UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

Form 10-K

Commission file number 0-18391

Aspect Communications Corporation

(Exact name of registrant as specified in its charter)

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

(Address of principal executive offices and zip code)

(408) 325-2200

(Registrant’s telephone number)

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

NONE

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

Common Stock, $0.01 par value

(Title of class)

Preferred Share Purchase Rights

(Title of class)

     Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.     Yes þ          No 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, 2004, was $838,424,317 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 February 28, 2005, was 60,984,371.

DOCUMENTS INCORPORATED BY REFERENCE

      Portions of the Proxy Statement for the 2005 Annual Meeting of Stockholders are incorporated by reference in Part III hereof.

ASPECT COMMUNICATIONS CORPORATION

INDEX TO ANNUAL REPORT ON FORM 10-K

FOR THE FISCAL YEAR ENDED DECEMBER 31, 2004

FORWARD-LOOKING STATEMENTS

      The matters discussed in this report including, but not limited to, statements relating to anticipated capital budget and spending levels for 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.

PART I

Company Overview

      We are a leading provider of contact center solutions and services that enable businesses to manage and optimize customer communications. We develop, market and license products that enable our customers to manage their customer-care related communications, workforce and information in ways best suited for their businesses. Our products and services help businesses to manage their customer interactions in ways that drive greater customer intimacy, while increasing the effectiveness and productivity of the workforce. Our products can be used by businesses to connect their customers to live and self-service resources regardless of the user’s location and communication channel. We have focused on contact center solutions since our inception in 1985. We have a global customer base that includes more than two-thirds of the Fortune 50, in a broad range of industries including transportation, financial services, insurance, telecommunications and outsourcing. We are headquartered in San Jose, California, with offices around the world.

Industry Overview

      The contact center is becoming an increasingly important component of business strategy, evolving from being perceived as a cost center used to process customer interactions into a commerce center that can provide greater strategic value. Historically, call centers were viewed as a necessary expense for providing customer support, primarily utilizing telephone communications. Today, enterprises manage customer communications across a wide variety of technologies, including email, Web, and short messaging communications. Therefore, traditional voice-based call centers are evolving to serve customers via a variety of communications channels and transport technologies including both traditional Public Switched Telephone Network or PSTN, as well as the newer Internet Protocol, or IP. Also, the strategic value of contact centers is increasing because detailed customer information generated by contact centers can be used more frequently and more easily than in the past to help drive business decisions. This is because the technologies necessary to integrate data and turn them into meaningful information have increased in sophistication, are easier to use and are cost-effective to acquire and integrate. Therefore, it is becoming easier for enterprises to use contact center information to understand customer buying trends, target markets more effectively, and increase revenue. This confluence of factors is helping businesses consider new ways to use their contact centers to drive commerce instead of viewing them as just 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 third parties. For example, companies have been moving or outsourcing their contact centers to countries such as India and the Philippines that have large, educated workforces but lower labor costs. The outsourcing and off-shoring of contact center operations and the globalization of customer bases will increase the demand for contact center solutions that can function seamlessly across global data networks and manage the related security and quality control challenges. Many companies are exploring options to centralize the management of contact centers while geographically dispersing agents with the aim of reducing costs while simplifying administration, reporting and analysis.

      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 helps forecast customer demand based on changing business and customer requirements, schedules staff according to agent skill level and customer demand, and plans employee schedules. Also, it accommodates new communication media as they are added and integrates with training applications so agent training on new products or skills is part of the agent’s work schedule. By matching the contact center operational needs with individual agent 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 timely 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 analysis and reporting. They must be dynamic enough to allow users to view high-level operational metrics as well as to allow them to view details specific to particular agents. This enables 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. Voice over Internet Protocol, or VoIP, together with other Internet technologies is anticipated to be the next major trend in communications. VoIP permits the movement of voice traffic over an Internet Protocol based network, lowering transmission costs relative to the PSTN, both by enabling the consolidation of networks and by bypassing the toll charges for long distance voice transmissions. Instead of two separate networks for voice and data, voice calls flow over the data network like other communications such as e-mail. Therefore, in order to optimize VoIP, contact centers must 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. Aspect offers three product lines for managing contact center communications, workforces and information:

      Classic The Classic product line encompasses Aspect’s products for managing contact centers based mostly on the traditional PSTN network. The Classic product line offers a full set of products for receiving, managing and routing live- and self-service interactions (both phone and Web-based email and chat), and computer-telephony integration: the Aspect Call Center, Aspect Contact Server, Aspect Enterprise Contact Server, and Aspect Customer Self-Service. The Classic product line also includes Aspect Uniphi Connect, which was introduced in 2004 and allows customers to bridge from traditional solutions to next-generation Voice-over-IP solutions.

      Aspect Uniphi Suite The Uniphi Suite product line includes Aspect’s next-generation products that are designed to harness the power, flexibility and intelligence of an IP environment. The product line takes its name from the primary product in this category, Aspect Uniphi Suite, which is an integrated set of advanced contact center applications that deliver a full range of contact center functionality. Further, Uniphi Suite is built using open standards-based software, with a consistent single point of control for viewing and managing contact center operations. Uniphi Suite’s functionality includes call center capabilities; computer-telephony integration as well as integration support for various data sources; the handling and routing of voice calls, internet-based mail and chat, and other sophisticated integration with Aspect’s eWorkforce Management product.

      Workforce Productivity The Workforce Productivity product line encompasses Aspect’s products for managing contact center workforces for optimal productivity. Products in this category offer a range of functionality including, for example, modules for scheduling, forecasting and notification. Customers can customize a workforce productivity solution for their contact centers and use the functionalities most appropriate for their business. Included in this product line are Aspect eWorkforce Management, Aspect Customer DataMart, and Aspect Agent Performance Optimization and AIMCall which is a sophisticated analytic tool for building applications to report on and analyze a wide-range of contact center data.

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 make use of open standards in the design of our products to optimize the integration and interoperability with third-party 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 SAP and Siebel Systems. By integrating with these applications, our solutions deliver valuable customer information to any live or self-service resource serving any given customer.

      Standards-based products are a critical part of our Uniphi solutions. As such, we ensure compliance with a range of communications, workforce management and information exchange standards. In addition, we also support common operating systems, languages, hardware, networking protocols, database and data storage mediums and front office applications.

      We continuously evaluate and invest in 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 use 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 that 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 2004.

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 diverse 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.

      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 and speaking engagements. 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 offerings in the market we serve. These efforts are largely driven by current and anticipated customer and strategic partner needs. Our research and development expenditures for 2004, 2003 and 2002 were $44.5 million, $49.3 million and $56.8 million, respectively, which represented 12%, 14% and 14% of total revenues, respectively.

Manufacturing

      We outsource our manufacturing operations to contract manufacturers. Our products include materials with varying 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, our contracts with our contract manufacturers generally authorize them and commit us to acquire materials and build standard sub-assemblies based on forecasted production requirements. Upon receipt of firm orders from our customers, we instruct our contract manufacturers to assemble, configure, test and ship systems to meet our customers’ request dates. We have established manufacturing procedures with our contract manufacturers that are designed to achieve rapid response to customer orders.

      We depend on certain critical components such as certain server computers, integrated circuits, power supplies, cables and plastic housings in the production of our products. Some of these components are obtained only from single suppliers and only in limited quantities, although we have taken steps to mitigate the risk presented by our dependence on limited suppliers and quantities, including purchasing quantities of these components that we believe will meet anticipated needs and by designing our products in a way that will allow us to modify our products if necessary to accommodate alternate supplier components.

Product Backlog

      Our backlog as of December 31, 2004, was approximately $6.0 million compared with a backlog of approximately $7.4 million as of December 31, 2003. Our backlog includes only orders confirmed with a purchase order to be shipped within 90 days to customers with approved credit status. While we believe that all of the orders included in our backlog are firm we may determine that it is in our best interest to allow orders to be cancelled without penalty.

Competition

      The contact center market in which we operate, which includes ACD, IVR, CTI, workforce management and reporting and analytics vendors, is intensely competitive and rapidly changing.

      Product lines with which we compete in the ACD, IVR and CTI portion of the market include those offered by diversified communications equipment companies such as Avaya; Cisco Systems; Genesys, a subsidiary of Alcatel; Intervoice; Nortel Networks and Siemens.

      Product lines with which we compete in the workforce management software and reporting and analytics portion of the market include those of Blue Pumpkin (acquired by Witness Systems in 2005) and IEX, a subsidiary of Tekelec, and those of diversified communications equipment companies like Genesys. Other communications equipment companies such as Avaya also compete against us in these markets through vendor alliances they have established.

      The principal competitive factors in our industry include functionality, quality, reliability, performance, price, level of customer support, reputation, timely introduction of new products, investment protection, and market presence. We believe we have competed effectively to date with respect to these factors.

      Our future anticipated growth and success will depend on our ability to compete favorably on the basis of the above factors, as well as by developing superior, cost-effective products, continuing to develop alliances with key technology partners, providing superior customer service and support, and expanding 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 therefore devote substantial resources to developing and marketing 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, 2005, we held 114 issued United States patents and a lesser number of issued foreign patents and have pending 35 United States patent applications and a lesser number of corresponding foreign patent applications that cover various components of our technology. Our United States issued patents expire on dates ranging from 2005 through 2022. There can be no assurance that any of the claims in the pending applications will be allowed, that any issued patents will be upheld, that competitors will not circumvent our patents, or that any patents or licenses will provide competitive advantages for us or our products. Historically, the revenues we have generated from the licensing of our patent portfolio have not been material, although the portfolio continues to support our hardware and software revenue generation efforts.

      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, there is no assurance 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. Accordingly, although we believe our patent portfolio is valuable to our business generally, we do not view any particular patent or patents we possess as particularly significant to our business.

Employees

      As of December 31, 2004, we had 1,254 full-time employees. None of our employees are 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

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

      As of December 31, 2004, our headquarters occupied 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 total approximately 209,000 square feet. 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, 2004.

      We have several leased 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 significant European facilities are located in Germany and the Netherlands. In Asia, we occupy sales and support offices in Japan, Singapore, Hong Kong and Australia.

      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 with us and EDS in December 2000 in which we outsourced certain IT needs to EDS. A dispute arose between us and EDS over the services and charges to be performed and paid under the Master Services Agreement and we terminated the Master Services Agreement for EDS’s breach of the agreement. EDS alleged that we breached the Master Services Agreement and implied warranties associated with the Master Services Agreement, and committed fraud and engaged in negligent misrepresentation in inducing EDS to enter into the Master Services Agreement. On June 11, 2003, we filed our answer and counterclaims in which we denied every allegation made by EDS, denied that EDS was owed any amount in damages, and counterclaimed that EDS breached the Master Services Agreement, committed fraud in inducing us to not terminate for cause the Master Services Agreement earlier, and engaged in fraudulent and unfair business practices. On May 4, 2004, we received the interim award of the arbitrator. The arbitrator ruled that EDS breached the Master Services Agreement and ordered EDS to pay $1.4 million in damages to us. The arbitrator rejected the parties’ claims of fraud, negligent misrepresentation, fraudulent misrepresentation and fraudulent and unfair business practices. The arbitrator also allowed further briefing, if desired by EDS, to consider whether we performed services that should have been transferred to EDS, and if so whether EDS should be entitled to any lost profits associated with those services. In the parties’ respective briefs, EDS claimed it was entitled to between $1 million to $2.1 million in lost profits. We claimed EDS was entitled to nothing. On July 7, 2004, the arbitrator ruled that EDS is not entitled to any damages and affirmed the interim award of damages payable to us. Judgment has been entered by the California Superior Court for Santa Clara County and EDS paid the amounts owed to us in December 2004.

      No matters were submitted to a vote of security holders during the quarter ended December 31, 2004.

PART II

      Aspect Communications Corporation’s common stock is traded on The Nasdaq National Market under the symbol “ASPT”. As of December 31, 2004, there were approximately 1,001 shareholders of record of Aspect’s common stock.

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

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 economic climate in 2004 continued its slight improvement that began in 2003 as compared to the difficult environment in 2002 and 2001 which had resulted in dramatically decreased capital spending. We believe that the rate of decline in our revenues from 2002 to 2003 was generally comparable to that of the market in which we operate. This climate had a pronounced effect on our ability to generate new license fees, as IT budgets were frozen and large capital expenditures like those required to purchase some of our products were quite limited. Even now we continue to see senior executive approval required in many cases and strong competition for sales opportunities as well as intense price competition both for new licenses and for support services.

      Many companies had increased their capital spending on communications and computing products such as ours from the late 1990s to 2000 partially as a result of their preparation for the highly publicized “Year 2000 bug.” The Year 2000 concern resulted in a technology product upgrade cycle to replace products that were either deemed not to be Year 2000 compliant or would not be cost-effective to upgrade to Year 2000 compliant. We believe that demand for our products returned to “pre-Year 2000 levels”, like products of many other technology companies, once this upgrade cycle was completed in 2000.

      We believe the general downturn in the economy since 2001 caused many of our customers’ revenues to decline and therefore caused them to defer, reduce or cut entirely their capital spending on contact centers. Moreover, some customers have combined or closed their contact centers in order to reduce expenses, which further contributed to the decline in our revenues. As with many competing products, some customers are price sensitive due to the negative economic conditions they are experiencing and therefore demand more contact center capabilities and feature at a lower price as the technology evolves, which may lead to downward pricing pressures across our industry.

      While we believe our installed base continues to represent a solid recurring revenue opportunity and a significant cash flow generator, and while our pricing has remained relatively consistent over the past three years, we cannot provide any assurance that these pressures on IT spending will ease, or that general economic climate will improve. Continued competitive pressure and a weak economy could have a continuing pronounced effect on our operating results. We have undertaken a variety of cost reduction measures designed

to bring our operating expenses in line with our perceptions of the business climate. Some of these measures included:

      Workforce adjustments: We reduced our workforce substantially in 2001 and 2002 and made further minor reductions in 2003; our full-time headcount at December 31, 2002 was 1,391, at December 31, 2003 was 1,291 and at December 31, 2004 was 1,254. As a result of our workforce adjustments, direct employee costs declined from $219 million in 2001, to $160 million in 2002, to $140 million in 2003 and $134 million in 2004.

      Outsourcing of manufacturing: While historically we engaged in some of our manufacturing efforts internally, we made the strategic decision to outsource substantially all of our manufacturing operations in late 2001. By outsourcing our manufacturing operations, we shifted our manufacturing to a more variable cost structure that leveraged our outsourced manufacturers’ economies of scale from purchasing volumes while substantially reducing our fixed costs associated with manufacturing. Our manufacturing fixed costs declined from $11.5 million in 2002 to $7.9 million in 2003 to $7.7 million in 2004, primarily due to headcount reductions from 32 manufacturing employees in 2002 to 17 manufacturing employees in 2004.

      Renegotiation of contracts: We renegotiated a variety of supply contracts and license arrangements to reduce the aggregate payments or to extend the period of time for payments we would be required to make. As a result of renegotiating supply contracts in IT and telecommunications, we reduced spending by $3 million in 2002, $13 million in 2003 and $7 million in 2004.

      During 2004, we strengthened our financial position by increasing revenues and net income as compared to 2003. Our cash and short-term investments balance at December 31, 2004 was $202.6 million after repaying $40 million outstanding under the revolving credit facility.

      Our product revenues are derived from license fees for software products and, to a lesser extent, sales of hardware products. With respect to our product revenues, a limited number of product lines, including call center hardware and software, workforce productivity, customer self service and contact center integration products, have accounted for substantially all our product revenues. We also generate a substantial portion of our revenues from fees for services complementing such products, including software license updates, product support (maintenance), professional and education services. 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 updates and 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 based 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 indirect sales channels. Our ability to achieve revenue growth and improved operating margins, as well as increased worldwide sales, in the future will depend in 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, restructuring and self insurance 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, valuation allowance and realization of deferred income taxes, and restructuring and self insurance reserves. Actual amounts could differ significantly from these estimates. We are not currently aware of any material changes in our business that would cause these estimates to differ significantly except by application of the methodologies described below. 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 unless title and risk of loss transfers upon delivery to the customer. In any sales transaction through a distributor or reseller, we recognize revenues when the distributor or reseller sells to an identified end user.

      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 results. Charges to the reserve were consistent with the original estimates. The