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SECURITIES AND EXCHANGE COMMISSIONWASHINGTON, D.C. 20549

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FORM 10-K

|ý                                                                    | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934    
|-------------------------------------------------------------------- | ----------------------------------------------------------------------------------------
|For the fiscal year ended December 31, 2002                         
|or                                                                  
|o                                                                    | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|For the transition period
from                                    to

Commission file number 000-29335

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

|Delaware(State or Other Jurisdiction of Incorporation or Organization)               |  | 23-2518693(I.R.S. Employer Identification No.)
|------------------------------------------------------------------------------------ |  | ----------------------------------------------
|300 Colonial Center Parkway
Roswell, Georgia(Address of Principal Executive Offices) |  | 30076(Zip Code)                               

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

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

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

|Title of each class                     |  | Name of each exchange on which registered
|--------------------------------------- |  | -----------------------------------------
|Common Stock, par value $0.01 per share |  | NASDAQ                                   

Indicate
by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes ý    No o

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

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

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

DOCUMENTS INCORPORATED BY REFERENCE

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

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PART I

Item 1.    Business

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

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

Overview

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

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

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

Industry Background

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

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

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

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

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

The eQuality Solution

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



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



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Strategy

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



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Products

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

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

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



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

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

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

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

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

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

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

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

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

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

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

Professional Services

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

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

Customers

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

Sales and Marketing

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

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

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

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

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Research and Development

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

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

Competition

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



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

The
principal competitive factors in our market include:



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

Proprietary Rights

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

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

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

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

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

Item 2.    Properties

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

Item 3.    Legal Proceedings

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

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

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

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

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

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PART II

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



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

High

LowYear Ended December 31, 2002:Fourth quarter

$
6.44

$
1.97Third quarter

$
7.47

$
3.89Second quarter

$
14.46

$
5.05First quarter

$
14.51

$
10.05Year Ended December 31, 2001:Fourth quarter

$
13.90

$
7.03Third quarter

$
11.32

$
6.51Second quarter

$
14.95

$
7.35First quarter

$
17.00

$
5.63


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

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

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

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

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Item 6.    Selected Financial Data

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

|                                                       |                                                  | Year Ended December 31,                                                |       
|------------------------------------------------------ | ------------------------------------------------ | ---------------------------------------------------------------------- | ------
|
|
|Statement of Operations Data:                          |                                                  |                                                                        |       
|Revenue:                                               |                                                  |                                                                        |       
|                                                       | License                                          |                                                                        | $     
|                                                       | Services                                         |                                                                        |       
|                                                       | Hardware                                         |                                                                        |       
|                                                       |                                                  |                                                                        |       
|                                                       |                                                  | Total revenue                                                          |       
|                                                       |                                                  |                                                                        |       
|Cost of revenue:                                       |                                                  |                                                                        |       
|                                                       | License                                          |                                                                        |       
|                                                       | Services                                         |                                                                        |       
|                                                       | Hardware                                         |                                                                        |       
|                                                       |                                                  |                                                                        |       
|                                                       |                                                  | Total cost of revenue                                                  |       
|                                                       |                                                  |                                                                        |       
|                                                       |                                                  | Gross profit                                                           |       
|Operating expenses:                                    |                                                  |                                                                        |       
|                                                       | Sales and marketing                              |                                                                        |       
|                                                       | Research and development                         |                                                                        |       
|                                                       | General and administrative                       |                                                                        |       
|                                                       | Charge for termination of distribution agreement |                                                                        |       
|                                                       | Acquired in-process research and development     |                                                                        |       
|                                                       |                                                  |                                                                        |       
|                                                       |                                                  | Operating loss                                                         |       
|Interest and other income (expense), net               |                                                  |                                                                        | 1,570 
|                                                       |                                                  |                                                                        |       
|                                                       |                                                  | Income (loss) before provision for income taxes and extraordinary loss |       
|Provision for income taxes                             |                                                  |                                                                        | 261   
|                                                       |                                                  |                                                                        |       
|                                                       |                                                  | Income (loss) before extraordinary loss                                |       
|Extraordinary loss on the early extinguishment of debt |                                                  |                                                                        |      
|                                                       |                                                  |                                                                        |       
|                                                       |                                                  | Net income (loss)                                                      |       
|Preferred stock dividends and accretion                |                                                  |                                                                        |      
|                                                       |                                                  |                                                                        |       
|                                                       |                                                  | Net income (loss) applicable to common stockholders                    |       
|                                                       |                                                  |                                                                        |       
|Net income (loss) per sharebasic:                     |                                                  |                                                                        |       
|                                                       | Income (loss) before extraordinary loss          |                                                                        | $     
|                                                       |                                                  |                                                                        |       
|                                                       | Extraordinary loss                               |                                                                        |       
|                                                       |                                                  |                                                                        |       
|                                                       |                                                  | Net income (loss)                                                      |       
|                                                       |                                                  |                                                                        |       
|Net income (loss) per sharediluted:                   |                                                  |                                                                        |       
|                                                       | Income (loss) before extraordinary loss          |                                                                        | $     
|                                                       | Extraordinary loss                               |                                                                        |       
|                                                       |                                                  |                                                                        |       
|                                                       |                                                  | Net income (loss)                                                      |       
|                                                       |                                                  |                                                                        |       
|Shares used in computing net income (loss) per share:  |                                                  |                                                                        |       
|                                                       | Basic                                            |                                                                        |       
|                                                       |                                                  |                                                                        |       
|                                                       | Diluted                                          |                                                                        |       
|                                                       |                                                  |                                                                        |       
|Balance Sheet Data:                                    |                                                  |                                                                        |       
|Cash and cash equivalents                              |                                                  | $                                                                      | 36,391
|Working capital (deficit)                              |                                                  |                                                                        | 59,435
|Total assets                                           |                                                  |                                                                        | 87,141
|Long-term debt, less current portion                   |                                                  |                                                                        |      
|Total convertible preferred stock                      |                                                  |                                                                        |      
|Total stockholders' equity (deficit)                   |                                                  |                                                                        | 65,074

15

---



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

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

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

Overview

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

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

16

---

Sources of Revenue and Revenue Recognition Policy

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

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

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

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

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

17

---

Cost of Revenue and Operating Expenses

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

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

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

Critical Accounting Policies and Estimates

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

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

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

18

---

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

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

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

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

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

Year ended December 31,2002

2001

2000Historical net income (loss)

$
48

$
(5,180
)
$
(2,214
)Add: Stock-based employee compensation


115


171


271Deduct: Total stock-based compensation expense determined under fair value based method for all awards


11,472


9,278


4,903Pro forma net loss

$
(11,309
)
$
(14,287
)
$
(6,846
)Pro forma basic and diluted net loss per share

$
(0.50
)
$
(0.64
)
$
(0.34
)


19

---

Results of Operations

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

Year Ended December 31,2002

2001

2000Statement of Operations Data:Revenue:License

49
%
64
%
68
%Services

51

36

32Total revenue

100

100

100Cost of revenue:License

2

1

1Services

18

17

19Total cost of revenue

20

18

20Gross profit

80

82

80Operating expenses:Sales and marketing

44

47

50Research and development

22

22

23General and administrative

16

18

20Acquired in-process research and development



8

Operating loss

(2
)
(13
)
(13
)Interest and other income, net

2

5

9Income (loss) before provision for income taxes and extraordinary loss



(8
)
(4
)Provision for income taxes





(1
)Income (loss) before extraordinary loss



(8
)
(5
)Extraordinary loss





(1
)Net income (loss)


%
(8
)%
(6
)%


Revenue

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

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

20

---

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

Cost of Revenue

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

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

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

Operating Expenses

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

21

---

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

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

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

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

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

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

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

22

---

Interest and Other Income, Net

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

Provision for Income Taxes

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

Quarterly Results of Operations

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

|                                                |                                              | Three Months Ended    |       
|----------------------------------------------- | -------------------------------------------- | --------------------- | ------
|
|Revenue:                                        |                                              |                       |       
|                                                | License                                      |                       | $     
|                                                | Services                                     |                       |       
|                                                |                                              |                       |       
|                                                |                                              | Total revenue         |       
|Cost of revenue:                                |                                              |                       |       
|                                                | License                                      |                       |       
|                                                | Services                                     |                       |       
|                                                |                                              |                       |       
|                                                |                                              | Total cost of revenue |       
|                                                |                                              |                       |       
|Gross profit                                    |                                              |                       | 13,417
|Operating expenses:                             |                                              |                       |       
|                                                | Sales and marketing                          |                       |       
|                                                | Research and development                     |                       |       
|                                                | General and administrative                   |                       |       
|                                                | Acquired in-process research and development |                       |       
|                                                |                                              |                       |       
|Operating income (loss)                         |                                              |                       | (326  
|Interest income, net                            |                                              |                       | 335   
|                                                |                                              |                       |       
|Income (loss) before provision for income taxes |                                              |                       | 9     
|Provision for income taxes                      |                                              |                       | 61    
|                                                |                                              |                       |       
|Net income (loss)                               |                                              | $                     | (52   
|                                                |                                              |                       |       

23

---

|                                                |                                              | Three Months Ended    |   
|----------------------------------------------- | -------------------------------------------- | --------------------- | --
|
|As a Percentage of Total Revenue:               |                                              |                       |   
|Revenue:                                        |                                              |                       |   
|                                                | License                                      |                       | 45
|                                                | Services                                     |                       | 55
|                                                |                                              |                       |   
|                                                |                                              | Total revenue         |   
|                                                |                                              |                       |   
|Cost of revenue:                                |                                              |                       |   
|                                                | License                                      |                       | 3 
|                                                | Services                                     |                       | 20
|                                                |                                              |                       |   
|                                                |                                              | Total cost of revenue |   
|                                                |                                              |                       |   
|Gross profit                                    |                                              | 77                    |   
|Operating expenses:                             |                                              |                       |   
|                                                | Sales and marketing                          |                       | 41
|                                                | Research and development                     |                       | 22
|                                                | General and administrative                   |                       | 16
|                                                | Acquired in-process research and development |                       |  
|                                                |                                              |                       |   
|Operating income (loss)                         |                                              | (2                    | ) 
|Interest income, net                            |                                              | 2                     |   
|                                                |                                              |                       |   
|Income (loss) before provision for income taxes |                                              |                      |   
|Provision for income taxes                      |                                              |                      |   
|                                                |                                              |                       |   
|Net income (loss)                               |                                              |                      |   
|                                                |                                              |                       |   

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

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

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

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

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Liquidity and Capital Resources

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

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

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

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

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

25

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

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

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

December 31,2003

$
3,8062004


3,5452005


3,3512006


2,7982007


2,585Thereafter


13$
16,098


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

Transactions with Management

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

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Recent Accounting Pronouncements

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

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

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

In
April 2002, the FASB issued SFAS No. 145,Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and
Technical Corrections. Prior to the issuance of SFAS No. 145, SFAS No. 4 had required that all gains and losses from extinguishment of debt were to be aggregated
and, if material, classified as an extraordinary item, net of related income tax effect. SFAS No. 145 rescinds SFAS No. 4 and the related required classification of extraordinary items.
This SFAS is effective for fiscal years beginning after May 15, 2002. We do not anticipate that the adoption of this SFAS will have a material impact on our financial statements.

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

Subsequent Event

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

27

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

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

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

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

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

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



28

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

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



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

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

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

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

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

29

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



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

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

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

30

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

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

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

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



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

Conducting business internationally poses risks that could affect our financial results

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

31

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

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

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



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

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

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

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

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

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

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

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

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



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

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

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

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

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

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

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

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

34

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

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

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

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

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

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

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

35

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

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

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

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

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

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

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

36

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

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



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

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

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

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

37

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



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

Our stock price has been volatile

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

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

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

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

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

38

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

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

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

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

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

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

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

Item 7A.    Qualitative and Quantitative Disclosures About Market Risk

None.

Item 8.    Financial Statements and Supplementary Data

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

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

None.

39

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PART III

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

Item 10.    Directors and Executive Officers of Registrant

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

Item 11.    Executive Compensation

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

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

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

Item 13.    Certain Relationships and Related Transactions.

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

Item 14.    Controls and Procedures

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

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

| |  |    |  |                                                 |  | Page
| |  | -- |  | ----------------------------------------------- |  | ----
| |  | 1. |  | Financial Statements                            |  |     
| |  |    |  | Independent Auditors' Report                    |  | F-2 
| |  |    |  | Consolidated Balance Sheets                     |  | F-3 
| |  |    |  | Consolidated Statements of Operations           |  | F-4 
| |  |    |  | Consolidated Statements of Stockholders' Equity |  | F-5 
| |  |    |  | Consolidated Statements of Cash Flows           |  | F-6 
| |  |    |  | Notes to Consolidated Financial Statements      |  | F-7 
| |  | 2. |  | Financial Statement Schedule                    |  |     
| |  |    |  | Schedule IIValuation and Qualifying Accounts   |  | F-22
| |  | 3. |  | Signatures                                      |  | S-1 
| |  | 4. |  | Certifications                                  |  | S-2 

40

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41

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|Exhibit
Number |  | Description                                                                                                                                                                                                                                                                                                                     
|-------------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|3.1(2)         |  | Fifth Amended and Restated Certificate of Incorporation of the Company.                                                                                                                                                                                                                                                         
|3.2(1)         |  | Amended and Restated Bylaws of the Company.                                                                                                                                                                                                                                                                                     
|3.3(8)         |  | Form of Certificate of Designation for Series A Junior Participating Preferred Stock                                                                                                                                                                                                                                            
|4.1(2)         |  | See Exhibit 3.1 for provisions of the Fifth Amended and Restated Certificate of Incorporation of the Company defining rights of the holders of Common Stock of the Company.                                                                                                                                                     
|4.2(4)         |  | See Exhibit 3.2 for provisions of the Amended and Restated Bylaws of the Company defining rights of the holders of Common Stock of the Company.                                                                                                                                                                                 
|4.3(1)         |  | Specimen Stock Certificate.                                                                                                                                                                                                                                                                                                     
|4.4(8)         |  | Form of Rights Agreement, dated October 25, 2002, between the Company and SunTrust Bank which includes the form of Certificate of Designation for the Series A Junior Participating Preferred Stock as Exhibit A, the form of Rights Certificate as
Exhibit B and the Summary of Rights to Purchase Preferred Stock as Exhibit C
|10.1(3)        |  | Lease Agreement between Company and Colonial Center at Mansell Overlook/Colonial Business Center dated July 28, 2000.                                                                                                                                                                                                           
|10.2(1)        |  | Amended and Restated Stock Incentive Plan of the Company.                                                                                                                                                                                                                                                                       
|10.3(2)        |  | Amendment No. 1 to the Company's Amended and Restated Stock Incentive Plan.                                                                                                                                                                                                                                                     
|10.4(5)        |  | Form of Stock Option Grant Certificate.                                                                                                                                                                                                                                                                                         
|10.5(1)        |  | Form of Amendment to Stock Option Grant Certificate between the Company and certain of the officers of the Company.                                                                                                                                                                                                             
|10.6(4)        |  | Employee Stock Purchase Plan of the Company.                                                                                                                                                                                                                                                                                    
|10.7(1)        |  | Employment Agreement entered into between David B. Gould and the Company effective February 2, 1999.                                                                                                                                                                                                                            
|10.8(1)        |  | Amendment No. 1 to Employment Agreement entered into between David B. Gould and the Company, dated as of August 2, 1999.                                                                                                                                                                                                        
|10.9(9)        |  | Promissory Note dated March 15, 2002, between the Company and David Gould.                                                                                                                                                                                                                                                      
|10.10(9)       |  | Form of Pledge Agreement between the Company and David Gould.                                                                                                                                                                                                                                                                   
|10.11(1)       |  | Restricted Stock Award Agreement dated March 31, 1999, between the Company and David Gould.                                                                                                                                                                                                                                     
|10.12(1)       |  | Amended and Restated Registration Rights Agreement dated as of August 2, 1999, as amended, among the Company and certain shareholders of the Company.                                                                                                                                                                           
|10.13(1)       |  | Subsidiary License and Distribution Agreement.                                                                                                                                                                                                                                                                                  
|10.14(1)       |  | Form of Indemnification Agreement for executive officers and directors of the Company.                                                                                                                                                                                                                                          
|10.15(6)       |  | Loan and Security Agreement between the Company and Silicon Valley Bank dated April 3, 2002.                                                                                                                                                                                                                                    
|               |  |                                                                                                                                                                                                                                                                                                                                 

42

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|10.16(6) |  | Loan Modification Agreement between the Company and Silicon Valley Bank dated November 12, 2002.                                           
|-------- |  | -------------------------------------------------------------------------------------------------------------------------------------------
|10.17(6) |  | Revolving Promissory Note between the Company and Silicon Valley Bank dated November 12, 2002.                                             
|10.18(7) |  | Notice of Forbearance between the Company and David Gould dated October 17, 2002.                                                          
|21.1*    |  | List of subsidiaries.                                                                                                                      
|23.1*    |  | Independent Auditors' Report on Financial Statement Schedule of KPMG LLP.                                                                  
|23.2*    |  | Independent Auditors' Consent of KPMG LLP.                                                                                                 
|99.1*    |  | Certification of David B. Gould pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.  
|99.2*    |  | Certification of William F. Evans pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
|99.3(10) |  | U.K. Offer Document of Registrant, dated February 28, 2003, commencing the recommended all cash offer of all the shares of Eyretel.        

---

43

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WITNESS SYSTEMS, INC.

Index to Consolidated Financial Statements

|                                                                                                      |  | Page
|----------------------------------------------------------------------------------------------------- |  | ----
|Independent Auditors' Report                                                                          |  | F-2 
|Consolidated Balance Sheets as of December 31, 2002 and 2001                                          |  | F-3 
|Consolidated Statements of Operations for the years ended December 31, 2002, 2001, and 2000           |  | F-4 
|Consolidated Statements of Stockholders' Equity for the years ended December 31, 2002, 2001, and 2000 |  | F-5 
|Consolidated Statements of Cash Flows for the years ended December 31, 2002, 2001, and 2000           |  | F-6 
|Notes to Consolidated Financial Statements                                                            |  | F-7 

F-1

---



Independent Auditors' Report

The
Board of Directors
Witness Systems, Inc.:

We
have audited the accompanying consolidated balance sheets of Witness Systems, Inc. and subsidiaries (the "Company") as of December 31, 2002 and 2001, and the related
consolidated statements of operations, stockholders' equity and cash flows for each of the years in the three-year period ended December 31, 2002. These consolidated financial
statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

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

In
our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Witness Systems, Inc. and subsidiaries
at December 31, 2002 and 2001, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2002 in conformity
with accounting principles generally accepted in the United States of America.

| |  | /s/ KPMG LLP
| |  | ------------

Atlanta,
Georgia
January 24, 2003, except as
    to Note 11, which is as of
    February 28, 2003

F-2

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WITNESS SYSTEMS, INC. AND SUBSIDIARIES    CONSOLIDATED BALANCE SHEETS    (In thousands, except share data)

|                                     |                                                                                                                                                                                               | December 31,               |       
|------------------------------------ | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | -------------------------- | ------
|
|ASSETS                               |                                                                                                                                                                                               |                            |       
|Current assets:                      |                                                                                                                                                                                               |                            |       
|                                     | Cash and cash equivalents                                                                                                                                                                     |                            | $     
|                                     | Restricted cash                                                                                                                                                                               |                            |       
|                                     | Investments                                                                                                                                                                                   |                            |       
|                                     | Accounts receivable, net of allowance for doubtful accounts of $1,339 in 2002 and $1,454 in 2001                                                                                              |                            |       
|                                     | Prepaid and other current assets                                                                                                                                                              |                            |       
|                                     |                                                                                                                                                                                               |                            |       
|                                     |                                                                                                                                                                                               | Total current assets       |       
|Restricted cash and cash equivalents |                                                                                                                                                                                               |                            |      
|Property and equipment, net          |                                                                                                                                                                                               |                            | 5,057 
|Intangible and other assets, net     |                                                                                                                                                                                               |                            | 582   
|                                     |                                                                                                                                                                                               |                            |       
|                                     |                                                                                                                                                                                               | $                          | 87,141
|                                     |                                                                                                                                                                                               |                            |       
|LIABILITIES AND STOCKHOLDERS' EQUITY |                                                                                                                                                                                               |                            |       
|Current liabilities:                 |                                                                                                                                                                                               |                            |       
|                                     | Accounts payable                                                                                                                                                                              |                            | $     
|                                     | Accrued expenses                                                                                                                                                                              |                            |       
|                                     | Deferred revenue                                                                                                                                                                              |                            |       
|                                     |                                                                                                                                                                                               |                            |       
|                                     |                                                                                                                                                                                               | Total current liabilities  |       
|                                     |                                                                                                                                                                                               |                            |       
|                                     |                                                                                                                                                                                               | Total liabilities          |       
|                                     |                                                                                                                                                                                               |                            |       
|Commitments and contingencies        |                                                                                                                                                                                               |                            |       
|Stockholders' equity:                |                                                                                                                                                                                               |                            |       
|                                     | Preferred stock, $.01 par value; 10,000,000 shares authorized (50,000 shares of which have been designated as Series A Junior Participating Preferred Stock), no shares issued or outstanding |                            |       
|                                     | Common stock, $.01 par value; 50,000,000 shares authorized, 22,035,756 and 22,479,360 shares issued and outstanding at December 31, 2002 and 2001, respectively                               |                            |       
|                                     | Additional paid-in capital                                                                                                                                                                    |                            |       
|                                     | Accumulated deficit                                                                                                                                                                           |                            |       
|                                     | Notes receivable for stock                                                                                                                                                                    |                            |       
|                                     | Accumulated other comprehensive income (loss)                                                                                                                                                 |                            |       
|                                     |                                                                                                                                                                                               |                            |       
|                                     |                                                                                                                                                                                               | Total stockholders' equity |       
|                                     |                                                                                                                                                                                               |                            |       
|                                     |                                                                                                                                                                                               | $                          | 87,141
|                                     |                                                                                                                                                                                               |                            |       

See
accompanying notes to consolidated financial statements.

F-3

---



WITNESS SYSTEMS, INC. AND SUBSIDIARIES    CONSOLIDATED STATEMENTS OF OPERATIONS    (In thousands, except per share data)

|                                                   |                                                    | December 31,                                                               |                  
|-------------------------------------------------- | -------------------------------------------------- | -------------------------------------------------------------------------- | -----------------
|
|Revenue:                                           |                                                    |                                                                            |                  
|                                                   | License                                            |                                                                            | $                
|                                                   | Services                                           |                                                                            |                  
|                                                   |                                                    |                                                                            |                  
|                                                   |                                                    | Total revenue                                                              |                  
|                                                   |                                                    |                                                                            |                  
|Cost of revenue:                                   |                                                    |                                                                            |                  
|                                                   | License                                            |                                                                            |                  
|                                                   | Services                                           |                                                                            |                  
|                                                   |                                                    |                                                                            |                  
|                                                   |                                                    | Total cost of revenue                                                      |                  
|                                                   |                                                    |                                                                            |                  
|                                                   |                                                    | Gross profit                                                               |                  
|Operating expenses:                                |                                                    |                                                                            |                  
|                                                   | Sales and marketing                                |                                                                            |                  
|                                                   | Research and development                           |                                                                            |                  
|                                                   | General and administrative                         |                                                                            |                  
|                                                   | Acquired in-process research and development       |                                                                            |                  
|                                                   |                                                    |                                                                            |                  
|                                                   |                                                    | Operating loss                                                             |                  
|Interest and other income, net                     |                                                    |                                                                            | 1,570            
|                                                   |                                                    |                                                                            |                  
|                                                   |                                                    | Income (loss) before provision for income taxes and
    extraordinary loss |                  
|Provision for income taxes                         |                                                    |                                                                            | 261              
|                                                   |                                                    |                                                                            |                  
|                                                   |                                                    | Income (loss) before extraordinary loss                                    |                  
|Extraordinary loss on early extinguishment of debt |                                                    |                                                                            |                 
|                                                   |                                                    |                                                                            |                  
|                                                   |                                                    | Net income (loss)                                                          |                  
|Preferred stock dividends and accretion            |                                                    |                                                                            |                 
|                                                   |                                                    |                                                                            |                  
|                                                   |                                                    | Net income (loss) applicable to common stockholders                        |                  
|                                                   |                                                    |                                                                            |                  
|Net income (loss) per share:                       |                                                    |                                                                            |                  
|                                                   | Basic:                                             |                                                                            |                  
|                                                   |                                                    | Income (loss) before extraordinary loss                                    |                  
|                                                   |                                                    | Extraordinary loss                                                         |                  
|                                                   |                                                    |                                                                            |                  
|                                                   |                                                    |                                                                            | Net income (loss)
|                                                   |                                                    |                                                                            |                  
|                                                   | Basic weighted-average common shares outstanding   |                                                                            |                  
|                                                   |                                                    |                                                                            |                  
|                                                   | Diluted:                                           |                                                                            |                  
|                                                   |                                                    | Income (loss) before extraordinary loss                                    |                  
|                                                   |                                                    | Extraordinary loss                                                         |                  
|                                                   |                                                    |                                                                            |                  
|                                                   |                                                    |                                                                            | Net income (loss)
|                                                   |                                                    |                                                                            |                  
|                                                   | Diluted weighted-average common shares outstanding |                                                                            |                  
|                                                   |                                                    |                                                                            |                  

See
accompanying notes to consolidated financial statements.

F-4

---



WITNESS SYSTEMS, INC. AND SUBSIDIARIES    CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY  (In thousands)

|                                                                          |                                          | Common Stock               |   |   |     |   |   |        |   | Treasury Stock |         |        |   |        |  
|------------------------------------------------------------------------- | ---------------------------------------- | -------------------------- | - | - | --- | - | - | ------ | - | -------------- | ------- | ------ | - | ------ | -
|
|
|Balance at December 31, 1999                                              |                                          | 10,317                     |   | $ | 103 |   | $ | 4,347  |   | $              | (20,591 | )      | $ | (2,594 | )
|Accretion on Series A, Series B, and Series C convertible preferred stock |                                          |                           |   |   |    |   |   | (604   | ) |                |        |        |   |       |  
|Dividends accrued on Series A convertible preferred stock                 |                                          |                           |   |   |    |   |   | (7     | ) |                |        |        |   |       |  
|Conversion of preferred stock upon initial public offering                |                                          | 10,410                     |   |   | 104 |   |   | 23,344 |   |                |        |        |   |       |  
|Common stock issued upon initial public offering, net                     |                                          | 4,019                      |   |   | 40  |   |   | 73,197 |   |                |        |        |   |       |  
|Exercise of stock options and warrants                                    |                                          | 563                        |   |   | 6   |   |   | 665    |   |                |        |        |   |       |  
|Shares issued under employee stock purchase plan                          |                                          | 39                         |   |   |    |   |   | 510    |   |                |        |        |   |       |  
|Retirement of treasury stock                                              |                                          | (3,440                     | ) |   | (34 | ) |   | (6,887 | ) |                |        |        |   |       |  
|Repayment of notes receivable for stock                                   |                                          |                           |   |   |    |   |   |       |   |                |        |        |   | 181    |  
|Comprehensive loss:                                                       |                                          |                            |   |   |     |   |   |        |   |                |         |        |   |        |  
|                                                                          | Foreign currency translation adjustments |                            |  |   |     |  |   |        |  |                |         |       |   |        | 
|                                                                          | Unrealized gain on investments, net      |                            |  |   |     |  |   |        |  |                |         |       |   |        | 
|                                                                          | Net loss                                 |                            |  |   |     |  |   |        |  |                |         | (2,214 | ) |        | 
|                                                                          |                                          |                            |   |   |     |   |   |        |   |                |         |        |   |        |  
|                                                                          |                                          | Total comprehensive loss   |   |   |     |   |   |        |   |                |         |        |   |        |  
|                                                                          |                                          |                            |   |   |     |   |   |        |   |                |         |        |   |        |  
|Balance at December 31, 2000                                              |                                          | 21,908                     |   |   | 219 |   |   | 94,565 |   |                | (22,805 | )      |   | (2,413 | )
|Exercise of stock options and warrants                                    |                                          | 518                        |   |   | 5   |   |   | 1,174  |   |                |        |        |   |       |  
|Shares issued under employee stock purchase plan                          |                                          | 53                         |   |   | 1   |   |   | 485    |   |                |        |        |   |       |  
|Repayment of notes receivable for stock                                   |                                          |                           |   |   |    |   |   |       |   |                |        |        |   | 91     |  
|Comprehensive loss:                                                       |                                          |                            |   |   |     |   |   |        |   |                |         |        |   |        |  
|                                                                          | Foreign currency translation adjustments |                            |  |   |     |  |   |        |  |                |         |       |   |        | 
|                                                                          | Unrealized loss on investments, net      |                            |  |   |     |  |   |        |  |                |         |       |   |        | 
|                                                                          | Net loss                                 |                            |  |   |     |  |   |        |  |                |         | (5,180 | ) |        | 
|                                                                          |                                          |                            |   |   |     |   |   |        |   |                |         |        |   |        |  
|                                                                          |                                          | Total comprehensive loss   |   |   |     |   |   |        |   |                |         |        |   |        |  
|                                                                          |                                          |                            |   |   |     |   |   |        |   |                |         |        |   |        |  
|Balance at December 31, 2001                                              |                                          | 22,479                     |   |   | 225 |   |   | 96,224 |   |                | (27,985 | )      |   | (2,322 | )
|Exercise of stock options                                                 |                                          | 378                        |   |   | 4   |   |   | 985    |   |                |        |        |   |       |  
|Shares issued under employee stock purchase plan                          |                                          | 85                         |   |   | 1   |   |   | 369    |   |                |        |        |   |       |  
|Repayment of notes receivable for stock and related interest receivable   |                                          | (66                        | ) |   | (1  | ) |   | (871   | ) |                |        |        |   | 852    |  
|Stock repurchases                                                         |                                          | (840                       | ) |   | (9  | ) |   | (2,447 | ) |                |        |        |   |       |  
|Comprehensive income:                                                     |                                          |                            |   |   |     |   |   |        |   |                |         |        |   |        |  
|                                                                          | Foreign currency translation adjustments |                            |  |   |     |  |   |        |  |                |         |       |   |        | 
|                                                                          | Unrealized gain on investments, net      |                            |  |   |     |  |   |        |  |                |         |       |   |        | 
|                                                                          | Net income                               |                            |  |   |     |  |   |        |  |                |         | 48     |   |        | 
|                                                                          |                                          |                            |   |   |     |   |   |        |   |                |         |        |   |        |  
|                                                                          |                                          | Total comprehensive income |   |   |     |   |   |        |   |                |         |        |   |        |  
|                                                                          |                                          |                            |   |   |     |   |   |        |   |                |         |        |   |        |  
|Balance at December 31, 2002                                              |                                          | 22,036                     |   | $ | 220 |   | $ | 94,260 |   | $              | (27,937 | )      | $ | (1,470 | )
|                                                                          |                                          |                            |   |   |     |   |   |        |   |                |         |        |   |        |  

See accompanying notes to consolidated financial statements.

F-5

---



WITNESS SYSTEMS, INC. AND SUBSIDIARIES    CONSOLIDATED STATEMENTS OF CASH FLOWS    (In thousands)

|                                               |                                                                                                                              | December 31,                                 |                         
|---------------------------------------------- | ---------------------------------------------------------------------------------------------------------------------------- | -------------------------------------------- | ------------------------
|
|Cash flows from operating activities:          |                                                                                                                              |                                              |                         
|                                               | Income (loss) before extraordinary loss                                                                                      |                                              | $                       
|                                               | Adjustments to reconcile income (loss) before extraordinary loss
    to net cash provided by (used in) operating activities: |                                              |                         
|                                               |                                                                                                                              | Depreciation and amortization                |                         
|                                               |                                                                                                                              | Provision for doubtful accounts              |                         
|                                               |                                                                                                                              | Other non-cash items, net                    |                         
|                                               |                                                                                                                              | Changes in operating assets and liabilities: |                         
|                                               |                                                                                                                              |                                              | Accounts receivable     
|                                               |                                                                                                                              |                                              | Prepaid and other assets
|                                               |                                                                                                                              |                                              | Accounts payable        
|                                               |                                                                                                                              |                                              | Accrued expenses        
|                                               |                                                                                                                              |                                              | Deferred revenue        
|                                               |                                                                                                                              |                                              |                         
|                                               |                                                                                                                              |                                              |                         
|                                               |                                                                                                                              |                                              |                         
|Cash flows from investing activities:          |                                                                                                                              |                                              |                         
|                                               | Capital expenditures                                                                                                         |                                              |                         
|                                               | Purchases of investments                                                                                                     |                                              |                         
|                                               | Proceeds from sales and maturities of investments                                                                            |                                              |                         
|                                               | Purchases of other assets                                                                                                    |                                              |                         
|                                               | Allocation from (to) restricted cash                                                                                         |                                              |                         
|                                               |                                                                                                                              |                                              |                         
|                                               |                                                                                                                              |                                              |                         
|                                               |                                                                                                                              |                                              |                         
|Cash flows from financing activities:          |                                                                                                                              |                                              |                         
|                                               | Proceeds from exercise of stock options                                                                                      |                                              |                         
|                                               | Proceeds from employee stock purchase plan                                                                                   |                                              |                         
|                                               | Repayments of notes receivable from stockholders                                                                             |                                              |                         
|                                               | Proceeds from issuance of common stock, net                                                                                  |                                              |                         
|                                               | Repayments on long-term debt                                                                                                 |                                              |                         
|                                               | Stock repurchases                                                                                                            |                                              |                         
|                                               |                                                                                                                              |                                              |                         
|                                               |                                                                                                                              |                                              |                         
|                                               |                                                                                                                              |                                              |                         
|                                               | Effect of exchange rate changes on cash                                                                                      |                                              |                         
|                                               |                                                                                                                              |                                              |                         
|Cash and cash equivalents at beginning of year |                                                                                                                              |                                              | 23,209                  
|                                               |                                                                                                                              |                                              |                         
|Cash and cash equivalents at end of year       |                                                                                                                              | $                                            | 36,391                  
|                                               |                                                                                                                              |                                              |                         
|Supplemental cash flow information:            |                                                                                                                              |                                              |                         
|                                               | Cash paid for interest                                                                                                       |                                              |                         
|                                               |                                                                                                                              |                                              |                         
|                                               | Cash paid for income taxes                                                                                                   |                                              | $                       
|                                               |                                                                                                                              |                                              |                         

See
accompanying notes to consolidated financial statements.

F-6

---

(1)  Summary of Significant Accounting Policies

(a)  Principles of Consolidation and Reclassifications



(b)  Description of Business



(c)  Use of Estimates



(d)  Revenue Recognition and Deferred Revenue



F-7

---



(e)  Cash and Cash Equivalents and Investments



(f)    Prepaid and Other Current Assets



(g)  Property and Equipment



December 31,2002

2001(In thousands)Property and equipmentComputer equipment

$
3,287

$
6,275Software


1,792


2,874Other equipment


2,008


1,390Furniture and fixtures


276


217Leasehold improvements


1,575


1,2148,938


11,970Less accumulated depreciation and amortization


3,881


6,740$
5,057

$
5,230


F-8

---



(h)  Intangible and Other Assets



Intangible
and other assets are comprised of the following:

December 31,2002

2001(In thousands)Deposits

$
397

$
262Intangible assets


298


1,150695


1,412Less accumulated amortization of intangible assets


113


711$
582

$
701




(i)    Impairment of Long-Lived and Intangible Assets



(j)    Advertising Costs



(k)  Research and Development and Software Development Costs



F-9

---



(l)    Income Taxes



(m)  Stock Compensation



Year ended December 31,2002

2001

2000Historical net income (loss)

$
48

$
(5,180
)
$
(2,214
)Add: Stock-based employee compensation


115


171


271Deduct: Total stock-based compensation expense determined under fair value based method for all awards


11,472


9,278


4,903Pro forma net loss

$
(11,309
)
$
(14,287
)
$
(6,846
)Pro forma basic and diluted net loss per share

$
(0.50
)
$
(0.64
)
$
(0.34
)




(n)  Net Income (Loss) Per Share



F-10

---



Year ended December 31,2002

2001

2000Income (loss) before extraordinary loss

$
48

$
(5,180
)
$
(1,966
)Preferred stock dividends and accretion








(611
)Net income (loss) applicable to common stockholders

$
48

$
(5,180
)
$
(2,577
)Average shares of common stock outstanding:
Basic common shares outstanding


22,626


22,258


19,997Effect of stock options


898





Diluted common shares outstanding


23,524


22,258


19,997Basic net income (loss) per share before extraordinary loss

$
0.00

$
(0.23
)
$
(0.13
)Diluted net income (loss) per share before extraordinary loss

$
0.00

$
(0.23
)
$
(0.13
)




(o)  Business and Credit Concentration



(p)  Segment and Geographic Information



(q)  Fair Value of Financial Instruments



F-11

---

(r)  Foreign Currency



(s)  Recent Accounting Pronouncements



F-12

---



(2)  Line of Credit



(3)  Investments



UnrealizedDecember 31, 2002Cost

Gain

Loss

Market(in thousands)Cash and cash equivalents:Cash

$
4,991







$
4,991Money market fund


25,098








25,098Auction rate securities


6,302








6,302Total cash and cash equivalents

$
36,391







$
36,391Investments:Auction rate securities

$
1,501

$


$


$
1,501Corporate debt securities


13,383


164





13,547U.S. Government Agency securities


13,888


11


(10
)

13,889Total investments

$
28,772

$
175

$
(10
)
$
28,937


F-13

---



UnrealizedDecember 31, 2001Cost

Gain

Loss

Market(in thousands)Cash and cash equivalents:Cash

$
1,818







$
1,818Money market fund


11,649








11,649Auction rate securities


15,000








15,000Total cash and cash equivalents


28,467








28,467Less: Restricted cash and cash equivalents


(5,258
)







(5,258
)Unrestricted cash and cash equivalents

$
23,209







$
23,209Investments:Auction rate securities

$
3,850

$


$


$
3,850Corporate debt securities


10,927


52





10,979U.S. Government Agency securities


17,682


7


(18
)

17,671Total investments

$
32,459

$
59

$
(18
)
$
32,500




(4)  Acquired In-Process Research and Development and Related Charges



F-14

---



(5)  Other Balance Sheet Information



December 31,2002

2001(in thousands)Accrued compensation and benefits

$
3,167

$
2,748Sales taxes payable


743


988Other miscellaneous accrued expenses


2,579


2,828$
6,489

$
6,564


Accumulated
other comprehensive income (loss) consisted of the following:

December 31,2002

2001(in thousands)Cumulative foreign currency translation adjustments

$
(164
)
$
(129
)Unrealized gain on investments, net


165


41$
1

$
(88
)


(6)  Stockholders' Equity







F-15

---



(7)  Employee Benefit Plans



F-16

---



Number
of shares

Weighted-
average
exercise priceBalance at December 31, 1999

2,882,058

$
2.44Granted

1,811,871


11.22Exercised

(534,724
)

1.25Cancelled

(360,722
)

5.76Balance at December 31, 2000

3,798,483


6.43Granted

2,637,630


9.02Exercised

(422,455
)

2.52Cancelled

(643,511
)

7.94Balance at December 31, 2001

5,370,147


7.82Granted

1,383,607


8.65Exercised

(378,017
)

2.37Cancelled

(769,620
)

9.82Balance at December 31, 2002

5,606,117


8.12




ExercisableWeighted-
Average
Remaining
Life

Weighted-
Average
Exercise
PriceRange of
Exercise Prices

Number
Outstanding

Number
of shares

Weighted-
Average
Exercise Price$0.12  $5.81

1,257,437

7.3 years

$
3.08

742,044

$
1.77$5.82  $7.99

2,190,520

7.5 years


6.97

765,690


7.05$8.00  $12.99

1,104,545

8.6 years


9.86

461,061


9.56$13.00  $38.25

1,053,615

8.5 years


14.70

361,435


15.615,606,117

7.9 years


8.12

2,330,230


7.19






F-17

---







(8)  Income Taxes



2002

2001Federal

$
(32
)
$
52State





32Foreign


293


32Total

$
261

$
116




F-18

---



Year ended December 31,2002

2001

2000Computed "expected" tax expense (benefit)

$
105

$
(1,722
)
$
(753
)Increase (decrease) in income taxes resulting from:State income taxes, net of federal income taxes


(7
)

(186
)

(54
)Nondeductible meals & entertainment


148


127


113Other permanent differences


(356
)

(206
)

(33
)Income tax effect attributable to foreign operations at different rates


384


(160
)

272Generation of research and experimentation credit carryforward


(440
)

(332
)

(100
)Increase in valuation allowance


411


2,589


553Other, net


16


6


2$
261

$
116







December 31,2002

2001Deferred income tax assets:Allowance for bad debts

$
449

$
589Accruals not deducted for tax


145


184Property and equipment, principally due to differences in depreciation


1,906


2,458Net operating loss and research and experimentation credit carryforwards


6,441


5,542Total gross deferred income tax assets


8,941


8,773Less valuation allowance


(8,941
)

(8,530
)Net deferred income tax assets





243Deferred income tax liabilities:Deferred stock compensation





(243
)







F-19

---



(9)  Long-Term Debt



(10) Commitments and Contingencies



December 31,2003

$
3,8062004


3,5452005


3,3512006


2,7982007


2,585Thereafter


13$
16,098




F-20

---



(11) Subsequent Event



F-21

---



SCHEDULE II

Valuation and Qualifying Accounts

Balance at
Beginning
of Year

Increases

Deductions

Balance at
End of YearAllowance for Doubtful Accounts:Year ended December 31, 2002

$
1,454

$
600

($
715
)
$
1,339Year ended December 31, 2001


775


1,624


(945
)

1,454Year ended December 31, 2000


438


544


(207
)

775Sales Allowances:Year ended December 31, 2002

$
169

$
308

($
242
)
$
235Year ended December 31, 2001


353


160


(344
)

169Year ended December 31, 2000


300


332


(279
)

353Hardware Warranty Reserve:Year ended December 31, 2002

$
18




($
18
)

Year ended December 31, 2001


90





(72
)

18Year ended December 31, 2000


163





(73
)

90


F-22

---



SIGNATURES

Pursuant to the requirements of Section 13 of 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, thereunto duly authorized.

Dated:
March 14, 2003

| |  | WITNESS SYSTEMS, INC.
| |  | ---------------------
| |  | By:                  

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

|                                    |  |                                                              |  |               
|----------------------------------- |  | ------------------------------------------------------------ |  | --------------
|                                    |  |                                                              |  |               
|/s/DAVID B. GOULDDavid B. Gould     |  | Chairman of the Board,
President and Chief
Executive Officer |  | March 14, 2003
|/s/WILLIAM F. EVANSWilliam F. Evans |  | Executive Vice President
and Chief Financial
Officer         |  | March 14, 2003
|/s/THOMAS J. CROTTYThomas J. Crotty |  | Director                                                     |  | March 14, 2003
|/s/JOEL G. KATZJoel G. Katz         |  | Director                                                     |  | March 14, 2003
|/s/PETER SINISGALLIPeter Sinisgalli |  | Director                                                     |  | March 14, 2003
|/s/DAN LAUTENBACHDan Lautenbach     |  | Director                                                     |  | March 14, 2003

S-1

---



CERTIFICATE OF THE CHIEF EXECUTIVE OFFICER

I, the Chief Executive Officer, of Witness Systems, Inc. (the "registrant"), certify that:





Dated
this 14th day of March 2003.

| |  |  | /s/DAVID B. GOULDDavid B. Gould Chairman of the Board,
President and Chief Executive Officer
| |  |  | --------------------------------------------------------------------------------------------

S-2

---



CERTIFICATE OF THE CHIEF FINANCIAL OFFICER

I, the Chief Financial Officer, of Witness Systems, Inc. (the "registrant"), certify that:





Dated
this 14th day of March 2003.

| |  |  | /s/WILLIAM F. EVANSWilliam F. Evans Executive Vice President and
Chief Financial Officer
| |  |  | ----------------------------------------------------------------------------------------

S-3

---

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