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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

NONE

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

Common Stock, $0.01 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 30, 2003, was $189,032,250 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 January 30, 2004, was 57,345,647.

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ASPECT COMMUNICATIONS CORPORATION

INDEX TO ANNUAL REPORT ON FORM 10-K

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Forward-Looking Statements

      The matters discussed in this report including, but not limited to, statements relating to 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 “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. We undertake 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.

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PART I

Company Overview

      We are a leading provider of software, hardware and services that enable businesses to manage and optimize enterprise communications. We develop, market, license and support an end-to-end, integrated suite of contact center software applications that supports and manages customer communications, customer and contact center information and workforce productivity. Our solutions allow businesses to better service their customers by connecting them to appropriate resources, functionalities or applications, regardless of user location or method of communication. We have focused exclusively on contact center solutions since our inception in 1985. We have a well established global customer base including more than two-thirds of the Fortune 50, in a broad range of industries including transportation, financial services, insurance, telecommunications and outsourcing.

Industry Overview

      The contact center has become an important component of business strategy, evolving from an organizational outpost to a vital strategic resource. Historically, call centers were viewed as a necessary expense for providing customer support. Today, enterprises manage customer communications across a wide variety of technologies, helping transform traditional voice-based call centers into integrated multi-channel contact centers. Contact centers provide valuable customer information that enables enterprises to understand customer buying trends, target markets more effectively, and increase revenue. Therefore, contact centers are now increasingly perceived as profit centers instead of cost centers.

      Evolution of Contact Center Technology. In the mid-1980s, call center technology was limited to the distribution of voice calls to customer service representatives using automatic call distributors, or ACDs. This technology grew to encompass inbound and outbound calls and the coordinated management of multiple call centers. As large numbers of enterprises implemented customer relationship management, or CRM, software systems to record and track front-office customer interactions, it became necessary to integrate contact center solutions with these systems. Computer telephony integration, or CTI, routed customer information along with voice calls to customer service representatives, enabling them to more efficiently service customers. The development of text-to-speech and speech recognition technologies allowed interactive voice response technology, or IVR, to service customers without employing live customer service representatives. The development of workforce management software helped companies automate the complex task of scheduling large workforces with varied skills and responsibilities. Quality monitoring and recording technology also became a critical call center component that enabled companies to constantly evaluate their interactions and processes. The widespread adoption of the Internet in the late 1990s required companies to manage a broader variety of customer contact channels, including e-mail and the Web. Contact center applications are also converging as key contact center functionalities such as those of ACDs, CTI, and IVR are integrated.

      Increased Demand for Open, Standards-Based Solutions. As call center infrastructure technology was developing, call center hardware and software solutions were typically purchased from a single vendor which had its own proprietary architecture and offered limited support for and interoperability with third-party applications and systems. While such systems may have initially provided a complete contact center solution, technological advances and the increasing heterogeneity of technology infrastructures have outpaced the ability of individual proprietary platform vendors to offer a comprehensive end-to-end solution. As a result, there is an increasing demand for open standards-based solutions that can address the full range of contact center needs.

      The Trend Towards Remote Contact Center Solutions. Advances in contact center technology and the reduction of international communications costs have been driving a significant industry trend towards remote call center solutions. Companies save substantial labor costs and are able to more cost-effectively provide around the clock customer support by off-shoring, or moving contact centers to international or other off-site locations, or by outsourcing contact center services to a third party. For example, companies have been moving

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      Workforce Management and Optimization Challenge. The most significant cost in operating a contact center is personnel and related expenses. The complexity of contact center operations and the related demands being placed on contact center managers create the need for effective tools for forecasting, scheduling, staffing, managing and optimizing contact center operations. Workforce management software allows supervisors to efficiently and effectively manage the challenges of contact center labor. An optimal workforce management solution should help forecast customer demand based on changing business and customer requirements, schedule staff according to agent skill level and customer demand, and plan employee schedules. Also, it should accommodate new communication media as they are added and integrate with training applications so agent training on new products or skills is part of the overall schedule consideration. By matching the contact center operation needs with the individual agent’s schedule preferences and skill sets, contact center managers can improve employee retention and job satisfaction and increase productivity in a cost-effective manner.

      Analytics and Consolidated Reporting. Multiple communications media, geographically dispersed sites and increasing pressures to increase operational efficiency are generating demand for applications that enable users to capture and view data in dynamic and immediate ways. These applications must gather data from a variety of media and contact center applications into an open-standards based repository against which standard tools can be applied for analytics and reporting. They should be dynamic enough to allow users to view high-level operational metrics as well as allow them to view details specific to particular agents. This would enable users to make informed decisions and rapid changes to how customer interactions are being handled based on the depth and breadth of information they can access.

      The Emergence of VoIP. VoIP, together with other Internet technologies is anticipated to be the next major advance in communications. VoIP permits the movement of voice traffic over the Internet using Internet Protocol, improving the performance of a converged system, and typically lowering transmission costs relative to PSTN by enabling the consolidation of networks and the bypass of toll charges for long distance voice. Instead of two separate networks for voice and data, voice calls flow over the data network similar to other communications such as e-mail. Therefore, in order to support VoIP, contact centers will have to employ software-based applications that blend voice, e-mail and Web communications into a single queue and route them intelligently over a data network to the optimal destination. Convergence of voice and data networks in the contact center has been and will continue to be evolutionary due to its mission critical role in business. This will drive the need for a migration strategy which is not disruptive to businesses and which offers support for legacy and converged networks.

Products

      We develop, market and support software and hardware products designed to enable organizations to provide a high level of service to their customers. Our solutions are based on our Uniphi architecture, which connects the contact center to the enterprise by integrating the applications that drive customer communications, customer and contact center information, and workforce productivity. We offer our software products as integrated suites or separate modules, depending on customer requirements.

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      The following table summarizes our software product suites, the individual application and the capability within the contact center:

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      We also provide hardware products and solutions including:

Technology and Architecture

      Our Uniphi business communications architecture extends the contact center across the enterprise by integrating the complex applications that drive customer communications, customer and contact center information, and workforce productivity.

      Our open architecture is modular, flexible and interoperable within multi-vendor environments. We incorporate open standards into the design of our products to optimize the integration and interoperability with third-party contact center technologies and applications such as quality monitoring and recording, outbound dialing and analytics. In addition, we offer integration modules that make connecting to a wide range of applications in the contact center and the enterprise less costly than developing customized interfaces to proprietary systems. We offer connectivity to key customer relationship management applications from leading vendors such as Oracle, PeopleSoft, SAP and Siebel Systems. By integrating with these applications,

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      Standards-based products are a critical part of our Uniphi solutions and product roadmap. As such, we continue to incorporate standards into our product roadmap as evidenced by the standards that we currently support in our range of communications, workforce and information solutions. In addition to incorporating standards, we support common operating systems, languages, hardware, networking protocols, database and data storage mediums and front office applications.

      We continuously evaluate and invest in research and development to expand our product roadmap to consider emerging standards. We developed our open architecture to easily accommodate the integration of emerging technologies such as Web services and Voice eXtensible Markup Language or VXML, and support our customer’s choice of standards. In addition, we enable our customers to create and quickly modify business rules to drive live and self-service communications between them and their customers. Our open architecture provides a flexible and low-cost solution that scales to address the evolving communication and infrastructure demands of our customers.

Customer Service and Support

      We believe that superior customer service and support is critical to retaining and expanding our customer base. Our customer service group provides technical support and maintenance, consulting, installation and education services to help our customers successfully implement, upgrade and utilize our products.

      Our technical support and maintenance services are provided primarily by support centers located around the world and include telephone support and remote field support. In addition, our eServices online support enables our customers to download software updates and technical information and open and track support cases on the Web. We offer various levels of support, ranging from basic support to 24 by 7 mission critical support. Pricing of support services is generally based on the level of support selected and the number of users authorized to access our products. Our contracts generally include update rights for licensed products.

      Our Global Professional Services group provides services that include the installation and implementation of our products. Our end-to-end consulting services include project design, requirements analysis, implementation, and closure. These services are generally billed on a fixed price or time and materials basis. We also partner with third-party systems integrators, or SIs, to provide additional coverage and complementary technical skills.

      Our education services include training courses, which are provided in our training centers or at customer sites around the world. These services are generally billed on a per person, per class basis.

Customers

      We have a well established global customer base including more than two-thirds of the Fortune 50, with customer deployments worldwide across a broad range of industries and markets including transportation, financial services, insurance, telecommunications and outsourcing. No customer accounted for 10 percent or more of revenue in 2003.

Sales and Marketing

      We sell and market our products and services in the U.S. primarily through our direct sales force and internationally through our direct sales force and VARs. Our direct sales force is comprised of inside sales and field sales personnel. Our sales people are located in more than 20 major cities worldwide. Our sales efforts target companies of varying sizes across diversified industries. A key aspect of our sales strategy is to increase sales through indirect channels including VARs and SIs. In addition, we plan to continue to develop alliances with key technology partners who integrate their products or services with our products or services to offer customers a complete solution.

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      We have a variety of marketing programs designed to create global brand recognition and market awareness for our product and service offerings. We market our products and services through our Web site, direct mail and online and print advertising. In addition, our marketing initiatives include hosting user conferences and active participation in tradeshows and industry events, cooperative marketing efforts with our customers and partners, publication of technical and educational articles in industry journals, sales training, product and strategy updates with industry analysts, speaking engagements, and preparation of competitive analyses. Our marketing organization also produces materials in support of sales to prospective customers that include programs and materials, brochures, data sheets, white papers, presentations, demonstrations and other marketing tools.

Research and Development

      Our product development efforts are focused on improving and enhancing our existing products as well as developing new products to broaden our offering and market opportunity. These efforts are largely driven by current and anticipated customer and strategic partner needs. Our research and development expenditures for 2003, 2002 and 2001 were $49 million, $57 million and $96 million, respectively, which represented 14%, 14% and 21% of total revenues, respectively.

      We invest a vast majority of our research and development budget to increase the functionality and interoperability of our software solutions.

Manufacturing

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

Competition

      The markets in which we operate are intensely competitive and rapidly changing. Our competition includes workforce management software vendors such as Blue Pumpkin and IEX, a subsidiary of Tekelec, and certain product lines of diversified communications equipment companies, including Avaya; Cisco Systems; Genesys, a subsidiary of Alcatel; and Nortel Networks. The principal competitive factors in our industry include quality, reliability, performance, price, level of customer support, reputation, timely introduction of new products, functionality and market presence.

      Our future success will depend on our ability to develop superior, cost-effective products, continue developing alliances with key technology partners, provide superior customer service and support, and expand our market reach relative to our competitors. Many of our competitors have greater name recognition, larger installed customer bases, longer operating histories and significantly greater financial, technical, sales, marketing and other resources than we do. Our competitors could introduce products with superior features, scalability and functionality at lower prices than our products, and could also bundle existing or new products with other more established products in order to compete with us. Our competitors could also gain market share by acquiring or forming strategic alliances with our other competitors.

Intellectual Property

      We rely on a combination of patent, trademark, copyright and trade secret laws and restrictions on disclosure to protect our intellectual property rights. We file patent applications to protect inventions and improvements that are significant to the development of our business. As of January 31, 2004, we held 96 issued United States patents and a lesser number of issued foreign patents and have pending 54 United States patent applications and a lesser number of corresponding foreign patent applications that cover various

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      We believe that customer perception of our brand and trademarks is important to our success. We have eight trademarks registered in various jurisdictions globally.

      We generally enter into non-disclosure agreements with our employees, consultants, customers and vendors, and generally control access to and distribution of our software, documentation and other proprietary information. We provide our proprietary software to customers under license agreements. Despite these precautions, unauthorized third parties may copy or otherwise obtain and use our technology. In addition, third parties may develop similar technology independently.

      We hold licenses from various third parties regarding rights to certain technology that we incorporate in our products. We have also entered into standard commercial agreements with several suppliers of operating systems, databases and other software used for development and implementation of our products. We believe that the licensing of complementary technologies and software from parties with specific expertise is an effective means of expanding the features and functionality of our products. These licenses are ongoing and generally involve the payment of a fixed license fee or royalties based on the volume of systems we ship over periods of time.

      Despite our efforts to protect our intellectual property, we cannot assure you that the steps we take will be adequate to prevent misappropriation of our technology or that our competitors will not independently develop technologies that are substantially equivalent or superior to our technology. The laws of many countries do not protect proprietary technology to as great an extent as do the laws of the United States. Moreover, the market for our products is subject to rapid technological change and therefore we also believe that factors such as the technological and creative skills of our personnel and new product developments and enhancements are essential to establishing and maintaining a technology leadership position.

Employees

      As of December 31, 2003, we had 1,291 full-time employees. None of our employees is represented by a labor union. We have never experienced a work stoppage and believe that our relationship with our employees is good.

Website Posting of SEC Filings

      The Company’s website provides a link to the Company’s SEC filings, which are available on the same day such filings are made. The specific location on the Company’s website where these reports can be found is http://www.aspect.com/ir/financials/index.cfm. The Company’s website also provides a link to the Company’s Section 16 filings which are available on the same day such filings are made.

      Our headquarters currently occupy three office buildings, totaling approximately 285,000 square feet, in San Jose, California. Two of the buildings are owned and the third building is leased. The owned buildings are approximately 209,000 square feet in total. We occupy approximately 90,000 square feet in facilities located in Tennessee that are leased through 2006. We also occupy 105,000 square feet in facilities located 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 61,000 square feet with leases expiring as late as 2010. Additionally, we lease approximately 244,000 square feet of space in North America that is currently unoccupied, of which we sublease approximately 39,000 square feet as of December 31, 2003.

      We have several facilities to support our European operations. Our principal U.K. operations are located near London in facilities totaling approximately 30,000 square feet and are leased through 2023. Other

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      We are 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, we do not believe that the outcome of any of these legal matters will have a material adverse effect on our business, operating results or financial condition. However, litigation in general, and intellectual property litigation in particular, can be expensive and disruptive to normal business operations. Moreover, the results of complex legal proceedings are difficult to predict.

      On May 20, 2003, Electronic Data Systems Corporation, or EDS, made a demand for arbitration with the American Arbitration Association in connection with the Master Services Agreement entered into by us and EDS in December 2000 in which we outsourced certain of our IT needs to EDS. A dispute arose between us and EDS over the services to be performed and charges paid under the Master Services Agreement and we terminated the Master Services Agreement for EDS’ breach of the agreement. EDS alleges that we breached the Master Services Agreement and implied warranties associated with the Master Services Agreement, committed fraud, engaged in negligent misrepresentation and that EDS is entitled to approximately $26 million in damages plus reasonable attorneys’ fees. On June 11, 2003, we filed our answer and counterclaims in which we denied every allegation made by EDS, denied that EDS is owed any amount in damages, and counterclaimed that EDS breached the Master Services Agreement, committed fraud, engaged in fraudulent and unfair business practices and therefore we are entitled to damages, restitution and disgorgement in an amount to be proven in the arbitration. The arbitration hearing began February 17, 2004.

      No matters were submitted to a vote of security holders during the quarter ended December 31, 2003.

PART II

      Aspect Communications Corporation’s common stock is traded on The Nasdaq National Market under the symbol “ASPT”. As of December 31, 2003, there were approximately 1,058 shareholders of record of Aspect’s common stock.

      Aspect has never paid cash dividends on its common stock and the terms of our credit arrangement prohibit our declaration of cash dividends without bank consent. 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

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Overview

      We are a leading provider of enterprise communication solutions that manage and optimize the contact center by integrating the applications that drive customer communications, customer and contact center information and workforce productivity. Our software and hardware solutions allow businesses to better service their customers by connecting them to appropriate resources, functionalities or applications, regardless of user location or method of communication. We understand the importance of unifying the applications that support customer communications, collect customer information and enhance workforce productivity, and we have focused exclusively on contact center solutions since our inception in 1985. We have a well established customer base, including more than two-thirds of the Fortune 50.

The Current Economic Environment

      The economic climate in which we operate has been difficult over the last three years, and capital spending has decreased dramatically. This has had a pronounced effect on our ability to generate new license fees, as IT budgets have been frozen and large capital expenditures like those required to purchase some of our products have been quite limited. Additionally, competition for these more limited sales opportunities has increased, and we have seen intense price competition both for new licenses and for support services. While we believe our installed base continues to represent a solid recurring revenue opportunity and a significant cash flow generator, we cannot provide any assurance that these pressures on IT spending will ease, or that the general economic climate will improve. Continued competitive pressure and a weak economy could have a

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Significant Financial Events in 2003

      During 2003, we generated $99 million in cash flow from operations, completed a private placement of preferred stock which generated net proceeds of $43 million and repaid $129 million of convertible subordinated debenture liabilities. In addition, we substantially lowered our days sales outstanding represented in our accounts receivable.

Sources of Revenues

      Our revenues are derived from license fees for software products and, to a lesser extent, sales of hardware products. We also generate a substantial portion of our revenues from fees for services complementing such products, including software license updates and product support (maintenance), installation, professional consulting and education. We typically license our products on a per user basis with the price per user varying based on the selection of products licensed. Our software license update support fees are generally based on the level of support selected and the number of users licensed to use our products. Our professional service fees are generally based on a fixed price or time and materials basis. Our education services are generally billed on a per person basis.

      We currently expect that services and support revenues will continue to account for a significant portion of our revenues for the foreseeable future.

      To date, revenues from license fees have been derived from direct sales of software products to end users through our direct sales force and from our channel and other alliance partners. Our ability to achieve revenue growth and improved operating margins, as well as increased worldwide sales, in the future will depend in large part upon our success in expanding and maintaining these indirect sales channels worldwide.

Critical Accounting Policies and Estimates

      Note 1 of the Notes to the Consolidated Financial Statements in this report includes a summary of the significant accounting policies and methods used in the preparation of Company’s Consolidated Financial Statements.

      Our 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 and restructuring reserves.

      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 reserves. Actual amounts could differ significantly from these estimates. The following is a brief discussion of the critical accounting policies and methods that we use.

      Revenue Recognition: We recognize 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 the product is delivered to a common carrier. In any sales transaction through a distributor or reseller, we recognize revenues when the distributor or reseller sells to the end user.

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      For multiple element arrangements, we defer the fair value of revenue associated with each undelivered element until such time as delivery occurs. Deferred revenue is allocated to each element using vendor specific objective evidence of fair value. Fair value is established through separate sales of each element to third parties.

      Revenue reserves: An estimate of the revenue reserve from customer returns is recorded as a reduction in revenues. In determining our revenue reserve estimate, and in accordance with internal policy, we rely on historical data, known returned goods in transit and direct feedback from our internal business units. Our revenue reserve can vary from what actually occurs in that more or less product may be returned from what was originally estimated. These factors and unanticipated changes in the economic and industry environment could make our return estimates differ from actual. The revenue reserve was $1.2 million as of December 31, 2003.

      Allowance for doubtful accounts: Our management must make estimates of the collectibility 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 key factors we use in assessing this allowance are the individual judgments on specific customer balances and the overall aging of the total receivables. Assumptions and judgments regarding collectibility of accounts could differ from actual events. The accounts receivable balance was $40 million, net of allowance for doubtful accounts of $4.8 million as of December 31, 2003.

      Accounting for income taxes: As part of the process of preparing consolidated financial statements, we are required to estimate our income taxes in each of the tax jurisdictions in which we operate. This process involves management’s estimation of our actual current tax exposure together with an assessment of temporary differences resulting from different treatments in tax and accounting of certain items. These differences result in net deferred tax assets and liabilities, which are included within the consolidated balance sheet. We must then assess the likelihood that the deferred tax assets will be recovered from future taxable income and to the extent we believe that recovery is not likely, we must establish a valuation allowance. To the extent we establish a valuation allowance or adjust this allowance in a period, we must include a tax expense or benefit within the tax provision in the statement of operations.

      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. We have a valuation allowance of $79 million as of December 31, 2003, due to uncertainties related to our ability to utilize all of our 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 we operate and the period over which the deferred tax assets will be recoverable. In the event that actual results differ from these estimates or we adjust these estimates in future periods, we may need to adjust our valuation allowance, which could favorably impact our results of operations.

      Excess and obsolete inventory: We value 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 write-down 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, we 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. The total writedowns during the year ended December 31, 2003, related to excess and obsolete inventory were $1.3 million.

      Impairment of long-lived assets: Our 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 we have invested, as well as volatility inherent in the external markets for these investments. In assessing potential impairment for these investments, we consider these

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      In assessing the recoverability of our property and equipment, goodwill and other intangible assets, we 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, we may be required to record impairment charges for these assets.

      Restructuring reserve: In 2002 and 2001, we reduced our workforce by 22% and 28%, respectively, and consolidated selected facilities in our continuing effort to better optimize operations. In connection with the workforce adjustments, a restructuring reserve was established based on estimated costs for severance and outplacement, consolidation of facilities and legal and other costs. Due to the decline in the commercial real estate market, it was expected that abandoned leased facilities would be vacant for several quarters or through the end of the lease term. If the facilities were subleased, it would be at rates below current contractual requirements. We recorded a charge related to the facilities abandonment, based on the difference between the expected cash outflows and the expected cash inflows related to these vacated properties. We periodically review factors such as further declines in the commercial real estate markets and our ability to terminate leases, and based on these reviews we adjust our restructuring reserve as necessary. The remaining restructuring reserve as of December 31, 2003 relates to consolidation of facilities costs and will be reduced going forward by lease payments offset by minimal sublease income. The restructuring reserve balance was $16.9 million as of December 31, 2003.

Results of Operations

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

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Comparison of Years Ended December 31, 2003, 2002 and 2001

Revenues
($ in thousands)

      Net revenues declined by 8% in 2003 as compared to 2002 and 11% in 2002 as compared to 2001. The general decline in revenues resulted from unfavorable global economic conditions. These conditions led to decreased growth in contact center operations and decreased capital spending by our customers.

      Net revenues derived from the Americas constituted 67%, 67% and 73% of total revenues in 2003, 2002 and 2001, respectively. Net revenues derived from Europe and Asia Pacific constituted 33%, 33% and 27% of total revenues in 2003, 2002 and 2001, respectively.

      Software license revenues declined by 14% to $71 million in 2003 as compared to $83 million in 2002 and 22% in 2002 from $107 million in 2001. Hardware revenues declined by 35% to $43 million in 2003 as compared to $66 million in 2002 and 15% in 2002 from $77 million in 2001. The decrease in software license and hardware revenues was primarily due to the continuing economic downturn experienced in both 2003 and 2002. As a result of the continued worldwide economic downturn, customers remained reluctant to increase capital spending on information technology.

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      Software license updates and product support revenues for 2003 resulted in an increase of 5% to $216 million as compared to 2002 with a slight decline as compared to 2001. The increase in revenue in 2003 was primarily attributable to support on new product purchases, overall improvements to the support renewal process and customers reinstating support on previously purchased products.

      Professional services and education revenues for 2003 declined by 21% as compared to 2002 and 25% in 2002 as compared to 2001. Professional services and education revenues consist primarily of installation of product, consulting services, and education fees. The decreases in service revenues resulted primarily from lower installation revenues due to the decline in hardware sales.

     Gross Margin

      Gross software license margin. Cost of software license revenues includes fees paid to various third parties and amortization of intangible assets. Our decreased margin in 2002 resulted from a $38 million charge related to an impairment of intangible assets incurred in the third quarter.

      Gross hardware margin. Cost of hardware revenues includes labor, materials, overhead, and other directly allocated costs involved in manufacture and delivery of our products. The decrease in gross margin for 2003 was primarily due to higher contract manufacturing costs. Increased hardware gross margin for 2002 was primarily due to the increased efficiencies gained from reducing headcount and outsourcing manufacturing activities to contract manufacturers.

      Gross services margin. Cost of service revenues consists primarily of employee salaries and benefits, facilities, systems costs to support maintenance, consulting and education. The increase in 2003 and 2002 services margins was due to increased productivity permitting headcount reductions, and a reduction of overhead costs.

Operating Expenses

      Research and development, or R&D, expenses relate to the development of new products, enhancements of existing products and quality assurance activities. These costs consist primarily of employee salaries and benefits, facilities, IT costs, and consulting expenses. R&D expenses decreased by 13% in 2003, as a result of reduced facilities costs due to restructuring of leased facilities of $4 million, reduced contractor and consulting expense of $1 million and decreased depreciation and amortization of $3 million due to reduced capital spending. As a percentage of net revenues, R&D expenses were 14% in 2003 and 2002. We anticipate that R&D expenses will remain relatively flat in absolute dollars in 2004.

      R&D expenses decreased by 41% in 2002 mainly due to continued workforce reduction, reduced contractor and consulting expense and the exclusion of the amortization of certain acquired intangible assets from R&D expenses. We reduced our R&D workforce by 43% in 2001 and by a further 9% in 2002. As a percentage of net revenues, R&D expenses were 14% in 2002 and 21% in 2001.

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      Selling, general and administrative, or SG&A, expenses consist primarily of employee salaries and benefits, commissions, facilities, information technology costs and administrative support. SG&A decreased by 29% in 2003 mainly due to continued workforce reduction representing a cost savings of $11 million, reduced facilities costs of $6 million due to restructuring of leased facilities and lower discretionary spending of $11 million. In addition, depreciation and amortization expense decreased $4 million in 2003. Bad debt expense decreased $12 million in 2003 which was the result of the collection of previously reserved receivables and improvement of receivables aging. SG&A expenses as a percentage of net revenues were 29% in 2003 and 38% in 2002. We anticipate that SG&A expenses in absolute dollars will remain relatively flat in 2004.

      SG&A decreased by 33% in 2002. The decrease was primarily due to a 27% reduction in headcount and the adoption of SFAS 142, which eliminated goodwill amortization beginning in 2002. SG&A expenses as a percentage of net revenues were 38% in 2002 and 50% in 2001.

      Restructuring charges consist of costs related to severance, outplacement and consolidation of facilities related to workforce adjustments. In 2003, there was a net restructuring charge of $3.8 million as a result of our revising our estimate upward for future facility related obligations by $4.3 million and reducing our estimate of remaining severance and outplacement costs by $0.5 million

      In 2002, we reduced our workforce by 22% and consolidated selected facilities in our continuing effort to optimize operations. The workforce adjustment resulted in the termination of 407 employees. These activities resulted in a restructuring charge of $22 million, which consisted of consolidation of facilities costs of $14 million, severance and outplacement costs of $6 million and other restructuring costs of $2 million. In 2001 we reduced our workforce by 28%, or 740 employees. These workforce adjustments and the consolidation of selected facilities resulted in restructuring charges of $44 million.

Interest and Other Income (Expense):

($ in thousands)

      Interest income decreased by $0.7 million from 2002 to 2003 and by $1.7 million from 2001 to 2002 primarily due to lower rates of return on short-term investments.

      Interest expense decreased by $4.7 million from 2002 to 2003 primarily due to a decrease in our outstanding debt of $132 million. Interest expense increased by $1.0 million from 2001 to 2002 primarily due to higher debt levels throughout 2002.

      Other income (expense) for 2003 includes fees charged for bank services of $0.7 million and debt issuance cost amortization of $0.7 million offset by $0.8 million in net gains recognized on the sale of investments. Other expense for 2002 includes a $9 million charge for the write-down of long-term investments, for which we determined a decline in value that was other than temporary. The write-down was mainly offset by a $7 million gain on extinguishment of debt resulting from the repurchase of convertible subordinated debentures. Other income for 2001 includes insurance recoveries of $3 million, which was offset by a $1 million charge for the write-down of long-term investments for a decline that was determined to be other than temporary.

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     Provision (Benefit) for Income Taxes

      In 2003, we recorded an income tax provision at an effective rate of 15.9%. The 2003 tax rate varies from the statutory rate primarily due to our having a full valuation allowance against our U.S. based deferred tax assets. This results in a tax provision based on current tax calculations in foreign jurisdictions and only nominal amounts in federal and state jurisdictions due to our substantial U.S. net operating losses. Our 2003 tax rate further varies from the statutory rate as a result of nondeductible expenses and the effect of different tax rates in foreign jurisdictions. We reassess the necessity of our valuation allowance on a periodic basis.

      In the loss years of 2002 and 2001, we recorded income tax benefits at effective tax rates of 32.5% and 2.8%, respectively. During the first quarter of 2002, there was a change in the tax law that increased the years to which we could carry back our 2001 tax loss from two to five years, resulting in a tax refund and tax benefit of $27 million. In addition, our 2002 tax rate varies from the statutory rate due to a valuation allowance being imposed on current year net losses and the write-off of nondeductible intangible assets during the year. Our 2001 tax rate differs from the statutory rate due to a valuation allowance being imposed on 2001 net losses, foreign losses for which no tax benefit may be realized, nondeductible goodwill amortization and research and development credits.

Accrued Preferred Stock Dividend and Accretion of Redemption Premium and Amortization of Beneficial Conversion Feature

      Due to the issuance of $50 million of our convertible Series B preferred stock in the first quarter of 2003 we accrued dividends at 10% compounded daily per annum, accreted the 125% redemption premium and amortized the beneficial conversion feature.

      The Series B convertible preferred stock that we issued to Vista contains certain participation rights. EITF Topic D-95, Effect of Participating Convertible Securities on the Computation of Basic Earnings, requires those securities to be included in the computation of basic earnings per share using the two-class method. The two-class method results in a lower per share calculation and since diluted earnings per share can not be greater than basic earnings per share, the reported diluted earnings per share and basic earnings per share for 2003 were the same.

      Pro forma diluted earnings per share is calculated as net income divided by the diluted weighted average shares outstanding for 2003 assuming the Series B convertible preferred stock was converted into common stock on the preferred stock issuance date. We use the pro forma diluted earnings per share in monitoring and evaluating our ongoing financial results and trends. We believe this information is useful for investors because the two-class method will not be applicable in light of the proposed conversion of the Series B convertible stock. As a result, we believe a review of the financial results using this pro forma disclosure provides important insights to our operating results and trends.

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      Basic earnings per share for the year ended December 31, 2003 is calculated using the two-class method as follows:

Basic EPS — Two-Class Method

Pro Forma Diluted EPS

      Pro forma diluted earnings per share for the year ended December 31, 2003 is calculated as follows:

Liquidity and Capital Resources

      As of December 31, 2003, cash, cash equivalents, and short-term investments totaled $164 million, representing 53% of total assets and our principal source of liquidity. In addition, we had restricted cash of $6 million related to various loan and letter of credit agreements.

      Net cash provided by operating activities was $99 million in 2003, as compared to $74 million in 2002. The main contributor to the increase in net cash provided by operating activities was our significantly improved profitability. Cash collections from customers during 2003 were $432 million. In addition, we reduced our days sales outstanding during the year by 11 days to a days sales outstanding of 34 days as of December 31, 2003.

      Net cash used in investing activities was $15 million in 2003 compared to $28 million in 2002. Net cash used in investing activities in 2003 related primarily to net purchases of short-term investments of $9 million as well as property and equipment purchases of $6 million. We currently anticipate 2004 capital expenditures to be approximately $16 million, which is expected to be funded from working capital.

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      Net cash used in financing activities was $76 million in 2003 compared to $53 million in 2002. Net cash used in financing activities in 2003 resulted from net repurchases of convertible debentures of $129 million, preferred stock proceeds of $44 million, common stock issuances relating to various stock purchase and option plans of $17 million and net payments on borrowings of $7 million.

      Net cash provided by operating activities was $74 million in 2002, while net cash used in operating activities was $35 million in 2001. This increase was mainly driven by an improvement in our net loss position. In addition, cash collections from customers during 2002 were $450 million. Days sales outstanding during the year decreased by 19 days to a days sales outstanding of 45 days as of December 31, 2002. In addition, we received a $27 million federal income tax refund due to a change in the tax law which increased the number of years to which we could carryback our 2001 loss from two years to five years.

      Net cash used in investing activities was $28 million in 2002 compared to $24 million in 2001. Net cash used in investing activities in 2002 related primarily to net purchases of short-term investments of $17 million as well as property and equipment purchases of $11 million.

      The net cash used in financing activities was $53 million in 2002 compared to net cash provided by financing activities of $48 million in 2001. Net cash used in financing activities in 2002 resulted from net repurchases of convertible debentures of $60 million, net borrowings of $5 million, and common stock issuances relating to various stock purchase and option plans of $3 million.

      On August 9, 2002, we entered into a Credit Agreement with Comerica Bank-California as administrative agent, and CIT Business Credit as collateral agent, which provides us with a $25 million three-year revolving loan facility and a $25 million senior secured four-year term loan. As of December 31, 2003, we had $17 million outstanding under the term loan with the applicable interest rate at 4.15%, no amounts outstanding under the revolver and had utilized $1.1 million in letters of credit. The term loan has a four-year term. During the first quarter of 2003, we signed Amendment No. 1 to the Credit Agreement. This amendment clarified the accounting for the convertible preferred stock in the covenant computations, revised the liquidity ratio and the tangible net worth covenant requirements, and gave bank consent for the repurchase of 100% of the convertible subordinated debentures with cash. During the second quarter of 2003, we signed Amendment No. 2 to the Credit Agreement. The agreement extended the deadline by which the stock of certain of our subsidiaries was required to be pledged as collateral. We were in compliance with all related covenants and restrictions as of December 31, 2003. On February 13, 2004, we entered into a $100 million revolving credit facility which restated and amended the August 9, 2002 credit agreement.

      We incurred $150 million of principal indebtedness ($490 million principal at maturity) from the sale of zero coupon convertible subordinated debentures in August 1998. During 2002, we repurchased $176 million principal at maturity utilizing $60 million of cash. In the first quarter of 2003, we paid $5.6 million to repurchase convertible debentures in the open market. This repurchase reduced the principal amount of the convertible debentures due at maturity from $314 million to $300 million. Pursuant to the terms of the debentures, we were obligated to re-purchase all debentures properly tendered on August 11, 2003 at a repurchase price of $412 for each $1,000 principal amount at maturity. In connection with the repurchase, we paid $122.8 million in cash to repurchase $298 million in principal amount at maturity, which represented 99% of the outstanding convertible subordinated debentures. On December 29, 2003, we paid $1 million to repurchase the final 1% of the outstanding convertible subordinated debentures. As of December 31, 2003, we had retired the entire balance of the convertible subordinated debentures.

      In October 2001, we entered into a five-year loan with Fremont Bank in the amount of $25 million and we currently have $23.8 million outstanding. During the third quarter of 2003, we signed a letter agreement to amend the Loan and Security Agreement to reduce the floor rate to 7% effective September 1, 2003. The loan is secured by a security interest in our buildings in San Jose and the bank also required that we supply a $3 million letter of credit, which is recorded as restricted cash on the balance sheet as of December 31, 2003.

      In addition to the line of credit, we have two outstanding bank guarantees with a European bank that are required for daily operations such as payroll, import/ export duties and facilities. As of December 31, 2003,

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      On November 14, 2002, we entered into a Preferred Stock Purchase Agreement with Vista Equity Fund II, L.P. (“Vista”) pursuant to which Vista agreed to purchase $50 million of our Series B convertible preferred stock, which represented approximately 30% of our outstanding shares on a fully diluted basis, assuming conversion at the initial conversion price. We received $44 million in net proceeds from this transaction. This equity entitled the holders to receive cumulative dividends, which accrued daily at 10% per annum. On or after the tenth anniversary of the closing, we had an obligation to redeem each share of unconverted Series B convertible preferred stock for cash at a redemption price equal to 125% of the original purchase price plus accrued and unpaid dividends. Additionally, in the event that we declare a dividend or distribution to the holders of common stock, the holders of Series B convertible preferred stock would have been entitled to equivalent participation on an as-if-converted basis in such dividend or distribution.

      We believe that cash, cash equivalents, and short-term investments will be sufficient to meet our operating cash needs for at least the next twelve months. However, we continually evaluate opportunities to improve our cash position by selling additional equity, debt securities, obtaining and re-negotiating credit facilities, and restructuring our long-term debt. The sale of additional equity or convertible debt securities could result in additional dilution to our stockholders. In addition, we will, from time to time, consider the acquisition of or investment in complementary businesses, products, services and technologies, and the retirement of debt, which might affect our liquidity requirements or cause us to issue additional equity or debt securities. There can be no assurance that financing will be available in amounts or on terms acceptable to us, if at all.

Contractual Obligations

(a)	Based on the terms of the February 13, 2004, debt refinancing as discussed in Note 21 to the Consolidated Financial Statements.
(b)	Purchase obligations include agreements to purchase goods or services that are enforceable and legally binding and that specify all significant terms, including: fixed or minimum quantities to be purchased; fixed, minimum or variable price provisions; and the approximate timing of the transaction. Purchase obligations exclude agreements that are cancelable without penalty.

Off-Balance Sheet Arrangements

      We have no material off-balance sheet arrangements other than operating leases that are discussed in Note 10 to the Consolidated Financial Statements.

Recent Developments

      On February 13, 2004, Vista agreed to convert all of its Series B convertible preferred stock into 22,222,222 shares of our common stock immediately prior to the completion of a proposed public offering

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      On February 13, 2004, we entered into a $100 million revolving credit facility with a number of financial institutions led by Comerica Bank, which is also administrative agent, and The CIT Group/Business Credit, Inc., which is also collateral agent. This credit facility amended and restated our prior $50 million credit facility with Comerica Bank entered into on August 9, 2002, which prior facility is described below. It eliminated the prior facility’s borrowing base requirements and other related restrictions. The revolver has a three-year term and is secured by substantially all of our assets, including the stock of our significant subsidiaries. We can select interest options for advances based on the prime rate or eurocurrency rates, which include margins that are subject to quarterly adjustment. The revolver includes a $10 million sub-line for issuance of stand-by letters of credit. Mandatory prepayment and reduction of the facility is required in the amount of 100% of permitted asset sales over $1 million annually and 100% of the proceeds of future debt issuances, subject to certain exclusions. The revolver can be used for working capital, general corporate purposes and the financing of capital expenditures. The credit agreement includes customary representations and warranties and covenants. The financial covenants include minimum liquidity ratio, minimum fixed charge coverage ratio, minimum earnings before interest expense, income taxes, depreciation and amortization, or EBITDA, maximum debt to EBITDA ratio and minimum tangible net worth tests. At December 31, 2003, we had $41 million outstanding under our borrowing agreements described in Note 9, of which $2 million was paid prior to February 13, 2004 in accordance with the original payment terms and the remaining $39 million was refinanced with this new $100 million revolving credit facility. The $39 million principal balance is due in February 2007 and is classified as long term borrowings in the Consolidated Financial Statements.

RISK FACTORS

      We operate in a rapidly changing environment that involves a number of risks, some of which are beyond our control. You should carefully consider the risks described below before making an investment decision. The risks described below are not the only ones facing our company. Additional risks not currently known to us or that we currently deem immaterial may also impair our business operations. You should also read the cautionary statements in this document, wherever they appear, as applying to all related forward-looking statements.

Risks Related to Our Business

We may experience a shortfall in revenues or earnings or otherwise fail to meet public market expectations in any particular quarter, which could materially and adversely affect our business and the market price of our common stock.

      Our revenues and operating results may fluctuate significantly because of a number of factors, many of which are outside of our control. Some of these factors include:

	•	changes in demand for our products and services;
	•	a shift in the timing or shipment of a customer order from one quarter to another;
	•	product and price competition;
	•	our ability to develop and market new products and control costs;
	•	timing of new product introductions and product enhancements;

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	•	failure by our customers to renew existing support or maintenance agreements in a timely manner, if at all;
	•	mix of products and services sold;
	•	delay or deferral of customer implementations of our products;
	•	size and timing of individual license transactions;
	•	length of our sales cycle;
	•	changes in domestic and foreign markets;
	•	success in growing our distribution channels;
	•	acquisitions by competitors; and
	•	performance by outsourced service providers, and the costs of the underlying contracts of these providers, that are critical to our operations.

      One or more of the foregoing factors may cause our operating expenses to be disproportionately high during any given period or may cause our revenues and operating results to fluctuate significantly. Based upon the preceding factors, we may experience a shortfall in revenues or earnings or otherwise fail to meet public market expectations, which could materially and adversely affect our business, financial condition, results of operations and the market price of our common stock.

Reductions in information technology spending could continue to harm our business.

      Our products typically represent substantial capital commitments by customers. As a result, customer purchase decisions may be significantly affected by a variety of factors, including trends in capital spending for telecommunications and enterprise software, competition and the availability or announcement of alternative technologies. Weakness in global economic conditions in recent periods and related reductions in information technology, or IT, spending have resulted in many of our customers delaying or substantially reducing their spending on contact center hardware, software and services. If the weakness in the global economy were to continue or worsen, demand for our products and services would likely continue to decrease and our business would be harmed.

The convergence of voice and data networks has led to industry changes that we may not address successfully.

      Historically, we have supplied the hardware, software and associated support services for implementing contact center solutions. Contact center technology is undergoing a change in which voice and data networks are converging into a single integrated network. Our approach to this convergence has been to provide migration software permitting the integration of existing telephony environments with networks in which voice traffic is routed through data networks. This integration is provided by a software infrastructure that requires enterprise-level selling and deployment of enterprise-wide solutions, rather than selling and deployment efforts focused solely on telephone communication. This industry transition has caused us to change many aspects of our business and as a result we have had to:

	•	make changes in our management and technical personnel;
	•	change our sales and distribution models;
	•	expand relationships with our customers as sales are now often made throughout the organization;
	•	modify the pricing and positioning of our products and services;
	•	address new competitors; and
	•	increasingly rely on systems integrators to deploy our solutions.

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      If we fail to successfully address the changed conditions in which we operate, our business could be harmed.

Our product revenues are dependent on the success of a small number of product lines.

      Historically, sales of a small number of product lines have accounted for a substantial portion of our revenues. Demand for our products could be adversely affected by any of our products not meeting customer specifications or by problems with system performance, system availability, installation or service delivery commitments, or market acceptance. We need to continue to develop new products and manage product transitions in order to succeed. If we fail to introduce new versions and releases of products, or enhancements to our existing products, in a timely manner, customers may license competing products, we may suffer lost sales and we could fail to achieve anticipated results. Our future operating results will depend on the demand for our product suite, including new and enhanced releases that are subsequently introduced. If our competitors release new products that are superior to our products in performance or price, demand for our products may decline. Our products may not be released on schedule or may contain defects when released which could result in the rejection of our products, damage to our reputation, lost revenues, diverted development resources and increased customer service and support costs and warranty claims. Any of the foregoing results could harm our business.

Because we rely on our installed customer base for support contract renewals and much of our future revenues, those revenues could be significantly impaired if our existing customers do not continue to purchase and use our products and services.

      We derive a significant portion of our revenues from support contracts. As a result, if we lose a major customer or if a support contract is delayed, reduced or cancelled, our revenues would be adversely affected. In addition, customers who have accounted for significant revenues in the past may not generate revenues in future periods. We also depend on our existing customers to purchase new products that we introduce to the market. We may not be able to obtain new customers to replace any existing customers that we lose.

We operate in an intensely competitive market that includes companies that have greater financial, technical and marketing resources than we do.

      The market for our products is intensely competitive, and competition is likely to intensify as companies in our industry consolidate to offer integrated solutions. Our principal competitors currently include companies in the contact center market and companies that market traditional telephony products and services. As the market develops for converged voice and data networks and products and the demand for traditional, telephony-based call centers diminishes, companies in these markets are merging, creating potentially larger and more significant competitors. Many current and potential competitors, including Avaya Inc., Cisco Systems, Genesys, a subsidiary of Alcatel and Nortel Networks, may have considerably greater resources, larger customer bases and broader international presence than us. Consequently, we expect to encounter substantial competition from these and other sources.

We may not be able to adapt our products and services quickly or efficiently enough to respond to technological change.

      The market for our products and services is subject to rapid technological change and new product introductions. Current competitors or new market entrants may develop new, proprietary products with features that could adversely affect the competitive position of our products. We may not successfully anticipate market demand for new products or services or introduce them in a timely manner.

      The convergence of voice and data networks, and of wired and wireless communications could require substantial modification and customization of our current products and business model, as well as the introduction of new products. Further, customer acceptance of these new technologies may be slower than we anticipate. We may not be able to compete effectively in these markets. In addition, our products must readily integrate with major third-party security, telephony, front-office and back-office systems. Any changes to these

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We may experience difficulty anticipating demand for our products and services, which may cause our operating results to suffer.

      The demand for and sales mix of our products and services depends on many factors and is difficult to forecast. If forecasted demand does not develop, we could have excess production and capacity resulting in higher inventories of finished products and components and underutilized personnel, which would use cash and could lead to write-offs of some or all of the excess inventories or returns, which could result in lower gross margins. In addition, we may also incur certain costs, such as fees for excess manufacturing capacity and cancellation of orders and charges associated with excess and obsolete materials and goods in our inventory, which could result in lower margins. If demand increases beyond what we forecast, we may have to increase production at our third-party manufacturers or increase our capacity to deliver products and services. We depend on our suppliers to provide additional volumes of components and those suppliers might not be able to increase production rapidly enough to meet unexpected demand or may choose to allocate capacity to other customers. Even if we are able to procure enough components, our third-party manufacturers might not be able to produce enough of our products to meet market demand. The inability of either our manufacturers or our suppliers to increase production rapidly enough or our inability to obtain qualified services personnel could cause us to fail to meet customer demand. Rapid increases or decreases in production levels could result in higher costs for manufacturing, supply of components and other expenses. These higher costs could reduce our margins. Furthermore, if production is increased rapidly, manufacturing yields could decline, which may also reduce our margins.

We are involved in litigation which could be expensive and divert our resources.

      We have in the past and continue to be involved in litigation for a variety of matters. Any claims brought against us will likely have a financial impact, potentially affecting the market performance of our common stock, generating costs associated with the disruption of business and diverting management’s attention. We are currently involved in a binding arbitration proceeding with Electronic Data Systems Corporation, or EDS, in which EDS is seeking $26 million in damages and we are counterclaiming for our damages. There can be no assurance as to the outcome of this arbitration. In addition, there has been extensive litigation regarding patents and other intellectual property rights in our industry, and we are periodically notified of such claims by third parties. We have been sued in the past for alleged patent infringement. We expect that software product developers and providers of software in markets similar to ours will increasingly be subject to infringement claims or demands for infringement indemnification as the number of products and competitors in our industry grows and the functionality of products overlap. Any claims, with or without merit, could be costly and time-consuming to defend, divert our management’s attention, cause product delays and have an adverse effect on our revenues and operating results. If any of our products were found to infringe a third party’s proprietary rights, we could be required to enter into royalty or licensing agreements to be able to sell our products, which may not be available on terms acceptable to us or at all. Moreover, even if we negotiate license agreements with a third party, future disputes with such parties are possible. If we are unable to resolve an intellectual property dispute through a license, settlement or successful litigation, we would be subject to pay damages and be prevented from making, using or selling certain products or services. In the future, we could become involved in other types of litigation, such as shareholder lawsuits for alleged violations of securities laws, claims by employees, and product liability claims.

We are subject to risks inherent in doing business internationally.

      We market our products and services worldwide and anticipate entering additional foreign markets in the future. If we fail to enter certain major markets successfully, our competitive position could be impaired and we may be unable to compete on a global scale. The financial resources required to enter, establish and grow

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	•	the cost and timing of the multiple governmental approvals and product modifications required by many countries;
	•	fluctuations in the value of foreign currencies;
	•	less effective protection of intellectual property;
	•	difficulties in staffing and managing foreign operations;
	•	global economic climate considerations including potentially negative tax and foreign and domestic trade legislation, which could result in the creation of trade barriers such as tariffs, duties, quotas and other restrictions;
	•	longer payment cycles; and
	•	seasonal reductions in business activity in international locales, such as during the summer months in Europe.

Our failure to grow and maintain our relationships with systems integrators or VARs could impact our ability to market and implement our products and reduce future revenues.

      Failure to establish or maintain relationships with systems integrators or VARs would significantly harm our ability to sell our products. Systems integrators and VARs market, sell, install and deploy our products, and perform custom integration of systems and applications. If these relationships fail, we will have to devote substantially more resources to the sales and marketing, implementation and support of our products than we would have had to otherwise. In addition, there could be channel conflict among our varied sales channels, which could harm our business, financial condition and results of operations.

We may experience difficulty expanding our distribution channels.

      We have historically sold our products and services through our direct sales force and a limited number of distributors. Changes in customer preferences, the markets we target, the competitive environment or other factors may require us to expand our third-party distributor, VARs, systems integrator, technology alliances, electronic and other alternative distribution channels, and we have continued to work on such expansion in recent periods. We may not be successful in expanding these distribution channels, and such failure could hurt our operating results by limiting our ability to increase or maintain our sales through these channels or by increasing our sales expenses faster than our revenues.

We are highly dependent on third-party suppliers and underperformance by our suppliers could impair our business.

      We have outsourced our manufacturing capabilities to third parties and rely on those suppliers to order components; build, configure and test systems and subassemblies; and ship products to meet our customers’ delivery requirements in a timely manner. Failure to ship product on time or failure to meet our quality standards would result in delays to customers, customer dissatisfaction or cancellation of customer orders.

      Should we have performance issues with our manufacturing sub-contractors, the process to move from one sub-contractor to another is a lengthy and costly process that could affect our ability to execute customer shipment requirements and might negatively affect revenues and costs. We depend on certain critical components in the production of our products and services. Some of these components are obtained only from a single supplier and only in limited quantities. In addition, some of our major suppliers use proprietary technology and software code that could require significant redesign of our products in the case of a change in vendor. Further, suppliers could discontinue their products, or modify them in a manner incompatible with our current use, or use manufacturing processes and tools that could not be easily migrated to other vendors.

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      We also outsource certain of our information technology activities to third parties. We rely heavily on these vendors to provide day-to-day support. We may experience disruption in our business if these vendors or we have difficulty meeting our requirements, or if we need to transition the activities to other vendors or ourselves, which could negatively affect our revenues and costs.

We may experience difficulty managing changes in our business.

      The changes we have experienced in the past and which may occur in the future in our business may place a significant strain on our operational and financial resources. We may experience substantial disruption from changes and could incur significant expenses and write-offs. We must carefully manage accounts receivables to limit credit risks. We must also maintain inventories at levels consistent with product demand. Inaccurate data (for example, credit histories or supply/demand forecasts) could quickly result in excessive balances or insufficient reserves. These changes have in the past and may in the future also place strains on our financial and reporting systems and controls.

If we fail to attract, motivate and retain highly qualified key personnel, our ability to operate our business could be impaired.

      Our future success will depend to a significant extent on our ability to attract, retain and motivate highly qualified technical, marketing, sales and management personnel. Competition for these employees is intense and the process of recruiting personnel with the combination of skills and attributes required to operate our business can be time consuming and expensive. We have recently undergone significant changes in senior management and other personnel. For example, our Chief Executive Officer was appointed in January 2004 after having been named Interim Chief Executive Officer in August 2003. Our failure to recruit, retain and motivate qualified personnel could be disruptive to our operations, and could have a material adverse effect on our operating results.

We intend to upgrade or replace certain parts of our information systems and may not be successful in implementing the changes.

      We intend to upgrade or replace certain information systems that support our operations, including systems to manage order processing, shipping, support entitlement, accounting and internal computing operations. Many of these systems are proprietary to us and are very complex. We may not be successful in implementing these new systems and transitioning data from our old systems to the new systems. Any failure or significant downtime in our information systems could prevent us from taking customer orders, shipping products, providing services or billing customers and could harm our business. In addition, our information systems require the services of personnel with extensive knowledge of these information systems and the business environment in which we operate. In order to successfully implement and operate our systems, we must be able to attract and retain a significant number of highly skilled employees. If we fail to attract and retain the highly skilled personnel required to implement, maintain and operate our information systems, our business could suffer.

Our intellectual property may be copied, obtained or developed by third parties.

      Our success depends in part upon our internally developed technology. Despite the precautions we take to protect our intellectual property, unauthorized third parties may copy or otherwise obtain and use our technology. In addition, third parties may develop similar technology independently. Unauthorized copying, use or reverse engineering of our products or independent development of technology similar to ours by competitors could materially adversely affect our business, financial condition and results of operations.

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We depend on licenses from third parties for rights to the technology used in several of our products. If we are unable to continue these relationships and maintain our rights to this technology, our business could suffer.

      We depend on licenses for some of the technology used in our products from a number of third-party vendors. If we were unable to continue using the technology made available to us under these licenses on commercially reasonable terms or at all, we may have to discontinue, delay or reduce product shipments until we obtain equivalent replacement technology, which could hurt our business. In addition, if our vendors choose to discontinue support of the licensed technology in the future, we may not be able to modify or adapt our own products.

Regulatory changes and future changes to generally accepted accounting principles may negatively impact our business.

      The electronic communications industry is subject to a wide range of regulations in the markets and countries in which we currently operate or may wish to operate in the future. In addition, new products and services may involve entering different or newly regulated areas. Changes in these environments may impact our business and could affect our ability to operate in certain markets or certain regions from time to time.

      Revisions to generally accepted accounting principles or related rules of the Securities and Exchange Commission will require us to review our accounting and financial reporting procedures in order to ensure continued compliance. From time to time, such changes have an impact on our accounting and financial reporting, and these changes may impact market perception of our financial condition. Additionally, recently adopted or new legislation or regulations, including compliance with Section 404 of the Sarbanes-Oxley Act of 2002, may lead to an increase in our costs related to audits in particular and regulatory compliance generally. A failure to comply with these new laws and regulations could materially harm our business.

We may engage in future acquisitions or investments that could prove difficult to integrate with our business and which may impair our operations.

      We have made a number of acquisitions in the past. Acquisitions or investments we make may experience significant fluctuations in market value or may result in significant write-offs or the issuance of additional equity or debt securities to finance or fund them. Acquisitions and investments can be costly and disruptive, and we may be unable to successfully integrate a new business or technology into our business. There are a number of risks that future transactions could entail, including:

	•	inability to successfully integrate or commercialize acquired technologies or otherwise realize anticipated synergies or economies of scale on a timely basis;
	•	diversion of management attention;
	•	disruption of our ongoing business;
	•	inability to assimilate or retain key technical and managerial personnel for both companies;
	•	inability to establish and maintain uniform standards, controls, procedures and processes;
	•	governmental, regulatory or competitive responses to the proposed transactions;
	•	impairment of relationships with employees, vendors or customers including, in particular, acquired distribution and VAR relationships;
	•	permanent impairment of our equity investments;
	•	adverse impact on our annual effective tax rate; and
	•	dilution of existing equity holders.

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Our operations are geographically concentrated and we are subject to business interruption risks.

      Significant elements of our product development, manufacturing, information technology systems, corporate offices and support functions are concentrated in San Jose, California, Nashville, Tennesse and Chelmsford, Massachusetts. Significant sales, administrative and support functions and related infrastructure to support our international operations are also concentrated at our U.K. offices. In the event of a natural disaster, such as an earthquake or flood, or localized extended outages of critical utilities or transportation systems that affects us, our customers or our suppliers, we could experience a significant business interruption.

Acts of terrorism and international political instability may impact our business.

      The threat of terrorist attacks and increased international political instability in various locations around the world have created uncertainty within the worldwide economic environment. Such uncertainty may halt or hinder our ability to do business, may increase our costs and may result in reduced spending by our customers.

Fluctuations in the value of foreign currencies could result in currency transaction losses.

      As we expand our international operations, we expect that our international business will increasingly be conducted in foreign currencies. Fluctuations in the value of foreign currencies relative to the United States dollar have caused, and we expect such fluctuations to continue to increasingly cause, currency transaction gains and losses. We cannot predict the effect of exchange rate fluctuations upon future quarterly and annual operating results. We may experience currency losses in the future.

Risks Related to Our Common Stock

The market price for our common stock may be particularly volatile, and our shareholders may be unable to resell their shares at a profit.

      The market price of our common stock has been subject to significant fluctuations and may continue to fluctuate or decline. From January 1, 2003 to December 31, 2003, the closing price per share of our common stock has ranged from a low of $2.86 to a high of $16.55. The stock markets have experienced significant price and trading volume fluctuations. The market for technology has been extremely volatile and frequently reaches levels that bear no relationship to the past or present operating performance of those companies. General economic conditions, such as recession or interest rate or currency rate fluctuations in the United States or abroad, could negatively affect the market price of our common stock. In addition, our operating results may be below the expectations of securities analysts and investors. If this were to occur, the market price of our common stock would likely significantly decrease. In the past, following periods of volatility in the market price of a company’s securities, securities class action litigation has often been instituted against that company. Such litigation could result in substantial cost and a diversion of management’s attention and resources.

      The market price of our common stock may fluctuate in response to various factors, some of which are beyond our control. These factors include, but are not limited to, the following:

	•	changes in market valuations or earnings of our competitors or other technology companies;
	•	actual or anticipated fluctuations in our operating results;
	•	changes in financial estimates or investment recommendations by securities analysts who follow our business;
	•	technological advances or introduction of new products by us or our competitors;
	•	the loss of key personnel;
	•	our sale of common stock or other securities in the future;
	•	intellectual property or litigation developments;
	•	changes in business or regulatory conditions;

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