T NETIX INC, 10-Q, 1999-11-15

T NETIX INC
10-Q, 1999-11-15
COMMUNICATIONS SERVICES, NEC

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<PAGE> 1

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549

----------------
FORM 10-Q

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

(X) Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934

( ) Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934

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

FOR THE QUARTER ENDED SEPTEMBER 30, 1999 COMMISSION FILE NUMBER 0-25016

T-NETIX, INC.
-------------
(Exact Name of registrant as Specified in Its Charter)

COLORADO 84-1037352
- ----------------------------------------- -----------------------------------
(State of Other (I.R.S.Employer
Jurisdiction of Incorporation) Identification No.)

67 INVERNESS DRIVE EAST
ENGLEWOOD, COLORADO 80112
- ----------------------------------------- -----------------------------------
(Address of principal executive offices) (Zip Code)

REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (303) 790-9111

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

Indicate by check (X) whether the registrant (1) has filed all reports
required to 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 11, 1999
- ------------------------------- --------------------------------
Common Stock, $.01 stated value 12,699,400

<PAGE> 2

T-NETIX, INC.
FORM 10-Q

INDEX

I. FINANCIAL INFORMATION

1. Financial Statements:

Consolidated Balance Sheets, September 30, 1999
and December 31, 1998 (Unaudited) 2

Consolidated Statements of Operations, Three Months Ended
September 30, 1999 and 1998, and Nine Months Ended
September 30, 1999 and 1998 (Unaudited) 3

Consolidated Statements of Cash Flows, Nine Months Ended
September 30, 1999 and 1998 (Unaudited) 4

Notes to Consolidated Financial Statements (Unaudited) 5

2. Management's Discussion and Analysis of Financial Condition and Results of
Operation 12

3. Quantitative and Qualitative Disclosures About Market Risk 23

II. OTHER INFORMATION - Items 1 through 6 25
</TABLE>

<PAGE> 3

PART I - FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS

T-NETIX, INC. AND SUBSIDIARIES
Consolidated Balance Sheets (Unaudited)

<TABLE>
<CAPTION>
September 30, December 31,
1999 1998(1)
-------------- --------------
(amounts in thousands)
<S> <C> <C>
ASSETS
Cash and cash equivalents $ 899 $ 678
Accounts receivable, net of allowance 15,100 16,353
Prepaid expenses 1,932 1,420
-------------- --------------
Total current assets 17,931 18,451
Property and equipment, at cost:
Telecommunications equipment 54,743 51,995
Construction in progress 5,866 5,185
Office equipment 8,838 7,382
-------------- --------------
Property and equipment 69,447 64,562
Less accumulated depreciation and amortization (37,475) (32,988)
-------------- --------------
Property and equipment, net 31,972 31,574
Patent license rights and other technology rights 3,859 1,877
Goodwill, net 5,327 5,823
Software development costs, net 1,599 3,016
Deferred tax assets 2,300 962
Other assets, net 3,543 3,583
-------------- --------------
$ 66,531 $ 65,286
============== ==============
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Accounts payable $ 9,037 $ 4,688
Accrued liabilities 5,556 5,488
Debt 28,496 21,710
-------------- --------------
Total current liabilities 43,089 31,886
Long-term debt 114 3,800
-------------- --------------
Total liabilities 43,203 35,686
Shareholders' equity:
Preferred stock, $0.01 stated value, 10,000,000 shares
authorized; no shares issued -- --
Common stock, $0.01 stated value, 70,000,000 shares
authorized; issued and outstanding 12,699,400 and
12,225,636 shares, respectively 127 122
Additional paid-in capital 35,792 33,053
Accumulated deficit (12,591) (3,575)
-------------- --------------
Total shareholders' equity 23,328 29,600
Commitments and contingencies
-------------- --------------
$ 66,531 $ 65,286
============== ==============
</TABLE>

(1) Restated for pooling of interests - See Note 2

See accompanying notes to consolidated financial statements.

<PAGE> 4

T-NETIX, INC. AND SUBSIDIARIES
Consolidated Statements of Operations (Unaudited)

<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
-------------------------------- --------------------------------
September 30, September 30, September 30, September 30,
1999 1998(1) 1999(1) 1998(1)
-------------- -------------- -------------- --------------
(amounts in thousands, except per share amounts)
<S> <C> <C> <C> <C>
Revenue:
Telecommunications services $ 9,761 $ 10,171 $ 29,631 $ 31,489
Direct call provisioning 6,811 5,564 20,334 17,106
Equipment sales 161 492 2,230 1,440
Voice print 29 109 88 322
-------------- -------------- -------------- --------------
Total revenue 16,762 16,336 52,283 50,357

Expenses:
Operating costs and expenses:
Telecommunications services 4,509 4,522 13,177 13,827
Direct call provisioning 6,281 5,248 18,820 15,942
Cost of equipment sold 55 185 929 542
Voice print 1 14 5 21
-------------- -------------- -------------- --------------
Total operating costs and expenses 10,846 9,969 32,931 30,332
Selling, general, and administrative 3,440 2,731 9,907 7,944
Pooling transaction expenses -- -- 1,017 --
Research and development 1,100 993 3,716 2,935
Impairment of telecommunications assets 4,632 -- 4,632 --
Depreciation and amortization 2,947 2,478 8,618 7,433
-------------- -------------- -------------- --------------
Total expenses 22,965 16,171 60,821 48,644

Operating income (loss) (6,203) 165 (8,538) 1,713
Interest and other income (expense),net (479) (444) (1,595) (1,213)
-------------- -------------- -------------- --------------
Earnings (loss) before income taxes (6,682) (279) (10,133) 500
Income taxes -- 45 1,117 (196)
-------------- -------------- -------------- --------------
Net earnings (loss) $ (6,682) $ (234) $ (9,016) $ 304
============== ============== ============== ==============

Basic and diluted earnings (loss) per
common share $ (0.53) $ (0.02) $ (0.72) $ 0.02
============== ============== ============== ==============
Weighted average common shares
outstanding - basic 12,699 12,220 12,448 12,197
============== ============== ============== ==============
Weighted average common shares
outstanding- diluted 12,699 12,220 12,448 13,017
============== ============== ============== ==============
</TABLE>

(1) Restated for pooling of interests - See Note 2

See accompanying notes to consolidated financial statements.

3
<PAGE> 5

T-NETIX, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows (Unaudited)
Nine months ended September 30, 1999 and 1998

<TABLE>
<CAPTION>
1999 1998
------------ ------------
(amounts in thousands)
<S> <C> <C>
Cash flows from operating activities:
Net earnings (loss) $ (9,016) $ 304
Adjustments to reconcile net earnings (loss) to net cash
provided by (used in) operating activities:
Depreciation and amortization 8,618 7,433
Impairment loss 4,632 --
Gain on sale of equipment (108) --
Deferred tax benefit (1,338) --
Changes in operating assets and liabilities, net of
acquisition of business:
Change in accounts receivable 1,253 (899)
Change in prepaid expenses (512) (522)
Change in other assets (186) (148)
Change in accounts payable 4,349 (1,040)
Change in accrued liabilities 68 (431)
------------ ------------

Cash provided by operating activities 7,760 4,697
------------ ------------

Cash flows from investing activities:
Capital expenditures (10,080) (3,683)
Other investing activities (803) (2,493)
------------ ------------

Cash used in investing activities (10,883) (6,176)
------------ ------------

Cash flows from financing activities:
Net proceeds (payments) under line of credit 5,877 (264)
Payments of debt (27,790) (2,470)
Proceeds from debt 25,000 3,061
Common stock issued for cash under option plans 257 221
------------ ------------

Cash provided by financing activities 3,344 548
------------ ------------

Net increase (decrease) in cash and cash equivalents 221 (931)

Cash and cash equivalents at beginning of period 678 945
------------ ------------

Cash and cash equivalents at end of period $ 899 $ 14
============ ============

Cash paid for interest $ 1,639 $ 1,243
============ ============
</TABLE>

(1) Restated for pooling of interests - See Note 2

See accompanying notes to consolidated financial statements.

4
<PAGE> 6

T-NETIX, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements

(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 1998
Annual Report on Form 10-K for the Company's accounting policies, which
are pertinent to these statements.

Year End

Effective December 1998, the Company changed its fiscal year from a
fiscal year ended July 31 to a fiscal year ended December 31. All 1998
amounts have been presented on the basis of the new fiscal year end.

Revenue Recognition

In October 1997, the AICPA issued Statement of Position (SOP) 97-2,
Software Revenue Recognition, which supersedes SOP 91-1. The provisions
of SOP 97-2 have been applied to transactions entered into after July
31, 1998. Prior to that date, the Company's revenue recognition policy
was in accordance with SOP No. 91-1.

SOP 97-2 generally requires revenue earned on software arrangements
involving multiple elements (i.e. software products,
upgrades/enhancements, post contract customer support, installation,
training, etc.) to be allocated to each element based on the relative
fair value of the elements. The fair value of an element must be based
on evidence, which is specific to the vendor. The revenue generally is
recognized upon delivery of the products. The revenue allocated to post
contract customer support generally is recognized ratably over the term
of the support and the revenue allocated to service elements (such as
training and installation) generally is recognized as the services are
performed. If a vendor does not have evidence of the fair value for all
elements in a multiple-element arrangement, all revenue from the
arrangement is deferred until such evidence exists or until all
elements are delivered. There was no material impact on the Company's
results of operations as a result of the adoption of SOP 97-2.

5
<PAGE> 7

T-NETIX, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements

Research and Development

Costs associated with the research and development of new technology or
significantly altering existing technology are charged to operations as
incurred.

Software development costs have been accounted for in accordance with
Statement of Financial Accounting Standards No. 86, Accounting for the
Costs of Computer Software to be Sold, Leased or Otherwise Marketed.
Under the standard, capitalization of software development costs begins
upon the establishment of technological feasibility, subject to net
realizable value considerations. Capitalized software costs are
amortized over the greater of: 1) the amount computed using the ratio
that current gross revenues for a product bear to the total current and
anticipated future gross revenues for that product; or 2) the straight
line method over the remaining estimated useful life of the product in
which the life is generally estimated to be three years.

Asset Impairment

The Company reviews its property and equipment and unamortized
intangible assets whenever events or changes in circumstances indicate
that the carrying amount may not be recoverable. During the three
months ended September 30, 1999 the Company recorded an impairment of
telecommunications assets of $4,632,000. Two events occurred in the
third quarter indicated that the carrying value of certain equipment
and intangible assets may not be recoverable.

In September 1999, the Company completed an evaluation of the future
viability of its new inmate calling platform ("DL Platform") it had
been developing over the past two years. The merger with Gateway
Technologies, Inc. ("Gateway") allowed the Company to consider an
alternative to the DL Platform. The Company decided that the Gateway
ComBridge Platform ("ComBridge"), would be the platform to install for
both new customers and upgrades of existing customers. However, over
the last year the Company had been awarded certain contracts where the
DL Platform was to be deployed. Since the Company believes that it
would not be cost effective to maintain and support two separate
systems, the Company proceeded to try to renegotiate all existing
contracts to install ComBridge instead of the DL platform. During the
quarter ended September 30, 1999, the Company was successful with these
negotiations. Due to the abandonment of the DL Platform, the Company no
longer has any anticipated cash flow to support the carrying value of
assets related to the DL Platform. Capitalized costs relating to the DL
Platform included the software development costs, components
(consisting primarily of telephony cards) and other supporting computer
peripheral equipment. The estimated impairment, being the excess of the
carrying costs over their estimated fair value of these assets, is
approximately $3,669,000 for the three and nine months ended September
30, 1999. As a result, software development costs at September 30, 1999
were impaired by $2,093,000 and construction in progress relating to
these products were impaired by $1,576,000. All of these charges are
applicable to the ICS Division.

<PAGE> 8

T-NETIX, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements

In addition, the Company has deployed a version of its old inmate
calling platform that resides in its customers network locations. The
Company has recently experienced a reduction in call volumes and
revenues from this platform. The customer has indicated to the
Company that it does not intend to use the platform as a source of
future services. Additionally, since the platform was based on the
predecessor to the DL Platform, there is not an upgrade path available
for the platform. Any new feature or service offering would be
evaluated based on the new ComBridge platform. The reduction in call
volumes caused the estimated fair value of these assets to be less
than its existing book value. The Company estimated fair value based
on the discounted cash flows from each service location. After
consideration of minimal salvage value of these assets due to their
specific use, the Company has recorded an impairment charge of
approximately $963,000. This charge is applicable to the ICS Division.

(2) POOLING OF INTERESTS

On June 14, 1999, the Company completed a merger with Dallas-based
Gateway Technologies, Inc. ("Gateway"), a privately held provider of
inmate telecommunications calling services, by exchanging 3,672,234
shares of its common stock for all of the common stock of Gateway. Each
share of Gateway was exchanged for 5.0375 shares of T-NETIX common
stock. In addition, outstanding Gateway stock options were converted at
the same exchange factor into options to purchase approximately 379,000
shares of T-NETIX common stock.

The merger constituted a tax-free reorganization and has been
accounted for as a pooling of interests under Accounting Principles
Board Opinion No. 16. Accordingly, all prior period consolidated
financial statements presented have been restated to include the
combined results of operations, financial position and cash flows
of T-NETIX and Gateway as though Gateway had always been a part of
T-NETIX.

Selected financial data of T-NETIX and Gateway, prior to its merger
with T-NETIX, on a combined basis, were as follows:

<TABLE>
<CAPTION>
NINE MONTHS ENDED SEPTEMBER 30, 1999
------------------------------------
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
T-NETIX GATEWAY COMBINED
---------- ---------- ----------
<S> <C> <C> <C>
Revenue $ 25,590 $ 26,693 $ 52,283
Net earnings (loss) $ (9,437) $ 421 $ (9,016)
Diluted earnings (loss) per
common share $ (1.08) $ (0.72)
</TABLE>

<TABLE>
<CAPTION>
NINE MONTHS ENDED SEPTEMBER 30, 1998
------------------------------------
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
T-NETIX GATEWAY COMBINED
---------- ---------- ----------
<S> <C> <C> <C>
Revenue $ 28,140 $ 22,217 $ 50,357
Net earnings (loss) $ (71) $ 375 $ 304
Diluted earnings (loss) per
common share $ (0.01) $ 0.02
</TABLE>

<PAGE> 9

T-NETIX, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements

In addition, in connection with the merger transaction, T-NETIX issued
375,341 shares of common stock to certain shareholders of Gateway in
exchange for terminating a Royalty Agreement. The Royalty Agreement
related to automated call processing technology and intellectual
property rights that were assigned to Gateway by the Royalty Owners in
exchange for royalty payments. The termination of the Royalty Owners'
interests resulted in the acquisition of an intangible asset. The asset
has been recorded at fair value, or $2,487,000. The fair value is based
on the value of T-NETIX common stock at February 10, 1999 (date of the
Merger Agreement), or $6.625, times the number of shares issued in
exchange for termination of the Royalty Owners' interests. The
intangible asset has an estimated useful life of 10 years.

Transactions between T-NETIX and Gateway prior to the merger consisted
of licensing revenue from each party. All such amounts have been
eliminated in the restated consolidated financial statements. Certain
reclassifications were made to the Gateway financial statements to
conform to T-NETIX's presentations.

In connection with the merger, the Company incurred pooling transaction
expenses of $1,017,000 for the nine months ended September 30, 1999.
Pooling transaction expenses consisted primarily of fees for investment
bankers, attorneys, accountants, financial printing and other related
charges.

(3) EARNINGS (LOSS) PER COMMON SHARE

Earnings (loss) per common share for the three and nine months ended
September 30, 1999 and 1998, are presented in accordance with the
provisions of Statement of Financial Accounting Standards No. 128,
Earnings Per Share. 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
reflects the potential dilution that could occur if securities or other
contracts to issue common stock were exercised or converted into common
stock. For the three and nine months ended September 30, 1999 and the
three months ended September 30, 1998 common stock equivalents were not
included in the diluted EPS calculation, as they would be
anti-dilutive. For the nine months ended September 30, 1998, diluted
common and common equivalent shares outstanding includes 820,000 of
common share equivalents, consisting of stock options, determined under
the treasury stock method.

(4) DEBT

In September 1999, the Company entered into a Senior Secured Revolving
Credit Facility ("Credit Facility") with a commercial bank. The Credit
Facility provides for maximum credit of $40,000,000. The proceeds of
the new credit facility were used to repay existing debt facilities and
to provide working capital. The revolving facility is comprised of a
one year LIBOR component of $15,000,000 at an interest rate of LIBOR
plus 2.75% at September 30, 1999; a one month LIBOR component of
$10,000,000 at an interest rate of LIBOR plus 2.75% at September 30,
1999; and $3,144,000 at the Bank's prime rate. As of September 30,
1999, the Company's interest rate ranged from 8.13% to 8.80%.

<PAGE> 10

T-NETIX, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements

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 conditions. 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
Credit Facility is for a period of two years. At September 30, 1999 the
Company was in violation of all of the financial covenants set forth in
the Credit Facility, and as such the lenders could demand payment on
the Credit Facility. The bank is currently reviewing the covenant
breaches and the Company has requested a waiver of the financial
covenants for a period of 30 days, pending review by the bank,
accordingly the debt to the bank has been classified as a current
liability.

(5) SUBSEQUENT EVENT

Acquisition

Effective October 28, 1999, the Company completed the acquisition of
substantially all of the assets of Evans and Ricker ("E&R"), of
Portland, Oregon for cash and acquisition costs of approximately
$1,400,000. E&R specializes in software used to control and manage
information for correctional facilities. E&R's product, Lock and Track
Corrections Information System ("Lock & Track") is a comprehensive
relational database designed to handle the operational control and
reporting needs of municipal, state, federal, and/or private
correctional facilities. The acquisition will be accounted for by the
purchase method of accounting. Assets acquired and liabilities assumed
will be recorded at their fair values, and are subject to adjustment
when additional information concerning asset and liability valuations
are finalized. The estimated excess of cost over the estimated fair
value of the net assets of approximately $1,100,000 will be allocated
to goodwill. The remaining net assets will be allocated primarily to
current assets and current liabilities. The acquisition was funded by
borrowings under the Company's line of credit.

<PAGE> 11

T-NETIX, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements

(6) SEGMENT INFORMATION

The Company operated in two business segments: inmate calling services
and SpeakEZ Voice Print(R). 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. Inmate calling services includes
the provisioning of specialized call processing and offender monitoring
services. Segment information for the three and nine months ended
September 30, 1999 and 1998 is as follows:

<TABLE>
<CAPTION>
THREE MONTHS ENDED SEPTEMBER 30, 1999
(AMOUNTS IN THOUSANDS)
---------------------------------------
INMATE CALLING
SERVICES SPEAKEZ TOTAL
-------- -------- --------
<S> <C> <C> <C>
Revenue from external customers ............................ $ 16,733 $ 29 $ 16,762
Operating income (loss) .................................... (5,628) (575) (6,203)
Depreciation and amortization .............................. 2,713 234 2,947
Interest and other expense, net ........................... 252 227 479
Segment earnings (loss) before taxes ....................... (5,880) (802) (6,682)
</TABLE>

<TABLE>
<CAPTION>
THREE MONTHS ENDED SEPTEMBER 30, 1998
(AMOUNTS IN THOUSANDS)
---------------------------------------
INMATE CALLING
SERVICES SPEAKEZ TOTAL
-------- -------- --------
<S> <C> <C> <C>

Revenue from external customers ............................ $ 16,227 $ 109 $ 16,336
Operating income (loss) .................................... 1,171 (1,006) 165
Depreciation and amortization .............................. 2,248 230 2,478
Interest expense ........................................... 274 170 444
Segment earnings (loss) before taxes ....................... 897 (1,176) (279)
</TABLE>

<TABLE>
<CAPTION>
NINE MONTHS ENDED SEPTEMBER 30, 1999
(AMOUNTS IN THOUSANDS)
---------------------------------------
INMATE CALLING
SERVICES SPEAKEZ TOTAL
-------- -------- --------
<S> <C> <C> <C>

Revenue from external customers ............................ $ 52,195 $ 88 $ 52,283
Operating income (loss) .................................... (6,593) (1,945) (8,538)
Depreciation and amortization .............................. 7,886 732 8,618
Interest expense ........................................... 914 681 1,595
Segment earnings (loss) before taxes ....................... (7,507) (2,626) (10,133)
</TABLE>

<TABLE>
<CAPTION>
NINE MONTHS ENDED SEPTEMBER 30, 1998
(AMOUNTS IN THOUSANDS)
---------------------------------------
INMATE CALLING
SERVICES SPEAKEZ TOTAL
-------- -------- --------
<S> <C> <C> <C>

Revenue from external customers ............................ $ 50,035 $ 322 $ 50,357
Operating income (loss) .................................... 4,816 (3,103) 1,713
Depreciation and amortization .............................. 6,736 697 7,433
Interest expense ........................................... 703 510 1,213
Segment earnings (loss) before taxes ....................... 4,113 (3,613) 500
</TABLE>

10
<PAGE> 12

T-NETIX, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements

There was no intersegment revenue for the three and nine months ended September
30, 1999 and 1998. Unallocated amounts to arrive at net earnings included income
tax (benefit) of $(45,000) for the three months ended September 30, 1998, and
$(1,117,000) and $196,000 for the nine months ended September 30, 1999 and 1998,
respectively. Consolidated total assets included eliminations of approximately
$16,862,000 and $14,507,000 as of September 30, 1999 and December 31, 1998,
respectively. Eliminations consist of intercompany receivables in the ICS
Division and intercompany payables in the SpeakEZ division related solely to the
intercompany borrowing of the SpeakEZ Division.

<PAGE> 13

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

For a comprehensive understanding of the Company's financial condition and
performance, this discussion should be considered within the context of the
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 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 would cause actual results to differ materially from those in the
forward-looking statements include, but are not limited to, the demand for the
Company's products and services including new services such as Lock & Track and
market acceptance risks which may affect the potential technological
obsolescence of existing systems, the renewal of existing site specific ICS
customer contracts, the ability to retain the base of current site specific
customer contracts, the continued relationship with existing customers, the
ability to win new contracts for its products, including Lock & Track, the
successful integration of Gateway Technologies, Inc. into T-NETIX's business,
the ability of the Company to penetrate the market for jail management systems,
the ability to reduce expenditures in the SpeakEZ Division and to successfully
license voice verification and fraud prevention technology, the effect of
economic conditions, the effect of regulation, including the Telecommunications
Act of 1996 that would affect the Company's sales or pricing, the effect of the
Year 2000 Issue, the impact of competitive products and pricing particularly in
the Company's ICS business, including Lock & Track, the Company's 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 herein.

OVERVIEW

ACQUISITION OF GATEWAY TECHNOLOGIES, INC.

On June 14, 1999, the Company completed a merger with Dallas-based Gateway
Technologies, Inc. ("Gateway"), a privately held provider of inmate
telecommunications calling services, by exchanging 3,672,234 shares of its
common stock for all of the common stock of Gateway. Each share of Gateway was
exchanged for 5.0375 shares of T-NETIX common stock. In addition, outstanding
Gateway stock options were converted at the same exchange factor into options to
purchase approximately 379,000 shares of T-NETIX common stock.

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

In addition, in connection with the merger transaction, T-NETIX issued 375,341
shares of common stock to certain shareholders of Gateway in exchange for
terminating a Royalty Agreement. The Royalty Agreement related to automated
call processing technology and intellectual property rights that were assigned
to Gateway by the Royalty Owners in exchange for royalty payments. The
termination of the Royalty Owners' interests resulted in the acquisition of an
intangible asset. The asset has been recorded at fair value, or $2,487,000. The
fair value is based on the value of T-NETIX common stock at February 10, 1999
(date of the Merger Agreement), or $6.625, times the number of shares issued in
exchange for termination of the Royalty Owners' interests. The intangible asset
has an estimated useful life of 10 years.

12
<PAGE> 14

Gateway's business model includes a revenue mix that was different than the
T-NETIX model prior to the transaction. Based on Gateway's historical financial
statements, direct call provisioning accounted for approximately 70% of total
revenue. Telecommunications services accounted for 25% and equipment sales
accounted for 5% of total revenue respectively. T-NETIX prior to the merger had
revenues that were 90% telecommunications services and 10% direct call
provisioning. It did not have any sales of equipment. The following discussion
reflects this change in overall revenue mix and the related changes in costs and
operating expenses.

T-NETIX, with the acquisition of Gateway plans on developing marketing
strategies that will utilize the strengths of the combined company. These
strengths consist of each individual company's prior marketing approaches.
Gateway's sales strategy is designed to focus on the individual jail or
correctional institution level. This direct sales force allows T-NETIX the
opportunity to deliver correctional products, in addition to its inmate calling
system, at the individual jail level. While at the same time, the relationship
based strategy of T-NETIX will be used to deliver through the sales force a new
set of products, including billing services and bad debt management to its
existing carrier customers.

ACQUISITION OF EVANS AND RICKER

In October 1999, the Company completed an asset acquisition of Evans and Ricker
(E&R), of Portland, Oregon. E&R specializes in software used to control and
manage information for correctional facilities. E&R's product, Lock and Track
Corrections Information System ("Lock & Track") is a comprehensive relational
database designed to handle the operational control and reporting needs of
municipal, state, federal, and/or private correctional facilities. The Company
plans to use its ICS sales force to promote Lock & Track to correctional
facilities and departments throughout the country. The Company expects that the
increase in personnel planned for ICS sales will be adequate to promote Lock &
Track. In addition, research and development expense will increase as the former
principals of E&R will now be Company employees.

INMATE CALLING SERVICES DIVISION

The Company derives revenue from three main sources, telecommunications
services, direct call provisioning and equipment sales. Each form of revenue
will have 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.

In telecommunications services, revenue is generated under long-term contracts,
which provide for transaction fees paid on a per-call basis. The per call charge
is primarily for the provisioning of specialized call processing services for
correctional facilities to its telecommunications carrier customer. Such
customers include AT&T, Ameritech, Bell Atlantic, US WEST, SBC Communications,
BellSouth, MCI WorldCom and GTE, and other telecommunications service providers.
The Company is paid a prescribed fee for each call completed and additional fees
for validating phone numbers dialed by inmates.

As a direct inmate call provider, the Company buys "wholesale" call services to
be re-sold as collect calls. The Company uses the services of third parties to
bill its calls. The Company enters into direct contracts with the correctional
facilities and generally pays commissions on the gross billed revenue to the
correctional facilities. The rates charged by the Company are consistent with
the collect call rates charged by the Local Exchange Carrier in the same service
area and the predominant Interexchange Carrier. Since all calls originating from
the inmate phones are collect calls, each phone generates higher than industry
average revenues. The uncertainty of the creditworthiness of the billed parties
results in a higher than industry average uncollectible cost.

The Company experienced increases in total revenue from 1998 to 1999. However,
the Company continues to experience reductions in call volumes that affect
telecommunications services revenue and overall financial performance. The
Company had a net reduction in call volume in 1999. The Company believes that
the primary causes for the reduction are due to price increases by its
telecommunications provider customers to the end user. Additionally, reductions
are also attributable to prisoner relocation programs and increased use of call
control measures by correctional

13
<PAGE> 15

institutions at existing sites. In addition, non-renewal of some existing
site-specific customer contracts in competitive bidding arrangements contributed
to the reduction. These factors were partially offset by increases associated
with the addition of new call processing systems. The Company will continue to
market its services to additional call providers; however, it expects growth in
call processing volumes and corresponding telecommunications services revenue
will come predominantly from adding new systems for existing customers. Systems
that are currently scheduled for installation are not expected to contribute to
significant call volume increases until the next fiscal year.

SPEAKEZ DIVISION

In December 1998, the Company began an evaluation of the SpeakEZ Division and
determined the best course of action was to combine its research and development
operations previously located in New Jersey with its corporate operations in
Englewood, Colorado. The Company completed the reorganization of the SpeakEZ
operations in February 1999. The reorganization included a change in marketing
strategy from a direct customer sales strategy to a technology licensing
strategy. A direct customer sales strategy markets a specifically developed
software product to a specific, end user customer. The strategy is then to find
other specific customers who have similar operating systems and market this
product to them. In contrast, a technology licensing strategy focuses on a
larger scale customer who can integrate the SpeakEZ software product into its
existing product line. This larger customer, such as a computer manufacturer,
would then be responsible for the product integration and ultimate delivery to
the end user customer.

Even with the changes in marketing strategy, there can be no assurance that the
SpeakEZ products will achieve the necessary market acceptance or become widely
adopted. The market for speaker verification software has only recently begun to
develop. As is typical in the case of a new and rapidly evolving market, demand
and market acceptance for recently introduced products and services are subject
to a high level of uncertainty. Voice print revenue for the Company has been
minimal to date. There is no assurance that the SpeakEZ products will be
commercially accepted or profitable in the future.

<PAGE> 16

RESULTS OF OPERATIONS

Three Months Ended September 30, 1999 and 1998

The following table sets forth certain statement of operations data as
a percentage of total revenue for the three months ended September 30, 1999 and
1998.

<TABLE>
<CAPTION>
THREE MONTHS ENDED SEPTEMBER 30,
------------------------------
1999 1998
---------- ----------
<S> <C> <C>
Revenue:
Telecommunications services ................... 58% 62%
Direct call provisioning ...................... 41 34
Equipment sales ............................... 1 3
Voice print ................................... -- 1
-------- --------
Total revenue ............................. 100 100

Expenses:
Operating costs and expenses .................. 65 61
Selling, general and administrative ........... 20 17
Research and development ...................... 7 6
Impairment of telecommunications assets ....... 28 --
Depreciation and amortization ................. 17 15
-------- --------
Operating income (loss) ..................... (37) 1
Interest and other income (expense), net ...... (3) (3)
-------- --------
Earnings (loss) before income taxes ......... (40) (2)
Income tax benefit ............................ -- 1
-------- --------
Net earnings (loss) ......................... (40)% (1)%
======== ========
</TABLE>

Total Revenue. Total revenue increased 3% to $16,762,000 for the three months
ended September 30, 1999, from $16,336,000 for the prior period. This increase
resulted primarily from an increase in direct call provisioning revenue offset
by decreases in telecommunications services revenue, equipment sales and voice
print revenue.

The 4% decrease in telecommunications services revenue to $9,761,000 for the
three months ended September 30, 1999, from $10,171,000 in the prior period, was
due primarily to a decrease in call volume on existing sites. The reduction in
call volumes is primarily due to price increases by its telecommunications
provider customers to the end user. Additionally, reductions are also
attributable to prisoner relocation programs and increased use of call control
measures by correctional institutions at existing sites. In addition,
non-renewal of some existing site-specific customer contracts in competitive
bidding arrangements contributed to the reduction. These factors were partially
offset by increases associated with the addition of new call processing systems.

Direct call provisioning revenue increased 22% to $6,811,000 for the three
months ended September 30, 1999 from $5,564,000 for the prior period. This
increase was due to the addition of sites in which the Company is provisioning
the long distance service. The addition of sites is primarily a result of the
Company being successful in competitive bidding arrangements for contracts
directly with correctional institutions.

Equipment sales decreased 67% to $161,000 for the three months ended September
30, 1999 from $492,000 for the prior period. The decrease was due primarily to a
reduction in sales arrangements with a single customer. This customer purchases
the Company's equipment for installation in correctional institutions and then
pays the Company a monthly maintenance and support fee for the product. The
amounts of such sales are dependent upon the timing of installations with this
customer and the customer's success rate in its territory.

<PAGE> 17

The Company also recognized SpeakEZ Voice Print(R) revenue in the amount of
$29,000 for the three months ended September 30, 1999 or a decrease of $80,000
from the corresponding prior period. SpeakEZ Voice Print(R) revenue was derived
primarily from the provisioning of services and from the sale of software
licenses and software development kits. Future amounts of voice print revenue
are unpredictable and depend upon market acceptance, technological success, and
impact of new competition.

Operating costs and expenses. Total operating costs and expenses increased to
$10,846,000 for the three months ended September 30, 1999, from $9,969,000 for
the corresponding prior period, and increased as a percentage of total revenue
to 65% for the three months ended September 30, 1999 from 61% for the
corresponding prior period. The increase was primarily due to an overall change
in the revenue mix to a greater amount of direct call provisioning revenue and
expenses and a lesser amount of telecommunications services revenue and
expenses. Operating costs and expenses of telecommunications services primarily
consist of service administration costs for correctional facilities, including
salaries and related personnel expenses, communication costs and inmate calling
systems repair and maintenance expense. Operating costs and expenses of
telecommunications services also include costs associated with call verification
procedures, primarily network expenses and database access charges. Operating
costs and expenses associated with direct call provisioning include the costs
associated with telephone line access, long distance charges, commissions paid
to correctional facilities, costs associated with uncollectible accounts and
billing charges. Cost of equipment sold included the purchase price of equipment
held for sale. Other equipment cost components were minimal. Voice print
operating costs for the three months ended September 30, 1999 were for royalty
charges.

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, 1999 and 1998.

<TABLE>
<CAPTION>
THREE MONTHS ENDED SEPTEMBER 30,
-----------------------------
1999 1998
---------- ----------
<S> <C> <C>

Operating costs and expenses:
Telecommunications services .......... 46% 44%
Direct call provisioning ............. 92 94
Cost of equipment sold ............... 34 38
Voice print .......................... 3 13
</TABLE>

Operating costs and expenses associated with providing telecommunications
services increased as a percentage of corresponding revenue to 46% for the three
months ended September 30, 1999, from 44% in the corresponding prior period. The
increase is primarily due to the reduction in telecommunications services
revenue and increases in personnel and telecommunications related costs. Direct
call provisioning costs decreased to 92% for the three months ended September
30, 1999 from 94% in the corresponding prior period. This percentage decrease is
primarily attributable to an increase in higher margin long distance related
direct call provisioning revenue. Cost of equipment sold decreased as a
percentage of corresponding revenue to 34% for the three months ended September
30, 1999 from 38% in the prior period primarily due to changes in product mix.
Voice print expenses decreased as a percentage of corresponding revenue
primarily due to a change in the revenue mix.

Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased to $3,440,000 for the three months ended
September 30, 1999, from $2,731,000 in the corresponding prior period, and
increased as a percentage of total revenue to 20% for the three months ended
September 30, 1999 from 17% for the prior period. Selling, general and
administrative expenses associated with the ICS Division increased by $1,082,000
to $3,297,000 for the three months ended September 30, 1999 from $2,215,000 for
the corresponding prior period. The total increase was primarily due to
increases in salary and benefits of $479,000 for primarily sales and marketing
personnel. Other expenses including travel and telecommunication cost increased
by $185,000 due to the merger with Gateway and addition sales and marketing
travel. Another component of the increase in selling, general and administrative
expenses was professional services and consulting fees, which increased by
$192,000. Included in these professional services and consulting fees is
$105,000

<PAGE> 18

associated with the upgrade of the Company's internal financial accounting
systems to be Year 2000 compliant. The Company anticipates an increase in
selling, general and administrative expenses due to an expansion of its sales
organization in order to leverage new corrections products and the new market
position established as a result of the merger with Gateway.

Selling, general and administrative expenses associated with the SpeakEZ Voice
Print(R) technology were $143,000 for the three months ended September 30, 1999
as compared to $516,000 for the corresponding prior period. The decrease was due
primarily to a reduction in personnel and travel costs of $259,000 and a
decrease in legal and other professional expenses of $42,000. The Company
anticipates maintaining the current level of administrative costs associated
with SpeakEZ. The Company believes it can implement these reductions without
sacrificing potential revenue growth.

Research and Development Expenses. Research and development expenses increased
to $1,100,000 for the three months ended September 30, 1999, from $993,000 in
the corresponding prior period. Research and development expenses for the Inmate
Calling Services division increased to $874,000 for the three months ended
September 30, 1999, from $639,000 in the corresponding prior period. The
increase is primarily due to increased personnel costs. The Company expects
research and development expense for the Inmate Calling Services Division to
increase to support new products and due to the increase in technical personnel.

Research and development expenses associated with the SpeakEZ Voice Print(R)
technology was $226,000 for the three months ended September 30, 1999 as
compared to $354,000 for the corresponding prior period. The decrease was due
to a reduction in personnel and consolidation of the research facilities into
the corporate headquarters. The research and development expense associated
with the SpeakEZ Voice Print(R) technology is expected to remain consistent
with present levels.

Impairment of Telecommunications Assets. During the three months ended
September 30, 1999, the Company recorded an impairment of telecommunications
assets of $4,632,000. Two events indicated that the carrying value of certain
equipment and intangible assets may not be recoverable.

In September 1999, the Company completed an evaluation of the future viability
of its new inmate calling platform ("DL Platform") it had been developing over
the past two years. The merger with Gateway allowed the Company to consider an
alternative to the DL Platform. The Company decided that the Gateway ComBridge
Platform ("ComBridge"), would be the platform to install for both new customers
and upgrades of existing customers. However, over the last year the Company had
been awarded certain contracts where the DL Platform was to be deployed. Since
the Company believes that it would not be cost effective to maintain and support
two separate systems, the Company proceeded to try to renegotiate all existing
contracts to install ComBridge instead of the DL Platform. During the quarter
ended September 30, 1999, the Company was successful with these negotiations.
Due to the abandonment of the DL Platform, the Company no longer has any
anticipated cash flow to support the carrying value of assets related to the DL
Platform. Capitalized costs relating to the DL Platform included the software
development costs, components (consisting primarily of telephony cards) and
other supporting computer peripheral equipment. As a result, software
development costs at September 30, 1999 were impaired by $2,093,000 and certain
components of construction in progress relating to these products were impaired
by $1,576,000.

In addition, the Company has deployed a version of its old inmate calling
platform that resides in its customers network locations. The Company has
recently experienced a reduction in call volumes and revenues from this
platform. The customer has indicated to the Company that it does not intend to
use the platform as a source of future services. Additionally, since the
platform was based on the predecessor to the DL Platform, there is not an
upgrade path available for the platform. Any new feature or service offering
would be evaluated based on the new ComBridge platform. The reduction in call
volumes caused the estimated fair value of these assets to be less than its
existing book value. The Company estimated fair value based on the discounted
cash flows from each location. After consideration of minimal salvage value of
these assets due to their specific use, the Company has recorded an impairment
charge of approximately $963,000. This charge is applicable to the ICS Division.

Depreciation and Amortization Expenses. Depreciation and amortization expenses
increased to $2,947,000 for the three months ended September 30, 1999, from
$2,478,000 in the corresponding prior period. The increase was due primarily to
the amortization of technology rights, capitalized software and goodwill of
approximately $309,000. The depreciation and amortization for the SpeakEZ
Division was $234,000 for the three months ended September 30, 1999 as compared
to $230,000 for the corresponding prior period. The Company anticipates that

<PAGE> 19

depreciation expense will increase, as new sites are added, however it will be
offset to the extent that equipment currently in use becomes fully depreciated.

Interest and Other Income (Expense), Net. Interest and other income (expense),
net increased to $479,000 for the three months ended September 30, 1999, from
$444,000 in the corresponding prior period. Included in other income is
approximately $108,000 gain on the sale of used equipment. Interest expense was
$587,000 for the three months ended September 30, 1999 compared to $444,000 for
the corresponding prior period. The increase is attributable to an increase in
the average amount of indebtedness outstanding during the period, offset by a
reduction in interest rates. The average debt balance increased primarily due
to the increase in capital expenditures and business acquisitions.

<PAGE> 20

Nine Months Ended September 30, 1999 and 1998

The following table sets forth certain statement of operations data as
a percentage of total revenue for the nine months ended September 30, 1999 and
1998.

<TABLE>
<CAPTION>
NINE MONTHS ENDED SEPTEMBER 30,
--------------------------------
1999 1998
---------- ----------
<S> <C> <C>
Revenue:
Telecommunications services ................... 57% 62%
Direct call provisioning ...................... 39 34
Equipment sales ............................... 4 3
Voice print ................................... -- 1
---------- ----------
Total revenue ............................. 100 100

Expenses:
Operating costs and expenses .................. 63 60
Selling, general and administrative ........... 19 16
Pooling transaction expenses .................. 2 --
Research and development ...................... 7 6
Impairment of telecommunications assets ....... 9 --
Depreciation and amortization ................. 16 15
---------- ----------
Operating income (loss) ..................... (16) 3
Interest and other income (expense), net ...... (3) (2)
---------- ----------
Earnings (loss) before income taxes ......... (19) 1
Income tax benefit (expense) .................. 2 (--)
---------- ----------
Net earnings (loss) ......................... (17)% 1%
========== ==========
</TABLE>

Total Revenue. Total revenue increased 4% to $52,283,000 for the nine months
ended September 30, 1999, from $50,357,000 for the prior year. This increase
resulted primarily from increases in direct call provisioning revenue and
equipment sales offset by decreases in telecommunications services revenue and
voice print revenue.

The 6% decrease in telecommunications services revenue to $29,631,000 for the
nine months ended September 30, 1999, from $31,489,000 in the prior year, was
due primarily to a decrease in call volume on existing sites. The reduction in
call volumes is primarily due to price increases by its telecommunications
provider customers to the end user. Additionally, reductions are also
attributable to prisoner relocation programs and increased use of call control
measures by correctional institutions at existing sites. In addition,
non-renewal of some existing site-specific customer contracts in competitive
bidding arrangements contributed to the reduction. These factors were partially
offset by increases associated with the addition of new call processing systems.

Direct call provisioning revenue increased 19% to $20,334,000 for the nine
months ended September 30, 1999 from $17,106,000 for the prior period. This
increase was due to the addition of sites in which the Company is provisioning
the long distance service. The addition of sites is primarily a result of the
Company being successful in competitive bidding arrangements for contracts
directly with correctional institutions.

Equipment sales increased 55% to $2,230,000 for the nine months ended September
30, 1999 from $1,440,000 for the prior period. The increase was due primarily to
sales arrangements with a single customer. This customer purchases the Company's
equipment for installation in correctional institutions and then pays the
Company a monthly maintenance and support fee for the product. The amounts of
such sales are dependent upon the timing of installations with this customer and
the customer's success rate in its territory.

<PAGE> 21

The Company also recognized SpeakEZ Voice Print(R) revenue in the amount of
$88,000 for the nine months ended September 30, 1999 or a decrease of $234,000
from the corresponding prior period. SpeakEZ Voice Print(R) revenue was derived
primarily from the provisioning of services and from the sale of software
licenses and software development kits. Future amounts of voice print revenue
are unpredictable and depend upon market acceptance, technological success, and
impact of new competition.

Operating costs and expenses. Total operating costs and expenses increased to
$32,931,000 for the nine months ended September 30, 1999, from $30,332,000 for
the corresponding prior period, and increased as a percentage of total revenue
to 63% for the nine months ended September 30, 1999 from 60% for the
corresponding prior period. The increase was primarily due to an overall change
in the revenue mix to a greater amount of direct call provisioning revenue and
expenses and a lesser amount of telecommunications services revenue and
expenses. Operating costs and expenses of telecommunications services primarily
consist of service administration costs for correctional facilities, including
salaries and related personnel expenses, communication costs and inmate calling
systems repair and maintenance expense. Operating costs and expenses of
telecommunications services also include costs associated with call verification
procedures, primarily network expenses and database access charges. There were
minimal costs directly associated with telecommunications licensing revenue.
Operating costs and expenses associated with direct call provisioning include
the costs associated with telephone line access, long distance charges,
commissions paid to correctional facilities, costs associated with uncollectible
accounts and billing charges. Cost of equipment sold includes the purchase price
of equipment held for sale. Other equipment cost components were minimal. Voice
print operating costs for the nine months ended September 30, 1999 were
primarily for royalty charges.

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, 1999 and 1998.

<TABLE>
<CAPTION>
NINE MONTHS ENDED SEPTEMBER 30,
-------------------------------
1999 1998
---------- ----------
<S> <C> <C>
Operating costs and expenses:
Telecommunications services .......... 44% 44%
Direct call provisioning ............. 93 93
Cost of equipment sold ............... 42 38
Voice print .......................... 6 7
</TABLE>

Operating costs and expenses associated with providing telecommunications
services remained consistent as a percentage of corresponding revenue at 44% for
the nine months ended September 30, 1999 and 1998. Direct call provisioning
costs remained consistent as a percentage of corresponding revenue to 93% for
the nine months ended September 30, 1999 and 1998. Cost of equipment sold
increased as a percentage of corresponding revenue to 42% for the nine months
ended September 30, 1999 from 38% in the prior period primarily due to changes
in product mix. Voice print expenses increased as a percentage of revenue
primarily due to a change in the revenue mix.

Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased to $9,907,000 for the nine months ended
September 30, 1999, from $7,944,000 in the corresponding prior period, and
increased as a percentage of total revenue to 19% from 16% in the corresponding
prior period. Selling, general and administrative expenses associated with the
Inmate Calling Services Division increased by $2,936,000 to $9,300,000 for the
nine months ended September 30, 1999 from $6,364,000 for the corresponding prior
period. The total increase was primarily due to increases in salary and benefits
of $1,252,000 for primarily sales and marketing and information services
personnel. Other expenses including travel and telecommunication costs increased
by $480,000 due to the merger with Gateway and additional sales and marketing
travel. Another component to the increase in selling, general and administrative
expenses was professional services and consulting fees, which increased by
$658,000. Included in these professional services and consulting fees is
$218,000 associated with the upgrade of the Company's internal financial
accounting systems to be Year 2000 compliant.

<PAGE> 22

Selling, general and administrative expenses associated with the SpeakEZ Voice
Print(R) technology were $607,000 for the nine months ended September 30, 1999
as compared to $1,580,000 for the corresponding prior period. The decrease was
due primarily to a reduction in personnel and travel costs of $708,000 and a
decrease in legal and other professional expenses of $175,000.

Pooling Transaction Expenses. These expenses were directly related to the merger
with Gateway and amounted to $1,017,000 for the nine months ended September 30,
1999. Pooling transaction expenses consisted primarily of fees for investment
bankers, attorneys, accountants, financial printing and other related charges.

Research and Development Expenses. Research and development expenses increased
to $3,716,000 for the nine months ended September 30, 1999, from $2,935,000 in
the corresponding prior period. Research and development expenses for the Inmate
Calling Services division increased to $3,027,000 for the nine months ended
September 30, 1999, from $1,808,000 in the corresponding prior period. The
increase is primarily due to personnel increases. The Company expects research
and development expense for the ICS Division to increase to support new products
and due to the increase in technical personnel.

Research and development expenses associated with the SpeakEZ Voice Print(R)
technology was $689,000 for the nine months ended September 30, 1999 as compared
to $1,127,000 for the corresponding prior period. The decrease was due to a
reduction in personnel and consolidation of the research facilities into the
corporate headquarters.

Impairment of Telecommunications Assets. During the nine months ended September
30, 1999, the Company recorded an impairment of telecommunications assets of
$4,632,000. Two events indicated that the carrying value of certain equipment
and intangible assets may not be recoverable.

In September 1999, the Company completed an evaluation of the future viability
of its new inmate calling platform ("DL Platform") it had been developing over
the past two years. The merger of Gateway allowed the Company to consider an
alternative to the DL Platform. The Company decided that the Gateway ComBridge
Platform ("ComBridge"), would be the platform to install for both new customers
and upgrades of existing customers. However, over the last year the Company had
been awarded certain contracts where the DL Platform was to be deployed. Since
the Company believes it would not be cost effective to maintain and support two
separate systems, the Company proceeded to try to re-negotiate, all existing
contracts to install ComBridge instead of the DL platform. During the quarter
ended September 30, 1999, the Company was successful with these negotiations.
Due to the abandonment of the DL Platform, the Company no longer has any
anticipated cash flow to support the carrying value of assets related to the DL
Platform. Capitalized costs relating to the DL Platform included the software
development costs, components (consisting primarily of telephony cards) and
other supporting computer peripheral equipment. As a result, software
development costs at September 30, 1999 were impaired by $2,093,000 and certain
components of construction in progress relating to these products were impaired
by $1,576,000.

In addition, the Company has deployed a version of its old inmate calling
platform that resides in its customers network locations. The Company has
recently experienced a reduction in call volumes and revenues from this
platform. The customer has indicated to the Company that it does not intend to
use the platform as a source of future services. Additionally, since the
platform was based on the predecessor to the DL Platform, there is not an
upgrade path available for the platform. Any new feature or service offering
would be evaluated based on the new ComBridge platform. The reduction in call
volumes caused the estimated fair value of these assets to be less than its
existing book value. The Company estimated fair value based on the discounted
cash flows from each location. After consideration of minimal salvage value of
these assets due to their specific use, the Company has recorded an impairment
charge of approximately $963,000. This charge is applicable to the ICS
Division.

Depreciation and Amortization Expenses. Depreciation and amortization expenses
increased to $8,618,000 for the nine months ended September 30, 1999, from
$7,433,000 in the corresponding prior period. The increase was due primarily to
the amortization technology rights, capitalized software and goodwill of
approximately $804,000. The depreciation and amortization for the SpeakEZ
Division was $732,000 for the nine months ended September 30, 1999 as compared
to $697,000 for the corresponding prior period. The Company anticipates that
depreciation expense will increase, as new sites are added, however it will be
offset to the extent that equipment currently in use becomes fully depreciated.

Interest and Other Income (Expense), Net. Interest and other income (expense),
net increased to $1,595,000 for the nine months ended September 30, 1999, from
$1,213,000 in the corresponding prior period. Included in other income is
approximately $108,000 gain on the sale of used equipment.

<PAGE> 23
Interest expense was $1,703,000 for the nine months ended September 30, 1999
compared to $1,213,000 for the corresponding prior period. The increase is
attributable to an increase in the average amount of indebtedness outstanding
during the period offset by a reduction in interest rates. The average debt
balance increased primarily due to the increase in capital expenditures.

LIQUIDITY AND CAPITAL RESOURCES

The Company has historically relied upon commercial borrowings and operating
cash flow to fund its operations and capital needs. Cash provided by operating
activities and financing activities supplied the Company with a majority of its
cash needs for the nine months ended September 30, 1999. The net cash provided
by financing activities was $3,344,000 for the nine months ended September 30,
1999 compared to $548,000 for the corresponding prior period. Cash provided by
operations was $7,760,000 for the nine months ended September 30, 1999 as
compared to $4,697,000 for the corresponding prior period. The change in cash
provided by operations was attributable to changes in net earnings, adjusted for
noncash expense items such as depreciation and amortization, impairment loss,
and gain on sale of equipment, and the change in the Company's deferred tax
provision. Comparably, these changes totaled $2,788,000 for the nine months
ended September 30, 1999 and $7,737,000 for the corresponding prior period. The
net change in operating assets and liabilities was the other offsetting
difference in the change in cash provided by operations. The total change for
the nine months ended September 30, 1999 consisted primarily of decreases in
accounts receivable of $1,253,000 and increases in accounts payable of
$4,349,000. The total change for the nine months ended September 30, 1998
consisted primarily of an increase in accounts receivable of $899,000 and
decreases in accounts payable of $1,040,000.

Cash used in investing activities was $10,883,000 for the nine months ended
September 30, 1999. This included capital expenditures of $10,080,000 for the
nine months ended September 30, 1999 as compared to $3,683,000 in the
corresponding prior period. The capital expenditures for the nine months ended
September 30, 1999 were mainly for telecommunications equipment and office
equipment. The telecommunications equipment was related to new sites pending
installation and for upgrade costs for existing sites that have been renewed.
Additional investing activities of $803,000 for the nine months ended September
30, 1999 was primarily for capitalized software development costs. Other
investing activities of $2,493,000 for the nine months ended September 30, 1998
included expenditures for investments in preferred stock of Cell-Tel and
capitalized software development costs. The acquisition of Cell-Tel was
completed as of December 31, 1998. The Company anticipates that capital
expenditures for telecommunications equipment will primarily follow the
installation of new systems and will increase as the current base of systems are
upgraded to provide increased functional capability.

The Company has been funding its operations by using cash provided by
operations and primarily from available borrowings under a line of credit. Due
to its continued capital requirements and the merger with Gateway, in September
1999, the Company entered into a Commitment Letter for a Senior Secured
Revolving Credit Facility ("Credit Facility") with a commercial bank. The
Credit Facility provides for a maximum credit of $40,000,000. The Credit
Facility is for a period of approximately two years. The Credit Facility is
being used for working capital and refinancing existing debt. However, the
Company is currently in default on all of its financial covenants and in the
event that it cannot come to an agreement with the Bank to waive or revise such
covenants it may be required to sell additional equity securities or obtain
alternative indebtedness to satisfy the covenant violations and fund the
Company's operations and anticipated new inmate call processing systems and
upgrades of existing systems. There can be no assurance that such financing
will be available or, if available, will be obtainable on satisfactory terms.

THE YEAR 2000 ISSUE

The Problem. The Year 2000 Issue is the result of computer programs being
written using two digits rather than four to define the applicable year. As a
result, any of the Company's computer programs that have date-sensitive software
may recognize a date using "00" as the year 1900 rather than the year

<PAGE> 24

2000. This could result in system failures or miscalculations causing
disruptions of operations of the Company and its suppliers and customers.

The Company's State of Readiness. The Company has instituted a Year 2000
Project. As part of the Company's Year 2000 Project, the Company hired
additional project management resources. The Company has completed its
evaluation of current computer systems, software, and embedded technologies. The
evaluation revealed that the Company's current proprietary inmate calling
platform deployed on behalf of the Company's customers, the internal network
hardware and operating system that provides the Company's Local Area Network
("LAN") and Wide Area Network ("WAN"), voice mail system, and accounting and
business process software are the major resources that do have Year 2000
compliance issues. The Company's internal systems and or programs have been
updated with Year 2000 compliant versions. The Company's internal network,
e-mail system and accounting and business process software have been updated
utilizing vendor provided upgrades. The Company's proprietary inmate calling
platform is scheduled to be completed with all Year 2000 compliant versions by
the end of November 1999.

As part of the Company's Year 2000 Project, the Company has contacted its
significant suppliers and large customers to determine the extent to which the
Company is vulnerable to those third parties' failure to remediate their own
Year 2000 Issue. The communications were completed in February 1999 and most
major vendors have verified their Year 2000 compliance. However, there can be no
guarantee that the systems of other companies on which the Company's business
relies will be converted timely, or that a failure to convert by another
company, or a conversion that is incompatible with the Company's systems would
not have a material adverse effect on the Company and its operations.

The Costs to Address the Company's Year 2000 Issues. Expenditures for the nine
months ended September 30, 1999 for the Year 2000 Project amounted to
approximately $505,000 and is approximately $705,000 to date. Management expects
that the completion of its Year 2000 Project may result in additional
expenditures of approximately $250,000.

The Risks Associated with the Company's Year 2000 Issues. The Company's failure
to resolve Year 2000 Issues on or before December 31, 1999 could result in
system failures or miscalculations causing disruption in operations, including
among other things, a temporary inability to process transactions, send
invoices, send and/or receive e-mail and voice mail, or engage in normal
business activities. Additionally, failure of third parties upon whom the
Company's business relies to timely remediate their Year 2000 Issues could
result in disruptions in the Company's supply of network parts and materials,
late, missed, or unapplied payments, temporary disruptions in order processing
and other general problems related to the Company's daily operations. While the
Company believes its Year 2000 Project will adequately address the Company's
internal Year 2000 issues, the overall risks associated with the Year 2000 Issue
remain difficult to accurately describe and quantify, and there can be no
guarantee that the Year 2000 Issue will not have a material adverse effect on
the Company and its operations.

The Company's Contingency Plan. The Company has developed its Year 2000
Contingency Plan. However, the Company does not anticipate a full implementation
of the contingency plan due the proximate completion of the Year 2000 upgrades.
It is the Company's goal to have the remaining Year 2000 Issues resolved by the
end of November 1999.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The Company is exposed to interest rate risk as discussed below.

Interest Rate Risk

<PAGE> 25

The Company has current debt outstanding under a line of credit of $28,144,000
at September 30, 1999. Under the terms of its debt agreement the maximum
available is $40,000,000 depending on certain financial covenant requirements.
The loan bears interest at different rates, $25,000,000 at LIBOR plus 2.75% and
the remaining balance at prime rate. Interest on LIBOR rate loans is payable at
the termination of the interest period applicable to the loan but not longer
than every three months. Interest on prime rate loans is payable every three
months. Since the interest rates on the loans outstanding are variable and are
reset periodically, the Company is exposed to interest rate risk.

<PAGE> 26

PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

Not applicable.

ITEM 2. CHANGES IN SECURITIES

Not applicable.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

Not applicable.

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

Not applicable.

ITEM 5. OTHER INFORMATION

Not applicable.

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

A. Exhibits
--------

27 Financial Data Schedule

<PAGE> 27

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.
---------------
(Registrant)

Date November 13, 1999 By: /s/ Alvyn A. Schopp
----------------- -------------------
(Signature)
Alvyn A. Schopp, Chief Executive Officer

By: /s/ John Giannaula
------------------
(Signature)
John Giannaula, Vice President Finance
(Principal Accounting Officer)

<PAGE> 28

EXHIBIT INDEX

<TABLE>
<CAPTION>
Exhibit No. Description
----------- -----------
<S> <C>
27 Financial Data Schedule
</TABLE>

<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM FINANCIAL
STATEMENTS INCLUDED IN T-NETIX, INC.'S QUARTERLY REPORT ON FORM 10-Q FOR THE
THREE AND NINE MONTHS ENDED SEPTEMBER 30, 1999 AND IS QUALIFIED IN ITS ENTIRETY
BY REFERENCE TO SUCH FINANCIAL STATEMENTS
</LEGEND>

<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JUL-01-1999
<PERIOD-END> SEP-30-1999
<CASH> 899
<SECURITIES> 0
<RECEIVABLES> 18,415
<ALLOWANCES> (3,315)
<INVENTORY> 0
<CURRENT-ASSETS> 17,931
<PP&E> 69,447
<DEPRECIATION> (37,475)
<TOTAL-ASSETS> 66,531
<CURRENT-LIABILITIES> 43,089
<BONDS> 0
0
0
<COMMON> 127
<OTHER-SE> 23,328
<TOTAL-LIABILITY-AND-EQUITY> 66,531
<SALES> 0
<TOTAL-REVENUES> 16,762
<CGS> 0
<TOTAL-COSTS> 10,846
<OTHER-EXPENSES> 12,119
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 497
<INCOME-PRETAX> (6,682)
<INCOME-TAX> 0
<INCOME-CONTINUING> (6,682)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (6,682)
<EPS-BASIC> (0.53)
<EPS-DILUTED> (0.53)

</TABLE>