuable management and product development resources. For example, depending on the outcome of our lawsuit against Knowlagent (as described above under the heading "Legal Proceedings"), we may be required to enter into royalty and licensing agreements on unfavorable terms, required to stop selling or to redesign our eQuality® NOW application, or to pay damages or to satisfy indemnification commitments with our customers.

        In addition, in the rapidly developing technological environment in which we operate, third parties may have filed a number of patent applications, many of which are confidential when filed. If our software is found to violate these patents when they are issued or any other intellectual property of others, we may become subject to claims for infringement. An infringement claim against us could result in the loss of our proprietary rights and, whether meritorious or not, could be time-consuming, result in costly litigation or require us to pay damages or enter into royalty or licensing agreements on terms that are unfavorable to us. Royalty or licensing agreements might not be available to us on reasonable terms or at all. In addition, our customers may become subject to claims if the software they license from us is alleged to infringe the intellectual property of others.

        If we decide to, or are forced to, litigate any of these claims, the litigation could be expensive and time-consuming, could divert our management's attention from other matters, and could otherwise materially and adversely affect our business, financial condition and results of operations, regardless of the outcome of the litigation. Litigation and intellectual property claims against us could also disrupt our sale of software. Additionally, it could lead to claims by third parties against our customers and others using our software. Our customers and these other users of our software would likely hold us responsible for these claims and any resulting harm they suffer.

        We expect that we and other participants in our industry and related industries will be increasingly subject to infringement claims as the number of competitors with patent and other intellectual property portfolios in these industries grows. Although patent and intellectual property disputes may be settled through licensing or similar arrangements, costs associated with these arrangements may be substantial and we cannot assure you that necessary licenses or similar arrangements will be made available to us on a reasonable basis or at all. Consequently, if we become subject to an adverse determination in a judicial or administrative proceeding or we fail to obtain necessary licenses it could prevent us from producing and selling some or potentially all of the components of our software. This would have a material adverse effect on our business, financial condition and results of operations.

We believe that our future success also depends upon the continued ability of our software to be compatible with the products and other technologies offered by other software and hardware companies

        Our software must integrate with software and hardware solutions provided by a number of our existing and potential competitors. These competitors or their business partners could alter their products so that our software no longer integrates well with them, or they could delay or deny our access to software releases that allow us to timely adapt our software to integrate with their products. They could thus effectively prevent us from modifying our software to keep pace with the changing technology of their

35

products. If we cannot adapt our software to changes in our competitors' technology, it may significantly impair our ability to compete effectively, particularly if our software must integrate with the software and hardware solutions of our competitors.

        New products may not be compatible with our software, but may be compatible with the products of our competitors. For example, our products must integrate with phone switches made by the telephone switch vendors, and computer telephony software applications offered by other software providers. If our products are not compatible with the new technologies offered by other software and hardware companies, it would have a material adverse effect on our business and results of operations.

If we do not continue to expand the distribution of our products through direct and indirect sales channels, we may be unable to expand our market share or increase our revenue

        To expand our market share and revenue, attract new customers and increase sales to existing customers, we may need to expand our direct and indirect sales channels of distribution. We also may need to expand our direct sales force by hiring additional sales personnel and management, and increase the number of relationships we have with companies that provide us with customer referrals or leads for new business. Historically, it has taken us up to six months to train new sales personnel before they reach an acceptable level of productivity. We have also experienced difficulty in finding new sales personnel with experience in computer and telephone integration technologies. We cannot assure you that we will be able to continue to find an adequate number of new sales personnel meeting our specific needs. If the personnel we hire are less qualified, it may take us more time to train them and they may take a longer time to reach an acceptable level of productivity.

        We also intend to derive revenue from our indirect sales channel through relationships with companies that resell our software. In particular, we intend to use resellers to increase our sales internationally and to market our software to small and medium contact centers. When we enter into agreements with these companies, they are not exclusive and may ordinarily be terminated by either party. Some of these companies have similar, and often more established, relationships with our competitors, and may recommend the products and services of our competitors to customers instead of our software and services. We cannot assure you that we will be able to maintain productive relationships or that we will be able to establish similar relationships with additional companies on a timely basis, or at all. In addition, we cannot be certain that these distribution partners will devote adequate resources to selling our software and services. If we are unable to maintain and expand our direct sales force and indirect distribution channels, we will not be able to increase our revenue and our business will suffer.

If our internal professional services employees do not provide installation services effectively and according to schedule, our customers may not use our installation services or may stop using our software

        Customers that license our products ordinarily purchase installation, training and maintenance services, which they typically obtain from our internal professional services organization. Because our software must be installed to work with a number of computer and telephone network systems, installation of our software can be difficult. These systems vary greatly from one customer site to another, and the versions and integration requirements of these third-party systems change frequently. We believe that the speed and quality of installation services are competitive factors in our industry. If our installation services are not satisfactory to our customers, the customers may choose to not use our installation services to install software they license from us. In addition, these customers may determine that they will not license our software and instead will use the products and services of one of our competitors. If this happens, we would lose licensing and services revenue from these customers, and it would likely harm our reputation in the industry in which we compete. This could materially and adversely affect our business, financial condition and results of operations.

36

We may make acquisitions or investments that are not successful and that adversely affect our ongoing operations

        We may acquire or make investments in companies, products, services and technologies which we believe complement our software and services. Because of the increasing use of new customer interaction mediums such as the Internet and e-mail, we believe that it may be important for us to acquire complementary technology to quickly bring new products to market. Our overall gross profit margins may decrease as we integrate additional third-party components into our new or existing products or make investments in third-party technology. We have very limited experience in making acquisitions and investments. As a result, our ability to identify prospects, conduct acquisitions and properly manage the integration of acquisitions is unproven. If we fail to properly evaluate and execute acquisitions or investments, it may seriously harm our business and operating results. In making or attempting to make acquisitions or investments, we face a number of risks, including:

•

identifying suitable acquisition or investment candidates, performing appropriate due diligence, identifying potential liabilities and negotiating acceptable terms for acquisitions and investments;



•

the potential distraction of our management, diversion of our resources and disruption of our business;



•

retaining and motivating key employees of the acquired companies;



•

managing operations that are distant from our current headquarters and operations;



•

entering into geographic markets in which we have little or no prior experience;



•

competing for acquisition opportunities with competitors that are larger than we are or have greater financial and other resources than we have;



•

accurately forecasting the financial impact of an acquisition or investment;



•

maintaining good relations with the customers and suppliers of the acquired company; and



•

effectively integrating acquired companies or investments into the company and achieving expected synergies.

        On February 26, 2003, we announced a recommended offer to purchase all of the outstanding shares of Eyretel, a company headquartered in the United Kingdom. We cannot guarantee that we will be able to complete the proposed transaction in a timely manner, if at all. If we are able to complete the acquisition successfully, we will face many of the risks discussed above, including integrating the acquired business, managing expanded operations in new geographic markets and achieving the anticipated synergies of the combined companies. In addition, since Eyretel has historically placed greater emphasis on hardware products, we will face certain risks related to Eyretel's operations.

        In addition, if we make or finance acquisitions using convertible debt or equity securities, our existing stockholders may be diluted, which could cause the market price of our stock to decline. If we make acquisitions out of our existing cash, our working capital may be significantly reduced, and our ability to expand, or to maintain our business in the face of a downturn in revenues or cash flow or unexpected increases in expenses, may be adversely affected, including our ability to make capital expenditures and fund operations. In that event, we may need additional financing, which may not be available or may only be available on unfavorable terms.

If we need additional financing to maintain or expand our business, it may not be available on favorable terms, or at all

        Although we believe our current cash and borrowing capacity will be sufficient to meet our anticipated cash needs for working capital and capital expenditures for at least the next 12 months and the foreseeable

37

future, we may need additional funds to expand or meet all of our operating needs. If we need additional financing, we cannot be certain that it will be available to us on favorable terms, or at all. If we raise additional funds by issuing equity securities, the ownership interest of our stockholders would be significantly diluted, and any additional equity securities we issue may have rights, preferences or privileges senior to the rights of our stockholders. Also, the terms of any additional financing we obtain may significantly limit our future financing and operating activities. If we need funds and cannot raise them on acceptable terms, we may be forced to sell assets or seek to refinance our outstanding obligations. We may also be unable to:

•

develop and enhance our software to remain competitive;



•

take advantage of future opportunities, such as acquisitions;



•

respond to changing customer needs and our competitors' innovations; or



•

attract and retain qualified key personnel.

        Any of these events could significantly harm our business and financial condition and limit our growth.

Our stock price has been volatile

        The market price of our common stock could be subject to significant fluctuations in response to variations in quarterly operating results and other factors. In addition, the securities markets have experienced significant price and volume fluctuations from time to time that have often been unrelated or disproportionate to the operating performance of particular companies. Any announcement with respect to any adverse variance in revenue or earnings from levels generally expected by securities analysts or investors for a given period could have an immediate and significant adverse effect on the trading price of our common stock. In addition, factors such as announcements of technological innovations or new products by us, our competitors or third parties, changing conditions in the market for products that record and analyze customer interactions, changes in estimates by securities analysts, announcements of extraordinary events, such as acquisitions or litigation, or general economic conditions may have an adverse effect on the market price of the common stock.

Government regulation of telephone and Internet monitoring could cause a decline in the use of our software, result in increased expenses for us or subject us and our customers to liability

        As the telecommunications industry continues to evolve, state, federal and foreign governments may increasingly regulate the monitoring of telecommunications and telephone and Internet monitoring and recording products, such as our software. We believe that increases in regulation could come in the form of a number of different kinds of laws, including privacy and employment regulations. The adoption of new laws governing the use of our software or changes made to existing laws could cause a decline in the use of our software and could result in increased expenses for us, particularly if we are required to modify our software to accommodate these new or changing laws. Moreover, new laws or changes to existing laws could subject us and our customers to liability. In addition, whether or not these laws are adopted, if we do not adequately address the privacy concerns of consumers, companies may be hesitant to use our software. If any of these events occur, it could materially and adversely affect our business.

We may face difficulty in attracting and retaining key personnel, which are necessary to effectively manage and expand our business

        Our future success will depend in large part on our ability to hire, train, retain and motivate a sufficient number of qualified personnel, particularly in sales, marketing, research and development, service and support. In particular, competition for research and development personnel with computer and telephone integration skills is intense, and turnover of technical personnel is particularly high in our industry. We expect to face additional difficulties retaining personnel who have stock options with exercise

38

prices above the fair market value of our stock. In order to retain some of our personnel, we will need to grant additional options to purchase common stock to these employees with exercise prices equal to the fair market value of our stock, which will cause dilution to our stockholders. If we are unable to attract and retain qualified personnel or if we experience high personnel turnover, it would increase our costs of operations and could prevent us from effectively managing and expanding our business.

        Our future success also depends upon the continued service of our executive officers, particularly our Chairman and Chief Executive Officer, David Gould. We have an employment agreement with Mr. Gould and limited non-compete agreements with all of our executive officers. However, any of our executive officers and other employees could terminate his or her relationship with us at any time. The loss of the services of our executive officers or other key personnel could materially and adversely affect our business. In addition, if one or more of our executive officers or key employees were to join one of our competitors or otherwise compete with us, it could harm our business.

Our management and affiliates control a large percentage of our voting stock and could exert significant influence over matters requiring stockholder approval

        At December 31, 2002, our executive officers and directors and their affiliates together controlled approximately 24% of our outstanding common stock. As a result, these stockholders, if they act together, will be able to exert significant influence over all matters requiring stockholder approval, including the election of our directors and the approval of significant corporate transactions.

Our certificate of incorporation and bylaws, as well as Delaware law, may prevent or delay a future takeover

        Our amended and restated certificate of incorporation and bylaws contain provisions which could make it harder for a third party to acquire us without consent of our board of directors. For example, if a potential acquirer were to make a hostile bid for us, the acquirer would not be able to call a special meeting of stockholders to remove our board of directors or act by written consent without a meeting. In addition, our board of directors has staggered terms which makes it difficult to remove all our directors at once. The acquirer would also be required to provide advance notice of its proposal to remove directors at an annual meeting.

        Our board of directors has the ability to issue preferred stock which would significantly dilute the ownership of a hostile acquirer. In addition, Delaware law limits business combination transactions with 15% stockholders that have not been approved by the board of directors. In October 2002, our board of directors approved, and we have implemented, a stockholder rights plan which has the effect of causing substantial dilution to a person or group that attempts to acquire us on terms not approved by the board of directors.

Item 7A.    Qualitative and Quantitative Disclosures About Market Risk

        None.

Item 8.    Financial Statements and Supplementary Data

        Our consolidated financial statements, together with related notes and the report of KPMG LLP, our independent auditors, are set forth on the pages indicated in Item 15.

Item 9.    Changes in and Disagreements with Accountants on Accounting and Financial Disclosures

        None.

39

PART III

        Certain information required by Part III is omitted from this Report in that the Company will file a definitive proxy statement within 120 days after the end of this fiscal year pursuant to Regulation 14A (the "Proxy Statement") for its 2003 Annual Meeting of Stockholders proposed to be held on May 29, 2003, and the information included therein is incorporated herein by reference.

Item 10.    Directors and Executive Officers of Registrant

        The information required by this Item is incorporated by reference from the Proxy Statement under the headings "Election of Directors" and "Executive Compensation."

Item 11.    Executive Compensation

        The information required by this Item is incorporated by reference from the Proxy Statement under the heading "Executive Compensation."

Item 12.    Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

        The information required by this Item is incorporated by reference from the Proxy Statement under the heading "Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters."

Item 13.    Certain Relationships and Related Transactions.

        The information required by this Item is incorporated by reference from the Proxy Statement under the heading "Executive Compensation."

Item 14.    Controls and Procedures

        Based on their evaluation, as of a date within 90 days of the filing of this Form 10-K, the Company's Chief Executive Officer and Chief Financial Officer have concluded the Company's disclosure controls and procedures (as defined in Rules 13a-14 and 15d-14 under the Securities Exchange Act of 1934) are effective. There have been no significant changes in internal controls or in other factors that could significantly affect these controls subsequent to the date of their evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

Item 15.    Exhibits, Financial Statement Schedules and Reports on Form 8-K

a)

The following documents are filed as part of this report:

40

b)

Reports on Form 8-K:

The Company filed the following reports on Form 8-K filed during the fourth quarter of 2002:

(1)

On October 1, 2002, we filed a current report on Form 8-K under Item 5 to report our third quarter 2002 financial results.



(2)

On October 17, 2002, we filed a current report on Form 8-K under Item 5 to report the Board of Directors issuance of a Notice of Forbearance to the CEO regarding his Note Payable.



(3)

On November 4, 2002, we filed a current report on Form 8-K under Item 5 to report the adoption of a Stockholder Rights Plan.

41

(c)

Exhibits

42

*

Filed herewith

(1)

Incorporated by reference to exhibits previously filed with the Company's Registration Statement on Form S-1 (File No. 333-91383)

(2)

Incorporated by reference to exhibits previously filed with the Company's Registration Statement on Form S-8 (File No. 333-67416)

(3)

Incorporated by reference to exhibits previously filed with the Company's Quarterly Report on Form 10-Q for the period ended June 30, 2000

(4)

Incorporated by reference to exhibits previously filed with the Company's Annual Report on Form 10-K for the year ended December 31, 1999

(5)

Incorporated by reference to exhibits previously filed with the Company's Annual Report on Form 10-K for the year ended December 31, 2000

(6)

Incorporated by reference to exhibits previously filed with the Company's Quarterly Report on Form 10-Q for the period ended September 30, 2002

(7)

Incorporated by reference to exhibits previously filed with the Company's Current Report on Form 8-K on October 17, 2002

(8)

Incorporated by reference to exhibits previously filed with the Company's Current Report on Form 8-K on November 4, 2002

(9)

Incorporated by reference to exhibits previously filed with the Company's Annual Report on Form 10-K for the year ended December 31, 2001

(10)

Incorporated by reference to exhibits previously filed with the Company's Current Report on Form 8-K on March 3, 2003

43