Back to GetFilings.com

Table of Contents

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Form 10-K

Commission file number 0-18391

Aspect Communications Corporation

1320 Ridder Park Drive, San Jose, California 95131-2312

(408) 325-2200

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

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

Common Stock, $.01 par value

Preferred Share Purchase Rights

     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 o

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

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

     The aggregate market value of the voting stock held by non-affiliates of the Registrant as of June 28, 2002, the last day of the Registrant’s second fiscal quarter, was $161 million based upon the last sale price reported for such date on the Nasdaq Stock Market. For purposes of this disclosure, shares of Common Stock held by persons known to the Registrant (based on information provided by such persons and/or the most recent schedule 13G’s filed by such persons) to beneficially own more than 5% of the Registrant’s Common Stock and shares held by officers and directors of the Registrant have been excluded because such persons may be deemed to be affiliates. This determination is not necessarily a conclusive determination for other purposes.

     The number of shares of the Registrant’s Common Stock outstanding as of June 28, 2002, was 52,560,148.

DOCUMENTS INCORPORATED BY REFERENCE

Parts of the Proxy Statement for the 2002 Annual Meeting of Shareholders are incorporated by reference into items 10, 11, 12, and 13 hereof.

Table of Contents

ASPECT COMMUNICATIONS CORPORATION

INDEX TO ANNUAL REPORT ON FORM 10-K

1

Table of Contents

Forward-Looking Statements

      The matters discussed in this report including, but not limited to, statements relating to anticipated gross margin levels, anticipated spending levels for capital equipment, research and development, and selling, general and administrative expenses, adequacy of our financial resources to meet currently anticipated cash flow requirements for the next twelve months, lack of significant changes in financial market risk exposures to the Company, and general economic conditions are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended; Section 21E of the Securities and Exchange Act of 1934, as amended; and the Private Securities Litigation Reform Act of 1995; and are made under the safe-harbor provisions thereof. Such forward-looking statements, which may be identified by phrases such as “we anticipate”, “we expect”, and “on a forward-looking basis”, are subject to certain risks and uncertainties that could cause actual results to differ materially from those projected. Specific factors that may cause results to differ include the hiring and retention of key employees; changes in product line revenues; insufficient, excess, or obsolete inventory and variations in valuation; and foreign exchange rate fluctuations. For a discussion of additional risks, see “Business Environment and Risk Factors”, appearing under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of this Annual Report on Form 10-K. Readers are cautioned not to place undue reliance on these forward-looking statements, which reflect management’s analysis only as of the date hereof. Aspect undertakes no obligation to publicly release any revision to these forward-looking statements that may be made to reflect events or circumstances after the date hereof.

2

Table of Contents

Item 1.     Business

Background

      Aspect Communications Corporation (Aspect or the Company) is a leading provider of business communications solutions that help companies improve customer satisfaction, reduce operating costs, gather market intelligence and increase revenue. Aspect is the trusted mission-critical partner of two-thirds of the Fortune 50 companies, daily managing more than 3 million customer sales and service professionals worldwide. Aspect provides the mission critical software and hardware platforms, development environment and applications that seamlessly integrate traditional telephony, e-mail, voicemail, web, fax, wireless business communications and Voice over Internet Protocol (VoIP), while providing investment protection in a company’s existing data and telephony infrastructures. Aspect’s leadership in business communications solutions is based on more than 17 years of experience and more than 8,000 implementations deployed worldwide. Aspect was incorporated on August 16, 1985, in California and is headquartered in San Jose, California. Aspect has offices around the world, as well as an extensive global network of systems integrators, technology partners and distribution partners.

      Aspect has expertise in providing the software and hardware platforms that serve all customers, any place and through any wired or wireless media, by being able to connect them to the appropriate resource, functionality or application — even to those outside of the company. Aspect is a leader in building multi-channel contact centers that serve as the foundation of any successful Customer Relationship Management (CRM) strategy. With its mission-critical solution, Aspect offers a business communications platform today and a migration path that allows businesses to leverage their existing infrastructure as they move to the converged network of tomorrow.

Industry Background and Market Trends

      Many companies today are recognizing that managing customer contacts in a cost effective way that provides quality services is key to continued attraction and retention of customers. With more enterprises having a global presence, providing a consistent level of customer interaction becomes increasingly important, with customers wanting the same service regardless of their location, the time of day, the medium they are using (voice, e-mail, fax or the web), the location from which the assistance is being supplied, or the individual providing the service.

      Call and contact centers are the most demanding enterprise business communications environments. In these environments, massive customer interaction volumes need to be blended across a universal queue to handle voice, e-mail and web interactions. Our key to a solution is an open business communications platform with mature tool sets, open Application Programming Interface (APIs), real-time interfaces, and an intuitive graphical user interface for creating routing scenarios based on business rules. This business communications platform integrates multiple communication channels with front and back-office systems and provides central control of multiple contact center sites. Sophisticated routing, blending and workflow capabilities greatly improve customer satisfaction by connecting customers the first time directly to the right agent who can quickly and efficiently resolve their problems. In addition, customers are empowered to use self-service channels like the web and interactive voice response. Contact centers are also increasingly using workforce optimization technologies to ensure they are adequately staffed to deal with peak customer demand.

      VoIP, working in concert with other Internet technologies, is anticipated to be the next major communications advance. Going forward, CRM solutions will be based increasingly on Internet Protocol (IP) technology, and as contact centers move into the IP world-handling VoIP calls, e-mail, web chat, and Customer Service Representative (CSR) assisted browsing. Businesses will have new opportunities to better serve their customers and build more lasting and profitable customer relationships. In IP contact centers, the entire operation is run by a software-based switching application that blends voice, e-mail, and web communications into a unified queue, then routes them cost-effectively over a single data network to any

3

Table of Contents

Products

      Aspect’s integrated suite of applications and customer services are developed around the Aspect Contact Server platform and can leverage both legacy technology and newer VoIP technologies, including software and hardware products.

      The Aspect Contact Server is at the center of Aspect’s solutions architecture and can integrate a company’s CRM and business communications resources. The Aspect Enterprise Contact Server handles multi-channel queuing across voice, email and web contacts as well as management and centralized administration of multi-site contact centers.

      Aspect’s integrated applications address three primary opportunity areas in the market for contact centers and business communications. These are:

      1.     Contact Center Management

	Aspect Call Center processes and routes both inbound and outbound calls and permits multi-site integration, outbound call management, and remote staffing across both Public Switched Telephone Network (PSTN) and hybrid VoIP networks.
	Aspect Contact Server enables customer contact routing so that a business can route customer data with voice to the appropriate desktop. Enterprise routing makes it possible to route contacts based on a combination of customer information, business rules, and multiple agent skills, and enables centralized management and administration of multiple contact center sites. Multichannel routing enables a business to view telephone, e-mail, and interactive web contact channels as components of a single multichannel contact center.
	Aspect Internet Protocol Contact Server (IPCS) Enterprise can move all communications to a single data network and extend contact center business communications throughout the enterprise enabling streamlined processes and significant cost saving opportunities. IP-enabled contact centers reduce expenses by eliminating expensive PSTN switch equipment and long-distance costs for home-based CSR. Traditional voice-routing capabilities are easily carried forward and blended with e-mail and web channels.
	Aspect Web Interaction is Web-collaboration software that makes the Web an integral part of a contact center by allowing customers to interact directly with a CSR. It incorporates shared browsing, page markup, text chat, and collaborative form completion.
	Aspect Customer DataMart consolidates information from enterprise resources in multiple contact centers and enables customers to analyze multisite operations as a single, virtual contact center.
	Aspect Carrier Routing reduces PSTN charges by making routing decisions while the call is in a carrier network.

      2.     Workforce Optimization

	Aspect eWorkforce Management enables efficient management of contact center agent resources across multiple channels, including e-mail, web, and voice. It allows managers to forecast workloads and develop employee schedules, thus optimizing service levels and minimizing labor costs.

      3.     Self-Service

	Aspect Customer Self-Service allows customers to conduct self-service transactions conveniently and around-the-clock with options such as Interactive Voice Response (IVR), speech recognition and text-to-speech.

4

Table of Contents

Customer Services

      Aspect offers technical support and maintenance, consulting, and education services to ensure the Company’s customers’ continued growth and success.

      To enhance all of Aspect’s software solutions, Aspect Customer Services offers complete end-to-end strategy, design, development, implementation, training, and ongoing technical support for all Aspect solutions.

      Aspect’s technical support and maintenance services include on-site and remote access to support personnel, which are provided primarily by Aspect support centers located around the world. Pricing of support services is generally based on the level of support contracted and the number of users authorized to access the products. These contracts generally include update rights for licensed products.

      Aspect’s consulting services include professional services and installation, which are provided by employees, consultants or partners and are primarily based on time and material contracts.

      Aspect’s education services include training courses, which are provided in the Company’s training centers or at customer sites around the world.

Product Development

      The Company has a continuing program of product development directed toward the enhancement of existing products based upon current and anticipated customer needs. The Company’s research and product development efforts also emphasize introduction of new products to broaden the Company’s product lines and to reach a larger segment of the business communications software market. During the past three years, the Company has made investments in its product development efforts, spending $57 million on research and development in 2002, $96 million in 2001 and $109 million in 2000, which represented 27%, 30% and 32%, respectively, of total operating expenses excluding restructuring and purchased in-process technology charges.

Manufacturing

      The Company’s manufacturing operations have been outsourced to third party suppliers. The Company orders materials with different lead times, generally 30 to 90 days ahead of required date of delivery. Because this is a longer time frame than the average customer order to shipment cycle, the Company authorizes its third party suppliers to acquire materials and build standard sub-assemblies based on forecasted production requirements. Upon receipt of firm orders from customers, the Company instructs its third party suppliers to assemble, configure, test and ship systems to meet customers’ request dates. The Company has established manufacturing procedures with its third party suppliers that are designed to achieve rapid response to customer orders.

Markets, Segments, and Customers

      The Company’s operations are reported as two operating segments, which are Product and Services. The complete financial segment information, as well as geographical information, can be found in the notes to the consolidated financial statements thereto in this Annual Report on Form 10-K. The Company markets and sells its products and services primarily to large organizations in diversified industries worldwide. Aspect markets its products in the United States largely through its direct sales force and internationally has a direct sales force supplemented through distribution partners and Value-Added Resellers (VARs) in various countries. A key part of Aspect’s overall strategy is to increase sales through indirect channels including VARs, Technology Alliances (TAs), and System Integrators (SIs). The Company plans to continue to develop alliances with key technology players who integrate their products or services with Aspect products or services thereby enabling the customer to purchase a complete solution.

5

Table of Contents

Backlog

      The Company’s backlog at December 31, 2002, was approximately $5 million compared with a backlog of approximately $3 million at December 31, 2001. The Company includes in its backlog only orders confirmed with a purchase order for products to be shipped within 90 days to customers with approved credit status. While the Company believes that all of the orders included in its backlog are firm, the Company may determine that it is in its best interest to allow orders to be cancelled without penalty.

Competition

      The market for Aspect’s products is intensely competitive, and competition is likely to intensify as companies in Aspect’s industry consolidate to offer integrated solutions. Aspect’s principal competitors currently include companies in the contact center market and companies that market traditional telephony products and services.

      As the hardware requirements for a traditional call center diminish due to the emergence of the Internet, local area networks, and other factors, companies in these markets are merging and obtaining significant positions in the contact center and traditional telephony products market. Many current and potential competitors, including Avaya Inc., Nortel Networks Corporation, Rockwell International Corporation, Alcatel SA, Siemens AG, Cisco Systems Inc., IEX Corporation, and Blue Pumpkin, Inc., may have considerably greater resources, larger customer bases and broader international presence than Aspect. Consequently, Aspect expects to encounter substantial competition from these companies and other sources.

      The Company believes that the principal competitive factors in its market include the quality, performance, reliability, price and market acceptance of the Company’s products; the Company’s level of customer support and reputation with its customers; the timeliness and quality of new products; and the Company’s market presence.

Intellectual Property and Related Matters

      The Company’s success depends in part upon its internally developed technology. The Company generally enters into non-disclosure agreements with its employees, consultants, and vendors, and generally controls access to and distribution of its software, documentation, and other proprietary information. Despite these precautions, unauthorized third parties may copy or otherwise obtain and use the Company’s technology. In addition, third parties may develop similar technology independently.

      The Company files patent applications to protect inventions and improvements that are significant to the development of its business. The Company currently holds approximately 119 issued United States patents and a lesser number of issued foreign patents and has pending approximately ten United States patent applications and a lesser number of corresponding foreign patent applications that cover various components of its technology. The Company’s United States issued patents expire on dates ranging from 2004 through at least 2022. There can be no assurance that any of the claims in the pending applications will be allowed, or that any issued patents will be upheld, or that competitors will not circumvent the Company’s patents, or that any patents or licenses will provide competitive advantages for the Company’s products.

      The Company develops and maintains proprietary software that is licensed to its customers.

      The Company holds licenses from multiple third parties regarding rights to certain technology that the Company incorporates in its products. The Company has also entered into standard commercial license agreements with several suppliers of operating systems, databases, and other software used for development and implementation of the Company’s products. These licenses are ongoing and generally involve the payment of royalties based on the volume of systems the Company ships over periods of time.

6

Table of Contents

Employees

      As of December 31, 2002, the Company employed 1,391 employees.

Website Posting of SEC Filings

      The Company website provides a link to the Company’s SEC filings, which are available on the same day such filings are made. The Company website is www.aspect.com/ir/index.cfm.

Item 2.     Properties

      Aspect’s headquarters currently occupies three office buildings, totaling approximately 285,000 square feet, in San Jose, California. Two of the buildings are owned and the third one is leased. The owned buildings are approximately 209,000 square feet in total. The Company occupies approximately 67,000 square feet in facilities located in Tennessee that are leased through 2006. The Company also occupies 80,000 square feet in Massachusetts that are leased through 2009. Other North American sales and support functions operate from various leased multi-tenant offices nationwide covering a total of 76,000 square feet with leases expiring as late as 2010. Additionally, the Company leases approximately 297,000 square feet of space in North America that is currently unoccupied, of which the Company subleases approximately 128,000 square feet as of December 31, 2002 to third parties.

      Aspect has several facilities to support its European operations. The principal UK operations are located near London in facilities totaling approximately 30,000 square feet and are leased through 2023. Other significant European facilities are located in France, the Netherlands and Germany. In Asia, the Company occupies sales and support offices in Japan, Singapore, Hong Kong and Australia.

      The Company believes its existing facilities are adequate to meet current requirements and that suitable additional or alternative space will be available as needed on commercially reasonable terms. See Note 13 to “Notes to Consolidated Financial Statements”, in item 8 of this Annual Report on Form 10-K.

Item 3.     Legal Proceedings

      The Company is subject to various legal proceedings and claims that arise in the normal course of business. While the outcome of these proceedings and claims cannot be predicted with certainty, management does not believe that the outcome of any of these legal matters will have a material adverse effect on the Company’s business, operating results or financial condition.

      The Company was involved in an arbitration proceeding in the United Kingdom relating to a dispute between the Company and Universities Superannuation Scheme Limited (USS) regarding an Agreement to Lease between the Company and USS executed June 2000 pursuant to which the Company leased certain facilities from USS. Pursuant to a court order issued on November 28, 2002, the Company paid $15 million to USS. On January 6, 2003, the Company and USS executed the Deed of Settlement (the “Settlement”) terminating the Agreement to Lease.

      No matters were submitted to a vote of security holders during the quarter ended December 31, 2002. However, in January of 2003, the Company submitted two matters to a vote of security holders at its Special Meeting of Shareholders on January 21, 2003. The first matter voted upon was the issuance and sale of $50 million of Series B convertible preferred stock in a private placement, which shares were initially convertible into 22.2 million shares of common stock. This matter was approved by the requisite vote of shareholders (26,481,555 votes in favor, 11,276,985 votes opposed, 12,159,146 broker non-votes, and 96,262 votes abstaining). The second matter voted upon by the shareholders was an amendment to the Company’s Amended and Restated Articles of Incorporation to increase the authorized number of shares of common stock from 100 million shares to 200 million shares. This matter was approved by the requisite vote of shareholders (37,618,325 votes in favor, 12,286,280 votes opposed, and 109,707 votes abstaining). Each of these two matters submitted to a vote of security holders is described more fully in the proxy statement distributed by the Company to its shareholders on December 9, 2002.

7

Table of Contents

      Stock Listing: Aspect Communications Corporation’s common stock is traded on the Nasdaq Stock Market under the symbol “ASPT”. As of December 31, 2002, there were approximately 1,047 shareholders of record of Aspect’s common stock.

      Dividend Policy: Aspect has never paid cash dividends on its common stock. Pursuant to the terms of the Series B convertible preferred stock set forth in the Company’s Certificate of Determination of Rights, Preferences and Privileges of Series B Convertible Preferred Stock, the Company may not declare or pay dividends on any class of stock junior to that of the Series B convertible preferred stock without the prior written consent of the holders of a majority of the shares of the Series B convertible preferred stock then outstanding. Additionally, the Company is now obligated to accrue dividends on each share of Series B convertible preferred stock, compounded on a daily basis at the rate of 10% per annum. The undeclared preferred stock dividends are forfeited in the event of conversion. The Company is permitted to pay up to 50% of accrued dividends in the form of Common Stock. If there has been no conversion or no cash dividend payments upon the tenth anniversary of the date of issuance of the Series B convertible preferred stock, the Company is required to pay a liquidation preference equal to 125% of the outstanding accumulated unpaid dividends to the Series B convertible preferred shareholders. Subject to the foregoing, we currently anticipate that we will retain all available funds for use in our business.

8

Table of Contents

Item 6.     Selected Financial Data

(a)	Upon adoption of Statement of Financial Accounting Standard (SFAS) No. 142 Goodwill and Other Intangible Assets, the Company recorded a non-cash charge of $51 million as a cumulative effect of a change in accounting principle effective January 1, 2002, for the impairment of the goodwill related to the Products segment. During 2002, the Company recorded an impairment charge of $39 million to write off certain acquired intangible assets relating to previous acquisitions, a restructuring charge of $22 million, gains of $7 million on extinguishment of debt in other income, an impairment of $9 million to write-down a long-term investment and a $27 million non-recurring tax refund.
(b)	During 2001, the Company recorded a restructuring charge of $44 million.
(c)	In February 2000, Aspect acquired PakNetX Corporation. The transaction was accounted for as a purchase and a charge of $5 million was recorded for purchased in-process technology that had no alternative uses. During 2000, Aspect recorded a gain on the sale of appreciated equity securities of $20 million.
(d)	In May 1998, Aspect acquired Voicetek Corporation. The transaction was accounted for as a purchase and a charge of $10 million was recorded for purchased in-process technology that had no alternative future use.

9

Table of Contents

(e)

Long-term debt as of December 31, 2002, included long-term borrowings of $41 million and the long-term portion of capital lease obligations of $189,000. Long-term debt as of December 31, 2001, included the 1998 convertible subordinated debentures of $184 million, long-term borrowings of $25 million and the long-term portion of capital lease obligations of $299,000. Amounts in other years include the convertible subordinated debentures and in 2000, capital lease obligations of $852,000. In August 1998, Aspect completed a private placement of approximately $150 million ($490 million principal amount at maturity) of zero coupon convertible subordinated debentures due 2018.

The convertible subordinated debentures can be put to the Company on August 10, 2003. Accordingly, the Company classified the debentures as current liabilities as of December 31, 2002. The exercise of this put could require the Company to pay for the then accreted value of approximately $130 million in stock, cash or any combination thereof, at the Company’s discretion. If the put is exercised, the Company currently intends to redeem the convertible subordinated debentures with cash.

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

Overview

      Aspect is a leading provider of business communications solutions that help companies improve customer satisfaction, reduce operating costs, gather market intelligence and increase revenue. Aspect provides the mission-critical software and hardware platforms, development environment and applications that seamlessly integrate traditional telephony, e-mail, voicemail, web, fax, wireless business communications and VoIP, while providing investment protection in a company’s existing data and telephony infrastructures.

      During fiscal 2001, in response to dramatic changes in the global economy, Aspect reorganized the Company to more effectively leverage the Company’s relationships with existing as well as new partners and maximize the Company’s ability to capitalize on market opportunities. In February 2001, April 2001 and October 2001, the Company reduced its workforce by 6%, 11% and 10% respectively. In addition, the Company consolidated selected facilities in its continuing effort to better optimize operations. These actions resulted in restructuring charges of $7 million, $13 million and $24 million, respectively.

      During fiscal 2002, the Company continued its efforts to right size the Company, which resulted in restructuring charges of $22 million, which represented a 25% reduction in the Company’s workforce.

Critical Accounting Policies

      Note 1 of the Notes to the Consolidated Financial Statements in the Company’s “Annual Report on Form 10-K for the fiscal year ended December 31, 2002”, includes a summary of the significant accounting policies and methods used in the preparation of Company’s Consolidated Financial Statements.

      The preparation of financial statements in conformity with accounting standards generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the dates of the financial statements and the reported amounts of revenues and expenses during the reporting periods. The most significant estimates and assumptions relate to the allowance for doubtful accounts, revenue reserves, excess and obsolete inventory, impairment of long-lived assets, valuation allowance and realization of deferred income taxes, and restructuring reserve. Actual amounts could differ significantly from these estimates.

      Aspect’s critical accounting policies include revenue recognition, revenue reserves, allowance for doubtful accounts, accounting for income taxes, excess and obsolete inventory and impairment of long-lived assets. The following is a brief discussion of the critical accounting policies and methods used by the Company.

      Revenue recognition: The Company derives its revenue primarily from two sources (i) product revenues, which include software licenses and hardware, and (ii) service revenues, which include support and maintenance, installation, consulting and training revenue.

      The Company applies the provisions of Statement of Position 97-2, “Software Revenue Recognition”, as amended by Statement of Position 98-9, “Modification of SOP 97-2, Software Revenue Recognition, With

10

Table of Contents

      The Company recognizes revenue from the sale of software licenses and hardware when persuasive evidence of an arrangement exists, the product has been delivered, title and risk of loss have transferred to the customer, the fee is fixed or determinable and collection of the resulting receivable is probable. Delivery generally occurs when product is delivered to a common carrier.

      At the time of the transaction, the Company assesses whether the fee associated with its revenue transactions is fixed or determinable and whether collection is probable. The assessment of whether the fee is fixed or determinable is based partly on the payment terms associated with the transaction and financial strength of the customer. If a significant portion of a fee is due after its normal payment terms, which are 30 to 90 days from invoice date, the Company accounts for the fee as not being fixed or determinable; in which case, the Company recognizes revenue as the fees become due.

      The Company assesses collection based on a number of factors, including past transaction history with the customer and the credit worthiness of the customer. The Company does not typically request collateral from its customers. If the Company determines that collection of a fee is not probable, then the Company will defer the fee and recognize revenue upon receipt of cash.

      For arrangements with multiple elements, the Company allocates revenue to each component of the arrangement using the residual value method based on vendor specific objective evidence of the undelivered elements. This means that the Company defers the arrangement fee equivalent to the fair value of the undelivered elements until these elements are delivered. The fair value of each element is determined based on prices of stand-alone sales of these elements to third parties.

      A key part of the Company’s overall strategy is to increase sales through indirect channels such as VARs and partnering with SIs and TAs on the direct sales efforts. In any sales transaction through a distributor or reseller, the Company recognizes revenue when the distributor or reseller sells to the end customer.

      The Company recognizes revenue for maintenance services ratably over the contract term. The training and consulting services are billed based on hourly rates, and the Company generally recognizes revenue as these services are performed. However, at the time of entering into a transaction, the Company assesses whether any services included within the arrangement are essential to the functionality of other elements of the arrangement. If services are determined to be essential to other elements of the arrangement, the Company recognizes the license, consulting and training revenue using the percentage-of-completion method. The Company estimates the percentage of completion based on its estimate of the total costs estimated to complete the project as a percentage of the costs incurred to date and the estimated costs to complete. To date, the amount of revenue recognized under the percentage-of-completion method has not been significant.

      Revenue reserves: An estimate of the revenue reserve for losses on receivables resulting from customer cancellations or terminations is recorded as a reduction in revenues at the time of the sale. The revenue reserve is estimated based on an analysis of the historical rate of cancellations or terminations of product and services arrangements. The accuracy of the estimate is dependent on the rate of future cancellations or terminations being consistent with the historical rate. If the rate of actual cancellations or terminations is greater than the historical rate, then the revenue reserve may not be sufficient to provide for actual losses.

      Allowance for doubtful accounts: The Company’s management must make estimates of the uncollectibility of accounts receivable. Management specifically analyzes historical bad debts, customer concentrations, customer credit worthiness, current economic trends and changes in customer payment terms when evaluating the adequacy of the allowance for doubtful accounts. The accounts receivable balance was $51 million, net of allowance for doubtful accounts of $12 million as of December 31, 2002.

      Accounting for income taxes: As part of the process of preparing its consolidated financial statements, the Company is required to estimate its income taxes in each of the tax jurisdictions in which the Company operates. This process involves management’s estimation of the Company’s actual current tax exposure

11

Table of Contents

      Significant management judgment is required in determination of the provision for income taxes, deferred tax assets and liabilities and any valuation allowance recorded against net deferred tax assets. The Company has a valuation allowance of $84 million as of December 31, 2002, due to uncertainties related to the Company’s ability to utilize all of its deferred tax assets, primarily consisting of certain net operating losses carried forward and research tax credits, before they expire. The valuation allowance is based on estimates of taxable income by jurisdiction in which the Company operates and the period over which the deferred tax assets will be recoverable. In the event that actual results differ from these estimates or the Company adjusts these estimates in future periods, the Company may need to adjust its valuation allowance which could materially impact its financial position and results of operations.

      Excess and obsolete inventory: The Company values inventory at the lower of the actual cost or the current estimated net realizable value of the inventory. Management regularly reviews inventory quantities on hand and records a provision for excess and obsolete inventory based primarily on production and supply requirements. Management’s estimates of future production and supply requirements may prove to be inaccurate, in which case inventory may be understated or overstated. In the future, if the carrying value of the inventory were not realizable, the Company would be required to recognize write-downs to net realizable value as additional cost of goods sold at the time of such determination. Although management makes every effort to ensure the accuracy of its forecast of future production requirements and supply, any unanticipated changes in technological developments could have a significant impact on the value of our inventory and our reported operating results.

      Impairment of long-lived assets: The Company’s long-lived assets include property and equipment, long term investments, goodwill and other intangible assets. The fair value of the long-term investments is dependent on the performance of the companies in which the Company has invested, as well as volatility inherent in the external markets for these investments. In assessing potential impairment for these investments, the Company considers these factors as well as the forecasted financial performance of its investees. The Company records an investment impairment charge when it believes an investment has experienced a decline in value that is other than temporary. During 2002, the Company recognized $9 million of impairment losses related to its long-term investments. As of December 31, 2002, the carrying value of the Company’s long-term investment was $150,000.

      In assessing the recoverability of the Company’s property and equipment, goodwill and other intangible assets, the Company must make assumptions regarding estimated future cash flows and other factors to determine the fair value of the respective assets. If these estimates or their related assumptions change in the future, the Company may be required to record impairment charges for these assets.

      In June 2001, the Financial Accounting Standard Board (FASB) issued Statement of Financial Accounting Standard (SFAS) No. 142, Goodwill and Other Intangible Assets. SFAS No. 142 addresses the initial recognition and measurement of intangible assets acquired outside of a business combination and the accounting for goodwill and other intangible assets subsequent to their acquisition. SFAS No. 142 provides that intangible assets with finite useful lives will be amortized and that goodwill and intangible assets with indefinite lives will not be amortized, but will rather be tested at least annually for impairment. The Company adopted SFAS No. 142 for its fiscal year beginning January 1, 2002. Upon adoption of SFAS No. 142, the Company discontinued the amortization of its recorded goodwill, identified its reporting units based on its current segment reporting structure and allocated all recorded goodwill, as well as other assets and liabilities, to the reporting units.

12

Table of Contents

      The Company determined the fair value of its reporting units utilizing discounted cash flow models and relative market multiples for comparable businesses. The Company compared the fair value of each of its reporting units to its carrying value. This evaluation indicated that an impairment might exist for the Company’s Products reporting unit. The Company then performed Step 2 under SFAS No. 142 during the second quarter of 2002 and compared the carrying amount of goodwill in the Products reporting unit to the implied fair value of the goodwill and determined that an impairment loss existed. This impairment is primarily attributable to the change in the evaluation criteria for goodwill from an undiscounted cash flow approach, which was previously utilized under the guidance in Accounting Principle Board Opinion No. 17 Intangible Assets, to the fair value approach, which is stipulated in SFAS No. 142 and the requirement under SFAS No. 142 to evaluate goodwill impairment at the reporting unit level. A non-cash charge totaling $51 million was recorded as a change in accounting principle effective January 1, 2002, to write-off the goodwill related to the Products segment. The remaining recorded goodwill for the Services segment is $3 million as of December 31, 2002. In the first quarter of 2003, the Company will evaluate its remaining goodwill per SFAS No. 142 requirements.

13

Table of Contents

Results of Operations

      The following table sets forth statements of operations data for the three years ended December 31, 2002, expressed as a percentage of total revenues: