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SECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549

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FORM 10-Q

|ý | QUARTERLY REPORT PURSUANT TO SECTION 13 OF THE
SECURITIES EXCHANGE ACT OF 1934          
|- | ----------------------------------------------------------------------------------------
|  | For the quarterly period ended September 30, 2002                                       
|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)                               

Registrant's telephone number, including area code770-754-1900

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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 the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.

Class

Outstanding at November 1, 2002Common Stock, par value $.01 per share

22,826,057


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WITNESS SYSTEMS, INC.    FORM 10-Q    INDEX

|               |  |                                                                                                                 |  | Page
|-------------- |  | --------------------------------------------------------------------------------------------------------------- |  | ----
|PART I.        |  | FINANCIAL INFORMATION                                                                                           |  |     
|Item 1.        |  | Financial Statements:                                                                                           |  |     
|               |  | Condensed Consolidated Balance Sheets at
September 30, 2002 and December 31, 2001                               |  | 3   
|               |  | Condensed Consolidated Statements of Operations
for the three and nine months ended September 30, 2002 and 2001 |  | 4   
|               |  | Condensed Consolidated Statements of Cash Flows
for the nine months ended September 30, 2002 and 2001           |  | 5   
|               |  | Notes to the Condensed Consolidated Financial Statements                                                        |  | 6   
|Item 2.        |  | Management's Discussion and Analysis of
Financial Condition and Results of Operations                           |  | 12  
|Item 3.        |  | Quantitative and Qualitative Disclosures About Market Risk                                                      |  | 30  
|Item 4.        |  | Controls and Procedures                                                                                         |  | 30  
|PART II.       |  | OTHER INFORMATION                                                                                               |  |     
|Item 1.        |  | Legal Proceedings                                                                                               |  | 31  
|Item 6.        |  | Exhibits and Reports on Form 8-K                                                                                |  | 31  
|SIGNATURES     |  | 32                                                                                                             
|CERTIFICATIONS |  | 33                                                                                                             

2

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PART I.  FINANCIAL INFORMATION

Item 1. Financial Statements

WITNESS SYSTEMS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
(unaudited)

|                                                                                                                                                                              |  | September 30,
2002 |         | December 31,
2001 |  
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------------ | ------- | ----------------- | -
|Assets                                                                                                                                                                        |  |                    |         |                   |  
|Current assets:                                                                                                                                                               |  |                    |         |                   |  
|Cash and cash equivalents                                                                                                                                                     |  | $                  | 32,507  |                   | $
|Restricted cash                                                                                                                                                               |  |                    |        |                   |  
|Short term investments                                                                                                                                                        |  |                    | 28,604  |                   |  
|Accounts receivable, net of allowance for doubtful accounts of $1,284 at September 30, 2002 and $1,454 at December 31, 2001                                                   |  |                    | 13,038  |                   |  
|Prepaid and other current assets                                                                                                                                              |  |                    | 2,989   |                   |  
|                                                                                                                                                                              |  |                    |         |                   |  
|Total current assets                                                                                                                                                          |  |                    | 77,138  |                   |  
|Restricted cash                                                                                                                                                               |  |                    |        |                   |  
|Property and equipment, net                                                                                                                                                   |  |                    | 5,390   |                   |  
|Intangible and other assets, net                                                                                                                                              |  |                    | 653     |                   |  
|                                                                                                                                                                              |  |                    |         |                   |  
|                                                                                                                                                                              |  | $                  | 83,181  |                   | $
|                                                                                                                                                                              |  |                    |         |                   |  
|Liabilities and Stockholders' Equity                                                                                                                                          |  |                    |         |                   |  
|Current liabilities:                                                                                                                                                          |  |                    |         |                   |  
|Accounts payable                                                                                                                                                              |  | $                  | 1,462   |                   | $
|Accrued expenses                                                                                                                                                              |  |                    | 5,249   |                   |  
|Deferred revenue                                                                                                                                                              |  |                    | 9,083   |                   |  
|                                                                                                                                                                              |  |                    |         |                   |  
|Total current liabilities                                                                                                                                                     |  |                    | 15,794  |                   |  
|Total liabilities                                                                                                                                                             |  |                    | 15,794  |                   |  
|                                                                                                                                                                              |  |                    |         |                   |  
|Commitments and contingencies                                                                                                                                                 |  |                    |         |                   |  
|Stockholders' equity:                                                                                                                                                         |  |                    |         |                   |  
|Preferred stock, $.01 par value; 10,000,0000 shares authorized, no shares issued or outstanding                                                                               |  |                    |        |                   |  
|Common stock, $.01 par value; 50,000,000 shares authorized; 22,793,198 and 22,479,360 shares issued and outstanding at September 30, 2002 and December 31, 2001, respectively |  |                    | 228     |                   |  
|Additional paid-in capital                                                                                                                                                    |  |                    | 96,541  |                   |  
|Accumulated deficit                                                                                                                                                           |  |                    | (27,885 | )                 |  
|Notes receivable for stock                                                                                                                                                    |  |                    | (1,470  | )                 |  
|Accumulated other comprehensive loss                                                                                                                                          |  |                    | (27     | )                 |  
|                                                                                                                                                                              |  |                    |         |                   |  
|Total stockholders' equity                                                                                                                                                    |  |                    | 67,387  |                   |  
|                                                                                                                                                                              |  |                    |         |                   |  
|                                                                                                                                                                              |  | $                  | 83,181  |                   | $
|                                                                                                                                                                              |  |                    |         |                   |  

The
accompanying notes are an integral part of these condensed consolidated financial statements.

3

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WITNESS SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
(unaudited)

|                                                                 |  | Three months ended
September 30, |        | Nine months ended
September 30, |  
|---------------------------------------------------------------- |  | -------------------------------- | ------ | ------------------------------- | -
|
|Revenue:                                                         |  |                                  |        |                                 |  
|License                                                          |  | $                                | 6,590  |                                 | $
|Services                                                         |  |                                  | 8,461  |                                 |  
|                                                                 |  |                                  |        |                                 |  
|Total revenue                                                    |  |                                  | 15,051 |                                 |  
|                                                                 |  |                                  |        |                                 |  
|Cost of revenue:                                                 |  |                                  |        |                                 |  
|License                                                          |  |                                  | 261    |                                 |  
|Services                                                         |  |                                  | 3,036  |                                 |  
|                                                                 |  |                                  |        |                                 |  
|Total cost of revenue                                            |  |                                  | 3,297  |                                 |  
|                                                                 |  |                                  |        |                                 |  
|Gross profit                                                     |  |                                  | 11,754 |                                 |  
|Operating expenses:                                              |  |                                  |        |                                 |  
|Sales and marketing                                              |  |                                  | 6,996  |                                 |  
|Research and development                                         |  |                                  | 3,698  |                                 |  
|General and administrative                                       |  |                                  | 2,638  |                                 |  
|Acquired in-process research and development and related charges |  |                                  |       |                                 |  
|                                                                 |  |                                  |        |                                 |  
|Operating loss                                                   |  |                                  | (1,578 | )                               |  
|Interest and other income, net                                   |  |                                  | 379    |                                 |  
|                                                                 |  |                                  |        |                                 |  
|(Loss) income before provision for income taxes                  |  |                                  | (1,199 | )                               |  
|Provision for income taxes                                       |  |                                  |       |                                 |  
|                                                                 |  |                                  |        |                                 |  
|Net (loss) income                                                |  | $                                | (1,199 | )                               | $
|                                                                 |  |                                  |        |                                 |  
|Net (loss) income per share:                                     |  |                                  |        |                                 |  
|Basic                                                            |  | $                                | (0.05  | )                               | $
|                                                                 |  |                                  |        |                                 |  
|Diluted                                                          |  | $                                | (0.05  | )                               | $
|                                                                 |  |                                  |        |                                 |  
|Weighted-average common shares outstanding:                      |  |                                  |        |                                 |  
|Basic                                                            |  |                                  | 22,775 |                                 |  
|                                                                 |  |                                  |        |                                 |  
|Diluted                                                          |  |                                  | 22,775 |                                 |  
|                                                                 |  |                                  |        |                                 |  

The
accompanying notes are an integral part of these condensed consolidated financial statements.

4

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WITNESS SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)

|                                                                                                    |  | Nine months ended
September 30, |        
|--------------------------------------------------------------------------------------------------- |  | ------------------------------- | -------
|
|Cash flows from operating activities:                                                               |  |                                 |        
|Net income (loss)                                                                                   |  | $                               | 100    
|Adjustments to reconcile net income (loss) to net cash provided by (used for) operating activities: |  |                                 |        
|Depreciation and amortization                                                                       |  |                                 | 2,897  
|Other non-cash items                                                                                |  |                                 | 516    
|Changes in operating assets and liabilities:                                                        |  |                                 |        
|Accounts receivable                                                                                 |  |                                 | 361    
|Prepaid and other assets                                                                            |  |                                 | 214    
|Accounts payable                                                                                    |  |                                 | (1,903 
|Accrued expenses                                                                                    |  |                                 | (1,293 
|Deferred revenue                                                                                    |  |                                 | 863    
|                                                                                                    |  |                                 |        
|Net cash provided by (used for) operating activities                                                |  |                                 | 1,755  
|                                                                                                    |  |                                 |        
|Cash flows from investing activities:                                                               |  |                                 |        
|Purchases of property and equipment and other assets, net                                           |  |                                 | (2,539 
|Purchases of investments                                                                            |  |                                 | (39,525
|Maturities of investments                                                                           |  |                                 | 43,363 
|Allocation from (to) restricted cash                                                                |  |                                 | 5,258  
|                                                                                                    |  |                                 |        
|Net cash provided by investing activities                                                           |  |                                 | 6,557  
|                                                                                                    |  |                                 |        
|Cash flows from financing activities:                                                               |  |                                 |        
|Proceeds from exercise of stock options and employee purchase plan                                  |  |                                 | 1,116  
|                                                                                                    |  |                                 |        
|Net cash provided by financing activities                                                           |  |                                 | 1,116  
|                                                                                                    |  |                                 |        
|Effect of exchange rate changes on cash and cash equivalents                                        |  |                                 | (130   
|                                                                                                    |  |                                 |        
|Net change in cash and cash equivalents                                                             |  |                                 | 9,298  
|Cash and cash equivalents at beginning of period                                                    |  |                                 | 23,209 
|                                                                                                    |  |                                 |        
|Cash and cash equivalents at end of period                                                          |  | $                               | 32,507 
|                                                                                                    |  |                                 |        
|Supplemental disclosure of cash flow information:                                                   |  |                                 |        
|Cash paid for income taxes                                                                          |  | $                               | 167    
|                                                                                                    |  |                                 |        

The
accompanying notes are an integral part of these condensed consolidated financial statements.

5

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WITNESS SYSTEMS, INC.        NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS        September 30, 2002        (unaudited)

1. General and Basis of Presentation

Witness Systems, Inc. and subsidiaries (the "Company") provide an integrated performance optimization software suite to help companies capture customer
intelligence and optimize workforce performance. Comprised of business-driven multimedia recording, performance analysis and e-learning management applications, the browser-based software
solution is designed to enhance the quality of customer interactions across multiple communications media, including the telephone, e-mail and Web. The closed-loop suite
enables companies to record, evaluate and analyze customer contacts, and then launch e-learning to develop staff, generate additional revenue, and achieve greater customer retention and
loyalty. The Company is headquartered in Roswell, Georgia with other offices in the United States, Canada, Mexico, Brazil, the United Kingdom, the Netherlands, Japan, Australia and Singapore. The
Company was originally incorporated in 1988 in Georgia and was reincorporated in Delaware on March 13, 1997.

The
unaudited interim condensed consolidated financial statements include the accounts of Witness Systems, Inc. and its wholly-owned subsidiaries. All significant intercompany
accounts and transactions have been eliminated in consolidation. Certain prior year amounts have been reclassified to conform with the current year presentation.

The
financial statements herein have been prepared in accordance with the requirements of Form 10-Q and, therefore, do not include certain information and footnotes
required by generally accepted accounting principles in the United States. However, in the opinion of management, all adjustments (which, except as disclosed elsewhere herein, consist only of normal
recurring accruals) necessary for a fair presentation of the results of operations for the relevant periods have been made. Results for the interim periods are not necessarily indicative of the
results to be expected for the year. These financial statements should be read in conjunction with the summary of significant accounting policies and the notes to the consolidated financial statements
included in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2001, filed with the U.S. Securities and Exchange Commission.

2. Revenue Recognition and Deferred Revenue Policy

The Company recognizes revenue in accordance with Statement of Position ("SOP") 97-2,Software Revenue
Recognition, and SOP 98-9,Modification of SOP 97-2, Software Revenue Recognition, With Respect to Certain
Transactions. Revenue is derived from licensing software and providing related services including maintenance. Revenue is allocated to each element of the arrangement based on
its relative fair value, which is established by the price charged when the respective element is sold separately.

Revenue
from license fees 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. Services revenue includes installation, training, consulting, maintenance and reimbursable travel expenses. Revenue from installation, training and consulting services are recognized upon
performance of the related services and are offered and billed as separate elements of contracts. Reimbursable travel expenses revenue is recognized upon incurrence of the related expenses. The
functionality of the software is not dependent on installation and training 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 in advance, is deferred and recognized ratably over the term of the related contract. Specified
upgrades are not typically offered to customers.

6

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3. Net (Loss) Income Per Share

The following table presents the computation of basic and diluted net (loss) income per share for the three and nine months ended September 30, 2002 and
2001:

Three months ended
September 30,

Nine months ended
September 30,2002

2001

2002

2001(in thousands, except per share amounts)Net (loss) income

$
(1,199
)
$
20

$
100

$
(5,683
)Average shares of common stock outstanding:Basic


22,775


22,371


22,680


22,203Effect of stock options





1,412


1,079


Diluted common shares
outstanding


22,775


23,783


23,759


22,203Net (loss) income per share:Basic

$
(0.05
)
$
0.00

$
0.00

$
(0.26
)Diluted

$
(0.05
)
$
0.00

$
0.00

$
(0.26
)


For
the three months ended September 30, 2002 and for the nine months ended September 30, 2001, the Company has excluded stock options of 531,157 and 1,598,291,
respectively, from the calculation of diluted net loss per common share because all such securities were anti-dilutive.

4. Comprehensive Income (Loss)

The following table presents the components of total comprehensive income (loss), net of income tax, and accumulated other comprehensive loss:

Three months ended
September 30,

Nine months ended
September 30,2002

2001

2002

2001(in thousands)Net (loss) income

$
(1,199
)
$
20

$
100

$
(5,683
)Other comprehensive income (loss), net of income tax:Foreign currency translation adjustments


(22
)

35


(95
)

(32
)Unrealized net holding gain (loss) on investments


142


(27
)

156


40Total comprehensive income (loss), net of income tax

$
(1,079
)
$
28

$
161

$
(5,675
)


7

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September 30,
2002

December 31,
2001(in thousands)Accumulated other comprehensive loss:Cumulative foreign currency translation adjustments

$
(224
)
$
(129
)Unrealized net holding gain on investments


197


41Total accumulated other comprehensive loss, net of income tax

$
(27
)
$
(88
)


5. Line of Credit

In April 2002, the Company entered into a $7.5 million revolving line of credit with Silicon Valley Bank which was scheduled to mature in
April 2003. In November 2002, the Company amended that line of credit to increase it to $15.0 million and extend the maturity date to November 2003. At the Company's
discretion, borrowings under the line of credit bear interest at the bank's prime rate, which was 4.75% on September 30, 2002, or LIBOR plus 300 basis points. The revolving line of credit is
secured by all assets of the Company 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 June 2002, the Company caused Silicon Valley Bank to issue its three irrevocable standby letters of
credit under this facility, which secure the leases on the corporate headquarters facility and furniture and relieved its restricted cash of $4.8 million. The letter of credit requirements of
the leases have decreasing schedules that ultimately expire in 2002 and 2007. The amount available under the line of credit at September 30, 2002 was $3.2 million, which was net of the
outstanding letters of credit of $4.3 million. To date, the Company has not borrowed any funds under the line of credit.

6. Stock Repurchase Program

In September 2002, the Company's board of directors authorized a stock repurchase program under which up to 1,000,000 shares of the Company's common stock
may be repurchased in the open market or in privately negotiated block transactions from time to time. As of September 30, 2002, no shares had
been repurchased. In October 2002, the board of directors amended the stock repurchase program to authorize spending up to $10 million to repurchase Company common stock.

7. Notes Receivable for Stock

In 1999, the Company issued 269,195 shares of common stock from treasury shares to certain officers and directors of the Company in exchange for individual notes
receivable aggregating $800,000 which were due in February 2002 as a result of the Company's initial public offering ("IPO") in February 2000. Certain officers paid their notes in full,
totaling $273,000, prior to maturity. During the first quarter of 2002, the remaining officer notes, totaling $527,000, were satisfied by delivering, at current fair market value, shares of the
Company's common stock to the Company, which the officers had held for longer than six months.

8

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In
1999, the Company issued 879,763 shares of restricted common stock to the CEO of the Company in exchange for a note receivable of $1.5 million. Also in 1999, the CEO was
granted and exercised options to acquire 112,230 shares of the Company's common stock in exchange for a note receivable of $334,000. The restricted stock fully vested and the maturity dates of the
notes were set at February 2002 as a result of the Company's IPO. During the first quarter of 2002, the CEO refinanced a part of these notes with a note (the "2002 Note") for approximately
$1.5 million; the balance of the original notes was satisfied by the CEO delivering, at current fair market value, shares of common stock to the Company which he had held for more than six
months. The 2002 Note bears interest at a floating rate of 325 basis points over the Federal Funds Rate, is payable in three equal payments of principal and interest due annually through
February 2005, and is a full recourse obligation secured by the shares of Company common stock.

At
September 30, 2002, and presently, the value of the underlying shares of Company common stock held as collateral did not meet the collateral maintenance requirements of the
2002 Note. The board of directors of the Company has delivered to the CEO a notice of forbearance advising the CEO that, for the time being, the Company will forbear pursuit of its rights to demand
additional collateral or prepayment of the 2002 Note. However, the notice advised that the Company 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.

8. Acquired In-process Research and Development and Related Charges

During 2000, the Company entered into an option agreement to purchase in-process research and development ("IPR&D") technology that had a carrying
value of $650,000. In March 2001, the Company paid $2.0 million to exercise this option to purchase the underlying technology. Also, during
the first quarter of 2001, the Company 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, the Company purchased for $1.1 million software-based IPR&D technology relating to the development of on-line analytical processing
and multi-dimensional analysis capabilities. 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 Statement of
Financial Accounting Standards ("SFAS") No. 86,Accounting for the Costs of Computer Software to Be Sold, Leased or Otherwise Marketed. At the
time of each transaction, the Company 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 the Company's ability to complete the development projects within a timeframe acceptable to the
market, and failure to do so would have caused the Company's competitive position in the market to erode. Additionally, the amount of development required to enable the acquired technology to
integrate with the Company's 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, the Company recorded charges totaling $4.8 million during the nine months ended September 30, 2001, as acquired IPR&D.

9

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9. Relocation of Corporate Headquarters

During 2000, the Company adopted a plan to relocate its corporate headquarters to a larger facility within the Atlanta metropolitan area. In accordance with the
Emerging Issues Task Force's ("EITF") abstract No. 94-3,Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity
(including Certain Costs Incurred in a Restructuring),the Company estimated that the net costs associated with its then existing facilities, which were under noncancellable
leases expiring on June 30, 2002, would be approximately $525,000. The Company 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, the Company recorded an additional obligation of $155,000 in the second quarter of 2001 for the additional estimated loss. As
of June 30, 2002, there were no remaining obligations.

10. Geographic Information

The Company's international revenue derived from customers outside the United States and Canada was $2.8 million and $5.2 million for the three and
nine months ended September 30, 2002, respectively; and $1.4 million and $2.7 million for the three and nine months ended September 30, 2001, respectively. International
revenue was derived from customers in Europe, Latin America and Asia Pacific.

11. Recent Accounting Pronouncements

In June 2002, the Financial Accounting Standards Board ("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. The Company does not anticipate that the adoption of this SFAS will have a material impact on its results of operations or financial position.

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. The Company does not anticipate that the adoption of this SFAS will have a material impact on its results of operations or
financial position.

Effective
January 1, 2002, the Company adopted 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. The Company had historically recorded reimbursements as a reduction of services cost of revenue. In accordance with EITF No. 01-14, the Company reclassified
$180,000 and $498,000 of reimbursable travel expenses to services revenue from cost of services revenue resulting in no change to gross profit for the three and nine months ended September 30,
2001, respectively. Gross profit margins decreased to 83% and 82% for the three and nine months ended September 30, 2001, respectively, from 84% and 83%, respectively, after the effect of EITF
No. 01-14.

10

---

In
October 2001, the FASB issued SFAS No. 144,Accounting for the Impairment or Disposal of Long-lived Assets,
which supersedes SFAS No. 121,Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed
of,and Accounting Principles Board ("APB") Opinion No. 30,Reporting the Results of OperationsReporting the Effects of Disposal of
a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions. SFAS No. 144 amends accounting and reporting standards for the
disposal of segments of a business and addresses various issues related to the accounting for impairments or disposals of long-lived assets. This SFAS is effective for fiscal years
beginning after December 15, 2001. The adoption of this SFAS did not have a material impact on the Company's results of operations or financial position.

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. The Company does not anticipate that the adoption of this SFAS will have a material impact on its results of operations or financial position.

In
July 2001, the FASB issued SFAS No. 141,Business Combinations, and SFAS No. 142,Goodwill
and Other Intangible Assets, effective for fiscal years beginning after December 15, 2001. Under the new rules, the pooling-of-interests method
is no longer permitted, and goodwill and other intangible assets that have indefinite useful lives will no longer be amortized but will be subject to annual impairment tests in accordance with the
statements. Most other intangible assets will continue to be amortized over their useful lives. Goodwill and intangible assets acquired after June 30, 2001 are subject to the new rules. The
adoption of this SFAS did not have a material impact on the Company's results of operations or financial position.

12. Subsequent Event

In October 2002, the board of directors of the Company approved a stockholder rights plan (the "Rights Plan") which has the effect of causing substantial
dilution to a person or group that attempts to acquire the Company on terms not approved by the board of directors. Under the Rights Plan, the Company issued a dividend of one right for each share of
the Company's common stock, par value of $0.001 per share, held by stockholders of record as of the close of business on November 4, 2002. Each right will entitle stockholders to purchase one
unit of a share of the Company's preferred stock for $25.00. The rights generally will be exercisable only upon the occurrence of certain events, and will expire on November 4, 2012.

The
Rights Plan has no present dilutive effect on the Company's capital structure, nor will it affect reported earnings per share or change the way the Company's shares of common stock
are traded. Neither the adoption of the Rights Plan, nor the dividend distribution of the rights, is taxable to the Company or its shareholders.

11

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Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

This quarterly report on Form 10-Q contains forward-looking statements that are not historical facts but rather are based on current
expectations, estimates and projections about our business and industry, and 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 Condensed Consolidated Financial Statements and
Notes thereto included elsewhere in this report.

Overview

We provide an integrated performance optimization software suite to help global enterprises capture customer intelligence and optimize workforce performance.
Comprised of business-driven multimedia recording, performance analysis and e-learning management applications, the browser-based software solution is designed to enhance the quality of
customer interactions across multiple communications media, including the telephone, e-mail and Web. The closed-loop suite enables companies to record, evaluate and analyze
customer contacts, and then launch e-learning to develop staff, generate additional revenue, and achieve greater customer retention and loyalty. 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 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
the third quarter of 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 the third quarter of 2002 increased compared to the prior year period, services revenue was also adversely affected as a
result of 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 also been adversely impacted by the increase in international revenues as well as 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. According to Gartner
Dataquest, information technology spending will decline by 0.5% in 2002. We believe a continued deterioration in the economy, specifically a reduction in the level of corporate spending for
information technology, will continue to have an adverse effect on our financial condition and results of operations.

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 nine months ended September 30, 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 near future as we continue to develop new alliances and strengthen existing relationships.

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During
the three and nine months ended September 30, 2002, revenue derived from customers outside the United States and Canada increased to 14% and 15%, respectively, from 8%
during the three and nine months ended September 30, 2001. We expect the proportion of future revenue derived from international markets will continue to increase and may be denominated in the
currency of the applicable market.

Revenue
is allocated to each element of the arrangement based on its relative fair value, which is established by the price charged when the respective element is sold separately.
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. 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. Revenue from installation, training and consulting services is
recognized upon performance of the related services. Reimbursable travel expenses revenue 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 the nine months ended September 30, 2002, 96% of active customer installation sites renewed their annual
maintenance contracts.

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 charges. Personnel costs include salaries, bonuses, benefits and stock-based compensation expenses. We classify all
charges to the operating expense categories based on the nature of the expenditures. Allocated charges 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, and allocated charges. Research and development expenses consist primarily of personnel and
consulting costs to support product development, and allocated charges. 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, legal and
facilities, as well as provisions for allowance for doubtful accounts and allocated charges.

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We
had 320 full-time employees at September 30, 2002, down from 327 at December 31, 2001 and up from 307 at September 30, 2001. 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 condensed 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, property and equipment, intangible assets, research and development and software development costs and provision for income taxes. 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 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 do not prove to be consistent with 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, there is no way to 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.

Impairment of Long-lived Assets and Intangible Assets.We evaluate the balance sheet accounts for property and
equipment and intangible assets by comparing the carrying amount of the asset against the estimated undiscounted cash flows associated with it. Should the sum of the expected future cash flows be less
than the carrying value of the asset being evaluated, we use the fair value in determining the amount of impairment loss that should be recorded. The determination of undiscounted net operating cash
flows requires management to make estimates.

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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.

Results of Operations

The following table sets forth the results of operations for the three and nine months ended September 30, 2002 and 2001 expressed as a percentage of total
revenue.

|                                                                 |  | Three months ended
September 30, |    | Nine months ended
September 30, |  
|---------------------------------------------------------------- |  | -------------------------------- | -- | ------------------------------- | -
|
|Revenue:                                                         |  |                                  |    |                                 |  
|License                                                          |  | 44                               | %  | 62                              | %
|Services                                                         |  | 56                               |    | 38                              |  
|                                                                 |  |                                  |    |                                 |  
|Total revenue                                                    |  | 100                              |    | 100                             |  
|                                                                 |  |                                  |    |                                 |  
|Cost of revenue:                                                 |  |                                  |    |                                 |  
|License                                                          |  | 2                                |    | 1                               |  
|Services                                                         |  | 20                               |    | 16                              |  
|                                                                 |  |                                  |    |                                 |  
|Total cost of revenue                                            |  | 22                               |    | 17                              |  
|                                                                 |  |                                  |    |                                 |  
|Gross profit                                                     |  | 78                               |    | 83                              |  
|Operating expenses:                                              |  |                                  |    |                                 |  
|Sales and marketing                                              |  | 46                               |    | 45                              |  
|Research and development                                         |  | 25                               |    | 21                              |  
|General and administrative                                       |  | 18                               |    | 21                              |  
|Acquired in-process research and development and related charges |  |                                 |    |                                |  
|                                                                 |  |                                  |    |                                 |  
|Operating loss                                                   |  | (11                              | )  | (4                              | )
|Interest and other income, net                                   |  | 3                                |    | 4                               |  
|                                                                 |  |                                  |    |                                 |  
|(Loss) income before provision for income taxes                  |  | (8                               | )  |                                |  
|Provision for income taxes                                       |  |                                 |    |                                |  
|                                                                 |  |                                  |    |                                 |  
|Net (loss) income                                                |  | (8                               | )% |                                |  
|                                                                 |  |                                  |    |                                 |  

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Revenue

Total revenue decreased 3% to $15.1 million in the third quarter of 2002 from $15.4 million in the third quarter of 2001 due primarily to a decrease
in license revenue. For the nine months ended September 30, 2002, revenue increased 11% to $50.3 million from $45.2 million due primarily to an increase in services revenue. The
number of installed customer sites grew to 1,099 sites at the end of the third quarter of 2002 from 793 sites at the end of the third quarter of 2001.

License
revenue decreased 32% to $6.6 million in the third quarter of 2002 from $9.6 million in the third quarter of 2001. For the nine months ended September 30,
2002, license revenue decreased 13% to $25.5 million from $29.4 million in the same year ago period. These decreases were due to fewer contracts signed by customers during 2002,
especially during the third quarter, which we believe was attributable to a reduction in the level of corporate spending for information technology. The decreases in license revenue as a percentage of
total revenue were also a result of increased services revenue, as discussed below.

Services
revenue, consisting of installation, training, consulting and maintenance services revenue, as well as reimbursable travel expense revenue, increased 46% to $8.5 million
in the third quarter of 2002 from $5.8 million in the third quarter of 2001. For the nine months ended September 30, 2002, services revenue increased 57% to $24.7 million from
$15.7 million in the same year ago period. These increases were primarily attributable to the growth in maintenance revenue due to additional customer sites and higher renewal rates charged for
annual maintenance contracts from existing customer sites. Although maintenance revenue increased from the prior year, some customers resisted price increases for maintenance renewal amounts due to a
weakened economy. Installation and consulting revenue increased in the third quarter of 2002 due primarily to growth in new consulting services offerings. Installation, training and consulting revenue
increased in the nine months ended September 30, 2002 due to a related increase in the number of customer sites installed during 2002 compared to 2001, growth in new consulting services
offerings and overall increased services revenue per customer site. We expect services revenue in absolute dollars to continue to increase over time due to maintenance revenue from new customer sites,
the compounding effect of renewals of annual maintenance contracts from existing customer sites and the increase of services offerings.

Cost of Revenue

Total cost of revenue increased 25% to $3.3 million in the third quarter of 2002 from $2.6 million in the third quarter of 2001. For the nine months
ended September 30, 2002, total cost of revenue increased 15% to $9.4 million from $8.2 million in the same year ago period. Gross profit margins decreased to 78% in the third
quarter of 2002 from 83% in the third quarter of 2001 due primarily to an increase in cost of services revenue as a percentage of total revenue. Gross profit margins decreased to 81% in the nine
months ended September 30, 2002 from 82% in the same year ago period. We expect gross profit margins to decrease over time as we expand our services and integrate additional third-party
components into our new or existing products or make investments in third-party technology.

Cost
of license revenue increased 149% to $261,000 in the third quarter of 2002 from $105,000 in the third quarter of 2001. For the nine months ended September 30, 2002, cost of
license revenue increased 36% to $577,000 from $424,000 in the same year ago period. These increases were primarily attributable to new third-party software components associated with new products
sold in 2002. We expect cost of license revenue to increase over time as a greater proportion of revenue is derived from products containing third-party software components.

Cost
of services revenue increased 20% to $3.0 million in the third quarter of 2002 from $2.5 million in the third quarter of 2001. For the nine months ended
September 30, 2002, cost of services revenue increased 14% to $8.9 million from $7.8 million in the same year ago period. These increases were primarily a result of an increase in
the number of employees and contractors engaged in installation, training, consulting and customer maintenance services. Cost of services revenue as a percentage of services revenue decreased to 36%
in the third quarter of 2002 from 44% in the third quarter of 2001. For the nine months ended September 30, 2002, cost of services revenue as a percentage of services revenue decreased to 36%
from 49% in the same year ago period. 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. Although we anticipate that the services revenue will increase as we grow our customer base, we do not anticipate cost of
services revenue as a percentage of services revenue to change significantly in the near future.

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Operating Expenses

Sales and Marketing.Sales and marketing expense remained fairly constant at $7.0 million in the third quarter of 2002
and 2001. For the nine months ended September 30, 2002, sales and marketing expense
increased 5% to $22.4 million from $21.4 million in the same year ago period. These increases were due primarily to increases in the average number of employees engaged in sales and
marketing activities, specifically in Europe, Latin America and Asia Pacific. We expect sales and marketing expense to remain fairly constant as a percentage of total revenue in the near future.

Research and Development.Research and development expense increased 17% to $3.7 million in the third quarter of 2002
from $3.2 million in the third quarter of 2001. For the nine months ended September 30, 2002, research and development expense increased 10% to $11.2 million from
$10.2 million in the same year ago period. 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 expense to remain fairly constant in the near future.

General and Administrative.General and administrative expense decreased 19% to $2.6 million in the third quarter of
2002 from $3.3 million in the third quarter of 2001. For the nine months ended September 30, 2002, general and administrative expense decreased 4% to $8.2 million from
$8.5 million in the same year ago period. These decreases were primarily due to a decrease in the provision for bad debts in the 2002 periods. We expect general and administrative expense to
remain fairly constant as a percentage of total revenue in the near future.

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 during the nine months ended September 30, 2001, as acquired IPR&D.

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 39% to $379,000 in the third quarter of 2002 from $625,000 in the third quarter of 2001. For the nine months ended September 30, 2002, interest and
other income, net decreased 48% to $1.2 million from $2.4 million in the same year ago period. These decreases were due to lower yields earned on our investments.

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Provision for Income Taxes

We did not record a provision for state and foreign income tax and federal alternative minimum tax in the third quarter of 2002. For the nine months ended
September 30, 2002 and 2001, we recorded a provision of $200,000 and $84,000, respectively, for state and foreign income tax and federal alternative minimum tax. We have recorded a full
valuation allowance against deferred tax assets generated as a result of net operating loss carryforwards aggregating $6.3 million for U.S. tax purposes and approximately $6 million for
foreign tax purposes at December 31, 2001, as the future realization of the tax benefits is not currently considered more likely than not.

Liquidity and Capital Resources

We generated $1.8 million in cash flows from operating activities during the nine months ended September 2002 compared to cash used in operating
activities of $5.7 million during the same year ago period. This increase in cash flow from operations was due primarily to the $3.8 million cash paid for IPR&D during the nine months
ended September 30, 2001 and the reduction in operating expenses as a percentage of total revenue during the nine months ended September 30, 2002. Net cash provided by investing
activities was $6.6 million for the nine months ended September 30, 2002 as compared to $13.3 million for the same year ago period. Investing activities consisted of capital
expenditures totaling $2.5 million and $2.4 million for the nine months ended September 30, 2002 and 2001, respectively, which was used primarily to acquire computer equipment and
leasehold improvements. These capital expenditures were more than offset by maturing investments and the release of restricted cash, as discussed more fully in the following paragraph. In 2003, our
capital expenditures may be more than our net proceeds from maturing investments. Net cash provided by financing activities for the nine months ended September 30, 2002 and 2001 was
$1.1 million and $1.2 million, respectively, which represented the proceeds received from the exercise of stock options and employee stock purchases. Beginning in the fourth quarter of
2002, our stock repurchase program will be a use of funds included in the financing activities. Overall, up to $10 million of stock repurchases have been authorized. At September 30,
2002, we had $61.3 million in working capital, which included $61.1 million in cash and cash equivalents and short-term investments.

In
November 2002, we amended our existing line of credit of $7.5 million and increased it to $15.0 million, and extended the maturity date to November 2003.
At our discretion, borrowings under the line of credit bear interest at the bank's prime rate, which was 4.75% on September 30, 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 June 2002, we caused our bank to issue our irrevocable standby letters of credit under this
facility, which secure the leases on the corporate headquarters facility and furniture and relieved our restricted cash of $4.8 million. The letter of credit requirements of the leases have
decreasing schedules that ultimately expire in 2002 and 2007. The amount available under the line of credit at September 30, 2002 was $3.2 million, which was net of the outstanding
letters of credit of $4.3 million. To date, we have not borrowed any funds under the line of credit.

We
expect to have total capital expenditures of approximately $3.1 million in 2002. 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 and cash equivalents and
short-term investments will be more than sufficient to meet our anticipated cash needs for working capital and capital expenditures for the next 12 months and the foreseeable
future. 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.

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Our
accounts receivable days sales outstanding increased to 79 days at September 30, 2002 from 72 days at December 31, 2001, due to an increase in the length
of our collections cycle which was primarily attributable to increased international sales 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 near future.

Our
interest income is sensitive to changes in interest rates of investment grade securities. We expect that interest income in 2002 and 2003 will be less than in 2001 due to lower
yields on the underlying investments. 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
Canada, Mexico, Brazil, the United Kingdom, the Netherlands, Japan, Australia and Singapore 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. For the three and nine months ended September 30, 2002 and 2001, net foreign exchange gains and losses
were not material.



During the first quarter of 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. Notes receivable from our 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. At September 30, 2002, and presently, 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 has 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, the notice advised that 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.

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 our other public filings.

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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 as well as the following risks:



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 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 revenue growth has 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.

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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 will 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:



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.



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:



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We achieved a quarterly operating profit in the first and second quarters of 2002. We incurred a loss in the third quarter 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 September 30, 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 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 September 30, 2002, we have recognized less than 20% of our quarterly 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.



Revenue from customers located outside of North America, including the United States and Canada, accounted for approximately 14% and 8% of our total revenue for
quarters ended September 30, 2002 and 2001, respectively. We intend to continue to expand our international operations through internal business expansion and strategic business relationships.
Our operations outside of North America at September 30, 2002 consisted of 37 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. 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:



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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.



Even if we are successful in expanding our operations internationally, 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 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.



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.

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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 31% and 12% of
our license revenue for the quarters ended September 30, 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 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.



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:



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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.



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 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 September 30, 2002, we had five U.S. registered trademarks, two patents generally relating to our voice/data synchronization technology and data capture technique and 12
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 the trademark "eQuality" and its variations that predate our use of, and U.S. trademark
application for, our trademark eQuality. It is possible that the U.S. Patent and Trademark Office will deny our U.S. trademark application. In addition, 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 prevent us from registering and/or using the trademark eQuality,
and may also seek compensation for damages resulting from our use of this trademark. As a result, we cannot assure you that our efforts to use and register this trademark will ultimately be
successful, or that this use will not result in liability for trademark infringement, trademark dilution, and/or unfair competition.

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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.



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.

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.



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

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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 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.



The market for customer relationship management software, including software that records and analyzes customer interactions, is still emerging. However, recent
economic conditions have caused many of our customers and prospective customers to experience either severe financial difficulties or bankruptcies and have increased the potential for call center
consolidation. 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.



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.

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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.



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.



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 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.



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

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vacation schedules. We believe that these fluctuations are caused in part by customer buying patterns, 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.



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 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.



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.



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.

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At September 30, 2002, our executive officers and directors and their affiliates together controlled approximately 23% 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 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 3. Quantitative and Qualitative Disclosures About Market Risk

None.

Item 4. Controls and Procedures

Based on their evaluation, as of a date within 90 days of the filing of this Form 10-Q, 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.

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PART II.  OTHER INFORMATION

Item 1. Legal Proceedings

From time to time we may be involved in legal proceedings and/or litigation arising in the ordinary course of business. As of the date hereof, we are not party to
any litigation or other legal proceedings that we believe could have a material adverse effect on our business, operating results or financial condition.

Item 6. Exhibits and Reports on Form 8-K

(10.1)

Loan and Security Agreement between Witness Systems, Inc. and Silicon Valley Bank dated April 3, 2002(10.2)

Loan Modification Agreement between Witness Systems, Inc. and Silicon Valley Bank dated November 12, 2002(10.3)

Revolving Promissory Note between Witness Systems, Inc. and Silicon Valley Bank dated November 12, 2002


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



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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned
thereunto duly authorized.

|Dated: November 12, 2002 |  | WITNESS SYSTEMS, INC.
|------------------------ |  | ---------------------
|                         |  | By:                  
|                         |  | By:                  

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CERTIFICATE OF THE CHIEF EXECUTIVE OFFICER

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

1.    I
have reviewed this quarterly report on Form 10-Q of the registrant;

2.    Based
on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements
made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;

3.    Based
on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial
condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;

4.    The
registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act
Rules 13a-14 and 15d-14) for the registrant and have:



5.    The
registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of the
registrant's board of directors:



6.    The
registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other
factors that could significantly affect internal controls subsequent to the date of their evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

Dated
this 12th day of November 2002.

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

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CERTIFICATE OF THE CHIEF FINANCIAL OFFICER

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

1.    I
have reviewed this quarterly report on Form 10-Q of the registrant;

2.    Based
on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements
made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;

3.    Based
on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial
condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;

4.    The
registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act
Rules 13a-14 and 15d-14) for the registrant and have:



5.    The
registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of the
registrant's board of directors:



6.    The
registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other
factors that could significantly affect internal controls subsequent to the date of their evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

Dated
this 12th day of November 2002.

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

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