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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

(Mark one)

SECURITIES EXCHANGE ACT OF 1934

OR

SECURITIES EXCHANGE ACT OF 1934

Commission File Number 0-15454

TANGRAM ENTERPRISE SOLUTIONS, INC.

(Exact Name of Registrant as Specified in Its Charter)

11000 Regency Parkway, Suite 301

Cary, NC 27511

(Address of Principal Executive Offices) (Zip Code)

(919) 653-6000

(Registrant’s telephone number, including area code)

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

None

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

Common Stock, $0.01 par value

(Title of class)

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  þ  No  ¨

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

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

The aggregate market value of shares of common stock held by non-affiliates on June 28, 2002, the last business day of the registrant’s most recently completed second fiscal quarter (as reported on the NASDAQ SmallCap Market under the symbol TESI) was approximately $2,009,546. For purposes of determining this amount only, the registrant has defined affiliates as including (a) the executive officers named in Part III of this 10-K report, (b) all directors of the registrant, and (c) each shareholder that has informed the registrant by February 28, 2003 that it is the beneficial owner of 10% or more of the outstanding common stock of the registrant.

As of February 28, 2003 there were 19,802,439 shares of the Company’s common stock outstanding.

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Tangram Enterprise Solutions, Inc.

Index to Form 10-K

For the Fiscal Year Ended December 31, 2002

PART I

In this Form 10-K, the “Company,” “Tangram,” “Tangram Enterprise Solutions,” “we,” “us” and “our” refer to Tangram Enterprise Solutions, Inc., a Pennsylvania corporation.

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PART I

Item 1. Business

General

Tangram Enterprise Solutions, Inc. (“Tangram”) develops and markets lifecycle information technology (“IT”) asset management (“ITAM”) software for large and mid-sized organizations across all industries, in both domestic and international markets. Our ITAM program consists of Asset Insight^® and Enterprise Insight^®, which together deliver the market’s first unified tool to manage physical, contractual, and financial IT asset data in a single repository for a comprehensive view of the enterprise. Our core business strategy and operating philosophy focus on delivering world-class customer care, creating a more personal and productive ITAM experience through a phased solution implementation, providing tailored solutions that support evolving customers’ needs, and maintaining a leading-edge technical position. Additionally, it allows us to optimize the results of each customer engagement, promote ongoing customer loyalty, and maximize shareholder value.

The following discussion contains “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, including, among others, statements containing the words “believes,” “anticipates,” “estimates,” “expects,” and words of similar import. Such statements are subject to certain risks and uncertainties, which include but are not limited to those important factors discussed in cautionary statements throughout the section below and elsewhere in this document, and are qualified in their entirety by those cautionary statements.

Background and Strategy

For more than 20 years, Tangram has been working closely with our customers to design and develop software that addresses the most demanding business requirements. During this time, we have obtained a keen understanding of the mission-critical issues our customers must grapple with each day, and we have proven that our solutions provide immediate benefits and offer long-term value.

Since 1996, we have focused our business on the asset tracking market and the sale of Asset Insight, our flagship asset tracking point solution. Designed for diverse business leaders, Asset Insight is a best-of-breed solution that automatically tracks the hardware, software, software usage, configuration, user information, and location of each workstation, server, and network device in the enterprise. To date, hundreds of worldwide organizations have purchased Asset Insight to manage millions of workstations, servers, and infrastructure devices. These organizations rely on Asset Insight’s current and historical asset information to ensure information technology investments are in line with corporate initiatives, improve end-user support services, plan technology upgrades, and reduce the overall cost of asset ownership.

Our strategy is to become a leader in the ITAM market. According to IDC, the worldwide ITAM software market is estimated to reach $1.3 billion in 2006, growing at an annual rate of approximately 9.3%. At the same time, the market is largely under-penetrated; Gartner and Giga estimate that only 25% to 50% of U.S. organizations have implemented an asset management program.

Tangram’s strategy builds upon our core Asset Insight tracking technology and Enterprise Insight, a full lifecycle asset management offering. This lifecycle offering allows business leaders to manage their information technology assets from initial planning and procurement through final disposal — ensuring information technology is maximized to cost-effectively support corporate objectives. In early February 2003, we released what we believe to be the market’s first and only fully unified ITAM solution. This unified Insight solution automatically and seamlessly combines the physical IT asset information tracked by Asset Insight with the financial and contractual information managed by Enterprise Insight, delivering a single, holistic view of all enterprise IT assets from a common user interface, without the need for costly and difficult-to-implement data integrations. Tangram’s unified Insight solution allows customers to more quickly, efficiently, and accurately tackle critical IT business issues, such as software license compliance, disaster recovery planning, loss prevention, and lease management.

Our strategy is to deliver phased asset management solutions that address our customers’ most pressing business demands, as they are ready to address them. Specifically, we work closely with our customers to understand their corporate mission, devise solutions that evolve with their businesses, and implement the solutions—one phase at a time.

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More importantly, after the implementation of each phase, we conduct customer “checkups” to validate the immediate and long-term benefits of our solution in the customers’ enterprise. We believe this phased, customer-centric approach ensures that our solutions are aligned with our customers’ business drivers as they evolve. Additionally, it allows us to optimize the results of each customer engagement, promote ongoing customer loyalty, and maximize shareholder value.

We are committed to providing world-class customer care and becoming a leader in the ITAM market by supporting an active development program that broadens the utility of our asset tracking and asset management products. Product development efforts include expanding the depth and breadth of the information tracked by our asset tracking technology, extending our asset management capabilities, and enhancing the integration between our asset tracking and asset management solutions to assist companies in relating their information technology assets to business processes, decisions, and objectives.

Tangram’s original software offerings, Arbiter^® and AM:PM^®, are still in use today by organizations throughout the world, enabling them to perform electronic software distribution, automated data collection, and remote resource management on diverse enterprise systems. We are no longer actively marketing or selling the Arbiter, AM:PM, or traditional mainframe product lines, and as such, we anticipate that the trend of reduced product license and post-contract customer support renewals will continue.

We continually evaluate our products and corporate strategy and have in the past and will in the future undertake organizational changes and product and marketing strategy modifications that are designed to maximize market penetration, optimize the use of limited resources, and develop new products and product channels. There can be no assurance that these efforts will be successful. Our failure to do so could have a material adverse effect on Tangram’s business, operating results, and financial condition.

Industry Background

IT has had a profound impact on corporate productivity and bottom line performance, as technology has fueled everything from e-business to supply chain management to the management of customer relationships. In fact, the IT business unit is now recognized as a strategic business partner, inextricably tied to corporate operations and execution of corporate business strategy.

In today’s environment where organizations are under increasing pressure to control expenses to improve bottom line performance and reduce corporate risks, business managers need an effective asset management program that combines physical, contractual and financial IT asset data in a single repository for a comprehensive view of the enterprise. This comprehensive view is necessary to identify innovative ways to maximize organizations’ return on technology investments, expand IT and employee productivity, and harness the costs associated with managing the lifecycle of distributed assets. Following the events of September 11, 2001, business managers have also realized the critical importance of asset management for disaster recovery, security and contingency planning initiatives. In a disaster, the ability to provide business continuity with the rebuilding of computer systems and information showing an accurate view of platform configurations, OS, installed software, and associated contracts and financial data is of paramount concern. In fact, ITAM is now being recognized as an invaluable tool to help manage security issues ranging from virus protection, hardware theft and protection of sensitive corporate data. Corporate senior management is now considering ITAM as an increasingly important corporate initiative. To that end, industry experts believe that asset management will be one of the top five initiatives undertaken by chief information officers in the next year or two. Today, the market is largely under-penetrated due to the lack of awareness by IT managers of asset solutions that perform asset discovery, repository, license management and usage functions and its security benefits.

ITAM is often confused with the very limited asset discovery capabilities of alternatives such as electronic software distribution or configuration management. A full ITAM solution, however, is an integral tool to senior IT and financial managers in scenarios such as:

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what the license agreements included. This information allows organizations to reassign licenses as appropriate, remove older versions and avoid penalties and legal fees.

Asset Management Definition and Applications

ITAM is the process of controlling hardware and software assets throughout their lifecycle — from procurement, through daily operations, through final disposal. While asset management is primarily a business practice, it is supported by repository technology that consolidates diverse financial, contractual, ownership, and physical asset data.

For example, a central asset repository provides a single view of purchase requests, purchase orders, asset deliveries, software license agreements, leasing contracts, maintenance and warranty terms, asset costs, departmental and user data, physical attributes, vendor performance, depreciation schedules, and so on. By analyzing and reporting on the information in a central repository, organizations can determine everything they need to know about an asset — how much did it cost, what hardware and software does it include, is the software licensed, who did we buy it from, who is using it, where is it physically located, which department code should the cost be assigned to, which vendor should be called when support is needed, when does the lease expire, when should the asset be retired, what are the depreciation rates, etc.

There are numerous tactical and strategic benefits associated with the consolidation of this information. Organizations can better plan and budget for IT investments to meet corporate objectives, obtain volume discounts, streamline procurement processes, reassign assets no longer in use, ensure procured assets meet corporate standards,

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avoid costly software license violations, prevent unnecessary lease penalties and buyouts, improve support services, perform departmental chargebacks, efficiently retire and dispose of assets, avoid paying taxes and maintenance on disposed assets, prevent the proliferation of viruses, and develop business continuity plans — all leading to reduced costs and improved effectiveness of IT investments.

Products and Services

Tangram’s family of solutions provides both mid-sized and large companies with a full range of asset tracking and asset management capabilities. To support our phased solution strategy, each product component can be purchased separately, allowing customers to implement the functionality they require based on their unique business demands. To help customers leverage the extensive benefits of our solutions, we also offer a variety of deployment planning, strategic implementation, business process, best practices, and training services.

Asset Tracking Products

Asset Insight is an asset tracking solution designed for large organizations with diverse networks. On a scheduled basis, Asset Insight automatically discovers hardware, software, and configuration changes and associates this information with desktop users and departments across the enterprise. Asset data on workstations, servers, laptops, network systems, and handheld PDA (personal digital assistant) devices is automatically gathered and readily available from an easy-to-use, web-based reporting tool. With this accurate, historical information, decision makers can forward plan technology requirements, optimize end-user productivity, manage software license compliance, identify missing hardware components, enforce standards, and resolve workstation, server, and PDA problems quickly. Asset Insight employs an open data repository, using standard relational database technology that gives corporations access to their data and facilitates integration with third-party products.

Asset Insight express is an asset tracking solution targeted at mid-sized organizations. The express solution boasts many of the same high-value features Asset Insight customers have come to appreciate and depend upon to track their IT assets worldwide. By empowering mid-sized organizations with historical intelligence on the location, user, and configuration of each hardware and software asset in the enterprise, executives can reduce costs and improve the success of key initiatives, such as technology migrations, desktop move, adds and changes, desktop standards enforcement, and help desk support.

Asset Insight Software Usage Monitor automatically tracks software usage on each device in the enterprise. Detailed information, such as application start and end times, as well as processing times, is automatically discovered and stored in the central repository. This information is vital to every license management initiative, allowing organizations to ensure sufficient license coverage, prevent unnecessary overbuys, and redeploy applications that are not in use. Software Usage Monitoring is an optional add-on component to Asset Insight.

Asset Insight PDA Tracker discovers the user, components, and configuration of handheld systems. As PDAs typically house sensitive information, such as customer lists, and they are now an integral part of corporate productivity, organizations are under increased pressure to manage these devices as carefully as other systems in the enterprise. With Asset Insight’s detailed information on each PDA, organizations can minimize their risk exposure when employees leave the company and improve support services throughout the lifecycle of the device. PDA Tracker is an optional add-on component to Asset Insight.

Asset Insight Infrastructure Subsystem automatically discovers and tracks the location and history of any network device that responds to the Simple Network Management Protocol (SNMP), including bridges, switches, routers, hubs, and printers. The information that is collected is easily accessible using Asset Insight’s built-in reporting and viewing features, allowing business and technology managers to control diverse network assets, which are essential to corporate productivity. Infrastructure Subsystem is an optional add-on component to Asset Insight.

Asset Insight Suite Manager facilitates the evaluation, implementation, and management of enterprise systems management suites, such as Tivoli Enterprise, CA-Unicenter, and HP OpenView. Suite Manager enables organizations to compare suite solution requirements and compute the true cost of enterprise deployment, including the cost of upgrading the desktops and servers to meet each solution’s prerequisites. It also provides planning and tracking tools to assist in the planning and management of an optimum rollout. Post-deployment, Suite Manager proactively monitors the enterprise, generating alerts on desktops and servers that have configuration conflicts with the suite. Suite Manager is an optional add-on component to Asset Insight.

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Asset Management Products

Enterprise Insight is a full lifecycle asset management solution that enables customers to manage the financial, physical, and contractual data associated with enterprise IT assets. This information is essential for making strategic decisions that leverage information technology assets, optimize the return on investment, maximize corporate productivity, and ensure assets are meeting corporate objectives. Enterprise Insight includes three modules that, in accordance with our phased asset management strategy, are marketed separately to meet the individual business demands of each customer.

Asset Expert, the core Enterprise Insight module, allows customers to manage important service and contractual agreements related to enterprise assets. This includes software licenses, maintenance and warranty contracts, and financial data. With this information in a central database, customers can ensure all assets are properly covered under service agreements, dispatch the appropriate service provider when support is needed, avoid software license violations, assign costs to the appropriate business units, and reduce the overall costs associated with the management of enterprise assets.

Lease Manager automates the entire lease management cycle, from initial request to lease termination. Using the Lease Manager, organizations can request leased assets from a catalog, generate requests for quotes, submit orders, track lease agreements, and prepare for lease end. Additionally, organizations can receive notifications when leases are due to expire, allowing them to make informed renewal decisions and avoid unnecessary buyouts and penalties. As a result, customers can dramatically reduce the time and costs associated with ensuring the most effective use of leased assets to support corporate productivity.

Purchasing Manager allows customers to automate the entire procurement process. Specifically, customers can request items from a catalog, automatically submit purchase requests for approval, generate purchase orders, record the receipt of assets, and validate invoices. The automated procurement process enables customers to avoid duplicate and disparate procurement efforts among their various departments, make effective IT planning and budgeting decisions, ensure procured assets meet corporate configuration standards, and verify that invoiced items match the initial request. This results in considerable time, resource, and overall cost savings.

Unified Insight Solution

Those customers with both the Asset Insight and Enterprise Insight solutions can benefit from having a fully unified asset management solution. The Unified Insight solution offers the IntelliMatcher, a web-based tool that links and reconciles an organization’s physical, financial, and contractual asset information. The IntelliMatcher automatically matches the thousands of assets discovered by Asset Insight with the asset information “on the books” in Enterprise Insight, based on unique asset attributes such as serial number. This provides a single asset management solution without requiring complex and time-consuming data import or export. The unified asset information is then available to be viewed, reported on, and administered via a common user interface. Via seamless access to physical as well as financial and contractual asset information, customers can ensure software license compliance, minimize end-user downtime with accurate configuration information and maintenance details, enforce desktop standards, and manage technology upgrades.

Asset Insight Services

Tangram’s Consulting Services Group offers a variety of expert services to adapt our solutions to each customer’s unique enterprise and business requirement. We currently offer proof of concept, implementation, training, and several other expert services.

Proof of Concept Services are designed to allow prospective customers to install Asset Insight in their test enviroment in order to confirm its ability to meet business objectives and unique configuration requirements.

Implementation Services include initial planning and resource allocation, pilot implementation, knowledge transfer, and enterprise-wide rollout support.

Training Programs are provided to our customers and channel partners on the implementation, administration, and effective usage of our products in diverse customer environments.

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Additional Services are provided, allowing our Consulting Services Group to assist customers with database performance, the implementation of product upgrades, custom report requirements, application integrations, and the development of best practices for their business.

Enterprise Insight Services

To ensure customers maximize their investment in our Enterprise Insight solution, we offer a variety of implementation and best practices services.

Implementation Services allow Tangram consultants to walk customers through initial planning, process management, product deployment, support, and training of each Enterprise Insight module — Asset Expert, Lease Manager, and Purchasing Manager.

Asset Management Best Practices Analysis graphically captures the processes related to the customer’s current asset lifecycle management infrastructure and allows us to recommend improved processes with demonstrated cost and resource savings.

Additional Services will continue to be offered to assist customers with specific business issues, such as lease management, license management, procurement processes, etc., allowing customers to maximize their lifecycle asset management initiatives.

Product Development

Project teams handle product development from requirements, specification, design, and implementation to product release. These project teams operate as autonomous units and include developers, product managers from marketing, quality control managers, and members of senior management. Each product and enhancement is submitted through a process that determines the marketability of the product, revenue potential, development requirements, and support requirements. Critical technical factors are also considered in determining the viability of a Tangram family product, such as scalability, level of automation, ease of use, support for multiple platforms, and open architecture.

We have internally developed the majority of our products and associated documentation. We have acquired in the past, and we intend to continue to evaluate on an ongoing basis, the value of acquiring certain software technology from others and integrating those technologies into our product lines. In 2002, we expended $3.0 million for product development costs, compared with $4.9 million in 2001, and $5.5 million in 2000. In accordance with Statement of Financial Accounting Standards No. 86, the Company capitalizes certain development costs incurred to develop new software or to enhance our existing software. During fiscal 2002, 2001, and 2000, we capitalized $1.5 million, $1.8 million, and $2.1 million, respectively, or 51%, 37%, and 39%, respectively, of total product development costs. During 2002 and 2001, approximately $741,300 and $3.3 million, respectively, of fully amortized software development costs were removed from intangible assets and accumulated amortization. In 2001, we expended $3.5 million for software technology we acquired from Wyzdom Solutions, Inc. No material expenditures were made in fiscal 2002 or 2000 for the acquisition of software technology.

The principal materials and components used in our software products are CD-ROMs with documentation and, occasionally, hard copy installation guides. We occasionally use third-party vendors to print user manuals, packaging and related materials. All of the CD-ROM duplication is done at our distribution facility located in our corporate headquarters.

As a result of rapid technological change in the industry, our position in existing markets can be rapidly eroded by product advances. The lifecycles of our products are difficult to estimate and our growth and future financial performance depend in part upon our ability to improve existing products and develop and introduce new products that keep pace with technological advances, meet changing customer needs, and respond to competitive products. As such, we will continue to commit substantial resources to research and development efforts in the future.

Software products as complex as those that we offer, may contain errors that may be detected at any point in a product’s lifecycle. In the past, we have discovered software errors in certain parts of our products and have experienced delays in shipment of products during the period required to correct these errors. There can be no assurance that, despite our testing, errors will not be found.

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Customers

Our customer base is comprised of mid-sized and large, Fortune 1000 enterprises and government agencies that are managing heterogeneous enterprises and mission-critical applications. Our customers are located primarily in North America and Europe and include companies in industrial, institutional, and governmental markets. We operate in a single industry and are engaged in the design and sale of a limited number of software products. No single customer accounted for more than 10% of total revenue in 2002, 2001, or 2000. Our principal financial instrument subject to potential concentration of credit risk are accounts receivable, which are unsecured. We perform ongoing credit evaluations of our customers’ financial condition. We believe that the concentration of credit risk with respect to trade receivables is further mitigated as our customer base consists primarily of Fortune 1000 companies. We maintain reserves for credit losses and such losses historically have been within management estimates.

In order to grow our business, increase our revenues, and improve our operating results, we believe we must continue to expand internationally. In the past two years, we have expanded our direct sales support presence in the United Kingdom and expanded our list of European and Pacific Rim distributors. If we expend substantial resources pursuing an international strategy and are not successful, our revenues will be less than our management’s expectations, and our operating results will suffer. International expansion will require significant management attention and financial resources, and we may not successfully expand our international operations. Additionally, we have limited experience in developing localized 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. To date, the majority of our international revenue has been denominated in United States currency; therefore, we have not experienced any significant currency fluctuations or any other material adverse effects associated with doing business overseas. 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 be exposed to longer payment cycles, greater difficulty in accounts receivable collection, unexpected changes in regulatory requirements and tariffs, and fluctuating exchange rates. International revenue (including maintenance contracts) represented approximately 10%, 13%, and 12% of our total revenue in 2002, 2001, and 2000, respectively.

Sales and Marketing

Sales

In the past, many of our transactions were sourced, developed, and closed through our strategic and distribution partners, including resellers and system integrators. Many of our channel partners experienced internal management and financial performance problems in 2000 that impacted their ability to resell our products. In response, we have shifted from an exclusively indirect sales channel to a predominantly direct sales organization. In 2001, we began using a predominantly direct sales channel in North America that focuses on developing new account opportunities and expanding opportunities within individual customer accounts. Our small direct telesales group continues to concentrate on increasing our penetration of the small to mid-sized market. We continue to maintain a small indirect sales group that works closely with our major resellers to manage indirect channel activity. These domestic channel partners resell our ITAM solutions, while being allowed to sell other products that are complementary to, or compete with, those of Tangram. While we encourage our channel partners to focus on our products through marketing and support programs, there can be no assurance that these channel partners will not give greater priority to products of other suppliers, including competitors.

In order to grow our business, increase our revenues, and improve our operating results, we believe we must continue to expand internationally. We have expanded our European and Pacific Rim sales initiatives by establishing agreements with seven distributors that are marketing our Asset Insight and Enterprise Insight solutions in the United Kingdom, Germany, Ireland, Scandinavia, Switzerland, Italy, Portugal, Spain, the Benelux countries, Singapore, and Hong Kong. We carefully select distributors that share our customer-centric philosophy and are committed to selling Tangram’s solutions as their exclusive asset tracking and asset management offerings.

We are currently investing and intend to continue to invest additional resources in developing the direct sales organization in North America and our distributor channel in Europe. The sales organization continues to follow a sales process that shifts from a point solution to a business solution sale. Working closely with a prospective customer’s cross-functional management team, our sales team explores business issues and develops phased asset management solutions to address these issues. Customers can then invest in our solutions one phase at a time — as the customer’s business is ready to adopt the solution. At the completion of each phase, we work with the customer to demonstrate the

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value that the customer is receiving and then define and finalize the agreement for the next phase of the engagement. Our products and services require a sophisticated selling effort targeted at several key people within a prospective customer’s organization. This process requires the efforts of experienced sales personnel, as well as specialized consulting professionals. In addition, the complexity of our products, and issues associated with installing and maintaining them, require highly trained customer service and support personnel. Our direct sales force has limited experience selling and delivering our phased asset management solutions. If we are unable to successfully direct our sales force or hire these personnel in the future and train them in the use of our products, our business, operating results, and financial conditions could be harmed.

A key part of Tangram’s solution will be the continued delivery of expert asset management services. If we are unable to meet customers’ service requests with internal resources (due to limited capacity or business expertise), we will partner with our resellers and other third-party service providers for additional support. There can be no assurance that we will be able to effectively maintain this new sales process. Our failure to implement solutions that address customers’ requirements and provide timely and cost-effective customer support and service could have a material adverse effect on our business, operating results, and financial condition.

Marketing

Our marketing efforts are focused on penetrating the ITAM market with our Enterprise Insight and Asset Insight offerings, promoting our unique phased asset management approach, building the asset management market, and generating leads. We continue to leverage the position that Asset Insight has attained as the premier auto-discovery solution, which often serves as the core of any asset management initiative. We also continue to execute our market awareness programs through national trade periodicals, direct mail, public relations activities, seminars and our web site (http://www.tangram.com). These efforts are supplemented by listings in relevant trade directories, exhibitions at tradeshows and conference appearances. Initial leads are qualified by our tele-marketing operation before being turned over to either the direct sales force or tele-sales. We believe that customers generally choose our products and services based on the features they provide and upon a preference for the products modularity, our domain expertise and commitment to customer service, implementation time, and ease of use. A targeted marketing campaign on Fortune 1000 and mid sized companies throughout North America, Europe and Asia-Pacific will continue to be a critical element of our growth strategy. We are positioning our products as market-driven business solutions that help contain technology costs, reduce the risks associated with virus proliferation, support contingency planning, and improve overall corporate productivity. To ensure that the products reflect the changing market requirements, all of our product development efforts are integrated with marketing, our current customers, and other functions in a team approach.

Customer requests for enhancements to current products and the development of new products play a significant role in the development of our product marketing strategy. In 2002, we held our second annual Executive Advisory Board, comprised of senior IT executives from selected customer organizations. Working with our senior management team, the Executive Advisory Board provided important feedback on Tangram’s strategy, as well as possible future directions for our products and services. Tangram’s senior management team also makes regular customer visits to gain customer insight and feedback. Additionally, we conduct periodic customer surveys and an annual Tangram Users’ Group to evaluate overall customer satisfaction, provide additional education, and assess future product needs.

Competition

The competitive landscape has grown in the past five years as more vendors have recognized the opportunities presented by the under-penetrated ITAM market. Some competitors have sought to capitalize on these opportunities by introducing new ITAM products that these competitors acquired from third parties, rather than developed internally. We believe that many of these new product offerings are not as robust as Tangram’s solutions. Additionally, we believe that many competitors lack domain expertise, and most of our major competitors offer some form of asset management as only a small part of a much broader product line. This development has created confusion and overlap among vendors. There are many vendors in the infrastructure management market, which includes asset tracking and asset management, such as Peregrine, Altiris, MRO/MainControl, Computer Associates and Tally. Confusion in the ITAM market has been intensified by numerous vendor consolidations and bankruptcy filings of ITAM vendors in 2002. We believe that this disarray in the ITAM market creates an opportunity for Tangram to further differentiate itself and gain critical brand awareness. As one competitive differentiator, we are positioning our phased asset management solution as a unique offering that is tailored to customers’ business environments. Additionally, systems management suites provide auto-discovery features that overlap with our offerings. These vendors include Microsoft’s SMS, Hewlett-Packard’s OpenView, and Computer Associates’ Unicenter. In the mid-sized asset tracking market, Asset Insight express

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competes with low-end discovery tools, such as Blue Ocean’s TrackIT. We also face competition from numerous start-up and other entrepreneurial companies offering products that compete with the functionality offered by one or more of our ITAM products.

The asset management software and the application suite markets are highly fragmented and are characterized by ongoing technological developments, evolving industry standards, and rapid changes in customer requirements. Our success depends upon our ability to offer a broad range of asset tracking and asset management software products, to continue to enhance our existing products, to develop and introduce in a timely manner new products that leverage technological advances, and to respond promptly to new customer requirements. While we believe that we currently offer the broadest product in the asset tracking market and a unique, highly competitive asset management solution, the asset management market is continuing to evolve and customer requirements are continuing to change. As the market evolves and competitive pressures increase, we believe that we will need to further expand our product offerings and improve the integration between our asset tracking and asset management solution.

Intellectual Property

Our success is in part dependent upon proprietary technology. We rely primarily on a combination of copyright and trademark laws, confidentiality procedures, and contractual provisions to protect our proprietary rights. Our products are generally licensed to end users pursuant to a license agreement that restricts the use of the products to a limited number of control point processors and/or a designated site, or a limited number of nodes. We do not allow the source code to be distributed to customers. From time to time, we have been required to enter into source code escrow agreements with certain customers and distributors for certain of our products. These agreements require the release of source code only under very limited circumstances, principally a breach of our support obligations or a filing of bankruptcy. We seek to protect our software, documentation, and other written materials under trademark and copyright laws, which provide only limited protection.

We believe that patent, trade secret, and copyright protection is less significant than factors such as knowledge, customer relationships, experience of our personnel, new products, frequent product enhancements, name recognition, and ongoing, reliable product maintenance.

Asset Insight, Enterprise Insight, AM:PM, Arbiter, Tangram, and the Tangram puzzle are registered trademarks of Tangram Enterprise Solutions, Inc.

Employees

As of February 28, 2003, we employed 57 persons, including 29 in worldwide marketing, sales, customer support, and field operations; 19 in product development; and 9 in general and administrative. None of our employees is represented by a labor union, nor have we experienced any work stoppages. We believe that our relationship with our employee base is good.

We believe that our future success will depend in large part on our ability to attract and retain additional highly skilled technical, sales, management, and marketing personnel. In addition, our growth and success depend to a significant extent on the continued service of our senior management and other key employees. Competition for highly skilled business, product development, technical, and other personnel is increasingly intense. Our employees currently receive salaries, incentive bonuses, other fringe benefits, and stock options. New government regulations, poor stock performance, or other factors could diminish the value of the option program to current and prospective employees and force us into more of a cash compensation model. Accordingly, we expect to experience increased compensation costs that may not be offset through either improved productivity or higher prices. Additionally, we have at times in the past experienced difficulty in recruiting qualified personnel. New employees generally require substantial training in the use and implementation of our products. There can be no assurances that we will be successful in continuously recruiting and training new personnel and in retaining existing personnel, and the failure to do so could have a material adverse effect on our business, operating results, and financial condition.

Available Information

Our web site address is www.tangram.com. We make available free of charge through our web site our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports

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filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, as soon as reasonably practicable after such documents are electronically filed with or furnished to the Securities and Exchange Commission. Additionally, we will provide paper copies of these reports free of charge upon request. Please make your request to Investor Relations, telephone 919-653-6000, facsimile 919-653-6004, email info@tangram.com. The information on our web site is not, and shall not be deemed to be, a part of this report or incorporated into any other filings we make with the Securities and Exchange Commission.

Item 2. Properties

We lease our corporate headquarters in Cary, North Carolina. The leased facility consists of approximately 18,500 square feet and serves the following functions; executive, administrative, sales, development, marketing, customer support, and distribution center. We believe that our existing facility is adequate for our current needs. The lease expires on September 30, 2004.

Item 3. Legal Proceedings

There are no material pending legal proceedings to which the Company is a party or of which any of its property is subject.

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

None.

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PART II

Item 5. Market For Registrant’s Common Equity and Related Stockholder Matters

(a) Market Information. On October 2, 2002, we received a NASDAQ Staff Determination indicating that the Company had failed to comply with the minimum bid price requirement for continued listing on the NASDAQ SmallCap Market as set forth in Marketplace Rule 4310(c)(4); therefore, our common stock was subject to delisting from the NASDAQ SmallCap Market. Although we had the right to appeal the NASDAQ’s determination, we did not do so. Accordingly, our common stock was delisted from the NASDAQ SmallCap Market as of the opening of business on October 10, 2002. Our common stock currently trades on the Over-the-Counter Bulletin Board (OTC:BB) under the symbol “TESI.” Prior to October 10, 2002, the Company’s common stock was quoted on the NASDAQ SmallCap Market under the same symbol. As a result of our delisting, an investor could find it more difficult to dispose of, or to obtain accurate quotations as to the market value of, our common stock. In addition, if our common stock remains below $5.00 per share, trading in our common stock could also be subject to the requirements of certain rules promulgated under the Securities Exchange Act of 1934, as amended, which require additional disclosure by broker-dealers in connection with any trades involving a stock defined as a “penny stock” (generally, any non-NASDAQ and non-national exchange equity security that has a market price of less than $5.00 per share, subject to certain exceptions). The additional burdens imposed upon broker-dealers by such requirements could discourage broker-dealers from effecting transactions in our common stock, which could severely limit the market liquidity of our common stock and the ability of investors to trade our common stock. Many brokerage firms are reluctant to recommend lower price stocks for their clients, and the policies and practices of a number of brokerage houses tend to discourage individual brokers within those firms from dealing in lower price stocks. Also, the brokerage commission on the purchase or sale of a stock with a relatively low per share price generally tends to represent a higher percentage of the sales price than the brokerage commission charged on a stock with a relatively higher per share price, to the detriment of our shareholders and the market for our common stock.

The following table sets forth the high and low sales prices of the Company’s common stock from January 1, 2001 through December 31, 2002.

On February 28, 2003, the last reported sales price for the common stock on the Over-the-Counter Bulletin Board was $0.27 per share.

(b) Holders. On February 28, 2003, we estimate that there are approximately 530 holders of record of our common stock and a substantially greater number of beneficial owners.

(c) Dividends. Holders of the common stock are entitled to receive such dividends as may be declared by the Company’s board of directors. No dividends on the common stock have been paid by the Company. The Company intends to retain all future earnings for the expansion of its business and consequently does not presently intend to pay cash dividends on its common stock.

As of December 31, 2002, the Company had 3,000 shares of Series F Convertible Preferred Stock (“Series F Shares”) outstanding. Series F Shares have a par value of $0.01 per share. The Series F Shares were originally issued for $1,000 per share. The Series F Shares are entitled to certain preferences, limitations and special rights, including dividend rights, conversion rights, voting rights, anti-dilution rights, registration rights, and liquidation preferences. Holders of the Series F Shares are entitled to a cumulative quarterly dividend, when and if declared by the board of directors, at a rate per share equal to 2% of the issuance price per quarter. Each Series F Share is convertible at any time at the option of the holder into 500 shares of common stock, as adjusted pursuant to the terms of the Statement of Designations, Preferences and Rights of the Series F Convertible Preferred Stock. Commencing at any time on or after February 20, 2003, the Company may redeem all 3,000 of the Series F Shares by paying in cash a sum equal to 103% of

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the initial purchase price per share plus all accrued but unpaid dividends. Holders of the Series F Shares are entitled to one vote for each share of common stock into which the Series F Shares may be converted and may vote on all matters submitted to a vote of the holders of common stock. Each Series F Share is entitled to a liquidation preference of $1,000 plus all accrued but unpaid dividends. Liquidation on proceeds remaining after the satisfaction of such preference would be distributed ratably to the holders of common stock and to the holders of Series F Shares, with each Series F Share being treated as equaling the number of shares of common stock into which such Series F Share is then convertible. At December 31, 2002, the Company had reserved 1,500,000 shares of common stock for issuance upon the future conversion of the Series F Shares.

At December 31, 2002, dividends in arrears on the Series F Shares were approximately $475,200.

Item 6. Selected Financial Data

The following selected financial data of the Company have been derived from the Company’s audited financial statements. This data should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in Item 7 of this report and with the Company’s financial statements and the related notes thereto included in Item 8 of this report.