10-Q 1 d01247e10vq.txt FORM 10-Q ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 ---------- FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarter ended September 30, 2002 Commission file number 0-25016 T-NETIX, INC. (Exact name of registrant as specified in its charter) DELAWARE (State or Other Jurisdiction of 84-1037352 Incorporation) (I.R.S. Employer Identification No.) 2155 CHENAULT DRIVE, SUITE 410 CARROLLTON, TEXAS 75006 75006 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (972) 241-1535 ---------- 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 and Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practical date. CLASS OUTSTANDING AT NOVEMBER 4, 2002 -------------------------------- ------------------------------- Common stock, $0.01 stated value 15,051,460 ================================================================================ FORM 10-Q CROSS REFERENCE INDEX

2 PART I ITEM 1. FINANCIAL STATEMENTS INDEX TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS Condensed Consolidated Balance Sheets as of September 30, 2002 and December 31, 2001 (Unaudited)......................................................................................................... 4 Condensed Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2002 and 2001 (Unaudited)......................................................................................................... 5 Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2002 and 2001 (Unaudited)......................................................................................................... 6 Notes to Condensed Consolidated Financial Statements (Unaudited)......................................................... 7

3 T-NETIX, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AND SHARE AMOUNTS) (UNAUDITED)

See accompanying notes to unaudited condensed consolidated financial statements. 4 T-NETIX, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AND SHARE AMOUNTS) (UNAUDITED)

See accompanying notes to unaudited condensed consolidated financial statements. 5 T-NETIX, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AND SHARE AMOUNTS) (UNAUDITED)

See accompanying notes to unaudited condensed consolidated financial statements. 6 T-NETIX, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AND SHARE AMOUNTS) (UNAUDITED) (1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Unaudited Financial Statements The accompanying unaudited consolidated financial statements reflect all adjustments which, in the opinion of management, are necessary to reflect a fair presentation of the financial position and results of operations of T-NETIX, Inc. and subsidiaries (the "Company") for the interim periods presented. All adjustments, in the opinion of management, are of a normal and recurring nature. Some adjustments involve estimates, which may require revision in subsequent interim periods or at year-end. The financial statements have been presented in accordance with generally accepted accounting principles. Refer to notes to consolidated financial statements, which appear in the 2001 Annual Report on Form 10-K for the Company's accounting polices, which are pertinent to these statements. Acquisitions In January 2001, the Company completed the purchase of all the outstanding shares of common stock, not already owned, of TELEQUIP Labs, Inc., a provider of inmate calling systems. The purchase price was $605 per share, of which $573 per share was paid upon closing. The remaining $32 per share, payable on the first anniversary of the closing date upon determination that all representations and warranties were materially true and accurate as of the closing date and all covenants have been substantially fulfilled, has been paid. The excess of the purchase price over the fair value of the net identifiable assets acquired has been recorded as goodwill. The total cash paid in January 2001 was $1.5 million. The acquisition has been accounted for as a purchase and, accordingly, the results of operations of TELEQUIP Labs, Inc. have been included in the Company's consolidated financial statements from January 2001. In June 2002, the Company purchased substantially all of the assets of ACT Telecom, Inc., a Houston, Texas based prepaid calling platform provider and wholly-owned subsidiary of ClearMediaOne, Inc. Assets included a telecommunication switch, prepaid calling platform and associated software. The purchase price was approximately $0.7 million, including $0.3 million in cash and the issuance of a $0.4 million note due and payable on or before June 2003. Earnings (Loss) Per Common Share Earnings (loss) per common share are presented in accordance with the provisions of Statement of Financial Accounting Standards No. 128, Earnings Per Share ("SFAS 128"). Basic earnings per share excludes dilution for common stock equivalents and is computed by dividing income or loss available to common shareholders by the weighted average number of common shares outstanding during the period. Diluted earnings per share reflect the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock. The following is a reconciliation of the numerators and denominators of the basic and diluted earnings per share computations:

For the three and nine months ended September 30, 2002 and 2001, common stock equivalents of 1,920,000, 1,722,000, 1,619,000 and 1,127,000, respectively, were not included in the diluted earnings per share calculation, as their effect would be anti-dilutive. 7 T-NETIX, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AND SHARE AMOUNTS) (UNAUDITED) Recently Issued or Adopted Accounting Pronouncements In July 2001, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 141, "Business Combinations", which requires the use of the purchase method and eliminates the option of using pooling-of-interests method of accounting for all business combinations. The provisions in this statement apply to all business combinations initiated after June 30, 2001, and to all business combinations accounted for using the purchase method for which the date of acquisition is on or near July 1, 2001. As the Company did not have any significant business acquisitions, the adoption of this statement did not have a material impact on the Company's financial position, results of operations, or cash flows. In July 2001, the FASB issued SFAS No. 142, "Goodwill and Other Intangible Assets" ("SFAS 142"). In general, SFAS No. 142 is effective for fiscal years beginning after December 15, 2001. SFAS No. 142 addresses financial accounting and reporting for acquired goodwill and other intangible assets, and requires that all intangible assets acquired, other than those acquired in a business combination, be initially recognized and measured based on fair value. In addition, the intangible assets should be amortized based on useful life. If the intangible asset is determined to have an indefinite useful life, it should not be amortized, but shall be tested for impairment at least annually. The Company adopted the provisions of SFAS No. 142 on January 1, 2002. The effect of adoption was the cessation of amortization of goodwill recorded on previous purchase business combinations. The Company reviewed the recorded goodwill for impairment upon adoption of SFAS No. 142. To accomplish this, we identified the reporting units and determined the carrying value of each reporting unit. The Company defines its reporting unit to be the same as the reportable segments (see note 5). To the extent a reporting unit's carrying amount exceeds its fair value, the reporting unit's cost in excess of fair value of net assets acquired may be impaired and we must perform the second step of the transitional impairment test. In the second step, we must compare the implied fair value of the reporting unit's fair value to all of its assets (recognized and unrecognized) and liabilities in a manner similar to a purchase price allocation in accordance with SFAS No. 141, to its carrying amount, both of which would be measured as of January 1, 2002. Any transitional impairment loss is recognized as the cumulative effect of a change in accounting principle in our statement of operations. The Company has completed its transitional impairment tests and has determined that no impairment losses for goodwill and other intangible assets will be recorded as a result of the adoption of SFAS No. 142. The Company expects that its depreciation and amortization expense will decrease by approximately $0.8 million annually as a result of the adoption of SFAS No. 142. If amortization of goodwill had not been recorded, and if amortization of other intangible assets had been recorded using the revised life, the Company's net income and income per share for the three and nine months ended September 30, 2001 would have been as follows:

In August 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement Obligations". This statement addresses the financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. SFAS 143 requires that the fair value of a liability for an asset retirement obligation be recognized in the period in which it is incurred if a reasonable estimate of fair value can be made. The associated asset retirement costs are capitalized as part of the carrying amount of the long-lived asset and reported as a liability. This statement is effective for fiscal years beginning after June 15, 2002. The Company is currently evaluating the impact of the adoption of SFAS 143. In October 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets". This statement establishes a single accounting model, based on the framework established in SFAS 121, for long-lived assets to be disposed of by sale, whether previously held and used or newly acquired, and broadens the presentation of discontinued operations to include 8 T-NETIX, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AND SHARE AMOUNTS) (UNAUDITED) more disposal transactions. This statement is effective for fiscal years beginning after December 15, 2001. The adoption of this statement had no material impact upon the Company's financial position or results of operations. In May 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections." Under the provisions of SFAS No. 145, gains and losses from the early extinguishment of debt are no longer classified as an extraordinary item, net of income taxes, but are included in the determination of pretax earnings. The effective date for SFAS No. 145 is for fiscal years beginning after May 15, 2002, with early application encouraged. In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities." SFAS No. 146 addresses accounting and reporting for costs associated with exit or disposal activities by requiring that a liability for a cost associated with an exit or disposal activity be recognized and measured at fair value only when the liability is incurred. SFAS No. 146 also nullifies EITF Issue 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)." The provisions of SFAS No. 146 are effective for exit or disposal activities that are initiated after December 31, 2002. Reclassification Certain amounts in the 2001 financial statements have been reclassified to conform to the 2002 presentation. (2) BALANCE SHEET COMPONENTS Accounts receivable consist of the following:

Bad debt expense was $3.5 million and $1.7 million for the three months ended September 30, 2002 and 2001, respectively, and $9.5 million and $4.4 million for the nine months ended September 30, 2002 and 2001, respectively. Property and equipment consist of the following:

9 T-NETIX, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AND SHARE AMOUNTS) (UNAUDITED) Intangible and other assets consist of the following:

Accrued liabilities consist of the following:

(3) DEBT Debt consists of the following:

In September 1999, the Company entered into a Senior Secured Revolving Credit Facility (the "Credit Facility") with its commercial bank. The Credit Facility provided for maximum credit of $40.0 million subject to limitations based on certain financial covenants. In April 2001, the Company's lenders extended the maturity date on its credit agreement to March 2002. The maximum available borrowings on the Credit Facility was reduced to $30.0 million and interest was set at prime rate plus 1.25% effective June 30, 2001 increasing by 0.25% each quarter thereafter on June 30, September 30 and December 31, 2001. In addition, monthly payments of $0.2 million on the term loan commenced in April 2001. In March 2002, the maturity date of the Credit Facility was extended to June 26, 2002. Effective with the March 2002 extension, the maximum available borrowings on the Credit Facility was reduced to $21.8 million and interest was set at prime plus 2.25% (7.0% at September 30, 2002). The Company also pays a fee of 0.40% per annum on the unused portion of the line of credit. In April 2002, the Company obtained a further commitment from its lenders to extend, at the option of the Company, the Credit Facility beyond June 26, 2002 to January 2003. Effective June 2002, the Company elected to extend the existing Credit Facility and paid an option exercise fee to its lenders equal to 3.0% of the maximum available borrowing on the Credit Facility. This fee has been recorded as a pre-paid financing fee and will be expensed over the remaining term of the Credit Facility. Under the terms of the April 2002 extension, the maximum available borrowings on the Credit Facility was reduced to $18.7 million, consisting of a $7.2 million 10 T-NETIX, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AND SHARE AMOUNTS) (UNAUDITED) term portion and an $11.5 million line of credit. Further, maximum available borrowing under the line of credit will be reduced by $0.3 million per month beginning in August 2002 and monthly payments of $0.2 million on the term loan will continue through the maturity date. To facilitate the refinancing of the Credit Facility, the Company has retained J.P. Morgan Securities, Inc. to explore and advise us on various financing opportunities and strategies. The Credit Facility is collateralized by substantially all of the assets of the Company. Under the terms of the Credit Facility, the Company is required to maintain certain financial ratios and other financial covenants. These ratios include a debt to a four quarter rolling earnings before interest, taxes and depreciation and amortization (EBITDA) ratio, a ratio of fixed charges (interest and debt payments) to EBITDA, and minimum quarterly EBITDA. The Agreement also prohibits the Company from incurring additional indebtedness. The Company is in compliance with all debt covenants at September 30, 2002. The Company issued a subordinated note payable of $3.75 million, due April 30, 2001, to a director and significant shareholder of the Company. The note bears interest at prime plus one percent per annum (5.75% at June 30, 2002) which is payable every six months. The lender received warrants, which are immediately exercisable, to purchase 25,000 shares of common stock at an exercise price of $6.05 per share for a period of five years. This note was extended in April 2001 to April 2002 at which time the lender received additional warrants, which are immediately exercisable, to purchase 25,000 shares of common stock at an exercise price of $2.75 per share for a period of five years. The estimated fair value of the stock purchase warrants, calculated using the Black-Scholes model, has been recorded as deferred financing fees and is being amortized over the term of the debt. In March 2002 this note was extended to July 30, 2002. In April 2002 this note was further extended to February 2003 to facilitate the refinancing of our overall financing structure. Warrants to purchase 25,000 shares of common stock at an exercise price of $2.75 per share have been issued to the lender on terms similar to previous warrants; however, shares will vest proportionately over the term of the note extension. (4) DISCONTINUED OPERATIONS AND NET ASSETS FOR SALE In August 2001, the Company formalized the decision to offer for sale its voice verification business unit, which includes the SpeakEZ speaker verification products. The SpeakEZ Voice Print technology is proprietary software that compares the speech pattern of a current speaker with a stored digital voiceprint of the authorized person to confirm or reject claimed identity. To date, SpeakEZ revenues have been insignificant and operations have been substantially curtailed. Accordingly, related operating results have been reported as discontinued operations. The financial information for the discontinued speaker verification operations is as follows:

In September 2001, the Company announced that it had entered into an agreement to sell all of the assets of the SpeakEZ division; however, the transaction was not completed and the agreement was terminated. As of December 31, 2001, the Company had not sold the SpeakEZ speaker verification assets. For this reason, a one-time charge of $1.1 million, net of taxes, was recognized in 2001 related to the write off of the voice print patent and license assets related to the SpeakEZ product line. This write-off was based on an analysis which concluded that the carrying value of our voice print assets exceeded the present value of estimated future cash flows given current operating results and the absence of a definitive agreement to sell these assets. In July 2002, the Company completed the sale of the SpeakEZ speaker verification assets to SpeechWorks International, Inc. ("SpeechWorks") for $0.4 million cash and approximately 130,000 shares of SpeechWorks common stock valued at $0.3 million, subject to a 10% escrow provision and recognized a gain on the sale of discontinued operations of $0.3 million. In addition, SpeechWorks will pay the Company an earn-out fee based on the sale over the next two years of future SpeechWorks products incorporating the SpeakEZ technology. Payment of the earn-out fee, if any, will be made through the issuance of additional shares of SpeechWorks common stock. As part of the sales agreement, the Company retained the right to utilize the speech recognition technology in the corrections industry. SpeechWorks stock received by the Company will not be registered. 11 T-NETIX, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AND SHARE AMOUNTS) (UNAUDITED) (5) SEGMENT INFORMATION - CONTINUING OPERATIONS Statement of Financial Accounting Standards No. 131, "Disclosures About Segments of an Enterprise and Related Information," ("SFAS 131"), establishes standards for reporting operating segments in annual financial statements. SFAS 131 also establishes standards for disclosures about products and services, geographic areas and major customers. The Company has two reportable segments: the Corrections and Internet Services Divisions. Through its Corrections Division, the Company provides inmate telecommunication products and services for correctional facilities, including security enhanced call processing, call validation and billing services for inmate calling. Depending upon the contractual relationship at the site and the type of customer, the Company provides these products and services through service agreements with other telecommunications service providers, including Verizon, AT&T, SBC Communications, Sprint and Qwest and through direct contracts between the Company and correctional facilities. In addition, primarily through its subsidiary TELEQUIP Labs, the Company sells inmate call processing systems to certain telecommunication providers. Through its Internet Service Division, the Company provided interLATA Internet services to Qwest customers through a master service agreement, the "Qwest Agreement". Effective November 2001, substantially all services and associated revenue under this agreement ceased due to the expiration of this contract. Formerly, the Company reported a third business segment, the SpeakEZ Speaker Verification division. The SpeakEZ Voice Print technology is proprietary software that compares the speech pattern of a current speaker with a stored digital voiceprint of the authorized person to confirm or reject claimed identity. In August 2001, the Company formalized its decision to offer for sale its voice print business unit, which included the SpeakEZ speaker verification products. Accordingly, related operating results of this business unit have been reported as discontinued operations in the consolidated financial statements. Segment reporting has been conformed to correspond to the current presentation. As described in Note 4 of "Notes to Condensed Consolidated Financial Statements," the Company completed the sale of SpeakEZ assets in July 2002. The Company evaluates performance based on earnings (loss) before income taxes. Additional measures include operating income, depreciation and amortization, and interest expense. There are no intersegment sales. The Company's reportable segments are specific business units that offer different products and services. They are managed separately because each business requires different technology and marketing strategies. The accounting policies of the reportable segments are the same as those described in the summary of significant accounting policies. Segment information for the three and nine months ended September 30, 2002 and the comparable 2001 periods is as follows: 12 T-NETIX, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AND SHARE AMOUNTS) (UNAUDITED)

Substantially all revenue reported by our Internet Services Division for the three and nine months ended September 30, 2001 was attributable to our GSP agreement with Qwest which expired in November 2001. There was no intersegment revenue for the three and nine months ending September 30, 2002 and the comparable 2001 period. Consolidated total assets included eliminations of approximately $0.7 million as of September 30, 2002. Eliminations consist of intercompany receivables in the Corrections Division and intercompany payables in the TELEQUIP Labs subsidiary related solely to intercompany borrowings. (6) COMMITMENTS AND CONTINGENCY From time to time we have been, and expect to continue to be subject to various legal and administrative proceedings or various claims in the normal course of our business. We believe the ultimate disposition of these matters will not have a material adverse affect on our financial condition, liquidity, or results of operations. During 2000 Gateway won a dismissal of a case brought in the First Judicial District Court of the State of New Mexico, styled Valdez v. State of new Mexico, et al. An appeal of the case was certified and is still pending. The case named as defendants the State of new Mexico, several political subdivisions of the State of new Mexico, and several inmate telecommunications service providers, including Gateway. The complaint included a request for certification by the court of a plaintiffs' class action consisting of all persons who had been billed for and paid for telephone calls initiated by an inmate confined in a jail, prison, detention center or other New Mexico correctional facility. The complaint alleged violations of New Mexico Unfair Practices Act, the New Mexico Antitrust Act and the New Mexico Constitution, and also alleged unjust enrichment, constructive trust, economic compulsion, constructive fraud and illegality of contracts, all in connection with the provision of "collect only" inmate telecommunications services. The case was never certified as a class action suit. In August 2002, the New Mexico State Supreme Court affirmed the District Court's dismissal of the plaintiffs' case. T-NETIX is a defendant in a state case brought in the Superior Court of Washington for King County, styled Sandy Judd, et al. v. American Telephone and Telegraph Company, et al. In this case, the complaint joined several inmate telecommunications service providers as defendants, including T-NETIX. The complaint includes a request for certification by the court of a plaintiffs' class detention center or other Washington correctional facility. The complaint alleges violations of the Washington Consumer Protection Act (WCPA) and requests an injunction under the Washington Consumer Protection Act and common law to enjoin further violations. The trial court dismissed all claims with prejudice against all defendants except T-NETIX and AT&T. Plaintiffs have appealed the dismissal of the other defendants and T-NETIX has cross appealed. The T-NETIX and AT&T claims have been referred to the Washington Utilities and Transportation Commission while the trial court proceeding is in abeyance. The Commission has not yet commenced any proceedings. Gateway has been litigating an appeal from a favorable ruling in Kentucky federal court in the case Gus "Skip" Daleure, Jr., et al vs. Commonwealth of Kentucky, et al. Plaintiffs, a class of relatives of prisoners incarcerated in Kentucky correctional facilities, sued the Commonwealth of Kentucky, the Kentucky Department of Corrections, the state of Missouri, several municipal entities in the states of Kentucky, Missouri, Arizona and Indiana and various private telephone providers alleging antitrust violations and excessive rates in connection with the provision of telephone services to inmates. The plaintiffs alleged Sherman Act, Robinson-Patman Act, and Equal Protection violations. The district court held, on motions to dismiss, that Kentucky did not have personal jurisdiction over defendants not located in or doing business in the state of Kentucky; that telephone calls are not goods or commodities and thus are not subject to the antitrust provisions of the Robinson-Patman Act; that Plaintiffs did not state a claim for relief under the Equal Protection Clause of the Fourteenth Amendment; and that Plaintiffs had not shown any harm in support of its antitrust claim under Section 1 of the Sherman Act. The trial judge did not, however, dismiss the Plaintiff's petition for injunctive relief, despite these findings. Recently, the appeal brought by the Plaintiffs has been dismissed and no further action has been taken. In another case styled Robert E. Lee Jones, Jr. v. MCI Communications, et al, plaintiffs, 43 inmates of the Bland Correctional Center in Virginia, filed a pro se action alleging constitutional violations, RICO Act violations and violations of federal wiretapping laws. This case was dismissed on all counts in November 2001 and plaintiffs appealed. The dismissal was affirmed by the Fourth Circuit in July 2002. In October 2001, relatives of prisoners incarcerated in Oklahoma Department of Correctional facilities filed a putative class action against T-NETIX, AT&T, Evercom and the Oklahoma Department of Corrections for claims in anti-trust, under due process, equal protection and the First Amendment. This case, styled Kathy Lamon, et al v. Ron Ward, et al, was dismissed by the Plaintiffs in July 2002. In September 2001, T-NETIX filed patent litigation against MCI WorldCom, Inc. and Global Tel*Link Corporation. The lawsuit, filed in the Eastern District of Texas, alleges infringement of six United States patents protecting call processing equipment and services for the inmate calling industry. The case is in its discovery stages. In July 2002, MCI WorldCom, Inc. filed a Chapter XI bankruptcy proceeding that automatically stayed any further proceeding against them. On August 7, 2002, T-NETIX subsequently filed its motion to server MCI WorldCom from the patent litigation, which motion has not yet been ruled on. From September 1997 and through October 2001, pursuant to a written agreement entered into in connection with settlement of an arbitration proceeding, the Company was making monthly payments to a vendor of query transport services with the understanding that the payments were for future services to be utilized by the Company. The services to be provided by Illuminet under the contract were in the nature of the transport of queries by Illuminet to a certain database maintained by and available to Illuminet. In order to utilize such transport the queries were to be directed from the Company for connection to Illuminet utilizing certain technologies. Attempts were continually made by the Company over the time period to complete connectivity but connectivity was never accomplished. In November 2001, the vendor (Illuminet, Inc.) notified the Company that no credits for such services would be honored. In January 2002 Illuminet filed a claim before the original arbitration panel in Fairway, Kansas requesting money damages for T-NETIX' breach and declaratory relief that no credits are due T-NETIX. The Company has made payments totaling approximately $2.1 million pursuant to this written agreement. The payments are classified as a long-term prepayment included in Intangible and Other Assets at September 30, 2002 (See Note 2 of "Notes to Condensed Consolidated Financial Statements"). It is the contention of the Company, in the arbitration proceeding, that the fault in the lack of connectivity, be it the lack of proper technology, proper responsiveness on the part of Illuminet, or otherwise, was that of Illuminet. The Company intends to vigorously pursue its rights under the agreement. In the event the company is not supported in the arbitration or any related litigation, the prepaid expense of $2.1 million could be impaired. The arbitration hearing is currently set for the week of December 9, 2002. In August 2001, the U.S. Bankruptcy Court for the Central District of California approved the sale of assets of OAN Services, Inc. ("OAN"), a Chapter 11 debtor and the primary billing agent of the Company. The Company and about 20 other customers received a portion of the proceeds. The sole objecting customer appealed to the Bankruptcy Appellate Panel but it was dismissed as moot. In December 2001, the Bankruptcy Court granted OAN's Summary Judgment Motion and ruled against the objecting customer. In late August 2002, the United States District Court reversed the summary judgment and remanded the case to the Bankruptcy Court. The objecting customer has notified the other customers, including the Company, that if it ultimately prevails, it intends to pursue available claims against the bankruptcy estate and the customers receiving the portion of the proceeds. We believe the ultimate disposition of the foregoing matters will not have a material affect on our financial condition, liquidity, or results of operations. (7) SUBSEQUENT EVENTS In November 2002, the Company obtained new financing (the "New Credit Facility"). Net proceeds of this New Credit Facility were utilized to repay in full the existing Senior Secured Revolving Credit Facility (the "Credit Facility") with its commercial bank and the Subordinated Note Payable (see Note 3 of "Notes to Condensed Consolidated Financial Statements"). The New Credit Facility provides for maximum credit availability of $31.0 million, subject to limitations based on certain financial covenants, and consists of a $14.0 million Senior Secured Term Loan, a $9.0 million Senior Subordinated Promissory Note and a Revolving Credit Facility with an availability of up to $8.0 million. The Senior Secured Term Loan bears interest at LIBOR plus 6.0%, with 16 equal quarterly principal installment payments thorough December 2006. Due in 2008, the Senior Subordinated Promissory Note bears interest at a fixed rate of 13%, payable on a quarterly basis, with an additional 4.75% of payment in kind interest. In addition, the lender received warrants, which are immediately exercisable, to purchase 186,792 shares of common stock at an exercise price of $0.01 per share. The expiration date of these warrants is November 2010. Availability under the Revolving Credit Facility is based on the lesser of eligible accounts receivable or a calculated 13 T-NETIX, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AND SHARE AMOUNTS) (UNAUDITED) maximum leverage ratio. Interest on the Revolving Credit Facility is set at prime plus 3.5% with a 0.75% annual commitment fee assessed on the unused portion of this Facility. The New Credit Facility is collateralized by substantially all of the assets of the Company. Under the terms of the New Credit Facility, the Company is required to maintain certain financial ratios and other financial covenants. These ratios include a debt to four-quarter rolling earnings before interest, taxes and depreciation and amortization (EBITDA) ratio, a ratio of EBITDA less capital expenditures to fixed charges (interest, taxes and scheduled debt service payments), and a minimum capitalization ratio. The Agreement also places limits on the amount of additional indebtedness the Company can incur. 14 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS For a comprehensive understanding of our financial condition and performance, this discussion should be considered in the context of the condensed consolidated financial statements and accompanying notes and other information contained herein. The Private Securities Litigation Reform Act of 1995 provides a "safe harbor" for forward-looking statements. Certain information contained in this Management's Discussion and Analysis of Financial Condition and Results of Operations and elsewhere in this Form 10-Q includes forward-looking statements. Important factors that could cause actual results to differ materially from those in the forward-looking statements include, but are not limited to, those listed under the caption "Risk Factors" in the Company's Form 10-K for the year ended December 31, 2001 which may affect the potential technological obsolescence of existing systems, the renewal of existing site specific Corrections Division customer contracts, the ability to retain the base of current site specific customer contracts, the ability to perform under contractual performance requirements, the continued relationship with existing customers, the ability of our existing telecommunications service provider customers such as Verizon, AT&T and SBC Communications, to win new contracts for our products and services to maintain their market share of the inmate calling market, the effect of economic conditions, the effect of regulation, including the Telecommunications Act of 1996, that could affect our sales or pricing, the impact of competitive products and pricing in our Corrections Division, our continuing ability to develop hardware and software products, commercialization and technological difficulties, manufacturing capacity and product supply constraints or difficulties, actual purchases by current and prospective customers under existing and expected agreements, and the results of financing efforts, along with the other risks detailed therein. We make forward-looking statements in this report and may make such statements in future filings with the Securities and Exchange Commission. We also may make forward-looking statements in press releases or other public communications. These forward-looking statements are subject to risks and uncertainties and include information about our expectations and possible or assumed future results of operations. When we use any of the words "believe", "expect", "anticipate", "estimate" or similar expressions, we are making a forward-looking statement. While we believe that forward-looking statements are reasonable, you should not place undue reliance in such forward-looking statements, which speak only as of the date made. Other factors not currently anticipated by management may also materially and adversely affect our results of operations. Except as required by applicable law, we do not undertake any obligation to publicly release any revisions which may be made to any forward-looking statements to reflect events or circumstances occurring after the date of this report. CORRECTIONS DIVISION In the Corrections Division we derive revenue from three main sources: telecommunications services, direct call provisioning and equipment sales. Each form of revenue has specific and varying operating costs associated with such revenue. Selling, general and administrative expenses, along with research and development and depreciation and amortization are common expenses regardless of the revenue generated. Telecommunications services revenue is generated under long-term contracts (generally, three to five years) with our telecommunications service provider customers including Verizon, AT&T, SBC Communications, Qwest and Sprint. Here, we provide the equipment, security enhanced call processing, call validation, and service and support through the provider, rather than directly to the facility. The provider does the billing. We are paid a prescribed fee by our telecommunications services providers for each call completed. We receive additional fees for validating the phone numbers dialed by inmates. Our Corrections Division also provides our inmate calling services directly as a telecommunications provider to correctional facilities, or "Direct Customers". In a typical arrangement, we operate under site-specific contracts, generally for a period of two to three years. We provide the equipment, security enhanced call processing, call validation, and customer service and support directly to the facility. We then use the services of third parties to bill the calls on the called party's local exchange carrier bill. Direct call provisioning revenue is substantially higher than the percentage of revenue or transaction based pricing compensation associated with telecommunications services because the Company receives the entire retail value of the collect call. Due to commissions and other operating costs, including uncollectible costs, the gross margin percentage from this model is lower than our telecommunication service arrangements. 15 Under the direct call-provisioning model, the Company provides inmate-calling services directly to a correctional facility as a certificated telecommunications provider. In a typical arrangement, the Company operates under site-specific contracts with terms of generally two to three years. After the initial term of the contract, the correctional facility may choose to renew the contract with the existing provider or initiate a formal competitive bid process. The telecommunications industry, particularly the inmate calling market, is and can be expected to remain highly competitive. While the Company has historically maintained a high rate of retention of existing inmate calling service contracts, the Company may not be able to compete effectively with our current or future competitors for these contracts, which would have a material adverse effect on our business, operating results, and financial condition. Equipment sales and other revenue include the sales of our inmate calling system (primarily the systems of our wholly owned subsidiary, TELEQUIP Labs, Inc.) and digital recording systems. Currently, sales of inmate calling systems are generally made by TELEQUIP to a limited number of telecommunication service provider customers. INTERNET SERVICES DIVISION In December 1999, the Company entered into a master service agreement with US WEST ENTERPRISE (now named Qwest America, Inc.) (The "Qwest Agreement") to provide interLATA Internet services to Qwest customers. The Qwest Agreement, which commenced December 1, 1999, called for us to buy, resell and process billing of Internet bandwidth to these customers. The initial term of the Qwest Agreement was for a minimum of sixteen months until March 2001. Although the Qwest Agreement expired on March 2001, we continued providing services under the Qwest Agreement through October 2001. Effective November 2001, substantially all services and associated revenue under this agreement had ceased. The Company may incur additional costs in connection with the termination of the business of this Internet service division. Factors affecting margin include a negotiated base management fee and contract incentive payments based on cost savings. The costs associated with this contract are primarily the costs for Internet bandwidth. There were no capital outlays required to begin provisioning these services. SPEAKER VERIFICATION DIVISION The Company formerly reported a third business segment, the SpeakEZ Speaker Verification division. The SpeakEZ Voice Print technology is proprietary software that compares the speech pattern of a current speaker with a stored digital voiceprint of the authorized person to confirm or reject claimed identity. In August 2001, management of T-NETIX made the decision to curtail operations of this portion of the Company in order to enhance overall Company performance by reducing the negative impact of SpeakEZ operations on both the net earnings and cash flow. SpeakEZ assets were sold in July 2002 and the Company retained a license to use the technology in its corrections business. Pursuant to this strategy and due to the subsequent sale of the assets, related operating results of our SpeakEZ voice verification division have been recorded as discontinued operations in the consolidated financial statements. See Note 4 of "Notes to Condensed Consolidated Financial Statements". 16 RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2002 COMPARED TO SEPTEMBER 30, 2001 The following table sets forth certain statement of operations data as a percentage of total revenue for the three months ended September 30, 2002 and 2001.

Total Revenue. Total revenue for the three months ended September 30, 2002 was $31.7 million, an increase of 1% from $31.4 million for the corresponding 2001 period. This increase was attributable to increases in direct provisioning of $6.0 million and equipment sales and other of $3.0 million offset in part by decreases in Internet services of $7.4 million and telecommunications services of $1.3 million,. The decline in revenues from the Internet services segment was the result of the expiration of the Qwest Agreement in 2001. Effective November 2001, operations of this single purpose division had substantially ceased, including those under the Qwest Agreement. Telecommunications services revenue decreased 8% to $14.2 million for the three months ended September 30, 2002 from $15.5 million for the corresponding prior period. This decrease was primarily due to a one-time software upgrade service performed in the 2001 period and the transition of a department of corrections contract in 2002 to a direct call provisioning basis. Direct call provisioning revenue increased 89% to $12.7 million for the three months ended September 30, 2002 from $6.8 million in the corresponding prior period. This increase was primarily due to the recent awarding of several department of corrections contracts for which the Company is provisioning call processing services. The addition of these sites is a result of the Company's success in competitive bidding arrangements for contracts directly with correctional facilities. Equipment sales and other revenue increased 169% to $4.7 million for the three month period ended September 30, 2002 from $1.7 million in the corresponding prior period. This increase was largely attributable to the finalization of certain financial aspects associated with the Qwest Agreement in 2002. Equipment sales of TELEQUIP Labs, Inc., an inmate equipment provider, also increased in the 2002 period. Equipment sales of TELEQUIP are primarily associated with a single telecommunication service provider and revenue associated with such sales are dependent upon the timing of sales and installations for this customer. Operating costs. Total operating costs increased 9% to $19.3 million for the three months ended September 30, 2002 from $17.8 million in the corresponding prior period. This increase was primarily due to an increase in direct call provisioning expenses of $5.6 million, cost of equipment sold and other of $0.5 million and telecommunication services of $1.1 million offset partially by a decrease in Internet services of $5.6 million. The decline in operating costs for the Internet services segment was the result of the expiration of the Qwest Agreement in 2001. Effective November 2001, operations of this single purpose division had substantially ceased, including those under the Qwest Agreement. Operating costs of telecommunications services primarily consist of service administration costs for correctional facilities, including salaries and related personnel expenses, communication costs and inmate calling systems repair and maintenance expenses. Operating costs of telecommunications services also includes costs associated with call validation procedures, primarily network 17 expenses and database access charges. Operating costs associated with direct call provisioning also include the costs associated with telephone line access, long distance charges, commissions paid to correctional facilities, costs associated with uncollectible accounts and billing charges. Internet Services operating costs consist of purchased Internet bandwidth costs. The following table sets forth the operating costs and expenses for each type of revenue as a percentage of corresponding revenue for the three months ended September 30, 2002 and 2001.

Operating costs associated with providing telecommunications services, as a percentage of corresponding revenue, were 44% for the three months ended September 30, 2002, an increase from 34% for the comparable 2001 period. Total telecommunications services operating costs were $6.3 million for the three months ended September 30, 2002 and $5.2 million for the corresponding prior period. The increase in operating costs and costs as a percentage of applicable revenue in 2002 was due to increased repairs and maintenance and personnel costs, offset partially by lower communication expenses. Direct call provisioning costs, as a percentage of corresponding revenue, were 95% of revenue for the three months ended September 30, 2002, a decrease from 96% in 2001. Due to the awarding of several department of correction contracts, total direct call provisioning operating costs increased to $12.1 million for the three months ended September 30, 2002, compared to $6.5 million for the corresponding prior period. This decrease in costs as a percentage of applicable revenue was due primarily to lower communication expenses, offset partially by a proportional increase in commission and bad debt expenses associated with the increase in direct call provisioning revenue. Bad debt expense increased primarily due to a greater volume of calls being processed to Competitive Local Exchange Carriers ("CLEC") where the Company does not have billing arrangements. The Company, beginning in the first quarter of 2002, modified its call handling processes to block certain of these CLEC calls, thereby reducing its unbillable call volume. Cost of equipment sold and other as a percentage of corresponding revenue was 20% of revenue for the three months ended September 30, 2002, a decrease from 27% in 2001. Due to increased equipment sales of TELEQUIP Labs, Inc., total costs of equipment sold and other were $0.9 million for the three months ended September 30, 2002 compared to $0.5 million for the corresponding 2001 period. The decrease in costs as a percentage of applicable revenue was primarily due to the favorable impact of the settlement of certain claims and liabilities associated with the Qwest Agreement in 2002. Selling, General and Administrative Expenses. Selling, general and administrative expenses were $6.9 million and $6.1 million for the three months ended September 30, 2002 and 2001, respectively. The increase in 2002 was primarily due to increased contract labor, professional consulting fees and legal fees, offset partially by a deduction of an expense associated with the 2002 executive incentive compensation plan. Research and Development Expenses. Research and development expenses were $0.8 million and $1.0 million for the three months ended September 30, 2002 and 2001, respectively. Depreciation and Amortization Expenses. Depreciation and amortization expense was $3.3 million for the three months ended September 30, 2002, an increase from $3.1 million for the comparable 2001 period. Depreciation expense for the three months ended September 30, 2002 totaled $3.0 million and compared to $2.5 million in 2001. The increase was due to increased capital spending associated with system upgrades during 2002. Amortization expense declined to $0.3 million in the three months ended September 30, 2002 versus $0.6 million for the corresponding 2001 period. This decrease in amortization expense was primarily due to the impairment charge in 2001 related to the Contain(R) and Lock&Track(TM) jail management system products and to the adoption of SFAS 142, "Goodwill and Other Intangible Assets" in 2002. Interest and Other Expenses. Interest and other expense was $0.9 million for the three months ended September 30, 2002 compared to $0.6 million for the corresponding prior period. The increase in 2002 was attributable to fees associated with the extension of our Credit Facility in April 2002, offset partially by a decrease in the average amount of indebtedness outstanding and lower applicable interest rates. The average debt balance decreased primarily due to the pay down of debt as the result of improved 18 operating results. Other Expenses for the three months ended September 30, 2002 also included $0.2 million loss related to the writedown of an investment. RESULTS OF OPERATIONS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2002 COMPARED TO SEPTEMBER 30, 2001 The following table sets forth certain statement of operations data as a percentage of total revenue for the nine months ended September 30, 2002 and 2001.

Total Revenue. Total revenue for 2002 was $87.7 million, a decrease of 5% from $92.2 million for the corresponding 2001 period. This decrease was attributable to decreases in Internet services of $22.1 million and telecommunications services of $2.1 million, offset in part by increases in direct provisioning of $15.1 million and equipment sales and other of $4.5 million. The decline in revenues from the Internet services segment was the result of the expiration of the Qwest Agreement in 2001. Effective November 2001, all services of this single purpose division had substantially ceased, including those under the Qwest Agreement. Telecommunications services revenue decreased 5% to $44.6 million for the nine months ended September 30, 2002 from $46.7 million for the corresponding prior period. This decrease was primarily due to a decline in call volumes and the transition of certain department of corrections contract to a direct call provisioning basis. Direct call provisioning revenue increased 76% to $35.0 million for the nine months ended September 30, 2002 from $19.8 million in the corresponding prior period. This increase was primarily due to the recent awarding of several department of corrections contracts for which the Company is provisioning call processing services. The addition of these sites is a result of our being successful in providing competitive bidding arrangements for contracts directly with correctional facilities. Equipment sales and other revenue increased 126% to $8.1 million for the nine month period ended September 30, 2002 from $3.6 million in the corresponding prior period. This increase was largely attributable to increased equipment sales of TELEQUIP Labs, Inc., an inmate equipment provider. Sales of equipment at TELEQUIP are primarily associated with a single telecommunication service provider and revenue associated with such sales are dependent upon the timing of sales and installations for this customer. In addition, 2002 results include the finalization of certain financial aspects associated with the Qwest Agreement. Operating costs. Total operating costs decreased 1% to $52.7 million for the nine months ended September 30, 2002 from $53.4 million in the corresponding prior period. The decrease was primarily due to decreases in Internet services of $15.4 million and telecommunication services of $1.3 million, offset partially by an increase in direct call provisioning expenses of $15.0 million and the cost of equipment sold of $1.0 million. The decline in operating costs for the Internet services segment was the result of the expiration of the Qwest Agreement in 2001. Effective November 2001, substantially all services of this single purpose division had substantially ceased, including those under the Qwest Agreement. 19 Operating costs of telecommunications services primarily consist of service administration costs for correctional facilities, including salaries and related personnel expenses, communication costs and inmate calling systems repair and maintenance expenses. Operating costs of telecommunications services also includes costs associated with call validation procedures, primarily network expenses and database access charges. Operating costs associated with direct call provisioning also include the costs associated with telephone line access, long distance charges, commissions paid to correctional facilities, costs associated with uncollectible accounts and billing charges. Internet Services operating costs consist of purchased Internet bandwidth costs. The following table sets forth the operating costs and expenses for each type of revenue as a percentage of corresponding revenue for the nine months ended September 30, 2002 and 2001.

Operating costs associated with providing telecommunications services, as a percentage of corresponding revenue, was 38% for the nine months ended September 30, 2002, a decrease from 39% for the comparable 2001 period. Total telecommunications services operating costs were $17.0 million for the nine months ended September 30, 2002 and $18.3 million for the corresponding prior period. The decrease in 2002 was primarily due to reductions in personnel costs and lower contract labor, call validation fees, travel and communications expenses, partially offset by increased repairs and maintenance costs. Direct call provisioning costs, as a percentage of applicable revenue, were 95% of revenue for the nine months ended September 30, 2002 compared to 92% in the comparable 2001 period. Due to the awarding of several department of correction contracts, total direct call provisioning operating costs increased to $33.2 million for the nine months ended September 30, 2002 from $18.2 million for the corresponding 2001 period. This increase in costs as a percentage of applicable revenue was due primarily to a proportional increase in bad debt expense and commission expenses associated with the increase in direct call provisioning revenue. Bad debt expense increased primarily due to a greater volume of calls being processed to Competitive Local Exchange Carriers ("CLEC") where the Company does not have billing arrangements. The Company, beginning in the first quarter of 2002, modified its call handling processes to block certain of these CLEC calls, thereby reducing its unbillable call volume. Cost of equipment sold and other as a percentage of applicable revenue decreased to 31% of revenue for the nine months ended September 30, 2002 from 44% for the corresponding prior period. Due to increased equipment sales of TELEQUIP Labs, Inc., total costs of equipment sold and other were $2.5 million for the nine months ended September 30, 2002 compared to $1.6 million for the corresponding 2001 period. The decrease in costs as a percentage of applicable revenue was primarily due to the favorable impact of the settlement of certain claims and liabilities associated with the Qwest Agreement in 2002. Selling, General and Administrative Expenses. Selling, general and administrative expenses were $18.8 million and $17.9 million for the nine months ended September 30, 2002 and 2001, respectively. This increase was primarily due to increases in personnel costs, professional services fees and legal fees, offset partially by a deduction of an expense associated with the 2002 executive incentive compensation plan. Research and Development Expenses. Research and development expenses were $2.3 million in the nine months ended September 30, 2002 compared to $3.6 million for the corresponding prior period. This decrease was primarily due to reductions in personnel and contract labor expense in 2002, as compared to 2001 levels. Depreciation and Amortization Expenses. Depreciation and amortization expense was $8.7 million for the nine months ended September 30, 2002, a decrease from $9.2 million for the comparable 2001 period. Depreciation expense increased to $7.9 million in the nine months ended September 30, 2002 compared to $7.7 million in 2001. Amortization expense declined to $0.8 million in the nine months ended September 30, 2002 versus $1.5 million for the corresponding 2001 period. This decrease in amortization expense was primarily due to the impairment charge in 2001 related to the Contain(R) and Lock & Track(TM) jail management system products and to the adoption of SFAS 142, "Goodwill and Other Intangible Assets" in 2002. 20 Interest and Other Expenses. Interest and other expense was $1.8 million for the nine months ended September 30, 2002 compared to $2.0 million for the corresponding prior period. The decrease in 2002 was attributable to a decrease in the average amount of indebtedness outstanding and lower applicable interest rates, offset partially by fees associated with the extension of the Company's Credit Facility in April 2002. The average debt balance decreased primarily due to the pay down of debt as the result of improved operating results. Other Expenses for the nine months ended September 30, 2002 included a $0.2 million loss related to the writedown of an investment. LIQUIDITY AND CAPITAL RESOURCES Cash Flows The Company has historically relied upon operating cash flow, debt financing and the sale of equity securities to fund operations and capital needs. Our capital needs consist primarily of additions to property and equipment for site telecommunication equipment, upgrades to existing systems and to fund acquisitions. Cash provided by continuing operations was $6.6 million for the nine months ended September 30, 2002 compared to $12.1 million in the corresponding 2001 period. This decrease was primarily due to a $1.9 million increase in net working capital, combined with a $2.7 million decline in net income from continuing operations and a $0.6 million decline in depreciation and amortization expense. Net cash used in investing activity of continuing operations was $4.7 million for the nine months ended September 30, 2002 compared to $6.3 million in the corresponding 2001 period. This decrease was primarily due to the acquisition of TELEQUIP Labs, Inc. in 2001 for $1.7 million. Cash used in investing activities consisted primarily of purchases of property and equipment of $5.0 million for the nine month period ended September 30, 2002 compared to $4.2 million for the corresponding 2001 period. As part of the Company's on-going effort to dispose of underperforming assets, we completed the sale of assets associated with our Lock & Track(TM) jail management system product and the SpeakEZ speaker verification assets for $0.6 million during 2002. We anticipate that our capital expenditures in 2002 will exceed 2001 levels based on our anticipated growth in installed systems at correctional facilities. We believe our cash flows from operations and our availability under our Credit Facility will be sufficient in order for us to meet our anticipated cash needs for new installations of inmate call processing systems, upgrades of existing systems, and to finance our operations for at least the next twelve months. Cash used in financing activities of continuing operations consisted primarily of net payments on the Company's Credit Facility of $1.8 million during the nine months ended September 30, 2002 compared to net payments of $3.9 million in the corresponding 2001 period. Capital Resources In September 1999, the Company entered into a Senior Secured Revolving Credit Facility (the "Credit Facility") with its commercial bank. The Credit Facility provided for maximum credit of $40.0 million subject to limitations based on certain financial covenants. In April 2001, the Company's lenders extended the maturity date on its credit agreement to March 2002. The maximum available borrowings on the Credit Facility was reduced to $30.0 million and interest was set at prime rate plus 1.25% effective June 30, 2001 increasing by 0.25% each quarter thereafter on June 30, September 30 and December 31, 2001. In addition, monthly payments of $0.2 million on the term loan commenced in April 2001. In March 2002, the maturity date of the Credit Facility was extended to June 26, 2002. Effective with the March 2002 extension, the maximum available borrowings on the Credit Facility was reduced to $21.8 million and interest was set at prime plus 2.25% (7.0% at September 30, 2002). The Company also pays a fee of 0.40% per annum on the unused portion of the line of credit. In April 2002, the Company obtained a further commitment from its lenders to extend, at the option of the Company, the Credit Facility beyond June 26, 2002 to January 2003. Effective June 2002, the Company elected to extend the existing Credit Facility and paid an option exercise fee to its lenders equal to 3.0% of the maximum available borrowing on the Credit Facility. To facilitate the refinancing of the Credit Facility, the Company has retained J.P. Morgan Securities, Inc. to explore and advise us on various financing opportunities and strategies. Under the terms of the April 2002 extension, the maximum available borrowings on the Credit Facility was reduced to $18.7 million, consisting of a $7.2 million term portion and an $11.5 million line of credit. Further, maximum available borrowing under the line of credit will be reduced by $0.3 million per month beginning in August 2002 and monthly 21 payments of $0.2 million on the term loan will continue through the maturity date. The Company believes it is in compliance with all debt covenants. In June 2002, the Company elected to extend its existing Credit Facility to January 3, 2003. As of September 30, 2002, the Company had a total of $20.7 million of total indebtedness, including approximately $16.7 million in senior indebtedness outstanding under this Credit Facility. To facilitate the refinancing of this Credit Facility, the Company has retained J.P. Morgan Securities Inc. to explore and advise us on various financing opportunities and strategies in the private placement market. Our ability to refinance our existing Credit Facility is dependent on many factors, including our future financial and operational performance and the general state of the US economy and capital markets. The Company cannot provide any assurance that new financing can be obtained, that our existing indebtedness can be refinanced when required, or that satisfactory terms of any refinancing would be available. If we were not able to obtain new financing or refinance our indebtedness under these circumstances, the Company would have to consider other options, such as: sale of some assets; sales of equity; negotiations with other lenders to restructure applicable indebtedness; or other options available to us under applicable laws. In April 2000, the Company raised $7.5 million of debt and equity financing. The net proceeds of approximately $7.2 million were used to reduce the outstanding balance on the Credit Facility. The Company issued 3,750 shares of series A non-voting redeemable convertible preferred stock and five-year stock purchase warrants to acquire 340,909 common shares for net proceeds of $3.5 million. In November 2000, 500 shares of the preferred stock were converted into 250,630 shares of common stock at a conversion price of $2.09 per share. In February of 2001, the remaining 3,250 shares of preferred stock were converted into 1,770,179 shares of common stock at an average conversion price of $1.95. The unamortized discount on the preferred stock of $1.1 million was recognized as a charge to income (loss) applicable to common stockholders. The Company also issued a subordinated note payable of $3.75 million, due April 30, 2001, to a director and significant shareholder of the Company. The note bears interest at prime rate plus one percent per annum (5.75% at September 30, 2002) which is payable every six months. The lender received warrants, which are immediately exercisable, to purchase 25,000 shares of common stock at an exercise price of $6.05 per share for a period of five years. This note was extended in April 2001 to April 30, 2002, at which time the lender received additional warrants, which are immediately exercisable, to purchase 25,000 shares of common stock at an exercise price of $2.75 per share for a period of five years. In March 2002, this note was extended to July 30, 2002. In April 2002 this note was further extended to February 2003 to facilitate the refinancing of our overall financing structure. Warrants to purchase 25,000 shares of common stock at an exercise price of $2.75 per share have been issued to the lender on terms similar to previous warrants; however, shares will vest proportionately over the term of the note extension. CONTRACTUAL OBLIGATIONS AND COMMITMENTS Set forth below is a summary of the Company's material contractual obligations and commitments as of September 30, 2002:

Under the Company's existing Credit Facility, acceleration of principal payments would occur upon payment default, violation of debt covenants not cured within 30 days or breach of certain other conditions set forth in this Credit Facility. Subject to certain subordination terms, the subordinated note payable is subject to the same conditions of the Company's Credit Facility through cross default provisions. At September 30, 2002, the Company was in compliance with all of its debt covenants. There are no provisions within the Company's leasing arrangements that would trigger acceleration of future lease payments. (See Note 3 of "Notes to Condensed Consolidated Financial Statements"). The Company does not use securitization of trade receivables, affiliation with special purpose entities or synthetic leases to finance its operations. Additionally, the Company has not entered into any arrangement requiring the Company to guarantee payment of third party debt or to fund losses of an unconsolidated special purpose entity. 22 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK We are exposed to interest rate risk as discussed below. Interest Rate Risk We have current debt outstanding under the Credit Facility of $16.7 million at September 30, 2002. Under the terms of the debt agreement the maximum credit available at September 30, 2002 is $17.5 million. The loan bears interest at prime rate plus 2.25% (7.0% at September 30, 2002) with interest payable monthly. Since the interest rate on the loan outstanding is variable and is reset periodically, we are exposed to interest risk. An increase in interest rates of 1% would increase estimated annual interest expense by approximately $0.2 million based on the amount of borrowings outstanding under the Credit Facility at September 30, 2002. ITEM 4. CONTROLS AND PROCEDURES Within the 90-day period prior to the filing of this report, an evaluation was performed under the supervision and with the participation of our management, including the Chief Executive Officer ("CEO") and Chief Financial Officer ("CFO"), of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-14(c) under the Securities Exchange Act of 1934). Based on that evaluation, our management, including the CEO and CFO, concluded that our disclosure controls and procedures were effective. There have been no significant changes in our internal controls or in other factors that could significantly affect these controls subsequent to the date of their evaluation. 23 PART II OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS From time to time we have been, and expect to continue to be subject to various legal and administrative proceedings or various claims in the normal course of our business. We believe the ultimate disposition of these matters will not have a material adverse affect on our financial condition, liquidity, or results of operations. During 2000 Gateway won a dismissal of a case brought in the First Judicial District Court of the State of New Mexico, styled Valdez v. State of New Mexico, et al. An appeal of the case was certified and is still pending. The case named as defendants the State of New Mexico, several political subdivisions of the State of New Mexico, and several inmate telecommunications service providers, including Gateway. The complaint included a request for certification by the court of a plaintiffs' class action consisting of all persons who had been billed for and paid for telephone calls initiated by an inmate confined in a jail, prison, detention center or other New Mexico correctional facility. The complaint alleged violations of New Mexico Unfair Practices Act, the New Mexico Antitrust Act and the New Mexico Constitution, and also alleged unjust enrichment, constructive trust, economic compulsion, constructive fraud and illegality of contracts, all in connection with the provision of "collect only" inmate telecommunications services. The case was never certified as a class action suit. In August 2002, the New Mexico State Supreme Court affirmed the District Court's dismissal of the plaintiffs' case. T-NETIX is a defendant in a state case brought in the Superior Court of Washington for King County, styled Sandy Judd, et al. v. American Telephone and Telegraph Company, et al. In this case, the complaint joined several inmate telecommunications service providers as defendants, including T-NETIX. The complaint includes a request for certification by the court of a plaintiffs' class action consisting of all persons who have been billed for and paid for telephone calls initiated by an inmate confined in a jail, prison, detention center or other Washington correctional facility. The complaint alleges violations of the Washington Consumer Protection Act (WCPA) and requests an injunction under the Washington Consumer Protection Act and common law to enjoin further violations. The trial court dismissed all claims with prejudice against all defendants except T-NETIX and AT&T. Plaintiffs have appealed the dismissal of the other defendants and T-NETIX has cross appealed. The T-NETIX and AT&T claims have been referred to the Washington Utilities and Transportation Commission while the trial court proceeding is in abeyance. The Commission has not yet commenced any proceedings. Gateway has been litigating an appeal from a favorable ruling in Kentucky federal court in the case Gus "Skip" Daleure, Jr., et al vs. Commonwealth of Kentucky, et al. Plaintiffs, a class of relatives of prisoners incarcerated in Kentucky correctional facilities, sued the Commonwealth of Kentucky, the Kentucky Department of Corrections, the state of Missouri, several municipal entities in the states of Kentucky, Missouri, Arizona and Indiana and various private telephone providers alleging antitrust violations and excessive rates in connection with the provision of telephone services to inmates. The plaintiffs alleged Sherman Act, Robinson-Patman Act, and Equal Protection violations. The district court held, on motions to dismiss, that Kentucky did not have personal jurisdiction over defendants not located in or doing business in the state of Kentucky; that telephone calls are not goods or commodities and thus are not subject to the antitrust provisions of the Robinson-Patman Act; that Plaintiffs did not state a claim for relief under the Equal Protection Clause of the Fourteenth Amendment; and that Plaintiffs had not shown any harm in support of its antitrust claim under Section 1 of the Sherman Act. The trial judge did not, however, dismiss the Plaintiff's petition for injunctive relief, despite these findings. Recently, the appeal brought by the Plaintiffs has been dismissed and no further action has been taken. In another case styled Robert E. Lee Jones, Jr. vs. MCI Communications, et al, plaintiffs, 43 inmates of the Bland Correctional Center in Virginia, filed a pro se action alleging constitutional violations, RICO Act violations and violations of federal wiretapping laws. This case was dismissed on all counts in November 2001 and plaintiffs appealed. The dismissal was affirmed by the Fourth Circuit in July 2002. In October 2001, relatives of prisoners incarcerated in Oklahoma Department of Correctional facilities filed a putative class action against T-NETIX, AT&T, Evercom and the Oklahoma Department of Corrections for claims in anti-trust, under due process, equal protection and the First Amendment. This case, styled Kathy Lamon, et al v. Ron Ward, et al, was dismissed by the Plaintiffs in July 2002. 24 In September 2001, T-NETIX filed patent litigation against MCI WorldCom, Inc. and Global Tel*Link Corporation. The lawsuit, filed in the Eastern District of Texas, alleges infringement of six United States patents protecting call processing equipment and services for the inmate calling industry. The case is in its discovery stages. In July 2002, MCI WorldCom, Inc. filed a Chapter XI bankruptcy proceeding that automatically stayed any further proceeding against them. On August 7, 2002, T-NETIX subsequently filed its motion to sever MCI WorldCom from the patent litigation, which motion has not yet been ruled on. From September 1997 and through October 2001, pursuant to a written agreement entered into in connection with settlement of an arbitration proceeding, the Company was making monthly payments to a vendor of query transport services with the understanding that the payments were for future services to be utilized by the Company. The services to be provided by Illuminet under the contract were in the nature of the transport of queries by Illuminet to a certain database maintained by and available to Illuminet. In order to utilize such transport the queries were to be directed from the Company for connection to Illuminet utilizing certain technologies. Attempts were continually made by the Company over the time period to complete connectivity but connectivity was never accomplished. In November 2001, the vendor (Illuminet, Inc.) notified the Company that no credits for such services would be honored. In January 2002 Illuminet filed a claim before the original arbitration panel in Fairway, Kansas requesting money damages for T-NETIX' breach and declaratory relief that no credits are due T-NETIX. The Company has made payments totaling approximately $2.1 million pursuant to this written agreement. The payments are classified as a long-term prepayment included in Intangible and Other Assets at September 30, 2002 (See Note 2 of "Notes to Condensed Consolidated Financial Statements"). It is the contention of the Company, in the arbitration proceeding, that the fault in the lack of connectivity, be it the lack of proper technology, proper responsiveness on the part of Illuminet, or otherwise, was that of Illuminet. The Company intends to vigorously pursue its rights under the agreement. In the event the Company is not supported in the arbitration or any related litigation, the prepaid expense of $2.1 million could be impaired. The arbitration hearing is currently set for the week of December 9, 2002. In August 2001, the U.S. Bankruptcy Court for the Central District of California approved the sale of assets of OAN Services, Inc. ("OAN"), a Chapter 11 debtor and the primary billing agent of the Company. The Company and about 20 other customers received a portion of the proceeds. The sole objecting customer appealed to the Bankruptcy Appellate Panel but it was dismissed as moot. In December 2001, the Bankruptcy Court granted OAN's Summary Judgment Motion and ruled against the objecting customer. In late August 2002, the United States District Court reversed the summary judgment and remanded the case to the Bankruptcy Court. The objecting customer has notified the other customers, including the Company, that if it ultimately prevails, it intends to pursue available claims against the bankruptcy estate and the customers receiving the portion of the proceeds. We believe the ultimate disposition of the forgoing matters will not have a material affect on our financial condition, liquidity, or results of operations. ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS None. ITEM 3. DEFAULTS UPON SENIOR SECURITIES None. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. ITEM 5. OTHER INFORMATION None. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K None. 25 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. T-NETIX, INC. By: /s/ THOMAS E. LARKIN ------------------------- Thomas E. Larkin, Chief Executive Officer By: /s/ HENRY G. SCHOPFER ------------------------- Henry G. Schopfer, Chief Financial Officer Date: November 14, 2002 26 CERTIFICATION I, Thomas E. Larkin, certify that: 1. I have reviewed this quarterly report on Form 10-Q of T-NETIX, Inc. 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of and for the periods presented in this quarterly report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of the registrant's board of directors: a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal control; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officer and I have indicated in this quarterly report whether or not there were significant changes in internal control or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Dated: November 14, 2002 By: /s/ THOMAS E. LARKIN ------------------------- Thomas E. Larkin Chief Executive Officer 27 CERTIFICATION I, Henry G. Schopfer, certify that: 1. I have reviewed this quarterly report on Form 10-Q of T-NETIX, Inc. 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of and for the periods presented in this quarterly report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of the registrant's board of directors: a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal control; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officer and I have indicated in this quarterly report whether or not there were significant changes in internal control or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Dated: November 14, 2002 By: /s/ HENRY G. SCHOPFER ----------------------- Henry G. Schopfer Chief Financial Officer 28

T NETIX INC 10-Q