T NETIX INC, 10-K405/A, 1999-05-27

T NETIX INC
10-K405/A, 1999-05-27
COMMUNICATIONS SERVICES, NEC

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

FORM 10-K/A

AMENDMENT NO. 2 TO
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE YEAR ENDED JULY 31, 1998 COMMISSION FILE NUMBER 0-25016

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

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

67 INVERNESS DRIVE EAST
ENGLEWOOD, COLORADO 80112
(Address of principal executive offices) (Zip Code)
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Registrant's telephone number, including area code: (303) 790-9111

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

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

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

The aggregate market value of the voting stock held by non-affiliates of
the Registrant as of October 16, 1998, was approximately $36,686,000.

The number of shares outstanding of the Registrant's common stock as of
October 16, 1998, was 8,550,632.

The following document is incorporated herein by reference into the part of
the Form 10-K indicated: the Proxy Statement for the 1998 Annual Meeting of
Shareholders to be filed prior to November 30, 1998, pursuant to regulation 14A
of the General Rules and Regulations of the Commission is incorporated by
reference into Part III of this Form 10-K.
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FORM 10-K CROSS REFERENCE INDEX

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PART I
Item 1 Business.................................................... 1
Item 2 Properties.................................................. 18
Item 3 Legal Proceedings........................................... 19
Item 4 Submission of Matters to a Vote of Security-Holders......... 19

PART II
Item 5 Market for Registrant's Common Equity and Related 19
Stockholder Matters.........................................
Item 6 Selected Financial Data..................................... 20
Item 7 Management's Discussion and Analysis of Financial Condition 21
and Results of Operations...................................
Item 8 Financial Statements and Supplementary Data................. 30
Item 9 Changes in and Disagreements with Accountants on Accounting 30
and Financial Disclosures...................................

PART III
Item 10 Directors and Executive Officers of the Registrant.......... 30
Item 11 Executive Compensation...................................... 30
Item 12 Security Ownership of Certain Beneficial Owners and 30
Management..................................................
Item 13 Certain Relationships and Related Transactions.............. 30

PART IV
Item 14 Exhibits, Financial Statement Schedules and Reports on Form 31
8-K.........................................................
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PART I

ITEM 1. BUSINESS

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-K include forward-looking statements
that involve risks and uncertainties not limited to, the demand for the
Company's products and services and market acceptance risks which may affect the
potential technological obsolescence of existing systems, the renewal of
existing site specific customer contracts, the ability to retain the base of
current site specific customer contracts, the continued relationship with
existing customers, the effect of economic conditions, the effect of regulation,
including the Telecommunications Act of 1996, the effect of the Year 2000 Issue,
the impact of competitive products and pricing, 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, the progress of contract implementation
efforts that allow the Company to recognize revenue under its accounting
policies, and the results of financing efforts, along with the other risks
detailed herein.

THE COMPANY

T-NETIX, Inc. (the "Company" or the "Registrant") provides specialized call
processing and fraud control services to the telecommunications and other
service industries. The Company's primary customers include AT&T, Bell Atlantic,
US WEST, SBC Communications, Inc., BellSouth, MCI WorldCom and GTE. These
customers use the Company's products and services to provide annually over
93,000,000 billable inmate collect calls in over 800 correctional institutions.
The Company's products and services include comprehensive transaction
processing, call management and identification systems for the corrections
industry and special-purpose speech processing software and systems. The
Company's current products are based on proprietary software, the most critical
of which are patented or patent pending, and a combination of proprietary and
"off-the-shelf" electronic hardware. These systems are designed to be flexible
delivery platforms which are easily integrated with the Company's customer's
networks and information systems. The Company's revenue stream is mostly
recurring, as a result of the Company historically generally charging for its
services on a fee per transaction processed basis over long term contracts.

In October 1995, the Company acquired SpeakEZ, Inc. ("SPEAKEZ"). SpeakEZ is
a wholly-owned subsidiary and is engaged in the sale, marketing, and development
of new fraud prevention products and services based on its SpeakEZ Voice
Print(SM) speaker verification biometric technology. Developed by SpeakEZ, this
technology uses "voice prints" or speech patterns as a means to verify or
determine an individual's identity. The Company believes SpeakEZ Voice Print(SM)
products to have particular applicability to the fraud problems experienced in
the following markets: computer and network security, call centers,
telecommunications and government services.

T-NETIX is an operating company that through two separate business units
provides leading edge security and fraud prevention products, services, and
technologies. Its two-fold mission is to maintain and extend its leadership
position in its core Inmate Calling Services ("ICS") Division and to become the
global standard and industry leader for the emerging speaker verification market
through its SpeakEZ Division. To date, substantially all the Company's revenue
has been derived from its corrections industry call processing services.

TELECOMMUNICATIONS INDUSTRY BACKGROUND

In recent years, the telecommunications industry has become increasingly
competitive. In the US, established service providers such as AT&T and the
Regional Bell Operating Companies ("RBOCs") are experiencing intense competition
in long distance and local services from other providers such as MCI WorldCom
and Sprint, numerous re-sellers and specialized service providers. Competition
in the local and

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long distance markets is expected to increase as a result of the
Telecommunications Act of 1996 which will permit AT&T and the RBOCs to compete
with each other in their respective markets. Additionally, Competitive Local
Exchange Carriers or "CLEC's" have begun to offer access alternatives, while
traditional cable television providers can offer dial-tone services over their
cable distribution networks. Wireless operators, including Personal
Communications Services ("PCS") operators, offer services which will compete
with both local dial-tone and long distance services. The international
telecommunications services industry is also facing significant changes. Many
countries are privatizing their state-owned telecommunications monopolies, while
others have begun to open their markets to competition through deregulation.

Telecommunications service providers compete on the basis of price, service
differentiation and the introduction of new services and controlling fraud in
their networks. Technologies which enable these providers to lower the costs of
delivering their services and to introduce new services are increasingly
important. In addition, many local and long-distance providers "outsource"
certain support operations to third parties which offer more cost-effective and
flexible alternatives to internal solutions. By doing so, service providers are
able to develop services for customers with special needs and to reduce the time
required to introduce such services into the market. As a result, the Company
believes that new business opportunities are being created for third-party
organizations that can provide these technologies.

MARKETS

ALL SEGMENTS

Telecommunications

Public Communications services, broadly defined as calls not billed to the
originating telephone, includes local and long-distance credit and pre-paid card
calls, third-party calls and collect calls. These calls typically require
specialized network-based functionality to facilitate billing, call handling and
account validation. As a result, Public Communications calls generate higher
per-call revenues than standard residential and commercial calls.

While the industry has almost universally automated calling card calling to
reduce processing costs, the automation of collect and third-party calling has
presented greater challenges due to the customized handling required for these
calls. Such requirements include the need to identify the caller to the billed
party, to obtain billing acceptance, notification of rates, and in some cases,
verify the callers' billing authority. Moreover, automation of these services by
the major call providers faces significant technological hurdles, since their
networks were historically built upon a framework of large network switches
designed to reliably process a high volume of calls with few customized
features. The need to meet these challenges has created an opportunity for
vendors such as the Company to (1) provide custom call processing services
through premises-based equipment, adjunct call processing platforms or other
proprietary technology that is integrated within the telecommunications network
and (2) to offer validation of information associated with the call or calling
party.

Specialized call processing within the Public Communications market
requires the development of advanced capabilities such as control of outgoing
calls, flexible billing procedures and easy-to-use speaker identification and
verification procedures. The Company believes such services are also applicable
to calling card, bill-to-third number, and debit or pre-paid calling. Early
attempts by carriers to combat fraud resulted in the use of Personal
Identification Numbers ("PINs") along with special calling card numbers. These
methods, however, are cumbersome for the customer and easily compromised by the
parties wishing to defraud the carriers. In some cases, the carrier control
measures cause legitimate customers' use of its services to decline or, in the
worst case, to switch carriers. The Company is focused on methods of verifying a
caller's billing authority which are natural and intuitive to the caller, yet
reliable and effective at preventing fraud for the carrier.

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INMATE CALLING SERVICES DIVISION

Corrections

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

According to the U.S. Bureau of Justice Statistics as of December 1997 5.7
million adults were under some form of correctional supervision. Approximately
3.9 million adults were under parole or probation sanction. The number of
inmates in state and federal and local prisons reached approximately 1.7
million. From 1990 to 1997 this number increased an average of 6.5 percent
annually. During the last 25 years the federal and state inmate population has
increased sixfold from just 200,000 in 1972. There are approximately 4,700
correctional facilities in the U.S. These populations are the area in which the
Division delivers a majority of its products and services.

The inmate calling market presents unique and substantial challenges to the
call provider. Correctional facilities generally favor call providers who can
manage the inmate phone systems themselves, maintain consistent service and
easily process new inmates into the systems. Corrections officials generally
require control features that limit the length of calls, limit the time of day
calls are made, and restrict the ability of inmates to make harassing or
unapproved telephone calls. The call provider must be able to customize the call
control features by facility, cell block, telephone and, in some cases, each
inmate. One of the unique challenges is to prevent the fraudulent bypassing of
these controls through three-way calling. Inmates bypass traditional control
features by calling an accomplice at an approved number and having the
accomplice use three-way calling to conference a non-allowed party. Through this
method, inmates have been known to harass and intimidate people, such as
witnesses, whose numbers would otherwise be blocked, or to call merchants to
conduct fraudulent activities.

Correctional facilities generally select telephone/telecommunications
service providers on the basis of services and features provided and on the
level of commissions paid to the facilities. To date, intense competition among
the service providers has led to commission payments to correctional facilities
at levels that the ICS Division believes only the major service providers can
afford. In addition, to win new contracts and renew existing contracts, call
providers must differentiate their services from the competition. They do so by
offering advanced call control services as well as additional complementary
services such as booking and identification processes, trust fund and commissary
automation and management, investigation support and jail management support
systems.

SPEAKEZ DIVISION

Computer and Network Security

The market for Computer and Network Security is rapidly expanding as
businesses seek to make secure their internal and external data networks. While
a variety of new technology is being introduced in the market to address network
security technologies such as server firewalls, electronic tokens, digital
certificates and the like, the standard today for the identification of the
individual user of the secured system is the Personal Identification Number or
PIN -- and PINs are not very secure. Most recently, network planners have begun
to evaluate the use of biometric technologies -- those which use unique human
characteristics such as fingerprints, hand, facial or eye images and
voice -- for personal identification. Within this new area of biometrics SpeakEZ
Voice Print(SM) enjoys several competitive advantages: it does not require
additional and expensive special purpose hardware to support the technology
(SpeakEZ Voice Print(SM) uses in-place microphones and soundcards) and it is not
intrusive to the user.

A chronic challenge facing management information systems executives is to
balance the security requirements of their systems with the human factor
requirements (the degree to which a system is "user-friendly"). Traditional
typed passwords consistently fail to meet both requirements. Although secure
when

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used correctly (difficult-to-remember, frequent changes), typed passwords are
not user-friendly. When they are user-friendly (easy-to remember, infrequent
changes), they are insecure. Even when secured methods are used to "log-on," a
user to a data terminal, workstation or PC, networked servers cannot be assured
that the current user is the authorized user and not someone who has gained
access to the secured terminal or workstation. Networks which are not secured
from unauthorized user access are subject to fraudulent or intercepted e-mail,
exposure of proprietary or confidential file data, industrial espionage or
cyber-terrorism.

The solution to this problem lies with technologies which prove the
identity of the current user in addition to securing the device and the data
transmission between the voice and the network server. This technology must be
both highly accurate and user-friendly. Because biometric technologies measure
something that a person "is" rather than a piece of information or a piece of
equipment a person "has", they lend themselves well to solving the management
information system executive's dilemma. Specifically, speaker verification
offers the optimal combination of accuracy, user-friendliness, (it's
non-intrusive; natural), and value.

CALL CENTERS

Call Centers are becoming increasingly important service delivery vehicles
for most major businesses, particularly so in the financial services, insurance
and health care industries. Globally, these companies are making massive
investments in new call center technology to further lower the cost of providing
customer care and service without trading off customer loyalty or good will.
Call Center infrastructure technology includes communications systems such as
PBX and ACD, and automated speech technology ranging from simple recorded
announcements to Interactive Voice Response ("IVR") and natural language speech
recognition systems. The only security element currently used in most of these
automated processes is a Personal Identification Number or PIN. PINs have many
disadvantages from both the user and security perspectives. Users dislike PINs
because they are not intuitive, most often not chosen by the user, and intrusive
and difficult to remember among other reasons. PINs can be easily fraudulently
obtained through observance or "shoulder-surfing", customer service
manipulation, account maintenance abuse, transaction recording and intercept and
many other criminal methods.

SpeakEZ Voice Print(SM) products add compelling value to these
applications. The SpeakEZ Division has developed versions of its technology
which are compatible and easily integratable with the major embedded technology
systems in the Call Center market. Currently, the Company has software versions
of its product for the IBM, Periphonics, Aspect and Dialogic call center
platforms along with various forms of distribution agreements with these major
providers.

Government Services

The SpeakEZ Division has maintained a long term relationship with certain
agencies within the US Federal Government. Until now, the relationship has been
one of primarily of funded advance technology development. Recently, with a
shifting of R&D funding by the U.S. away from defense related applications, the
Division has new opportunities for additional funding and sales. During the last
year, SpeakEZ Voice Print(SM) technology was part of a trial conducted by the
U.S. Immigration and Naturalization Service for the use of voice verification to
identify frequent travelers between Mexico and the U.S. The eventual success of
this and other similar projects could lead to new government sales opportunities
in the future.

PRODUCTS AND SERVICES

The Company's primary focus in the design of its products and services is
to provide innovative, software-based solutions to "niche" problems with which
major services providers are faced. The Company believes this approach will
result in a willingness of its customers to pay more value for these solutions
and thus an opportunity to generate higher margin revenue. Also important is the
ease with which its solutions are supported by available hardware and operating
systems and integrated with its customers' in-place networks.

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INMATE CALLING SERVICES DIVISION -- PRODUCTS

Currently, substantially all of the Company's revenue is derived from the
services it provides to its customers for use in correctional facilities. During
fiscal 1998, the ICS Division expended significant research and development time
to upgrade its Inmate Calling Platform to a new technology. The new platform
utilizes graphical user interfaces, open architecture standardized telephony
modules and flexible database functionality. The ICS Division's products and
services for the inmate calling market include a comprehensive set of
technological and administrative features which provide call control, fraud
prevention and systems integration capabilities. The ICS Division offers the
following advanced features for each phase of the calling process:

Pre-connection Restriction Features. Unlimited individual number blocking
capabilities; personal identification number ("PIN") operation with allowed or
denied number lists; SpeakEZ Voice Print(SM) speaker verification technology;
restrictions based on calls per time period per inmate; restrictions on the
number of call attempts versus completions; restrictions on calls to a single
number; and real-time billed number validation by external database query.

Call Connection Automation. Automated operator; debit or collect calling
operation; custom call announcement and identification of facility and call
provider; customized introductory messages such as the possibility that the call
may be recorded; PIN-based automated inmate caller identification by which the
inmate is identified to the called party through a pre-recorded statement of the
inmate's name in his own voice; active billing acceptance which requires the
called party to respond with a key-press to accept the inmate call; and
multi-lingual and international call processing.

Post-connection Services. Three-way call detection/prevention technology
based on the ICS Division's patented Strike Three!(TM) technology that prevents
inmates from bypassing control features through three-way calling; "Hot Number"
operation, a real-time alert feature based on inmate PINs, destination number or
originating telephone number; automated attorney-client confidentiality which
precludes recording or monitoring of calls between the inmate and his attorney;
and comprehensive system reports for billing, administrative, law enforcement
and investigative support purposes.

PIN-LOCK(SM). The ICS Division recently announced another technological
innovation -- PIN-LOCK(SM)., Inmate Caller Verification Service, expected to
increase the competitive advantage provided by its patented Strike Three!(TM)
technology. Before this innovation, inmates might use another inmate's PIN to
subvert call restriction controls. PIN-LOCK(SM) prevents this practice by
denying the call if there is not a match with the proper inmate's "voice print".
The Division believes this technology will greatly enhance the security of its
call processing services.

Corrections Systems Integration Applications. The ICS Division's customers
offer additional services as an off-set to higher commission payments to win new
and retain existing inmate calling contracts. The Division offers to its
customers an expanded set of integrated automation, identification and
management applications. The Division's integration design focuses on inmate
identification. Identification attributes such as voice print, PIN, Video
Digital Image, recorded conversations and bar codes are common to the various
corrections applications. The individual applications offered by the Division
include the following:

Trust Fund and Commissary. The ICS Division's Trust Fund/Commissary
system ("TFC") provides for a fully-integrated, point-of-sale commissary or
canteen operation including inventory management, using the inmate bar
coded ID card for transaction processing. The commissary purchases are
electronically processed on a cashless, electronic funds transfer basis,
through the trust fund accounting system provided by the Division.

Video Imaging/Inmate Management. Video imaging is used primarily for
admission and release identification purposes. Corrections officers use a
Company-provided work station to take a digital image or snapshot of an
inmate, input pertinent information, such as allowed/denied calling
numbers, medical requirements, currency on hand, etc., and print an
identification card or wrist band which contains the bar-coded
representation of the inmate identification number or other code. This data
is saved in data bases, with the inmate calling application, the TFC
system, and Tel-Base investigative and Recording

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Access Management applications. The ICS Division's Video Imaging/Inmate
Management System eliminates the costly and cumbersome manual photography
process typically used today.

CELL-TEL MONITORING -- PRODUCTS

In 1998, the Company invested in Cell-Tel Monitoring, Inc. ("Cell-Tel"), a
company that provides a caseload management tool, Contain(SM), to parole
officers utilizing the SpeakEZ Voice Print(SM) speaker verification technology.
Contain(SM) is being marketed by the ICS Division to use its expertise and
contacts to accelerate the sales of the Contain(SM) product.

Contain(SM) is a product and service offering which uses voice verification
and the Internet for cost-effective offender caseload management by community
corrections, probation and parole agencies. A combination of advanced computer
telephony, automated speech and Internet technologies, Contain(SM) facilitates
automated, programmable telephone contact with the program subject during which
SpeakEZ Voice Print(SM) speaker verification technology is utilized to verify
the subject's identity. Exception reporting and system management is provided
via the Internet-based administration application.

SPEAKEZ DIVISION -- PRODUCTS

The SpeakEZ Voice Print(SM) speaker verification technology products have
been developed as a result of technology trials, limited commercial product
deliveries, and anticipated market demands. These products do not currently, nor
have they in the past generated significant revenue contribution.

Computer and Network Security

The SpeakEZ Division has developed a suite of products and a number of
strategic relationships to address this market. These products include
VoicEntry(SM) and VeriNet(SM). VoicEntry(SM) is a biometrics-based alternative
to typed password protection for individual and shared computer users.
VoicEntry(SM) is available for Microsoft(R) Windows95(R) and Windows NT(R)
users. Its latest version, VoicEntry(SM) 2.0 will be installed in Japan in the
fourth calendar quarter of 1998 for a wireless carrier's use in verifying the
identity of 1,500 sales agents. Future releases of the product are planned to
provide for the voice print securing of files, resources and even electronic
mail messages.

VeriNet(SM) is the newest of the SpeakEZ Division's product developments
and it is designed to provide network security through the use of speaker
verification technology. VeriNet(SM) consists of two primary versions,
VeriNetWEB(SM) for Internet-based applications including electronic commerce and
VeriNet CS(SM) for client server networks. Current versions are compatible with
Windows NT(R) systems.

To speed the market introduction of VeriNet(SM), the SpeakEZ Division
entered into a distribution relationship with and made an investment in a
start-up venture called Sentry Systems, Inc. ("Sentry"). Sentry is developing a
turnkey WEB security system for E-Commerce transactions.

In this market, it is important that one's products are based on or
compatible with various open systems architectures and emerging industry
standards. VoicEntry(SM) and VeriNet(SM) meet these requirements and in some
cases the Division's engineers have helped establish the standards. The Division
has also established distribution relationships with other network security
technology providers including several facial imaging companies, Miros and
Visionics, and electronic token company, Encotone Ltd., and a fingerprint
company, BioNetrix. The Division expects to continue building technology sharing
and strategic distribution agreements with other key industry players in the
future.

Call Centers

The SpeakEZ Voice Print(SM) technology application designed for the
financial services industry is Customer Verification Service(SM) (CVS). CVS is
designed for use by banks, brokerage houses, insurance companies, and other
financial institutions to authenticate customer transactions. CVS is designed to
work in conjunction with an overall Interactive Voice Response ("IVR") System to
provide customer service while protecting the financial institution from
fraudulent transactions from unauthorized persons. Access to services
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would only be permitted when requested by individuals whose voice print is on
file and whose real-time password utterance matches the stored voice print.

A customer simply dials the access number to the financial institution's
IVR system or call center. The customer is then instructed to enter their
account number, the financial institution's IVR system prompts the caller to
speak the password which was previously established by the caller in the
enrollment process. At this stage, CVS analyzes the characteristics of the
caller's statement of the password (Feature Extraction) and characterizes its
tonal aspects (Modulation Model). The process also results in characterization
and isolation of the channel environment (i.e., line type, hand-set type), and
results in the determination of a confidence coefficient as to the likelihood of
the match between the caller and the claimed identity.

The SpeakEZ Division believes CVS will be cost effective and easy to
implement for the financial institution. The caller uses an ordinary office,
home or public telephone -- unlike other biometric identification technologies
such as fingerprint, signature or retinal scans, no special hardware or devices
are required at the "point of sale". CVS is client server and network-based. It
can run in Window-NT(R), OS/2(R) and several versions of UNIX and supports the
prevalent IVR and Computer Telephony Integration ("CTI") environments.
Currently, the Division has developed versions of CVS which are compatible with
IBM's DirectTalk/ Call Path, Dialogic's Antares and Windows NT(R). In 1997, the
Division deployed a client-based CVS system at INTRUST Bank for use in the
bank's internal and external security applications. In addition other major
financial institutions have entered into trial agreements with the Division for
the evaluations of the performance, integration, and customer acceptance aspects
of CVS.

Telecommunications

The SpeakEZ Division has developed and installed for GTE Telecommunications
System Inc., its Verifi-Air(SM) product to address wireless telecommunications
fraud. Voice Verifi-Air(SM), compares a cellular caller's password utterance or
voice print, with the stored voice print of the authorized caller. With Voice
Verifi-Air(SM), the Division provides the carrier with subscriber enrollment
support, through IVR-driven interfaces with the carrier's customer care center.
The subscriber enrolls his or her voice print with Voice Verifi-Air(SM) in the
standard manner for SpeakEZ Voice Print(SM) applications -- by stating his or
her password 3-4 times. The subscriber's voice print is then linked to the
subscriber's Mobile Identification Number or MIN. Competing products and overall
market acceptance have stalled the Division's planned utilization of this
product. However, the industry itself is still struggling with methods of
combating fraud and the Division remains optimistic concerning the eventual use
and deployment of this SpeakEZ Voice Print(SM) application.

Through its distribution partner, Ottawa Telephony Group, and their
SecurPBX product line, SpeakEZ Voice Print(SM) technology is currently being
used to verify the identity of company employees who need to remotely access the
communications resources of the company. SecurPBX uses the Securi-Voice(SM)
product.

SYSTEM ARCHITECTURES AND TECHNOLOGY

INMATE CALLING SERVICES DIVISION

Call Processing Technology

The ICS Division's proprietary technology is designed for the specialized
call processing environment and includes the Division's system architectures
consisting of proprietary interface line cards or off-the-shelf Dialogic
computer telephony integration hardware. System features are implemented through
a combination of proprietary software and database management applications.
Remote system management and real-time system diagnostics across the Company's
wide area frame relay network are provided through the Company's Network
Operations Center which operates 24 hours a day, seven days a week.

In 1998, the ICS Division developed a new hardware platform delivery option
which is primarily composed of third party manufacturer product. The new
platform utilizes high density digital/analog network interfaces and shared
hardware resources to allow many channels of call control within a single
enclosure. This

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architecture significantly reduces the physical space, power and operational
maintenance requirements of the Division's current inmate calling system while
also increasing system features, functionality and efficiencies.

The technology referred to above can be deployed to service providers by
varying methods. In both the premises and network architectures, the telephones
and the interconnecting network lines are usually provided and maintained by the
Division's customers at their cost. Typically, the Division owns, installs and
operates at its cost the systems which interface with the customers' telephones
and their networks.

Correctional Industry Systems Architecture

The ICS Division has developed both premises-based and network-based
systems to provide flexibility in the provision of inmate calling services by
its customers. The Division's premises-based systems are located in secure areas
of the jail or prison.

Unlike the premises-based systems, the network-based systems (T-NET(TM))
are not directly connected to the inmate telephone. Instead, calls originating
from the inmate telephones are switched to the Division's equipment, located in
leased commercial office space referred to as a "point of presence" ("POP"),
through a software routing instruction programmed into the local carrier's
central office switch. The Division's network-based systems offer concentration
through networking efficiencies and are deployed without requiring the
installation of any of the Division's equipment within the correctional
facility.

The ICS Division's other network-based system is the adjunct architecture.
The T-NET(TM) adjunct is designed to work with the #5ESS switch, offering
advanced call processing services in a manner transparent to the larger customer
network. Currently, the Division has deployed 32 T-NET(TM) adjunct systems for
AT&T. Also, the Division has installed a large stand-alone system for an RBOC
customer located in the customer's central office. In 1997, the Division
migrated a number of stand-alone T-NET(TM) systems to adjunct systems.

The T-NET(TM) adjunct system was jointly developed with AT&T Bell Labs to
interface with the #5ESS network switching system. These systems have been
deployed in various AT&T switching offices across the country. The adjunct
version of T-NET(TM) has several economic advantages over its stand-alone
version. For example, the Division can obtain 100% coverage of the U.S. by
deploying in 35 geographic locations compared to 200 potential sites for the
stand alone version. This greatly reduces the Division's system administration,
office leasing and operating costs. Additionally, the new version has enhanced
interfaces with AT&T's billing and fraud databases which eliminates several back
office support functions currently being provided by the Company's Network
Operations Center.

SPEAKEZ DIVISION

Speaker Verification Technology

SpeakEZ Voice Print(SM) technology is proprietary software which compares
the speech pattern of a current speaker with a stored digital voice print of the
authorized person to confirm or reject claimed identity. The technology can be
used in a text independent or text dependent mode. The technology is both
language and vocabulary independent. The system uses a combination of neural
network technology and decision trees called a "neural tree network." Each node
of the system's decision tree consists of a single neuron. Training of neurons
requires four or five repetitions of a user-defined password (text dependent) or
a small sample of speech (text independent) and applies "discriminant training"
to the input. This discriminant training contrasts acoustic features of the
speaker being enrolled with features for all the speakers already enrolled in
the system. During verification, each neuron must decide whether acoustic
features of the spoken input are more like those of the person whose identity is
claimed or more like those of all other speakers in the system. Speakers are
enrolled using a personal abbreviated password, typically the person's name,
which they must say before being allowed to place a telephone call or perform a
transaction. The password utterance is then compared to the stored print for
that allowed user or users. The user population can be large and varied. The
system can reside on the public network as an intelligent peripheral or can be
placed as an adjunct servicing a customer phone system or PBX.

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SUPPORT INFRASTRUCTURE

INMATE CALLING SERVICES DIVISION

Call Processing

The Company operates a 24 hour, seven day per week trouble shooting help
desk. Located at the Company's headquarters in Englewood, Colorado, the National
Service Center ("NSC") provides a single point of contact for all customers for
remote diagnostic system maintenance, or a system problem. Once a call is
placed, the NSC Customer Service Analysts perform an initial problem diagnosis
and isolation. Many problems can be resolved during the first call. In addition
to remote repair capabilities, the ICS Division also has a network of trained
and experienced field support personnel who can perform on-site repairs and
maintenance. This field consists of over 245 employees covering 43 states. The
Division will deploy its service administrators depending on several criteria,
including the size of the facility, the feature set the facility requires (PIN
versus non-PIN), the geographic proximity of the Division's current service
administrator force and the correctional facility requirements.

Also located at the Company's headquarters is the Network Operations Center
("NOC"). This system monitors the wide area network that connects all of the
Company's installed systems and provides for centralized collection of call and
reporting data and real-time diagnostic information on the status of each major
system component. The Division also uses the network to process the on-line,
real-time called number validation, process its call records and transmit
administrative data between each location and headquarters. This call data is
then formatted and provided to the customer to be incorporated into their
billing process. As part of the system calling process, the Division performs
real-time billed number validation by external database query over the network
to an on-line database. The NOC provides 24-hour per day, seven days a week
system support.

SPEAKEZ DIVISION

The SpeakEZ Voice Print(SM) technology is designed for full service
delivery or for "plug-and-play" applications. The SpeakEZ Division has installed
both types of applications as part of limited sales contracts and in trial
platforms.

PRICING

INMATE CALLING SERVICES DIVISION

Transaction-based Pricing

The ICS Division's transaction-based pricing provides a recurring,
usage-driven revenue stream. In a typical arrangement, the Division operates
under long-term (three to five years) site-specific contracts with both a
long-distance carrier and a local call provider. The customer pays transaction
fees for each call processed by the Division, regardless of whether the customer
collects the revenue for the call. The transaction fee is determined by the type
of service performed by the Division and the total volume of calls processed for
the customer during the monthly billing period. The Division bills these
customers for transaction fees associated with calls processed during the
previous month on net 30-day terms.

The ICS Division offers its customers a volume-adjusted schedule of
transaction fees which provides discounts for higher volumes of calls processed
per month. Since the discounted fees apply to all of the Division's call
processing services, the customers have the incentive to increase the amount and
scope of services performed by the Division.

The ICS Division separately bills the customer for other network services
required by the customer, such as on-line database queries performed as part of
the collect call validation process, and for certain types of network access
lines. These services are billed to the customer with minimal margins on net
30-day terms.

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The ICS Division's transaction-based pricing structure was developed in
response to customers' demand for lower deployment costs and to reward customers
for increased utilization of the Division's services. The Division believes that
its transaction-based pricing policy differentiates it substantially from its
competitors, enables its customers to rapidly deploy advanced call processing
services to new sites and reinforces the relationships between the Division and
its customers.

Direct Call Provisioning

The ICS Division from time to time acquires new contracts to provide inmate
calling services directly as a long distance carrier or as an accommodation to
certain customers in situations where the customer has a contract to provide
long-distance services to the correctional facility but where the local exchange
carrier is not a customer and not a member of the bidding team. In these cases,
the Division then acts as the local call provider delivering a consistent level
of service for all inmate calls, local or long distance.

As a direct inmate call provider, the ICS Division buys "wholesale" call
services from the call providers to be re-sold as collect calls to the inmates'
called parties. The Division uses the services of third parties to bill its
calls to the billed parties. The Division enters into direct contracts with the
correctional facilities and generally pays commissions on the gross billed
revenue to the correctional facilities. Because of these and other operating
costs, including bad debt write-offs, the margins from this line of business are
significantly lower than the Division's transaction-based arrangements and the
risk is considerably higher.

SPEAKEZ DIVISION

Pricing for the SpeakEZ Voice Print(SM) technology includes directly
purchasing client-server systems, the licensing of software on a per voice print
basis, as well as transaction based pricing based on enrollments and
verifications. The SpeakEZ Division will also provide custom engineering
services at a standard hourly rate or contractual project rate.

CUSTOMERS

INMATE CALLING SERVICES DIVISION

Transaction Fee Customers

The ICS Division provides its call processing services to AT&T, MCI
WorldCom, Bell Atlantic, GTE, SBC Communications, Inc., U S West, BellSouth, and
other call providers. For the year ended July 31, 1998, AT&T, Bell Atlantic, SBC
Communications, Inc. and U S West accounted for approximately 31%, 21%, 15% and
15%, respectively, of the Company's total revenue. No other customer accounted
for more than 10% of the Company's total revenue in the same period. The ICS
Division believes that its customers have selected it on the basis of the
quality and breadth of its turn-key services, the capability of its technology
and its ability to price its services at competitive rates. The Division
generally establishes non-exclusive master agreements with its customers which
set forth the general terms and conditions, including price, under which the
Division will provide its call processing services. The Division then enters
into three to five year site-specific contracts under these master agreements
which govern the provision of services in specific correctional facilities. Each
master agreement provides that its term is automatically extended through the
term of any site-specific contract under the master agreement. Certain
site-specific contracts contain early termination provisions, including
penalties. The Division's services are generally evaluated by its customers
against both internal and external competition.

In a typical installation at a correctional facility, the ICS Division
provides its services to an IXC, for inter-LATA calls, and one of its other
customers for local and intra-LATA calls. Under this arrangement, the Division's
services are provided to both customers, who, in turn, can offer a consistent
service offering to the correctional facility.

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The ICS Division's strategic relationships with its customers have resulted
in several important benefits to the Division:

- A significant portion of the ICS Division's revenue has come from the
conversion of its customers' existing contracts with correctional
facilities.

- The ICS Division services over 800 correctional facilities containing
approximately 26% of the current U.S. inmate population.

- The ICS Division and its customers jointly submit proposals to state
departments of corrections and large correctional facilities for new
business opportunities. The Division is providing its services to 23 such
state departments (including the District of Columbia) as of July 31,
1998.

- The ICS Division services state, federal, and county facilities in 43
states and in addition services 26 of the 50 largest counties, or 52%,
based on inmate population.

- The ICS Division benefits from the scope of its customers' sales and
marketing staffs and greater market presence.

Direct Call Processing Customers

In 1998, the ICS Division installed its first significant location where
the Division is the long distance carrier. Due to the changing competitive
environment, the Division anticipates that it may potentially increase its role
as a long distance carrier and experience the associated revenue in the future.

CELL-TEL MONITORING CUSTOMERS

Contain(SM) is a product and service offering which uses SpeakEZ Voice
Print(SM) voice verification and the Internet for cost-effective caseload
management by community corrections, probation and parole agencies. The
Contain(SM) product has proceeded through several field trials. The trials were
held at two large county locations, in addition to a segment of a department of
criminal justice. The average number of parolee subjects that participated in
each trial location is 50. All of the trials used the Standard Contain(SM)
service product offering, which included daily verification and agency
reporting. The trials were completed in October 1998 and Contain(SM) is
currently being used commercially in a judicial district in Kansas.

SPEAKEZ DIVISION

The SpeakEZ Division markets its SpeakEZ Voice Print(SM) technology through
various marketing channels. This includes service provider delivery and
leveraging off current strategic partner relationships (e.g. GTE-TSI). In
addition, the Division has entered into various sales and distribution
agreements to deploy SpeakEZ Voice Print(SM) technology in various industries
(e.g. Lucent, IBM, and OTG). There have been no significant sales as a result of
the distribution agreements. The terms and conditions of the distribution
agreements do not contain any purchase commitment requirements.

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COMPETITION

INMATE CALLING SERVICES DIVISION

The telecommunications services industry, especially the Public
Communications sector and the inmate calling market, is and can be expected to
remain highly competitive. The ICS Division competes directly with other
suppliers of inmate call processing systems that sell their products to the
Division's customers, such as manufacturers of call processing equipment. These
include Lucent Technologies (formerly AT&T Network Systems), Nortel (formerly
Northern Telecom, Inc.), Gateway Technologies, Inc., Evercom Communications, and
Science Dynamics Corporation. The Division also competes with some of these same
companies that are teamed with various call providers, including the Division's
current customers. The Division believes that its ability to compete in the
inmate calling industry depends upon the quality of the features and services it
provides, its proprietary technology such as three-way call prevention, lower
cost of deployment through transaction-based pricing, the availability of
service administrators, the flexibility it offers through both premises-based
and network-based systems and the strength of its relationships with customers.
However, the Division often relies on its customers to market its services to
correctional facilities, which has the effect of limiting the Division's control
over the outcome of competitive bidding processes. In 1998, the Division
installed its first significant location where the Division is the long distance
carrier. Due to the changing competitive environment, the Division anticipates
that it may potentially increase its role as a long distance carrier and
experience the associated revenue in the future.

SPEAKEZ DIVISION

The market for speaker verification technology is just emerging. The
SpeakEZ Division will primarily compete with speaker verification companies
along with established speech recognition, IVR and telephone system companies.
These include AT&T, InterVoice, Inc., ITT Aerospace/Communication, Nortel,
Phillips, IBM, Lernout and Hauspie, Texas Instruments, Veritel Corporation and
Voice Control Systems, Inc., and Voice Processing Corporation. The Division also
faces competition from biometric technology providers such as Identix and from
network security technology providers such as Security Dynamics. The Division
believes that its ability to compete for the markets outlined previously,
depends on the performance of its technology, its feature-rich nature, and the
cost and ease with which it is integrated with customers networks. In addition,
the Division believes existing relationships and experience strengthen its
competitive position.

MANUFACTURING AND PRODUCT DESIGN

INMATE CALLING SERVICES DIVISION

The ICS Division designs and develops its proprietary technology for its
inmate calling systems. The Division has designed eleven proprietary printed
circuit boards for its products. The final assembly and systems installation
consists of rack-mounting multiple line cards, configuring the local area
network, calibrating and conditioning the system and configuring software as
required by the correctional facility. These procedures are performed by the
Division's installers and service administrators on site, or at the
point-of-presence in the case of a network-based installation. The Division
strongly emphasizes quality control in the design, manufacture, installation and
test phases of the product development and service delivery process.

In 1998, to remain on the forefront of innovative technology and a market
leader in the Corrections Industry, the ICS Division developed a new Computer
Telephony Interface Platform. This new Inmate Call Control System includes all
of the current voice response technology, fraud control features, and network
interfaces along with new data link interfaces, switching functions, a new
Graphical User Interface (GUI) and many new call control features. The hardware
is primarily composed of third party manufacturer product and utilizes high
density digital/analog network interfaces and shared hardware resources to allow
many channels of call control within a single enclosure. This architecture
significantly reduces the physical space, power and operational maintenance
requirements of the Division's current inmate calling system while also
dramatically increasing system features, functionality and efficiencies.

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SPEAKEZ DIVISION

SpeakEZ Voice Print(SM) technology is primarily software applications. The
hardware necessary for implementation is primarily provided by third party
manufacturers and is available from a variety of suppliers.

RESEARCH AND PRODUCT DEVELOPMENT

The Company believes that the timely development of new products and
enhancements to existing products is essential to maintain its competitive
position. The Company conducts research and development to enhance its existing
products (including inmate calling products and SpeakEZ Voice Print(SM)
products) and to build new products, both complementary to the existing product
line and in new functional areas. In addition to the research and development
effort noted above, the Company has devoted resources to two technology-based
joint ventures; Cell-Tel Monitoring, Inc. ("Cell-Tel") and Sentry Systems, Inc.
("Sentry"). Delays or difficulties associated with new products or product
enhancements could have a material adverse affect on the Company's business,
operating results and financial condition.

During fiscal 1998, 1997 and 1996, the Company's research and product
development expenditures were approximately $2.3 million, $2.8 million and $2.4
million. Such amounts in 1998 and 1997 are net of capitalized software
development costs of $1,117,000 and $469,000, respectively. There were no such
costs capitalized in 1996. Approximately $1.5 million of research and product
development expenditures were for the SpeakEZ Voice Print(SM) technology in 1998
and 1997. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations."

Cell-Tel engages in the sales and marketing and research and development of
a prisoner/parolee electronic monitoring device using the Company's SpeakEZ
Voice Print(SM) technology. Cell-Tel's product, Contain(SM) is designed to
provide a remote monitoring system with an Internet based case management
system. As of July 31, 1998 the Company had invested $1,343,000 in the preferred
stock of Cell-Tel. The Company anticipates purchasing additional preferred stock
of approximately $800,000 in fiscal 1999. These funds will be used by Cell-Tel
to continue the development and market deployment of its Contain(SM) product.

Sentry is an entity that the Company owns an interest of approximately
twenty percent. Sentry specializes in Internet Computer Network Security
applications. Sentry uses the SpeakEZ Voice Print(SM) technology in the delivery
of its products and services.

REGULATION

The Company's customers, and a minor portion of its current operations, are
subject to regulation by the FCC and public utility commissions of certain
states in which the Company and its customers operate. Regulatory actions have
impacted, and are likely to continue to impact, both the Company's customers and
its operations. For example, the adoption of regulations which would encourage
additional competition in the business of the Company's customers could have a
material adverse effect on the amount of business done by such customers and the
manner in which such business is done. A reduction in the amount of business
done by the Company's customers would have a material adverse impact on the
Company's revenue since such revenues are directly related to volumes of calls
processed under the Company's transaction fee pricing. Changes in the manner in
which the Company's customers conduct their business could have a material
adverse impact on the Company if, as a result of such changes, the Company's
services and features were no longer needed or desired or if the Company were
not able to modify, or add to, its services in a way that meets the new market
demands of its customers.

The FCC has adopted a petition filed by an industry group comprised of
independent inmate call providers asking the FCC to adopt regulations modifying
the treatment of the provision of inmate calling services by all Local Exchange
Carriers ("LECs") including the RBOCs. This petition requires the LECs to
provide separate accounting records for their public communication segments
which includes inmate calling. These regulations may be to require LECs to
allocate more of their costs to inmate calling services, thereby making the RBOC
customers of the Company less competitive in this market, which in turn could
have a material adverse effect on the Company.
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In 1996, Congress passed the Telecommunications Act of 1996. This
legislation opens up the network of local exchange carriers to further
competition, and to eliminate certain prohibitions upon LECs entering into other
lines of business. The legislation (i) opens local exchange service to
competition and preempts states from imposing barriers preventing such
competition, (ii) imposes new unbundling and interconnection requirements on
local exchange carrier networks, (iii) removes prohibitions on inter-LATA
services and manufacturing if certain competitive conditions are met, (iv)
transfers any remaining requirements of the Consent Decree (including its
nondiscrimination provisions) to the FCC's jurisdiction, (v) imposes
requirements to conduct certain competitive activities only through structurally
separate affiliates and (vi) eliminates many of the remaining cable and
telephone company cross-ownership restrictions. Additionally, the legislation
requires the special accounting provisions for the LECs as requested in the
petition described above.

This legislation will significantly change the competitive landscape of the
telecommunications industry as a whole. For example, permitting the RBOCs to
provide long-distance service cause the Company's RBOC customers to become
direct competitors of AT&T, which in turn could adversely affect the Company's
relationships with all such customers. For example, the Company's current
relationship with AT&T may foreclose opportunities to provide long distance
services to its current RBOC customers, if and when they enter the long-distance
market. As a result, a loss of long-distance market share by AT&T could result
in a corresponding loss of market share by the Company.

On January 29, 1998 the FCC issued Order 98-7. This Order required that all
called parties have the opportunity to receive a rate quote before accepting a
collect call. These rate quotes are necessary for all public payphones and all
inmate collect calling. Currently, the Company's equipment deployed in the field
does not provide such a feature. However, this feature has been developed and
will be installed in all of the Company's sites by the October 1, 1999 FCC
mandated deadline.

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

PATENTS AND OTHER PROPRIETARY RIGHTS

The Company relies on a combination of patents, copyrights, and
trade-secrets to establish and protect its proprietary rights in its systems.
The Company vigorously pursues protection of its proprietary technology and
other intellectual property. On June 7, 1994, the US Patent & Trademark Office
issued to the Company Patent No. 5,319,702 related to three-way call detection.
The Company has filed a corresponding patent application with the patent office
in Canada, but this application has not yet been acted upon. On July 23, 1997,
the US Patent Trademark Office issued to the Company Patent No. 5,539,812 which
is a continuation-in-part of Patent No. 5,319,702. While the Company considers
any patents issued to be a significant factor in enabling it to compete in the
inmate calling industry, the Company believes its success is primarily dependent
on the knowledge, ability and experience of its personnel, its customer service
and its ongoing ability to develop services to meet its customers' needs. The
Company has sought federal and state trademark protection for certain of its
trademarks, including Strike Three!(TM) and T-NET(TM). Additionally, the Company
is seeking patent protection under a pending application for significant
enhancements to its three-way detection technology.

Rutgers University had developed technology relating to speaker and speech
recognition. Such technology centered around the verification of a speaker by
comparison of spoken phrases to speech patterns stored on a computer. Rutgers
had entered into a license agreement with SpeakEZ to develop that technology,
prior to SpeakEZ's acquisition by the Company. The Company became a
successor-in-interest to SpeakEZ's rights under the license agreement. The
Company and Rutgers then negotiated an Assumed and Amended License Agreement in
1996. As a part of this agreement, the Company acquired exclusive worldwide
rights under
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existing Rutgers' patents and patent applications, copyrights and software
related to speaker and speech recognition technology developed at Rutgers. On
May 26, 1996, the United States Patent Office issued U.S. Patent No: 5,522,012
for "Speaker Identification and Verification System" to Rutgers. Several
additional Rutgers-owned patent applications are pending. The Company has also
filed patent applications in its own name for further development in that field.

Despite the precautions taken by the Company, it may be possible for
unauthorized third parties to copy aspects of the Company's products or to
obtain and use information that the Company regards as proprietary. The Company
has and intends to continue to enforce patents issued to it and protect its
trade secrets.

On October 21, 1996, the Company reached a settlement with Gateway
Technologies, Inc. of Carrollton, Texas ("Gateway") regarding the patent
infringement litigation between them. Included in the settlement, the Company
was granted a royalty-bearing, nonexclusive, non-assignable license, without
right to grant sublicenses, under certain Gateway Licensed Patents dealing
primarily with automated operator operations.

In December 1995, the Company was awarded a Consent Order from the U.S.
District Court in Colorado as a result of a patent infringement lawsuit it
brought against Communications Equipment and Engineering Corp. (CEECO). By terms
of the Consent Order, CEECO admitted infringement of the Company's technology
and agreed to cease the manufacturing of the infringing product. Included in the
CEECO settlement, the Company was granted an exclusive license for US Patent No.
4,993,062 for "Telephone Control System Including Stored Blocked and Allowed
Telephone Numbers: (the "DULA Patent").

EMPLOYEES

As of July 31, 1998, the Company had 371 full-time equivalent employees.
For the ICS Division, the departmental classification of such employees is as
follows: 18 engineering and product development personnel; 12 marketing and
sales personnel; 47 finance, information systems and administrative personnel;
10 production and installation personnel; and 245 field operations personnel.
For the SpeakEZ Division, the departmental classification of such employees is
as follows: 24 research and product development personnel; 10 marketing and
sales personnel; 5 administrative personnel. None of the Company's employees are
subject to a collective bargaining agreement.

RISK FACTORS

In addition to other information in this report, the following risk factors
should be considered carefully in evaluating the Company and its business. This
report may contain forward looking statements that involve risks and
uncertainties. When used in this report, the words "anticipate," "believe,"
"effect," "estimate," "expect," and similar expressions as they relate to the
Company or its management are intended to identify such forward-looking
statements. The Company's actual results, performance or achievements could
differ materially from the results expressed in or implied by these
forward-looking statements. Factors that might cause such differences include,
but are not limited to, those discussed in "Management's Discussion and Analysis
of Financial Condition and Results of Operations" and "Business" as well as
those discussed elsewhere in this report.

INMATE CALLING SERVICES DIVISION

Dependence on Major Customers. The Company is substantially dependent upon
its relationships with certain customers. For the year ended July 31, 1998 AT&T,
Bell Atlantic, US WEST, and SBC Communications, Inc. accounted for approximately
31%, 21%, 15%, and 15%, respectively of the Company's total revenue. The Company
anticipates that these customers will represent a substantial portion of the
Company's total revenue in the future. The loss of any of these four customers
would have a material adverse effect on the Company's business, operating
results and financial condition. The Company believes that its customers have
selected it on the basis of the quality and breadth of its turn-key service
offering, capability of its technology and on its ability to price its services
at competitive rates. If the Company fails to adequately monitor and

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<PAGE> 18

maintain the quality and expand the breadth of its service offerings, advance
its technology or continue to price its services competitively, one or more of
its major customers may select alternative call processing services.

In addition, the Company relies to a significant extent on its customers to
obtain new contracts with correctional facilities, which has the effect of
limiting the Company's control over the competitive bidding process. The Company
generally establishes non-exclusive master agreements with its customers which
set forth the general terms and conditions, including price, under which the
Company will provide its call processing services. The Company then enters into
site-specific contracts under these master agreements which govern the provision
of services in specific correctional facilities. Accordingly, revenue growth and
stability will depend in large part on the Company's ability to enter into new,
and renew existing site-specific contracts with its customers. There can be no
assurance that the Company will obtain new or renew existing master agreements
or site-specific contracts will be renewed or extended, or that these customers
may not enter into similar agreements with others. Certain of the site specific
contracts contain early termination provisions, including penalties.
Notwithstanding such provisions, termination of one or more of these contracts
could have a material adverse effect on the Company. See
"Business -- Customers."

Government Regulation. The operations of the Company and its customers are
subject to regulation by the Federal Communications Commission (the "FCC") and
public utility commissions of certain states in which the Company and its
customers operate. Regulatory actions have impacted and are likely to continue
to impact, both the Company's and its customers' operations. For example, the
adoption of regulations which would encourage additional competition in the
business of the Company's customers could have a material adverse effect on the
amount of business done by such customers and the manner in which such business
is done. A reduction in the amount of business done by the Company's customers
would have a material adverse impact on the Company's revenue since such
revenues are directly related to volumes of calls processed under the Company's
transaction fee pricing. Changes in the manner in which the Company's customers
conduct their business could have a material adverse impact on the Company if,
as a result of such changes, the Company's services and features were no longer
needed or desired or if the Company were not able to modify, or add to, its
services in a way that meets the new market demands of its customers.

The FCC has adopted a petition filed by an industry group comprised of
independent inmate call providers asking the FCC to adopt regulations modifying
the treatment of the provision of inmate calling services by all LECs including
the RBOCs. This petition requires the LECs to provide separate accounting
records for their public communication segments which includes inmate calling.
These regulations may be to require LECs to allocate more of their costs to
inmate calling services, thereby making the RBOC customers of the Company less
competitive in this market, which in turn could have a material adverse effect
on the Company.

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Competition. The telecommunications industry, particularly the inmate
calling market, is and can be expected to remain highly competitive. The Company
competes directly against other suppliers of inmate call processing systems,
such as private pay phone operators and manufacturers of call processing
equipment. In addition, the Company and its customers jointly compete against
other call providers to obtain contracts for inmate calling services. Finally,
the Company may also compete against its customers who have used another call
provider on a particular bid. Changes in regulations have affected the
competitive dynamics within the Company's inmate calling market. Increased
competition could result in reduced transaction fees, reduced margins and loss
of market share, all of which would have a material adverse effect on the
Company's business, operating results and financial condition. See
"Business -- Regulation."

The Company believes that its ability to compete in the inmate calling
industry depend on the quality and breadth of its turn-key service offering, the
capability of its technology, its ability to price its services at competitive
rates, and its relationships with key customers. Although the Company has its
own sales force, it often relies on its customers to market its services to
correctional facilities, which has the effect of limiting the Company's control
over the marketing and bidding process. Marketing decisions by customers of the
Company to offer less competitive solutions could have a material adverse effect
on the Company.

Risk of System and Service Obsolescence. The telecommunications industry is
characterized by rapid technological advancements, frequent new service
introductions and evolving industry standards. The Company believes that its
continued and future success will depend upon its ability to anticipate and
respond to such changes. Current competitors or market entrants may develop
technologies, services or standards which could render the Company's technology
and systems obsolete or adversely affect the marketability of the Company's
system and service offerings. In addition, as the telecommunications networks
are modernized and evolve from analog-based to digital-based systems, certain
features offered by the Company may diminish in value. Moreover, regulatory
actions affecting the telecommunications industry may require significant
upgrades to its current technology or may render the Company's service offerings
obsolete or commercially unattractive. There can be no assurance that the
Company will have sufficient technical, managerial or financial resources to
develop or acquire new technology or to introduce new services or products that
would meet customer needs in a timely fashion. See "Business -- Regulation."

Protection of Proprietary Technology. The Company's success depends in part
on its proprietary technology, particularly in the area of three-way call
prevention. The Company relies on a combination of patent and copyright law and
non-disclosure agreements to establish and protect its proprietary rights in its
systems. Such protection may not preclude competitors from developing systems
with features similar to the Company's offerings. Although the Company intends
to defend its intellectual property rights vigorously, there can be no assurance
that any measures taken by the Company to defend its rights will be successful.
The Company believes it has a strong patent position in the area of three-way
call prevention. However, most of the Company's competitors also claim to have
such technology, and there can be no assurance that the Company's patents will
not be successfully challenged in court or that competitors will not develop
alternative means to provide this feature. Moreover, any litigation required to
protect the Company's proprietary rights could result in substantial costs and
diversion of financial, managerial and other resources. See Business -- Patents
and Other Proprietary Rights."

Risk of Infringing on Existing Patents. The Company believes that its
systems, trademarks, and other proprietary rights do not infringe upon any valid
proprietary rights of third parties. There can be no assurance that third
parties will not assert infringement claims against the Company in the future.
The cost of defending assertions of patent and trademark infringement could be
material, whether or not the assertion is ultimately determined to be valid. See
Business -- Patents and Other Proprietary Rights."

17
<PAGE> 20

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 remedial their Year 2000 Issues could result
in disruptions in the Company's supply of 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, until the Company receives responses from a significant number of the
Company's suppliers and customers, 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. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations."

SPEAKEZ DIVISION

Market and Product Acceptance. The Company's acquisition of SpeakEZ in
October 1995 has led to an increased focus on new technology, specifically
speaker verification and identification technologies. The Company believes that
its on going product development activities for the SpeakEZ Voice Print(SM)
technology will provide current and future opportunities for revenue. SpeakEZ
Voice Print(SM) products are available and ready for sale in the computer
network security, call centers, telecommunications and government services
markets. However, there can be no assurance that these products will achieve
market acceptance and 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. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations."

Variability of Sales Cycle; Fluctuations in Operating Results. The SpeakEZ
Voice Print(SM) products are also often subject to a long sales cycle. This is
especially true in the Company's target markets, where customers generally
commit significant resources to an evaluation of new software and require the
vendor to expend substantial time, effort, and money educating them about the
value of the vendor's solution. As a result, sales to these types of customers
generally require an extensive sales effort throughout the organization, and
often require final approval by an executive officer or senior level employee.
Further, in most cases the Company's SpeakEZ Voice Print(SM) software
applications must be integrated and made compatible with the customers' embedded
information systems. Typically, the system integration effort requires the
cooperation of other technology vendors which also contribute to the extension
of the sales cycle. The Company will likely experience delays following initial
contact with prospective customers and expend substantial funds and management
effort in connections with these sales. There can be no assurance that the
Company will be able to successfully execute such sales. The Company uses other
technology suppliers in addition to its own direct sales force to distribute its
technology and therefore at time lacks control over such partners. For these
reasons, revenue from the Company's SpeakEZ Voice Print(SM) products and
services will be difficult to predict. While the Company attempts to pursue
multiple market revenue opportunities at any given time, there can be no
assurance that the Company will not experience fluctuations in revenue from its
SpeakEZ Voice Print(SM) products and services. There is no assurance that these
products will be commercially accepted or profitable in the future. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."

ITEM 2. PROPERTIES

The Company's corporate headquarters and assembly operations are located in
approximately 38,000 square feet of leased office space in Englewood, Colorado.
The lease for such space terminates effective November 1, 2001. These facilities
are suitable and adequate for the Company's operations currently and through the
end of the lease. The Company also leases approximately 13,000 square feet in
Piscataway, New Jersey, where the company's SpeakEZ Voice Print(SM) research and
development operations are located. In

18
<PAGE> 21

addition, as of July 31, 1998, the Company leased 5 point of presence locations
throughout the country, with a maximum size of approximately 900 square feet.
These point of presence facilities are suitable and adequate for the Company's
operations in these locations currently and for the foreseeable future.

ITEM 3. LEGAL PROCEEDINGS

Except as set forth below, the Company is not a part to any pending
material legal proceedings before any court, administrative agency or other
tribunal. Further, the Company is not aware of any litigation which is
threatened against it in any court, administrative agency or other tribunal.

In August 1995, Independent Telecommunications Network, Inc. ("ITN") filed
a demand for arbitration with the American Arbitration Association, claiming the
Company had breached certain query transport services contracts with ITN by, ITN
alleges, terminating those contracts. In August 1997, the Company and ITN
entered into a settlement agreement whereby the Company agreed to a new
agreement for provisioning of telecommunication services. There was no material
effect on the Company as a result of the settlement.

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

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

PART II

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

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

<TABLE>
<CAPTION>
HIGH LOW
------ -----
<S> <C> <C>
Year Ended July 31, 1998
First quarter............................................. $11.00 $6.88
Second quarter............................................ 11.00 8.38
Third quarter............................................. 13.88 9.38
Fourth quarter............................................ 11.00 8.00
Year Ended July 31, 1997
First quarter............................................. $14.75 $8.50
Second quarter............................................ 14.13 9.25
Third quarter............................................. 12.25 7.00
Fourth quarter............................................ 10.25 6.75
</TABLE>

As of October 16, 1998, the number of record holders of the Company's
common stock was approximately 156, and the Company estimates that as of that
date there were 2,112 beneficial owners of its stock.

The Company has never declared or paid any cash dividends on its capital
stock. The Company currently intends to retain its earnings, if any, to finance
future growth and therefore does not anticipate paying any cash dividends in the
foreseeable future.

19
<PAGE> 22

ITEM 6. SELECTED FINANCIAL DATA

The selected financial data presented below under the captions "Statement
of Operations Data" and "Balance Sheet Data" for, and as of the end of, each of
the years in the five-year period ended July 31, 1998, are derived from the
audited consolidated financial statements of the Company and subsidiaries. The
consolidated financial statements as of July 31, 1998 and 1997, and for each of
the years in the three-year period ended July 31, 1998, are included elsewhere
in this Form 10-K.

<TABLE>
<CAPTION>
YEAR ENDED JULY 31,
-----------------------------------------------
1998 1997 1996 1995 1994
------- ------- ------- ------- -------
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenue:
Telecommunications services................ $34,860 $33,471 $30,249 $24,262 $ 7,529
Telecommunications licensing............... 205 750 -- -- --
Direct call provisioning................... 2,516 1,395 3,072 3,492 3,416
Voice print................................ 632 676 57 -- --
Equipment sales............................ -- -- -- -- 345
------- ------- ------- ------- -------
Total revenue...................... 38,213 36,292 33,378 27,754 11,290
Expenses:
Operating costs and expenses:
Telecommunications services............. 15,920 14,478 13,489 10,658 3,128
Direct call provisioning................ 2,311 1,297 2,940 3,370 2,840
Voice print............................. 78 170 -- -- --
Cost of equipment sold.................. -- -- -- -- 304
------- ------- ------- ------- -------
Total operating costs and
expenses......................... 18,309 15,945 16,429 14,028 6,272
Selling, general and administrative........ 7,448 7,488 6,434 5,413 2,703
Research and development................... 2,354 2,769 2,374 732 494
Depreciation and amortization.............. 8,250 8,135 5,920 3,607 1,099
------- ------- ------- ------- -------
Total expenses..................... 36,361 34,337 31,157 23,780 10,568
------- ------- ------- ------- -------
Operating income........................... 1,852 1,955 2,221 3,974 722
Interest expense........................... (1,055) (932) (548) (636) (1,044)
------- ------- ------- ------- -------
Earnings (loss) before income
taxes............................ 797 1,023 1,673 3,338 (322)
Income taxes............................... (198) (432) (46) (150) --
------- ------- ------- ------- -------
Net earnings (loss)................ $ 599 $ 591 $ 1,627 $ 3,188 $ (322)
======= ======= ======= ======= =======
Diluted earnings (loss) per common share... $ 0.07 $ 0.06 $ 0.18 $ 0.38 $ (0.06)
======= ======= ======= ======= =======
Weighted average common shares
outstanding -- diluted.................. 9,206 9,156 8,814 8,360 5,280
Number of Calls Processed.................... 93,303 90,953 79,760 61,650 19,846
</TABLE>

<TABLE>
<CAPTION>
JULY 31,
-----------------------------------------------
1998 1997 1996 1995 1994
------- ------- ------- ------- -------
(AMOUNT IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Total assets................................. $44,673 $46,910 $42,527 $34,904 $16,968
Loans from customer.......................... -- -- -- 449 3,728
Debt......................................... 10,803 13,378 6,809 5,613 5,883
Total liabilities............................ 16,203 20,058 16,968 14,449 15,401
Shareholders' equity......................... 28,470 26,852 25,559 20,455 1,567
</TABLE>

20
<PAGE> 23

ITEM 7.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.

OVERVIEW

Inmate Calling Services

The Company derives revenue under contracts with its customers, including
AT&T, Bell Atlantic, U S WEST, SBC Communications, Inc., BellSouth, MCI WorldCom
and GTE, and other telecommunications service providers, primarily from the
provisioning of specialized call processing services for correctional
facilities. This revenue is generated under long-term contracts which provide
for transaction fees paid on a per-call basis. The Company is paid a prescribed
fee for each call completed and additional fees for validating phone numbers
dialed by inmates. The Company also derives revenue as a direct provider of
inmate calls. The following table sets forth certain information concerning the
accepted calls processed by the Company for its customers in the inmate calling
market and excludes direct call provisioning.

<TABLE>
<CAPTION>
THREE MONTHS ENDED
-----------------------------------------------------------------------------------------------------
JUL. 31, APR. 30, JAN. 31, OCT. 31, JUL. 31, APR. 30, JAN. 31, OCT. 31,
1998 1998 1998 1997 1997 1997 1997 1996
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Call volumes
processed.......... 23,195,000 22,972,000 23,636,000 23,500,000 23,468,000 22,695,000 23,059,000 21,731,000
Average daily
transactions....... 252,000 258,000 257,000 255,000 255,000 255,000 250,000 236,000
</TABLE>

The Company's call volume and revenue growth have resulted primarily from
the net addition of call processing systems for both existing and new customers.
The Company believes it has also benefited, to a lesser extent, from the overall
growth in the inmate calling market. These factors have been offset somewhat by
the reductions in call volumes as a result of non-renewal of existing site
specific customer contracts in competitive bidding arrangements, prisoner
relocation programs, and increased use of call control measures by correctional
institutions. The Company will continue to market its services to additional
call providers; however, it expects growth in call processing volumes will come
predominantly from adding new systems for existing customers.

SpeakEZ Division

The Company's acquisition of SpeakEZ in October 1995 has led to an
increased focus on new technology, specifically speaker verification and
identification technologies. The Company believes that its ongoing product
development activities for the SpeakEZ Voice Print(SM) technology will provide
current and future opportunities for revenue. SpeakEZ Voice Print(SM) products
are available and ready for sale in the computer network security, call centers,
telecommunications and government services markets. However,

21
<PAGE> 24

there can be no assurance that these products will achieve market acceptance and
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.

The SpeakEZ Voice Print(SM) products are also often subject to a long sales
cycle. This is especially true in the Company's target markets, where customers
generally commit significant resources to an evaluation of new software and
require the vendor to expend substantial time, effort, and money educating them
about the value of the vendor's solution. As a result, sales to these types of
customers generally require an extensive sales effort throughout the
organization, and often require final approval by an executive officer or senior
level employee. Further, in most cases the Company's SpeakEZ Voice Print(SM)
software applications must be integrated and made compatible with the customers'
embedded information systems. Typically, the system integration effort requires
the cooperation of other technology vendors which also contribute to the
extension of the sales cycle. The Company will likely experience delays
following initial contact with prospective customers and expend substantial
funds and management effort in connections with these sales. There can be no
assurance that the Company will be able to successfully execute such sales. The
Company uses other technology suppliers in addition to its own direct sales
force to distribute its technology and therefore at time lacks control over such
partners. For these reasons, revenue from the Company's SpeakEZ Voice Print(SM)
products and services will be difficult to predict. While the Company attempts
to pursue multiple market revenue opportunities at any given time, there can be
no assurance that the Company will not experience fluctuations in revenue from
its SpeakEZ Voice Print(SM) products and services. There is no assurance that
these products will be commercially accepted or profitable in the future. See
"Business -- Risk Factors."

RESULTS OF OPERATIONS

Fiscal 1998 Compared to Fiscal 1997

The following table sets forth certain statement of operations data as a
percentage of total revenue for the years ended July 31, 1998 and 1997.

<TABLE>
<CAPTION>
YEAR ENDED
JULY 31,
-----------
1998 1997
---- ----
<S> <C> <C>
Revenue:
Telecommunications services............................... 91% 92%
Telecommunications licensing.............................. 1 2
Direct call provisioning.................................. 6 4
Voice print............................................... 2 2
--- ---
Total revenue..................................... 100 100
Expenses:
Operating costs and expenses.............................. 48 44
Selling, general and administrative....................... 19 21
Research and development.................................. 6 8
Depreciation and amortization............................. 22 22
--- ---
Operating income.................................. 5 5
Interest expense.......................................... (3) (2)
--- ---
Earnings before income taxes...................... 2 3
Income taxes.............................................. (1) (1)
--- ---
Net earnings...................................... 1% 2%
=== ===
</TABLE>

Total Revenue. Total revenue increased 5% to $38,213,000 for the year ended
July 31, 1998, from $36,292,000 for the prior year. This increase resulted from
increases in telecommunications services revenue, offset by a reduction in
telecommunications licensing and voice print revenue. The 4% increase in

22
<PAGE> 25

telecommunications services revenue to $34,860,000 for the year ended July 31,
1998, from $33,471,000 in the prior year, was due to a 3% increase in call
volume to 93,303,000 calls resulting primarily from a net increase in the number
of installed systems and an increase in revenue associated with call
verification procedures for new and existing customers. The Company recorded
$205,000 of telecommunications licensing revenue associated with the licensing
of the Company's Strike Three(TM) product for the year ended July 31, 1998
compared to $750,000 for the year ended July 31, 1997. The 1997 revenue was
associated with the licensing of the Company's Strike Three(TM) product to a
single customer. The Company does not expect significant contribution from
telecommunications licensing revenue in the near future.

Direct call provisioning revenue increased as a percentage of total
revenue. There was an increase in direct call provisioning revenue of $1,121,000
for the year ended July 31, 1998 compared to the prior year. This increase was
due to the addition of sites in which the Company is provisioning the long
distance service. The Company anticipates an increase in direct call
provisioning revenue in the event that it continues to be successful in
provisioning the long distance service on certain site contracts. The Company
also recognized SpeakEZ Voice Print(SM) revenue in the amount of $632,000 for
the year ended July 31, 1998 or a decrease of $44,000 from the corresponding
prior period. SpeakEZ Voice Print(SM) revenue was primarily for provisioning of
services and for the sale of software licenses and hardware systems, 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 $18,309,000 for the year ended July 31, 1998, from $15,945,000 for the year
ended July 31, 1997, and also increased as a percentage of total revenue to 48%
from 44% in the prior year due to the inclusion of a larger proportion of direct
call provisioning expenses and increases in telecommunication services expense
associated with personnel and communications. 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. The Company invoices these verification procedure costs
to its customers with minimal margins. 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, commissions paid to correctional facilities, costs
associated with uncollectible accounts and billing charges. Voice print
operating costs for the year ended July 31, 1998 include the cost of services
performed and 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 years ended
July 31, 1998 and 1997.

<TABLE>
<CAPTION>
YEAR ENDED
JULY 31,
-----------
1998 1997
---- ----
<S> <C> <C>
Operating costs and expenses:
Telecommunications services............................... 46% 43%
Direct call provisioning.................................. 92 93
Voice print............................................... 12 25
</TABLE>

Operating costs and expenses associated with providing telecommunications
services increased as a percentage of corresponding revenue to 46% for the year
ended July 31, 1998, from 43% in the prior year. The increase is primarily due
increases in personnel related expenses and communication costs associated with
the addition of new sites. Direct call provisioning costs decreased as a
percentage of corresponding revenue to 92% for the year ended July 31, 1998,
from 93% in the corresponding prior year. This percentage decrease is primarily
attributable to an increase in higher margin direct call provisioning revenue.
Most of the cost components have remained consistent. Voice print operating
expenses decreased to $78,000 for the year ended July 31, 1998 compared to
$170,000 for the prior period. The amounts for 1997 included approximately
$88,000 for the costs of hardware sales. There were no hardware sales in 1998.

23
<PAGE> 26

Selling, General and Administrative Expenses. Selling, general and
administrative expenses decreased to $7,448,000 for the year ended July 31,
1998, from $7,488,000 in the prior year, and decreased as a percentage of total
revenue to 19% from 21% in the corresponding prior year. The dollar decrease was
$40,000. Increases in costs associated with the marketing personnel and other
marketing and administrative costs to support the SpeakEZ Voice Print(SM)
products of $1,152,000 and increases in office expenses of $202,000 were offset
primarily by reductions in property taxes, travel expenses, and legal and other
professional fees aggregating approximately $1,258,000. Selling, general and
administrative expenses associated with the SpeakEZ Voice Print(SM) technology
were $2,090,000 for the year ended July 31, 1998 as compared to $938,000 for the
corresponding prior period. The Company anticipates a reduction in the sales and
marketing efforts associated with the SpeakEZ Voice Print(SM) products and
services due to personnel reductions. The Company believes it can implement
these reductions without sacrificing potential revenue growth. Selling, general
and administrative expenses associated with the ICS Division are expected to
increase due to personnel cost increases and other general cost increases. There
can be no assurance, however, that due to the potential lack of market
acceptance, risk of technological success, or impact of new competition that
revenue will grow at the same rate as that anticipated for selling, general and
administrative expenses.

Research and Development Expenses. Research and development expenses
decreased to $2,354,000 for the year ended July 31 1998, from $2,769,000 in the
corresponding prior period. The research and development expense for the ICS
Division decreased to $818,000 for the year ended July 31 1998, from $1,242,000
in the corresponding prior period. For the year ended July 31, 1998, the Company
capitalized $744,000 of computer software development costs associated with the
development of a new inmate calling platform compared to $58,000 for the
corresponding prior period. The research and development expense associated with
the SpeakEZ Voice Print(SM) technology was $1,536,000 for the year ended July 31
1998 as compared to $1,527,000 for the corresponding prior period. For the year
ended July 31 1998, the Company capitalized $373,000 of computer software
development costs associated with the SpeakEZ Voice Print(SM) technology
compared to $411,000 for the corresponding prior period. Under a government
contract, SpeakEZ is partially reimbursed for research and development expenses
incurred relating to this agreement. The reimbursement totaled approximately
$288,000 for the year ended July 31 1998 and was recognized as a reduction to
SpeakEZ Voice Print(SM) technology related research and development expenses.
Such reimbursements were $350,000 for the corresponding prior period. The
Company expects the research and development expense for the ICS Division to
increase in fiscal 1999 due to an increase in personnel costs. The research and
development expense associated with the SpeakEZ Voice Print(SM) technology is
also expected to increase due to the end of the government contract, however
this will be offset somewhat by personnel reductions.

Depreciation and Amortization Expenses. Depreciation and amortization
expenses increased to $8,250,000 for the year ended July 31, 1998, from
$8,135,000 in the corresponding prior period. The increase is due to an increase
in depreciation on office equipment and increased amortization of intangibles.
There was a net reduction in depreciation expense associated with
telecommunications equipment due to certain assets being fully depreciated. The
depreciation and amortization expense associated with the SpeakEZ Voice
Print(SM) technology and the related business acquisition was $924,000 for the
year ended July 31, 1998 as compared to $705,000 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 becomes
fully depreciated.

Interest Expense. Interest expense increased to $1,055,000 for the year
ended July 31, 1998, from $932,000 in the corresponding prior period. The
increase was primarily attributable to an increase in the average daily debt
balance. The increase in indebtedness was necessary to support capital
expenditures for inmate call processing systems.

24
<PAGE> 27

Fiscal 1997 Compared to Fiscal 1996

The following table sets forth certain statement of operations data as a
percentage of total revenue for the years ended July 31, 1997 and 1996.

<TABLE>
<CAPTION>
YEAR ENDED JULY
31,
----------------
1997 1996
----- -----
<S> <C> <C>
Revenue:
Telecommunications services............................... 92% 91%
Telecommunications licensing.............................. 2 --
Direct call provisioning.................................. 4 9
Voice print............................................... 2 --
--- ---
Total revenue..................................... 100 100
Expenses:
Operating costs and expenses.............................. 44 49
Selling, general and administrative....................... 21 19
Research and development.................................. 8 7
Depreciation and amortization............................. 22 18
--- ---
Operating income.................................. 5 7
Interest expense.......................................... (2) (2)
--- ---
Earnings before income taxes...................... 3 5
Income taxes.............................................. (1) --
--- ---
Net earnings...................................... 2% 5%
=== ===
</TABLE>

Total Revenue. Total revenue increased 9% to $36,292,000 for the year ended
July 31, 1997, from $33,378,000 for the prior year. This increase resulted from
a 11% increase in telecommunications services revenue to $33,471,000 for the
year ended July 31, 1997, from $30,249,000 in the prior year, due to a 14%
increase in call volume to 90,953,000 calls resulting primarily from an increase
in the number of installed systems and the conversion of direct call
provisioning to transaction based fee contracts with other call providers. The
Company recorded $750,000 of telecommunications licensing revenue during the
year ended July 31, 1997. This revenue was associated with the licensing of the
Company's Strike Three(TM) product to a single customer. There was no such
revenue in the corresponding prior period.

Direct call provisioning revenue decreased as a percentage of total revenue
in part due to the increase in telecommunications services revenue and other
forms of revenue and due to the conversion of direct sites to telecommunications
services revenue sites. There was a decrease in direct call provisioning revenue
of $1,677,000 due to conversion of certain sites serviced to transaction based
fees. The Company also recognized SpeakEZ Voice Print(SM) revenue in the amount
of $676,000 for custom engineering and for the sale of software licenses and
hardware systems.

Operating Costs and Expenses. Total operating costs and expenses decreased
to $15,945,000 for the year ended July 31, 1997, from $16,429,000 for the year
ended July 31, 1996, and also decreased as a percentage of total revenue to 44%
from 49% in the prior year. 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. The Company invoices these verification procedure costs to its
customers with minimal margins. 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, commissions paid to correctional facilities, costs
associated with uncollectible accounts and billing charges. Voice print
operating costs for the year ended July 31, 1997 include the cost of hardware
systems sold, installation costs, and royalty charges.

25
<PAGE> 28

The following table sets forth the operating costs and expenses for each
type of revenue as a percentage of corresponding revenue for the years ended
July 31, 1997 and 1996.

<TABLE>
<CAPTION>
YEAR ENDED
JULY 31,
-----------
1997 1996
---- ----
<S> <C> <C>
Operating costs and expenses:
Telecommunications services............................... 43% 45%
Direct call provisioning.................................. 93 96
Voice print............................................... 25 --
</TABLE>

Operating costs and expenses associated with providing telecommunications
services decreased as a percentage of corresponding revenue to 43% for the year
ended July 31, 1997, from 45% in the prior year. The decrease is primarily due
to cost containment measures implemented by the Company in the delivery of its
services. Direct call provisioning costs decreased as a percentage of
corresponding revenue to 93% for the year ended July 31, 1997, from 96% in the
corresponding prior year. This percentage decrease is primarily attributable to
the conversion of sites that had an overall higher cost structure due to a
higher commission expense than the remaining direct sites.

Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased to $7,488,000 for the year ended July 31,
1997, from $6,434,000 in the prior year, and increased as a percentage of total
revenue to 21% from 19% in the corresponding prior year. The dollar increase was
$1,054,000. This increase consists primarily of approximately $938,000 for
marketing personnel and other marketing costs to support the SpeakEZ Voice
Print(SM) products.

Research and Development Expenses. Research and development expenses
increased to $2,769,000 for the year ended July 31, 1997, from $2,374,000 in the
corresponding prior year, primarily due to the addition of personnel to develop
and commercialize the Company's SpeakEZ Voice Print(SM) technology. The research
and development expense associated with the SpeakEZ Voice Print(SM)technology
was $1,527,000 for the year ended July 31, 1997 as compared to $1,060,000 for
the corresponding prior year. For the year ended July 31, 1997, the Company
capitalized $411,000 of computer software development costs associated with the
SpeakEZ Voice Print(SM) technology. There were no such costs capitalized in the
corresponding prior year. In addition, under a government contract the Company
is partially reimbursed for expenses on this project. This reimbursement totaled
approximately $350,000 for the year ended July 31, 1997 and was recognized as a
reduction to SpeakEZ Voice Print(SM)technology related research and development
expenses. Such reimbursements were not significant for the corresponding prior
year. The Company capitalized $58,000 of computer software development costs
associated with the development of a new inmate calling platform during the year
ended July 31, 1997.

Depreciation and Amortization Expenses. Depreciation and amortization
expenses increased to $8,135,000 for the year ended July 31, 1997, from
$5,920,000 in the corresponding prior year. The increase is due to an increased
fixed asset base resulting from increased inmate call processing systems
installed by the Company. In addition, infrastructure additions in research and
development and selling, general and administrative functions also added to the
increase in depreciation for office and testing equipment. The depreciation and
amortization associated with the SpeakEZ Voice Print(SM) technology and the
related business acquisition was $705,000 for the year ended July 31, 1997 as
compared to $344,000 for the corresponding prior year.

Interest Expense. Interest expense increased to $932,000 for the year ended
July 31, 1997, from $548,000 in the corresponding prior period. The increase was
primarily attributable to a increase in the balance of indebtedness. The
increase in indebtedness was necessary to support capital expenditures for
inmate call processing systems and operating expenses.

26
<PAGE> 29

QUARTERLY RESULTS

The following tables present unaudited quarterly operating results for the
Company and in the opinion of management contain all adjustments necessary for a
fair presentation of the results of operations for these periods. Management
believes that quarter-to-quarter comparisons of the Company's financial results
should not be relied upon as an indication of annual or future performance.

<TABLE>
<CAPTION>
THREE MONTHS ENDED
-----------------------------------------
JUL. 31, APR. 30, JAN. 31, OCT. 31,
1998 1998 1998 1997
-------- -------- -------- --------
(AMOUNTS IN THOUSANDS)
<S> <C> <C> <C> <C>
Revenue:
Telecommunications services...................... $8,539 $8,539 $8,979 $8,803
Telecommunications licensing..................... 40 109 10 46
Direct call provisioning......................... 783 664 563 506
Voice print...................................... 49 122 81 380
------ ------ ------ ------
Total revenue............................ 9,411 9,434 9,633 9,735
Expenses:
Operating costs and expenses..................... 4,635 4,614 4,582 4,478
Selling, general and administrative.............. 2,079 1,774 1,732 1,863
Research and development......................... 636 606 530 582
Depreciation and amortization.................... 1,983 2,056 2,063 2,148
------ ------ ------ ------
Total expenses........................... 9,333 9,050 8,907 9,071
------ ------ ------ ------
Operating income................................. 78 384 726 664
Interest expense................................. (285) (237) (263) (270)
------ ------ ------ ------
Earnings (loss) before income taxes...... (207) 147 463 394
Income taxes..................................... 54 (37) (116) (99)
------ ------ ------ ------
Net earnings (loss)...................... $ (153) $ 110 $ 347 $ 295
====== ====== ====== ======
</TABLE>

The following table sets forth for the periods indicated the percentage of
total revenue represented by certain items in the Company's unaudited quarterly
statement of operations.

<TABLE>
<CAPTION>
THREE MONTHS ENDED
-----------------------------------------
JUL. 31, APR. 30, JAN. 31, OCT. 31,
1998 1998 1998 1997
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Revenue:
Telecommunications services...................... 90% 91% 93% 90%
Telecommunications licensing..................... 1 1 -- 1
Direct call provisioning......................... 8 7 6 5
Voice print...................................... 1 1 1 4
--- --- --- ---
Total revenue............................ 100 100 100 100
Expenses:
Operating costs and expenses..................... 49 49 48 47
Selling, general and administrative.............. 22 19 18 19
Research and development......................... 7 6 5 6
Depreciation and amortization.................... 21 22 21 21
--- --- --- ---
Operating income......................... 1 4 8 7
Interest expense................................. (3) (2) (3) (3)
--- --- --- ---
Earnings before income taxes............. (2) 2 5 4
Income taxes..................................... 1 (1) (2) (2)
--- --- --- ---
Net earnings............................. (1)% 1% 3% 2%
=== === === ===
</TABLE>

27
<PAGE> 30

The following table sets forth the operating costs and expenses for each
type of revenue as a percentage of corresponding revenue for each unaudited
quarter:

<TABLE>
<CAPTION>
THREE MONTHS ENDED
-----------------------------------------
JUL. 31, APR. 30, JAN. 31, OCT. 31,
1998 1998 1998 1996
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Operating costs and expenses:
Telecommunications services...................... 46% 46% 45% 45%
Direct call provisioning......................... 82 99 94 95
Voice print...................................... -- 7 44 24
</TABLE>

The Company recorded a net loss for the quarter ended July 31, 1998. At the
current rate of revenue and expenses, the Company anticipates a probable loss
for the first quarter of fiscal 1999. Details of the components of earnings and
loss are discussed in the following sections.

Total revenue decreased in the quarter ended July 31, 1998 to $9,411,000
from $9,434,000 in the quarter ended April 30, 1998. However, telecommunications
services revenue remained constant quarter to quarter. The offsetting difference
was a reduction in telecommunication licensing revenue of $69,000 and SpeakEZ
Voice Print(SM) revenue of $73,000. The Company does not expect a significant
increase in the quarterly amounts of telecommunications services revenue. This
consistent rate of total revenue is not expected to increase significantly and
is anticipated to contribute to a probable loss in the first quarter of fiscal
1999.

Total operating costs and expenses remained consistent for the quarter
ended July 31, 1998 as compared to the prior quarter. This is primarily
telecommunications services expense of $3,991,000. Telecommunications services
expense for the quarter ended April 30, 1998 was $3,947,000. As a percentage of
related revenue, telecommunications services expense remained constant at 46%
for the quarter ended July 31, 1998 and for the quarter ended April 30, 1998 due
to increases in personnel and telecommunication costs and the relative lack of
increase in corresponding revenue. The Company expects the cost percentage of
telecommunications services to increase over that generated in the quarter ended
July 31, 1998. Total expenses, which include a large component of salaries, are
anticipated to increase in the first quarter of fiscal 1999 due to the Company's
annual wage increases which are effective August 1, 1998.

Selling, general and administrative expenses increased by $305,000 in the
quarter ended July 31, 1998 as compared to the previous quarter primarily due to
increases in professional services. The total amount of selling, general, and
administrative expenses is expected to increase in fiscal 1999 due to personnel
cost increases and the expected increases in other costs and services. Research
and development expense remained consistent quarter to quarter, however it is
expected to increase in the fiscal 1999 quarters due to the end of a government
contract.

LIQUIDITY AND CAPITAL RESOURCES

The Company has historically relied upon commercial borrowings, the sale of
equity securities and operating cash flow to fund its operations and capital
needs. Cash provided by operations supplied the Company with a majority of its
cash needs for the year ended July 31, 1998. Cash provided by operations was
$8,682,000 for the year July 31, 1998 as compared to $1,986,000 for the prior
period. The change in cash provided by operations was primarily attributable to
increases in net earnings, adjusted for noncash expense items such as
depreciation and amortization, provision for losses on accounts receivable, and
deferred tax expense. Comparably, these net amounts totaled $9,734,000 for the
year ended July 31, 1998 and $9,389,000 for the same period in the prior year.
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 year ended July 31, 1998 was made up primarily of decreases in accounts
receivable of $799,000 and decreases in accounts payable of $220,000 and in
accrued liabilities of $1,060,000. The total change for the year ended July 31,
1996 was made up primarily of increases in accounts receivable of $3,745,000 and
decreases in accounts payable of $4,976,000, offset by increases in accrued
liabilities of $1,560,000. The net cash used in financing activities in the year
ended July 31, 1998 was $1,754,000.

28
<PAGE> 31

Cash used in investing activities was $6,703,000. This included capital
expenditures of $4,243,000 for the year ended July 31, 1998 as compared to
$7,346,000 in the prior period. The capital expenditures for the year ended July
31, 1998 were mainly for telecommunications equipment and office equipment.
Additional investing activities of $2,460,000 for the year ended July 31, 1998
and $1,208,000 for the year ended July 31, 1997 included expenditures for
investments in preferred stock, capitalized software development costs and
patent defense costs. The 1998 total included $1,117,000 for software
development costs and $1,343,000 in preferred stock investment in Cell-Tel
Monitoring, Inc., the Company's strategic partner in a home incarceration and
probation administration product, Contain(SM) 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 ability and to be compliant with FCC
regulations regarding rate announcements.

The Company has been funding its operations by using cash provided by
operations and available borrowings under a $20,000,000 line of credit.
Management believes that the credit facility should be sufficient to fund the
Company's operations and anticipated new inmate call processing systems,
upgrades of existing systems, and potential installations for SpeakEZ Voice
Print(SM) for the foreseeable future. If the borrowing facilities and cash from
operations are insufficient to satisfy the Company's requirements, the Company
may be required to sell additional equity securities or extend its borrowing
facilities. 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 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 a part of the Company's Year 2000 Project, the Company has completed
its initial evaluation of current computer systems, software, and embedded
technologies. The evaluation revealed that the Company's current proprietary
hardware based 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. These resources will need to be either
replaced or upgraded. Pursuant to the FCC Order 98-7, associated with the
requirement for rate quotes, the Company's inmate calling system must be
upgraded by October 1999. As a result of this upgrade, the inmate calling system
will be Year 2000 compliant. The Company's internal systems and or programs are
predominantly "off-the-shelf" products with Year 2000 versions now available.
The Company's internal network, e-mail system and accounting and business
process software are scheduled for update utilizing vendor provided upgrades by
June 1999.

As part of the Company's Year 2000 Project, the Company plans to contact
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 are planned to be completed by January,
1999. However, there can be no guarantee that the systems of other companies on
which the Company's business relies will be timely converted, 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 in fiscal
1998 for the Year 2000 Project amounted to less than $20,000. Management expects
that the completion of its Year 2000 Project may result in additional
expenditures of approximately $500,000. The estimated replacement cost of
certain network equipment associated with the WAN portion of the internal
network could be an additional $500,000.

29
<PAGE> 32

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, until the Company receives responses from a
significant number of the Company's suppliers and customers, 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 not, to date, implemented a
Year 2000 Contingency Plan. It is the Company's goal to have the major Year 2000
Issues resolved by October, 1999. As part of the Company's Year 2000 Project,
the Company plans to hire additional project management resources. The Company
has not yet been notified by its customers that it will be required to have an
outside consultant to verify and validate the Company's Year 2000 compliance.
Final Year 2000 verification and validation is scheduled to occur April, 1999.
However, the Company would expect to develop and implement a contingency plan by
the end of March, 1999, in the event the Company's Year 2000 Project should fall
behind schedule.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

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

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

Not Applicable.

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

Information regarding the Registrant's directors and executive officers
will be set forth in the Registrant's Proxy Statement for use in connection with
the Annual Meeting of Shareholders to be held on or about December 10, 1998.
Such information is incorporated herein by reference.

ITEM 11. EXECUTIVE COMPENSATION

Information regarding executive compensation will be set forth in the
Registrant's Proxy Statement for use in connection with the Annual Meeting of
Shareholders to be held on or about December 10, 1998. Such information is
incorporated herein by reference.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

Information regarding security ownership of certain beneficial owners,
directors and executive officers of Registrant will be set forth in the
Registrant's Proxy Statement for use in connection with the Annual Meeting of
Shareholders to be held on or about December 10, 1998. Such information is
incorporated herein by reference.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

Information regarding certain relationships and related transactions will
be set forth in the Registrant's Proxy Statement for use in connection with the
Annual Meeting of Shareholders to be held on or about December 10, 1998. Such
information is incorporated herein by reference.

30
<PAGE> 33

PART IV

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

(a) 1. Financial Statements:

<TABLE>
<S> <C>
Independent Auditors' Report................................ F-1
Consolidated Balance Sheets as of July 31, 1998 and 1997.... F-2
Consolidated Statements of Operations for the Years Ended
July 31, 1998, 1997 and 1996.............................. F-3
Consolidated Statements of Shareholders' Equity for the
Years Ended July 31, 1998, 1997 and 1996.................. F-4
Consolidated Statements of Cash Flows for the Years Ended
July 31, 1998, 1997 and 1996.............................. F-5
Notes to Consolidated Financial Statements.................. F-6
</TABLE>

2. Financial Statement Schedules:

Independent Auditors' Report on Financial Statement Schedule

Schedule II -- Valuation and Qualifying Accounts for the Years Ended
July 31, 1998, 1997 and 1996

3. Exhibit Index:

<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF EXHIBIT
------- ----------------------
<C> <S>
(2.1) -- Acquisition Agreement and Plan of Merger between
Registrant and SpeakEZ, Inc. dated October 11, 1995.****
(3.1) -- Articles of Amendment to the Articles of Incorporation of
Registrant****
(3.2) -- Amended and Restated Articles of Incorporation of
Registrant**
(3.3) -- Amended and Restated Bylaws of Registrant*
(10.1) -- 1991 Non-Qualified Stock Option Plan***
(10.2) -- Form of 1991 Non-Qualified Stock Option Agreement***
(10.3) -- 1991 Incentive Stock Option Plan***
(10.4) -- Form of 1991 Incentive Stock Option Agreement***
(10.5) -- 1993 Incentive Stock Option Plan***
(10.6) -- Form of 1993 Incentive Stock Option Agreement***
(10.7) -- Agreement between American Telephone and Telegraph
Company and Registrant dated November 1, 1991*
(10.8) -- Amendment Number One to the Loan Agreement between
Registrant and INTRUST BANK, N.A., dated as of June 2,
1998.*****
(10.9) -- Standard Industrial Lease between Pacifica Development
Properties, II LLC and Registrant dated April 15, 1996
and Amendment Number One thereto, dated May 20, 1996.****
(21) -- Subsidiaries of Registrant*
(23.1) -- Consent of KPMG Peat Marwick LLP*****
(27) -- Financial Data Schedule*****
</TABLE>

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

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

31
<PAGE> 34

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

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

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

***** Previously filed with the Commission as an exhibit to Amendment No. 1 to
the Company's Annual Report on Form 10-K for the fiscal year ended July
31, 1998.

(b) Reports on Form 8-K: There were no reports on Form 8-K filed during the
fourth quarter of the year ended July 31, 1998.

32
<PAGE> 35

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned on May 26, 1999.

T-NETIX, INC.

By: /s/ ALVYN A. SCHOPP
----------------------------------
Alvyn A. Schopp,
Chief Executive Officer

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

<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<C> <S> <C>
/s/ ALVYN A. SCHOPP Director/Chief Executive Officer May 26, 1999
-------------------------------------------------
Alvyn A. Schopp

/s/ JOHN GIANNAULA Vice President/Chief Accounting May 26, 1999
- ----------------------------------------------------- Officer
John Giannaula

/s/ DANIEL M. CARNEY Director/Chairman May 26, 1999
- -----------------------------------------------------
Daniel M. Carney

/s/ ROBERT A. GEIST Director May 26, 1999
- -----------------------------------------------------
Robert A. Geist

/s/ JAMES L. MANN Director May 26, 1999
- -----------------------------------------------------
James L. Mann

/s/ MARTIN T. HART Director May 26, 1999
- -----------------------------------------------------
Martin T. Hart

/s/ DANIEL J. TAYLOR Director May 26, 1999
- -----------------------------------------------------
Daniel J. Taylor

/s/ JOHN H. BURBANK III Director May 26, 1999
- -----------------------------------------------------
John H. Burbank III
</TABLE>

33
<PAGE> 36

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

INDEPENDENT AUDITORS' REPORT

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

We have audited the accompanying consolidated balance sheets of T-NETIX,
Inc. and subsidiaries as of July 31, 1998 and 1997, and the related consolidated
statements of operations, shareholders' equity, and cash flows for each of the
years in the three-year period ended July 31, 1998. These consolidated financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.

We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of T-NETIX,
Inc. and subsidiaries as of July 31, 1998 and 1997, and the results of their
operations and their cash flows for each of the years in the three-year period
ended July 31, 1998, in conformity with generally accepted accounting
principles.

KPMG PEAT MARWICK LLP

Denver, Colorado
October 18, 1998

F-1
<PAGE> 38

T-NETIX, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

ASSETS

<TABLE>
<CAPTION>
JULY 31,
-----------------------
1998 1997
---------- ----------
(AMOUNTS IN THOUSANDS)
<S> <C> <C>
Cash and cash equivalents................................... $ 415 $ 190
Accounts receivable, net of allowance for doubtful accounts
of $404,000 and $120,000 at July 31, 1998 and 1997,
respectively (note 5)..................................... 10,293 11,779
Prepaid expenses............................................ 487 236
-------- --------
Total current assets.............................. 11,195 12,205
Investment (note 3)......................................... 1,343 --
Property and equipment, at cost (notes 5 and 9):
Telecommunications equipment.............................. 42,435 39,065
Construction in progress.................................. 3,163 3,626
Office equipment.......................................... 4,937 3,901
-------- --------
Property and equipment................................. 50,535 46,592
Less accumulated depreciation and amortization............ (24,756) (17,798)
-------- --------
Property and equipment, net............................ 25,779 28,794
Patent license rights, net (note 4)......................... 2,085 2,586
Software development costs, net............................. 1,458 449
Other assets, net........................................... 2,813 2,876
-------- --------
Total assets...................................... $ 44,673 $ 46,910
======== ========

LIABILITIES AND SHAREHOLDERS' EQUITY

Liabilities:
Accounts payable.......................................... $ 2,772 $ 2,992
Accrued liabilities....................................... 2,628 3,688
Debt (notes 5 and 9)...................................... 10,803 13,378
-------- --------
Total current liabilities......................... 16,203 20,058
Total liabilities................................. 16,203 20,058
-------- --------
Shareholders' equity (note 6):
Preferred stock, $.01 stated value, 10,000,000 shares
authorized; no shares issued........................... -- --
Common stock, $.01 stated value, 70,000,000 shares
authorized; 8,544,507 and 8,314,583 shares issued and
outstanding at July 31, 1998 and 1997, respectively.... 85 83
Additional paid-in capital................................ 27,925 26,908
Retained earnings (deficit)............................... 460 (139)
-------- --------
Total shareholders' equity........................ 28,470 26,852
-------- --------
Commitments and contingencies (note 9)
Total liabilities and shareholders' equity........ $ 44,673 $ 46,910
======== ========
</TABLE>

See accompanying notes to consolidated financial statements.

F-2
<PAGE> 39

T-NETIX, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

<TABLE>
<CAPTION>
YEARS ENDED
JULY 31,
---------------------------
1998 1997 1996
------- ------- -------
(AMOUNTS IN THOUSANDS
EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C>
Revenue:
Telecommunications services............................... $34,860 $33,471 $30,249
Telecommunications licensing.............................. 205 750 --
Direct call provisioning.................................. 2,516 1,395 3,072
Voice print............................................... 632 676 57
------- ------- -------
Total revenue..................................... 38,213 36,292 33,378
------- ------- -------
Expenses:
Operating costs and expenses:
Telecommunications services............................ 15,920 14,478 13,489
Direct call provisioning (including bad debt expense of
$587,000, $261,000 and $493,000 for 1998, 1997 and
1996, respectively).................................. 2,311 1,297 2,940
Voice print............................................ 78 170 --
------- ------- -------
Total operating costs and expenses................ 18,309 15,945 16,429
Selling, general and administrative....................... 7,448 7,488 6,434
Research and development.................................. 2,354 2,769 2,374
Depreciation and amortization............................. 8,250 8,135 5,920
------- ------- -------
Total expenses.................................... 36,361 34,337 31,157
------- ------- -------
Operating income.................................. 1,852 1,955 2,221
Interest expense.......................................... (1,055) (932) (548)
------- ------- -------
Earnings before income taxes...................... 797 1,023 1,673
Income taxes (note 8)..................................... (198) (432) (46)
------- ------- -------
Net earnings................................................ $ 599 $ 591 $ 1,627
======= ======= =======
Basic earnings per common share............................. $ 0.07 $ 0.06 $ 0.21
======= ======= =======
Diluted earnings per common share........................... $ 0.07 $ 0.06 $ 0.18
======= ======= =======
Weighted average common shares -- basic..................... 8,493 8,232 7,793
======= ======= =======
Weighted average common shares -- diluted................... 9,206 9,156 8,814
======= ======= =======
</TABLE>

See accompanying notes to consolidated financial statements.

F-3
<PAGE> 40

T-NETIX, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY

<TABLE>
<CAPTION>
COMMON STOCK ADDITIONAL RETAINED TOTAL
---------------- PAID-IN EARNINGS SHAREHOLDERS'
SHARES AMOUNTS CAPITAL (DEFICIT) EQUITY
------ ------- ---------- --------- -------------
(AMOUNTS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
BALANCES AT AUGUST 1, 1995.................. 7,623 $76 $22,736 $(2,357) $20,455
Common stock issued upon exercise of stock
options................................ 303 3 195 -- 198
Common stock issued for assets acquired
(note 3)............................... 30 -- -- -- --
Common stock issued in business
acquisition (note 4)................... 195 2 2,269 -- 2,271
Stock option tax benefit (note 8)......... -- -- 1,008 -- 1,008
Net earnings.............................. -- -- -- 1,627 1,627
----- --- ------- ------- -------
BALANCES AT JULY 31, 1996................... 8,151 81 26,208 (730) 25,559
Common stock issued upon exercise of stock
options................................ 155 2 204 -- 206
Common stock issued in business
acquisition (note 4)................... 8 -- 94 -- 94
Stock option tax benefit (note 8)......... -- -- 402 -- 402
Net earnings.............................. -- -- -- 591 591
----- --- ------- ------- -------
BALANCES AT JULY 31, 1997................... 8,314 83 26,908 (139) 26,852
Common stock issued upon exercise of stock
options................................ 230 2 819 -- 821
Stock option tax benefit (note 8)......... -- -- 198 -- 198
Net earnings.............................. -- -- -- 599 599
----- --- ------- ------- -------
BALANCES AT JULY 31, 1998................... 8,544 $85 $27,925 $ 460 $28,470
===== === ======= ======= =======
</TABLE>

See accompanying notes to consolidated financial statements.

F-4
<PAGE> 41

T-NETIX, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
YEARS ENDED JULY 31,
----------------------------
1998 1997 1996
------- ------- --------
(AMOUNTS IN THOUSANDS)
<S> <C> <C> <C>
Cash flows from operating activities:
Net earnings................................................ $ 599 $ 591 $ 1,627
Adjustments to reconcile net earnings to net cash provided
by operating activities:
Depreciation and amortization............................. 8,250 8,135 5,920
Provision for losses on accounts receivable............... 687 261 493
Deferred tax expense...................................... 198 402 --
Noncash reductions of loans from customer................. -- -- (449)
Changes in operating assets and liabilities:
Change in accounts receivable.......................... 799 (3,745) 533
Change in prepaid expenses............................. (251) 60 (28)
Change in other assets................................. (320) (302) (163)
Change in accounts payable............................. (220) (4,976) 1,828
Change in accrued liabilities.......................... (1,060) 1,560 (287)
------- ------- --------
Cash provided by operating activities............. 8,682 1,986 9,474
------- ------- --------
Cash used in investing activities:
Capital expenditures...................................... (4,243) (7,346) (10,440)
Acquisition of business................................... -- -- (450)
Other investing activities................................ (2,460) (1,208) (668)
------- ------- --------
Cash used in investing activities................. (6,703) (8,554) (11,558)
------- ------- --------
Cash flows from financing activities:
Net proceeds (payments) under line of credit.............. (2,318) 6,765 1,695
Payments of debt.......................................... (257) (358) (499)
Common stock issued for cash under option plans........... 821 206 198
Payment for loan fees and offering costs.................. -- -- (37)
------- ------- --------
Cash provided by (used in) financing activities... (1,754) 6,613 1,357
------- ------- --------
Net increase (decrease) in cash and cash equivalents........ 225 45 (727)
Cash and cash equivalents at beginning of year.............. 190 145 872
------- ------- --------
Cash and cash equivalents at end of year.................... $ 415 $ 190 $ 145
======= ======= ========
</TABLE>

See accompanying notes to consolidated financial statements.

F-5
<PAGE> 42

T-NETIX, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JULY 31, 1998 AND 1996

(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

GENERAL

T-NETIX, Inc. and subsidiaries ("T-NETIX" or the "Company") was
incorporated in Colorado in 1986. The Company has two reportable segments;
Inmate Calling Services Division and the SpeakEZ Division or SpeakEZ, Inc.
("SpeakEZ").

The inmate calling segment manages its specialized telecommunications
hardware and software systems for long distance and local exchange carriers on a
contractual basis. The long distance and local exchange carriers in turn pay a
fee per call to the Company for each billable call made from a phone subject to
a contract with the Company. The Company also receives revenue from billing
collect calls made from correctional facilities in which the Company's
specialized telecommunications hardware and software systems are located.

SpeakEZ engages in the sales and marketing and the research and development
of speaker verification technology. This technology is incorporated into the
Company's proprietary telecommunication systems and is also designed for stand
alone verification systems.

BASIS OF PRESENTATION AND PRINCIPLES OF CONSOLIDATION

The consolidated financial statements include the accounts of the Company
and those of its wholly-owned subsidiaries. All significant intercompany
accounts and transactions have been eliminated in consolidation. Investments in
20% to 50% owned affiliates are accounted for on the equity method and
investments in less than 20% owned affiliates are accounted for on the cost
method.

CASH EQUIVALENTS

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

ACCOUNTS RECEIVABLE

Accounts receivable related to direct call provisioning were $1,107,000 and
$758,000 as of July 31, 1998 and 1997, respectively. The allowance for doubtful
accounts relates primarily to these receivables.

PROPERTY AND EQUIPMENT

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

Construction in progress represents the cost of material purchases and
construction costs, including interest capitalized during construction, for
telecommunications hardware systems in various stages of completion. During
1998, 1997 and 1996, interest capitalized was insignificant.

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

OTHER ASSETS

Other assets include deposits, purchased computer software, patent defense
costs, patents, and other intangible assets. Patents and intangible assets are
stated at cost. Amortization is computed on the straight-

F-6
<PAGE> 43
T-NETIX, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

line basis over 17 years for patent costs and periods ranging from 3 to 7 years
for other intangibles. Other assets are recorded net of accumulated amortization
of $710,000 and $324,000 at July 31, 1998 and 1997, respectively. Amortization
charged to expense was $386,000, $332,000, and $101,000 for the years ended July
31, 1998, 1997, and 1996, respectively.

IMPAIRMENT OF LONG-LIVED ASSETS

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

REVENUE RECOGNITION

Revenue and expenses from telecommunications services and direct call
provisioning are recognized at the time the telephone call is completed.

License revenue is recognized when a license agreement is in effect, the
product has been delivered, the license fee is fixed or determinable, no
significant vendor obligations remain and collectibility is reasonably assured.
Maintenance revenue is recognized ratably over the maintenance period. Revenue
from training, consulting and custom engineering services are recognized as the
services are performed.

The Company has research and development contracts with the government.
These contracts are fixed price contracts for specific research services. There
is no requirement for repayment under the terms of the contracts and revenue is
recognized as the services are performed.

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 of current and anticipated future gross revenues for that product; or 2)
the straight line method over the remaining estimated useful life of the product
which life is generally estimated to be three years.

401(k) PLAN

The Company established a 401(k) plan for all of its full time employees
effective January 1, 1994. In June 1998, the Company implemented a matching
program. The program calls for a Company match of 25% of an employees
contribution up to 6% of the individual employees total salary. Contributions
under the program were not significant for the year ended July 31, 1998.

INCOME TAXES

The Company utilizes the asset and liability method of accounting for
income taxes. Accordingly, deferred tax assets and liabilities are recognized
for the future tax consequences attributable to differences

F-7
<PAGE> 44
T-NETIX, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

between the financial statement carrying amounts of existing assets and
liabilities and their respective tax bases and operating loss and tax credit
carryforwards. Deferred tax assets and liabilities are measured using enacted
income tax rates expected to apply to taxable income in the years in which those
differences are expected to be recovered or settled. The effect on deferred tax
assets and liabilities of a change in income tax rates is recognized in the
results of operations in the period that includes the enactment date.

EARNINGS PER COMMON SHARE

Earnings per common share for the years ended July 31, 1998, 1997 and 1996,
are presented in accordance with the provisions of Statement of Financial
Accounting Standards No. 128, Earnings Per Share (SFAS 128). SFAS 128 replaced
the presentation of primary and fully diluted earnings per share (EPS), with a
presentation of basic EPS and diluted EPS. Under SFAS 128, basic EPS 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 EPS 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 years ended July 31, 1998,
1997 and 1996, diluted common and common equivalent shares outstanding includes
713,000, 924,000 and 1,022,000, respectively, of common share equivalents,
consisting of stock options, determined under the treasury stock method.

STOCK COMPENSATION

The Company accounts for employee stock options under the provisions APB
Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB 25") and has
adopted the "disclosure only" alternative described in Statement of Financial
Accounting Standards No. 123, "Accounting for the Stock-Based Compensation"
("SFAS 123"), which requires proforma disclosure of compensation expense using a
fair value based method of accounting for stock-based compensation plans.

ESTIMATES

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

COMPREHENSIVE INCOME

Statement of Financial Accounting Standards 130, "Reporting Comprehensive
Income," (SFAS 130) establishes standards for reporting and display of
comprehensive income and its components in a full set of general-purpose
financial statements. SFAS 130 will be adopted for the fiscal year beginning
August 1, 1998. The Company believes that the adoption of SFAS 130 will not have
a significant effect on the presentation of its financial statements.

SEGMENTS

On July 31, 1998 the Company adopted SFAS 131, "Disclosures about Segments
of an Enterprise and Related Information." (SFAS 131). SFAS 131 establishes
standards for the way public business enterprises report information about
operating segments in annual financial statements and requires that those
enterprises report selected information about operating segments in interim
financial reports to shareholders. It also establishes standards for related
disclosures about products and services, geographical areas, and major
customers. The adoption of SFAS 131 did not have an effect on the Company's
primary financial statements, but did affect the disclosure of segment
information contained in note 7.

F-8
<PAGE> 45
T-NETIX, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS

Statement of Position 98-1 (SOP 98-1), Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use, was issued in March 1998. SOP
98-1 provides guidance on accounting for the costs of computer software
developed or obtained for internal use. The adoption of SOP 98-1 is not expected
to have a significant impact on the Company's consolidated financial statements.

RECLASSIFICATION

Certain amounts in the 1997 financial statements have been reclassified to
conform with the 1998 presentation.

(2) SUPPLEMENTAL DISCLOSURES TO STATEMENTS OF CASH FLOWS

Cash paid for interest was approximately $1,025,000, $894,000 and $563,000
for the years ended July 31, 1998, 1997 and 1996, respectively. Cash payments
for income taxes during 1998, 1997 and 1996 were not significant.

(3) INVESTMENTS

The Company has several investments in less than majority owned affiliates.

INVESTMENT IN PREFERRED STOCK

In December 1997, the Company entered into an agreement with Cell-Tel
Monitoring, Inc. and its shareholders ("Cell-Tel"). Cell-Tel engages in the
sales and marketing and research and development of a prisoner/parolee
electronic monitoring device using the Company's SpeakEZ Voice Print(SM)
technology. Cell-Tel's product, Contain(SM) is designed to provide a remote
monitoring system with an Internet based case management system. As of July 31,
1998 the Company had invested approximately $1,343,000 in the preferred stock of
Cell-Tel representing and equity interest of approximately 15%. In October 1998,
the Company and Cell-Tel amended their agreement to allow for the Company to
purchase an additional $800,000 of preferred stock, representing and additional
6% of the equity of Cell-Tel expiring December 8, 1998. The Company also has an
option to purchase 100% of the common stock of Cell-Tel. Under this option, the
purchase price would consist of $90,000 in cash payable to the shareholders and
$1.6 million of the Company's common stock. The Company has accounted for the
investment in Cell-Tel preferred stock through July 31, 1998 using the cost
method of accounting.

INVESTMENTS IN JOINT VENTURES

Effective June 10, 1998, through its subsidiary, SpeakEZ, the Company
acquired a 20% interest in a limited liability company, Sentry Systems, Inc.
("Sentry"). Sentry is an entity specializing in Internet computer network
security applications. Sentry, through a separate License Agreement utilizes the
Company's SpeakEZ Voice Print(SM) technology. The Company acquired its interest
in Sentry in exchange for the license of SpeakEZ Voice Print(SM) technology.
There was no historical cost basis in the contributed technology and accordingly
no value has been assigned to the Sentry investment in the accompanying
financial statements. The Company has an option, at certain times to purchase
additional interests in Sentry up to 51% at a price based on a market value
formula. The Company accounts for its investment in Sentry under the equity
method of accounting. On September 1, 1998, the Company entered into a lending
arrangement with Sentry, whereby the Company provided Sentry with a $300,000
line of credit under a loan and security agreement. The loan carries an interest
rate of prime plus 2%. It also contains various conversion features into
additional shares of common stock of Sentry.

F-9
<PAGE> 46
T-NETIX, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

In November 1991, the Company entered into a joint venture created to
market the Company's specialized telecommunications hardware and software
systems in certain international markets. The Company initially owned 49% of the
joint venture. Effective October 30, 1995, the Company acquired the remaining
51% interest in the joint venture in exchange for 30,000 shares of restricted
common stock. The Company recorded its basis in the assets of the joint venture
at the predecessor cost of the related party, which was not material. There has
been no activity in the now wholly owned subsidiary since the remaining interest
was acquired.

(4) BUSINESS ACQUISITION

On October 12, 1995, the Company completed its acquisition of all of the
outstanding stock of SpeakEZ, a development stage company. SpeakEZ is developing
products using biometric identification technologies including voice print and
speaker identification software. Total consideration for the acquisition was
approximately $3,000,000. The initial consideration included $450,000 in cash
(including payment of previously issued notes payable), restricted common stock
of the Company valued at approximately $2,271,000 and approximately $279,000
payable pursuant to the final distribution agreement, in restricted stock and
cash. In fiscal 1997, the Company paid additional, final consideration in the
form of common stock of $94,000. The Company accounted for the acquisition using
the purchase method of accounting. Accordingly, the purchased assets and
liabilities have been recorded at their estimated fair value at the date of the
acquisition. Amounts in excess of the fair value of tangible assets acquired
were attributed to patent license rights to existing and pending patents and
other intangibles along with the related deferred income tax effects. The total
capitalized cost of the patent license rights and other intangibles is being
amortized on a straight line basis over seven years. The results of operations
of SpeakEZ have been included in the consolidated financial statements since the
date of the acquisition. Results of operations of SpeakEZ prior to the
acquisition were not significant.

(5) DEBT

Debt at July 31, 1998 and 1997 is summarized as follows:

<TABLE>
<CAPTION>
JULY 31,
-----------------
1998 1996
------- -------
(AMOUNTS IN
THOUSANDS)
<S> <C> <C>
Debt:
Line of credit agreement.................................. $10,734 $13,052
Other..................................................... 69 326
------- -------
$10,803 $13,378
======= =======
</TABLE>

In June 1998, the Company renewed its line of credit with its current
commercial bank. The amount available under the line of credit is $20,000,000.
Borrowings are at the prime rate (8.5% at July 31, 1998 and 1997) and are
secured by substantially all of the assets of the Company. The agreement
provides for various financial covenants, including maintaining certain
financial ratios and minimum net worth requirements. As of July 31, 1998, the
Company has an unused amount on the committed credit of $9,266,000. All of the
debt at July 31, 1998, matures within one year. The Bank has also issued a
standby letter of credit for $225,000 on behalf of the Company in favor of the
lessor on its office space (note 9). The letter of credit is for the term of the
lease.

F-10
<PAGE> 47
T-NETIX, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

(6) SHAREHOLDERS' EQUITY

STOCK OPTION PLANS

The Company has reserved 3,250,000 shares of common stock for employees and
non-employee directors under various stock option plans (collectively the
"Plans"): the 1991 Incentive Stock Option Plan ("the 1991 ISO Plan"); the 1991
Non-Qualified Stock Option Plan ("the 1991 NSO Plan"); and the 1993 Incentive
Stock Option Plan ("the 1993 ISO Plan"). The Plans provide for issuing both
incentive stock options, and non-qualified stock options, which must be granted
at not less than 100% of the fair market value of the stock on the date of
grant. All options to date have been granted at the fair market value of the
stock as determined by the Board of Directors. Options issued prior to 1994 had
vesting terms of one to three years from the date of grant. Substantially all of
the Incentive Stock Options issued after 1993 vest over four years from the date
of grant. The Options expire ten years from the date of grant.

<TABLE>
<CAPTION>
WEIGHTED
AVERAGE
SHARES RESERVED OPTIONS EXERCISE
FOR OPTIONS OUTSTANDING PRICE
--------------- ----------- --------
<S> <C> <C> <C>
Outstanding at August 1, 1995............................. 445,301 1,783,565 $2.83
Increase in authorized shares........................... 500,000 --
Granted................................................. (650,000) 650,000 7.70
Exercised............................................... -- (302,746) 0.65
Canceled................................................ 61,483 (61,483) 2.30
-------- ---------
Outstanding at July 31, 1996.............................. 356,784 2,069,336 4.61
Granted................................................. (239,500) 239,500 7.25
Exercised............................................... -- (155,968) 1.30
Canceled................................................ 82,750 (82,750) 6.76
-------- ---------
Outstanding at July 31, 1997.............................. 200,034 2,070,118 5.08
Granted................................................. (126,500) 126,500 9.09
Exercised............................................... -- (229,924) 3.57
Canceled................................................ 40,125 (40,125) 7.15
-------- ---------
Outstanding at July 31, 1998.............................. 113,659 1,926,569 5.48
======== =========
</TABLE>

<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
--------------------------------------- -------------------------
WEIGHTED
NUMBER OF AVERAGE WEIGHTED WEIGHTED
OUTSTANDING AT REMAINING AVERAGE NUMBER AVERAGE
RANGE OF JULY 31, CONTRACTUAL EXERCISE EXERCISABLE AT EXERCISE
EXERCISE PRICES 1998 LIFE PRICE JULY 31, 1998 PRICE
- --------------- -------------- ----------- -------- -------------- --------
<S> <C> <C> <C> <C> <C>
$0.20................................ 303,725 2.7 $ 0.20 303,725 $ 0.20
3.00-4.00........................... 256,194 4.8 3.25 256,194 3.25
5.50................................ 435,150 6.0 5.50 335,650 5.50
7.25................................ 762,000 7.5 7.25 333,667 7.25
8.25-13.71.......................... 169,500 8.7 10.33 46,250 13.60
--------- ---------
$0.20-13.71.......................... 1,926,569 1,275,486
========= =========
</TABLE>

The Company has not recorded compensation expense pursuant to the grants of
its stock options under APB 25. Had the Company determined compensation cost
based on the fair value at the grant date for its

F-11
<PAGE> 48
T-NETIX, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

stock options under SFAS 123, the Company's net earnings and net earnings per
common share would have been:

<TABLE>
<CAPTION>
JULY 31, 1998 JULY 31, 1997
------------------- -------------------
AS AS
REPORTED PROFORMA REPORTED PROFORMA
-------- -------- -------- --------
(AMOUNTS IN THOUSANDS)
<S> <C> <C> <C> <C>
Net earnings................................... $ 599 $ 168 $ 591 $ 11
===== ===== ===== ====
Earnings per common share
-- basic..................................... $0.07 $0.02 $0.06 $ --
===== ===== ===== ====
-- diluted................................... $0.07 $0.02 $0.06 $ --
===== ===== ===== ====
</TABLE>

Under SFAS 123, the per-share minimum value of stock options granted in
1998 and 1997 was $4.86 and $7.19, respectively. The minimum value was
calculated using an expected volatility of the underlying stock of 40% for both
1998 and 1997, a risk free interest rate of 5.13% and 6.02%, no expected
dividend yields, and an estimated option life of 7.52 years.

In July, 1997, the Board of Directors amended the 1993 ISO Plan and the
1991 NSO Plan to provide that the Compensation Committee may amend certain
outstanding options with an exercise price in excess of the current market price
in order to modify the exercise price to the current market price or greater. On
August 11, 1997, the Compensation Committee re-priced the exercise price to
$7.25 per share for certain outstanding options under the 1993 ISO Plan and the
1991 NSO Plan having an exercise price equal to or greater than $7.50 prior to
such re-pricing. This re-pricing affected 773,500 options under these Plans.

(7) SEGMENT INFORMATION

The Company operates in two business segments; inmate calling services and
SpeakEZ Voice Print(SM). 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. Segment
information for the years ended July 31, 1998, 1997 and 1996 are as follows:

<TABLE>
<CAPTION>
YEAR ENDED JULY 31, 1998
----------------------------
INMATE
CALLING
SERVICES SPEAKEZ TOTAL
-------- ------- -------
(AMOUNTS IN THOUSANDS)
<S> <C> <C> <C>
Revenue from external customers......................... $37,581 $ 632 $38,213
Operating income (loss)................................. 5,848 (3,996) 1,852
Depreciation and amortization........................... 7,326 924 8,250
Interest expense........................................ 463 592 1,055
Segment earnings (loss) before taxes.................... 5,385 (4,588) 797
Segment assets.......................................... 52,349 4,833 57,182
</TABLE>

F-12
<PAGE> 49
T-NETIX, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

<TABLE>
<CAPTION>
YEAR ENDED JULY 31, 1997
----------------------------
INMATE
CALLING
SERVICES SPEAKEZ TOTAL
-------- ------- -------
(AMOUNTS IN THOUSANDS)
<S> <C> <C> <C>
Revenue from external customers......................... $35,616 $ 676 $36,292
Operating income (loss)................................. 4,619 (2,664) 1,955
Depreciation and amortization........................... 7,430 705 8,135
Interest expense........................................ 565 367 932
Segment earnings (loss) before taxes.................... 4,394 (3,371) 1,023
Segment assets.......................................... 50,432 5,544 55,976
</TABLE>

<TABLE>
<CAPTION>
YEAR ENDED JULY 31, 1996
----------------------------
INMATE
CALLING
SERVICES SPEAKEZ TOTAL
-------- ------- -------
(AMOUNTS IN THOUSANDS)
<S> <C> <C> <C>
Revenue from external customers......................... $33,321 $ 57 $33,378
Operating income (loss)................................. 3,531 (1,310) 2,221
Depreciation and amortization........................... 5,576 344 5,920
Interest expense........................................ 499 49 548
Segment earnings (loss) before taxes.................... 3,032 (1,359) 1,673
Segment assets.......................................... 42,650 4,166 46,816
</TABLE>

Reconciliations of Revenue, Profit (Loss), and Assets for the Company's
reportable segments is as follows:

<TABLE>
<CAPTION>
YEAR ENDED JULY 31,
---------------------------
REVENUE 1998 1997 1996
- ------- ------- ------- -------
(AMOUNTS IN THOUSANDS)
<S> <C> <C> <C>
Total revenue for reportable segments................... $38,213 $36,292 $33,378
Elimination of intersegment revenue..................... -- -- --
------- ------- -------
Total consolidated revenue.................... $38,213 $36,292 $33,378
======= ======= =======
</TABLE>

<TABLE>
<CAPTION>
YEAR ENDED JULY 31,
----------------------
PROFIT OR LOSS 1998 1997 1996
- -------------- ---- ------ ------
(AMOUNTS IN THOUSANDS)
<S> <C> <C> <C>
Segment earnings (loss), before taxes....................... $797 $1,023 $1,673
Unallocated amounts, income taxes........................... (198) (432) (46)
---- ------ ------
Net earnings...................................... $599 $ 591 $1,627
==== ====== ======
</TABLE>

<TABLE>
<CAPTION>
JULY 31,
----------------------
ASSETS 1998 1997
- ------ ---------- ---------
(AMOUNTS IN THOUSANDS)
<S> <C> <C>
Total assets for reportable segments........................ $ 57,182 $55,976
Eliminations................................................ (12,509) (9,066)
-------- -------
Consolidated total................................ $ 44,673 $46,910
======== =======
</TABLE>

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 operations.

F-13
<PAGE> 50
T-NETIX, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Substantially all of the Company's reportable segment revenue is derived
within the United States. Revenue, as a percentage of total revenue,
attributable to significant customers was as follows:

<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Customer A.................................................. 15% 11% 10%
Customer B.................................................. 31% 36% 40%
Customer C.................................................. 15% 14% 13%
Customer D.................................................. 21% 15% 14%
</TABLE>

(8) INCOME TAXES

Income tax expense for the years ended July 31, 1998, 1997 and 1996 is as
follows:

<TABLE>
<CAPTION>
1998 1997 1996
------ ------ -----
(AMOUNTS IN THOUSANDS)
<S> <C> <C> <C>
Current:
Federal................................................... $ -- $ -- $ --
State..................................................... (25) (30) (46)
----- ----- ----
Total............................................. (25) (30) (46)
Deferred:
Federal................................................... (133) (348) --
State..................................................... (40) (54) --
----- ----- ----
Total............................................. (173) (402) --
----- ----- ----
Total income taxes................................ $(198) $(432) $(46)
===== ===== ====
</TABLE>

Income taxes differ from the expected statutory income tax benefit, by
applying the US federal income tax rate of 34% to pretax earnings, for the years
ended July 31, 1998, 1997 and 1996 due to the following:

<TABLE>
<CAPTION>
1998 1997 1996
------ ------ ------
(AMOUNTS IN THOUSANDS)
<S> <C> <C> <C>
Expected statutory income tax expense....................... $(271) $(348) $(569)
Amounts not deductible for income tax purposes.............. (99) (86) (61)
State taxes, net of federal benefit......................... (43) (55) (30)
Change in valuation allowance............................... 113 -- 614
Other....................................................... 102 57 --
----- ----- -----
Total income taxes................................ $(198) $(432) $ (46)
===== ===== =====
</TABLE>

F-14
<PAGE> 51
T-NETIX, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The tax effects of temporary differences that give rise to significant
portions of the deferred income tax assets and deferred income tax liabilities
are presented below:

<TABLE>
<CAPTION>
JULY 31
-----------------
1998 1997
------- -------
(AMOUNTS IN
THOUSANDS)
<S> <C> <C>
Deferred income tax assets:
Net operating loss carryforwards............................ $ 4,769 $ 4,255
Allowance for doubtful accounts............................. 154 46
Other....................................................... -- 137
------- -------
Total gross deferred income tax assets............ 4,923 4,438
Less valuation allowance.................................... (1,371) (1,484)
------- -------
3,552 2,954
Deferred income tax liabilities:
Intangible assets, due to difference in book/tax basis...... (642) (832)
Property and equipment, principally due to differences in
depreciation.............................................. (1,901) (1,349)
Other assets, due to differences in book/tax basis.......... (1,009) (773)
------- -------
Total gross deferred tax liabilities.............. (3,552) (2,954)
------- -------
-- --
======= =======
</TABLE>

At July 31, 1998, the Company had net operating loss carryforwards for tax
purposes aggregating approximately $12,500,000 which, if not utilized to reduce
taxable income in future periods, expire at various dates through the year 2009.
Approximately $1,300,000 of these net operating loss carryforwards are subject
to certain rules limiting their annual usage. The Company believes these annual
limitations will not ultimately affect the Company's ability to use
substantially all of its net operating loss carryforwards for income tax
purposes.

A valuation allowance is provided when it is more likely than not that some
portion or all of the net deferred tax asset will not be realized. The Company
has historically established valuation allowances primarily for net operating
loss carryforwards and portions of other deferred tax assets as a result of its
history of net losses. The Company has pre-tax net earnings for 1998, 1997 and
1996 and has reversed the valuation allowance in each of these years to the
extent that net operating loss carryforwards and other deferred tax assets were
used to offset taxable income. The net reduction in the valuation allowance in
these years resulted from decreases associated with tax benefits related to
utilization of net operating losses offset by increases attributable to certain
originating stock option deductions discussed below. The decrease in the
valuation allowance in 1998 and 1997 was recorded as an increase in paid-in
capital, and the decrease in the valuation allowance in 1996 was offset by
reductions in the provision for income taxes. The valuation allowance as of July
31, 1998 and 1997 is attributable to that portion of the Company's net operating
loss carryforward attributable to the tax deductions resulting from the exercise
of non-qualified stock options.

The exercise of stock options which have been granted under the Company's
1991 NSO stock option plan gives rise to compensation which is included in the
taxable income of the applicable option holder and is a deductible expense by
the Company for federal and state income tax purposes. Compensation expense
resulting from increases in the fair market value of the Company's Common Stock
subsequent to the date of NSO option grant of the applicable exercised stock
options is not recognized for financial accounting purposes, in accordance with
Accounting Principles Board Opinion No. 25. The tax benefits associated with the
exercise of the NSO options are recorded to additional paid-in capital when
realized.

F-15
<PAGE> 52
T-NETIX, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

(9) COMMITMENTS

The Company leases certain telecommunications and office equipment under
capital leases and leases office space under operating lease agreements.
Capitalized costs of the property and equipment under capital leases was not
significant at July 31, 1998. Rent expense under operating lease agreements for
the years ended July 31, 1998, 1997 and 1996 was approximately $717,000,
$789,000, and $450,000, respectively. Future minimum lease payments under these
lease agreements for each of the next five years are summarized as follows
(amounts in thousands):

<TABLE>
<S> <C>
Year ending July 31:
1999...................................................... $ 624
2000...................................................... 611
2001...................................................... 576
2002...................................................... 140
2003...................................................... --
------
Total minimum lease payments...................... $1,951
======
</TABLE>

In April 1996, the Company entered into a lease agreement for approximately
38,000 square feet of office space. The term of the lease is for five years and
commenced on November 1, 1996. The Bank has also issued a standby letter of
credit on behalf of the Company for $225,000 in favor of the lessor on the new
lease (note 5). The Company leases an additional 13,000 square feet of office
space for its SpeakEZ operations under a five year lease, and various point of
presence locations throughout the United States.

(10) QUARTERLY RESULTS -- (UNAUDITED)

The following tables present unaudited quarterly operating results for the
Company and in the opinion of management contain all adjustments, necessary for
a fair presentation of the results of operations for these periods. Management
believes that quarter-to-quarter comparisons of the Company's financial results
should not be relied upon as an indication of annual or future performance.

<TABLE>
<CAPTION>
THREE MONTHS ENDED
-----------------------------------------
JUL. 31, APR. 30, JAN. 31, OCT. 31,
-------- -------- -------- --------
(AMOUNTS IN THOUSANDS
EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C>
FISCAL YEAR 1998:
Total revenue.................................... $9,411 $9,434 $9,633 $9,735
Total expenses................................... 9,333 9,050 8,907 9,071
Operating income................................. 78 384 726 664
Net earnings (loss)(1)........................... (153) 110 347 295
Diluted earnings (loss) per common share(1)...... (0.02) 0.01 0.04 0.03
FISCAL YEAR 1997:
Total revenue.................................... $9,312 $9,470 $9,004 $8,506
Total expenses................................... 8,471 8,390 8,728 8,748
Operating income (loss).......................... 841 1,080 276 (242)
Net earnings (loss).............................. 259 643 86 (397)
Diluted earnings (loss) per common share......... 0.03 0.07 0.01 (0.04)
</TABLE>

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

(1) The Company restated income tax expense to reflect adjustments to its income
tax provision. These adjustments have been reflected in the table above.

F-16
<PAGE> 53
T-NETIX, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

<TABLE>
<CAPTION>
THREE MONTHS ENDED YEAR
----------------------------------------- ENDED
JUL. 31, APR. 30, JAN. 31, OCT. 31, JUL. 31,
-------- -------- -------- -------- --------
(AMOUNTS IN THOUSANDS EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C> <C>
INCOME TAXES:
As previously reported.................. $ (59) $(185) $(157)
Adjustment to federal tax provisions.... 22 69 58
----- ----- -----
As adjusted.......................... $ 54 $ (37) $(116) $ (99) $(198)
====== ===== ===== ===== =====
NET EARNINGS:
As previously reported.................. $ 88 $ 278 $ 237
Adjustment.............................. 22 69 58
----- ----- -----
As adjusted.......................... $ (153) $ 110 $ 347 $ 295 $ 599
====== ===== ===== ===== =====
DILUTED EARNINGS (LOSS) PER COMMON SHARE:
As previously reported.................. $0.01 $0.03 $0.03
Adjustment.............................. -- 0.01 --
----- ----- -----
As adjusted.......................... $(0.02) $0.01 $0.04 $0.03 $0.07
====== ===== ===== ===== =====
</TABLE>

F-17
<PAGE> 54

INDEPENDENT AUDITORS' REPORT

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

Under the date of October 10, 1998, we reported on the consolidated balance
sheets of T-NETIX, Inc. and subsidiaries as of July 31, 1998 and 1997, and the
related consolidated statements of operations, shareholders' equity, and cash
flows for each of the years in the three-year period ended July 31, 1998. In
connection with our audits of the aforementioned consolidated financial
statements, we also audited the related consolidated financial statement
Schedule II. This financial statement schedule is the responsibility of the
Company's management. Our responsibility is to express an opinion on this
financial statement schedule based on our audits.

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

KPMG PEAT MARWICK LLP

Denver, Colorado
October 18, 1998

S-1
<PAGE> 55

T-NETIX, INC. AND SUBSIDIARIES

SCHEDULE II

VALUATION AND QUALIFYING ACCOUNTS
YEARS ENDED JULY 31, 1998, 1997 AND 1996
(AMOUNTS IN THOUSANDS)

<TABLE>
<CAPTION>
BALANCE AT CHARGED TO BALANCE
BEGINNING COSTS AND DEDUCTIONS/ AT END
OF PERIOD EXPENSES WRITE-OFFS OF PERIOD
---------- ---------- ----------- ---------
<S> <C> <C> <C> <C>
Year ended July 31, 1996:
Allowance for doubtful accounts.................. $137 $493 $(501) $129
==== ==== ===== ====
Year ended July 31, 1997:
Allowance for doubtful accounts.................. $129 $261 $(270) $120
==== ==== ===== ====
Year ended July 31, 1998:
Allowance for doubtful accounts.................. $120 $687 $(403) $404
==== ==== ===== ====
</TABLE>

S-2
<PAGE> 56

EXHIBIT INDEX

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

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

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

***** Previously filed with the Commission as an exhibit to Amendment No. 1 to
the Company's Annual Report on Form 10-K for the fiscal year ended July
31, 1998.