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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

(Mark One)

OR

Commission file number: 0-18391

ASPECT COMMUNICATIONS CORPORATION

1320 Ridder Park Drive, San Jose, California 95131-2312
(Address of principal executive offices and zip code)

Registrant’s telephone number: (408) 325-2200

     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  x    No  o

     Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

Yes  x    No  o  

     The number of shares outstanding of the Registrant’s Common Stock, $.01 par value, was 53,668,047 at April 30, 2003.

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ASPECT COMMUNICATIONS CORPORATION

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ASPECT COMMUNICATIONS CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except par value and share amounts-unaudited)

See Notes to Condensed Consolidated Financial Statements

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ASPECT COMMUNICATIONS CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data-unaudited)

See Notes to Condensed Consolidated Financial Statements

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ASPECT COMMUNICATIONS CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands-unaudited)

See Notes to Condensed Consolidated Financial Statements

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ASPECT COMMUNICATIONS

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS-UNAUDITED

Note 1: Basis of Presentation

     The condensed consolidated financial statements include the accounts of Aspect Communications Corporation (Aspect or the Company) and all of its wholly-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated.

     The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and notes required by accounting principles generally accepted in the United States of America for annual financial statements. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included. Operating results for the three months ended March 31, 2003 are not necessarily indicative of the results that may be expected for the year ending December 31, 2003. For further information, refer to the consolidated financial statements and notes thereto included in the Company’s 2002 Annual Report on Form 10-K.

Note 2: Stock Based Compensation

     At March 31, 2003, the Company has based its calculation on six stock-based employee compensation plans. The Company accounts for those plans under the recognition and measurement principles of APB Opinion No. 25, Accounting for Stock Issued to Employees, and related Interpretations. The following table illustrates the effect on net income and earnings per share if the company had applied the fair-value recognition provisions of SFAS No. 123, Accounting for Stock-Based Compensation, to stock-based employee compensation (in thousands, except per share amounts).

Note 3: Inventories

     Inventories are stated at the lower of cost (first-in, first-out) or market. Inventories consist of (in thousands):

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Note 4: Other Current Assets

     Other current assets consist of (in thousands):

Note 5: Product Warranties

     The Company generally warrants its products against certain manufacturing and other defects. These product warranties are provided for specific periods of time and/or usage of the product depending on the nature of the product, geographic location of its sale and other factors. The Company accrues for estimated product warranty claims based primarily on historical experience of actual warranty claims as well as current information on repair costs. The following table summarizes the activity related to the product warranty reserve for the three month period ended March 31, 2003 (in thousands):

     The Company also indemnifies its customers against any claim that its products infringe any copyright, patent or trademark, or incorporate any misappropriated trade secrets. The Company has not been subject to any material infringement claims by customers in the past and does not have any significant claims pending as of March 31, 2003.

Note 6: Comprehensive Income (Loss)

     Comprehensive income (loss) for the three months ended March 31 is calculated as follows (in thousands):

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Note 7: Earnings (Loss) Per Share

     Basic earnings (loss) per share is computed using the weighted average number of common shares outstanding during the period. Diluted earnings (loss) per share includes the dilutive impact, if any, of convertible subordinated debentures, redeemable convertible preferred stock, stock options and restricted cash awards. Basic and diluted earnings (loss) per share for the three months ended March 31 are calculated as follows (in thousands, except per share data):

     The Company had approximately 13 million and 11 million common stock options outstanding as of March 31, 2003 and 2002, respectively, which could potentially dilute basic earnings per share. Additionally, the Company had 102,950 shares of restricted common stock outstanding at March 31, 2003.

     At March 31, 2002, the Company used $3.66 per share as the conversion price of the debt to determine the dilution effect of the convertible debentures on an as if converted basis. This assumed the Company would satisfy the debt using 100% common stock on the put date. The convertible subordinated debentures were included in the computation of diluted earnings per share for the three months ended March 31, 2002 because the computation was dilutive to the earnings per share before cumulative effect of change in accounting principle. As of December 31, 2002, the Company established a policy that the convertible subordinated debentures will be settled in cash, rather than common stock before or on August 10, 2003, which is the put date. Therefore, on an on-going basis, the Company uses $47.08 as the conversion price of the debt to determine the dilution effect of convertible debentures on an as if converted basis. Based on the conversion price of $47.08, the Company had 3 million shares of common stock issuable upon conversion of the convertible debentures. The dilutive effect of the convertible subordinated debentures was excluded from the computation of diluted earnings per share for the three months ended March 31, 2003 because the inclusion would have been anti-dilutive.

     The redeemable convertible preferred stock issued on January 21, 2003 are potentially convertible into 22.2 million shares of common stock, and were not included in the computation of diluted earnings per share because this inclusion would have been anti-dilutive.

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Note 8: Restructuring Charge

     In fiscal years 2002 and 2001, the Company reduced its workforce by 22% and 28%, respectively, and consolidated selected facilities in its continuing effort to better optimize operations. As of March 31, 2003, the total restructuring accrual was $18 million, of which, $9 million was a short-term liability recorded in other accrued liabilities, and $9 million was a long-term liability. Components of the restructuring accrual were as follows (in thousands):

     Severance and outplacement costs are related to the termination of employees in 2001 and 2002. Employee separation costs include severance and other related benefits. Functions impacted by the restructuring included sales and sales infrastructure, support services, manufacturing, marketing, research and development, and corporate functions. The remaining balance of $689,000 relates primarily to the July 2002 and December 2002 provisions and will be paid by the end of 2003.

     Consolidation of facilities costs includes rent of unoccupied facilities, net of expected sublease income, and write-offs of abandoned internal use software assets. The remaining accrual balance relates primarily to the June 2001 and October 2001 provisions and will be paid over the next seven years.

Note 9: Lines of Credit and Borrowings

     On August 9, 2002, the Company entered into a Credit Agreement with Comerica Bank-California as administrative agent and CIT Business Credit as collateral agent that provides the Company with a $25 million revolving loan facility and a $25 million senior secured term loan. The revolver has a three-year term and is secured by all of the Company’s assets, a negative pledge on the Company’s intellectual property and a pledge of stock in the Company’s foreign and domestic subsidiaries. The Company’s borrowing options under the revolver include a Eurocurrency Rate and a Base Rate plus the applicable margins adjusted on a quarterly basis. Availability under the revolver also includes up to $5 million in the aggregated in stand-by letters of credit. At March 31, 2003, the Company had $0 outstanding under the revolver and has utilized $1 million in letters of credit. The term loan has a four-year term. The term loan is also secured by all of the Company’s assets, a negative pledge on the Company’s intellectual property and a pledge of stock in the Company’s foreign and domestic subsidiaries. The Company’s borrowing options under the term loan include a Eurocurrency Rate and Base Rate plus applicable margins. As of March 31, 2003, the Company had $22 million outstanding under the term loan with the applicable interest rate of 4.39%.

     In the event that the Company terminates either facility prior to the maturity date, the lenders will receive a prepayment penalty fee from the Company. Proceeds from certain financing transactions are required to be used to prepay the credit facilities. Transactions that require 100% of the proceeds to be used to prepay the credit facilities include permitted asset sales and future debt issuances. In addition, 50% of the proceeds from future equity issuances, excluding the proceeds from the Series B convertible preferred stock issuance described in Note 10, must be used to prepay the credit facilities. The facilities can be used for working capital, general corporate purposes and to repurchase the Company’s outstanding convertible subordinated debt. The Credit Agreement includes customary representations and warranties and covenants. The financial covenants include unrestricted cash, liquidity ratio, fixed charge coverage ratio, tangible net worth and earnings before interest expense, income taxes, depreciation and amortization (EBITDA). During the first quarter of 2003, the Company signed Amendment No. 1 to the Credit Agreement. This amendment clarified the accounting for the redeemable 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. The Company was in compliance with all related covenants and restrictions as of March 31, 2003.

     In October 2001, the Company entered into a 5-year loan with Fremont Bank in the amount of $25 million which bears interest at an initial rate of 8% which is then re-measured semi-annually beginning May 2002 at the rate of LIBOR + 3.75%

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subject to a floor of 8% and a ceiling of 14%. The loan is secured by a security interest in the Company owned buildings in San Jose. Borrowings are payable in equal monthly installments including interest computed on a 20-year amortization schedule until November 1, 2006, at which time the outstanding loan balance will become payable. At March 31, 2003, the Company had $24 million outstanding under this loan. The bank also required that the Company supply a $3 million letter of credit, which is recorded as restricted cash in other assets on the balance sheet as of March 31, 2003.

     In addition to the line of credit, the Company has two outstanding bank guarantees with a European bank which are required for daily operations such as payroll, import/export duties and facilities. As of March 31, 2003, approximately $3 million is recorded as restricted cash in other current assets on the balance sheet related to these bank guarantees.

Note 10: Convertible Preferred Stock

     On January 21, 2003 the Company and Vista Equity Fund II, L.P. (“Vista”) closed a private placement for the sale of $50 million of the Company’s Series B convertible preferred stock. The shares of Series B convertible preferred stock were sold for $1,000 per share and the holders of the 50,000 outstanding shares of Series B convertible preferred stock are entitled to vote (on an as-converted basis) on all matters subject to a stockholder vote. On most issues, the holders of Series B preferred stock and common stock vote together as a single class; however, the holders of Series B convertible preferred stock have veto rights with respect to certain Company actions. The actions which require the affirmative vote of the holders of a majority of the outstanding shares of Series B convertible preferred stock are fully described in the Company’s Certificate of Determination of Rights Preferences and Privileges of Series B Convertible Preferred Stock. The shares of Series B convertible preferred stock are initially convertible into 22.2 million shares of the Company’s common stock (subject to certain anti-dilution protection adjustments) and are mandatorily redeemable on January 21, 2013. The shares of Series B convertible preferred stock have a liquidation preference over the shares of common stock such that (i) upon any liquidation, dissolution or winding up of the Company, the holders of Series B convertible preferred stock receive payments equal to 100% of their investment amount, plus unpaid dividends prior to payments to the holders of common stock, or (ii) in the event of a change of control of the Company, the holders of Series B convertible preferred stock receive payments equal to 125% of their investment amount, plus unpaid dividends prior to payments to the holders of common stock (or, in each case, if greater, the amount they would have received had the Series B convertible preferred stock converted to common stock immediately prior to such liquidation or change of control).

     Per the private placement agreement, the Company is now obligated to accrue dividends on each share of the 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. Accrued dividends were $982,000 for the three months ended March 31, 2003. In addition to dividend accrual, the Company is recording accounting charges associated with the accretion of the 125% redemption premium and the amortization of the beneficial conversion feature. The redemption premium of $18 million is calculated based on a redemption value of $63 million. Accretion of the redemption premium was $292,000 for the three months ended March 31, 2003. The beneficial conversion feature of $18 million is computed based on the difference between the conversion price of the preferred equity and the fair market value of the Company’s common stock on January 21, 2003. Amortization of the beneficial conversion feature was $265,000 for the three months ended March 31, 2003. These amounts are being amortized using the net interest method.

     The sale and issuance of the Series B convertible preferred stock to Vista followed the approval of the transaction by the Company’s shareholders at the Special Meeting of Shareholders on January 21, 2003. Pursuant to Vista’s contractual rights, following the sale and issuance of the Series B convertible preferred stock, Vista elected two new members to the Company’s Board of Directors. Additionally, the Company increased its authorized number of shares of common stock from 100 million to 200 million shares following approval of such action by the Company’s shareholders at the Special Meeting of Shareholders on January 21, 2003.

Note 11: Recent Accounting Pronouncements

     FIN No. 46

     In January 2003, the FASB issued Interpretation No. 46, Consolidation of Variable Interest Entities (FIN 46). FIN 46 clarifies the application of Accounting Research Bulletin No. 51 for certain entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. FIN 46 applies to variable interest entities created after January 31, 2003, and to variable interest entities in which an enterprise obtains an interest after that date. It applies in the third quarter of fiscal 2003 to variable interest entities in which the Company may hold a variable interest that is acquired before February 1, 2003. The provisions of FIN 46 require that the Company disclose certain information if it is reasonably possible that the Company will be required to consolidate or disclose variable interest entities in all financial statements issued after January

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31, 2003. Based on its preliminary analysis and assessment, the Company has determined that it does not hold any variable interests as of March 31, 2003.

     EITF No. 00-21

     In November 2002, the EITF reached a consensus on Issue No. 00-21, Revenue Arrangements with Multiple Deliverables. EITF Issue No. 00-21 provides guidance on how to account for certain arrangements that involve the delivery or performance of multiple products, services and/or rights to use assets. The provisions of EITF Issue No. 00-21 will apply to revenue arrangements entered into in fiscal periods beginning after June 15, 2003. While the Company will continue to evaluate the requirements of EITF Issue No. 00-21, management does not currently believe adoption will have a significant impact on its accounting for multiple element arrangements as such arrangements will generally continue to be accounted for pursuant to AICPA Statement of Position 97-2, Software Revenue Recognition, and related pronouncements.

Note 12: Segment Information

     Under SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information, the Company’s operations are reported in two operating segments, which are product and services. All financial segment information required by SFAS No. 131 can be found in the consolidated financial statements.

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Item 2. Management’s Discussion And Analysis Of Financial Condition And Results Of Operations

     The following discussion should be read in conjunction with the unaudited condensed consolidated financial statements and notes thereto included in Part I-Item 1 of this Quarterly Report and the audited consolidated financial statements and notes thereto and Management’s Discussion and Analysis in the Company’s 2002 Annual Report on Form 10-K.

Forward-looking Statements

     The matters discussed in this report including, but not limited to, statements relating to (i) the Company’s anticipated gross margin levels; (ii) changes in anticipated spending levels in capital expenditures, research and development, selling, general and administrative expenses; and (iii) the adequacy of our financial resources to meet currently anticipated cash flow requirements for the next twelve months 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. Forward-looking statements may be identified by phrases such as “we anticipate,” “are expected to,” and “on a forward-looking basis,” and are subject to certain risks and uncertainties that could cause actual results to differ materially from those reflected in such forward-looking statements. Specific factors that could cause actual earnings per share results to differ include a potentially prolonged period of generally poor economic conditions that could impact our customers’ purchasing decisions; 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 these and other risks related to our business, see the section entitled “Business Environment and Risk Factors” below. Readers are cautioned not to place undue reliance on these forward-looking statements, which reflect management’s analysis only as of the date hereof. Aspect undertakes no obligation to publicly release any revision to these forward-looking statements that may be made to reflect events or circumstances after the date hereof.

Background

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

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

Critical Accounting Policies

     Note 1 of the Notes to the Consolidated Financial Statements in the Company’s 2002 Annual Report on Form 10-K includes a summary of the significant accounting policies and methods used in the preparation of Company’s Consolidated Financial Statements.

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

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

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

     The Company applies the provisions of Statement of Position 97-2, “Software Revenue Recognition”, as amended by Statement of Position 98-9, “Modification of SOP 97-2, Software Revenue Recognition, With Respect to Certain Transactions” and certain provisions of Staff Accounting Bulletin (SAB) No. 101, “Revenue Recognition in Financial Statements” to all transactions involving the sale of software products and hardware.

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

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

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

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

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

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

     Revenue reserves: An estimate of the revenue reserve for losses on receivables resulting from customer cancellations or terminations is recorded as a reduction in revenues at the time of the sale. The revenue reserve is estimated based on an analysis of the historical rate of cancellations or terminations of product and services arrangements. The accuracy of the estimate is dependent on the rate of future cancellations or terminations being consistent with the historical rate. If the rate of actual cancellations or terminations is greater than the historical rate, then the revenue reserve may not be sufficient to provide for actual losses. The revenue reserve was $7 million as of March 31, 2003.

     Allowance for doubtful accounts: The Company’s management must make estimates of the uncollectibility of accounts receivable. Management specifically analyzes historical bad debts, customer concentrations, customer credit worthiness, current economic trends and changes in customer payment terms when evaluating the adequacy of the allowance for doubtful accounts. The accounts receivable balance was $42 million, net of allowance for doubtful accounts of $8 million as of March 31, 2003.

     Accounting for income taxes: As part of the process of preparing its consolidated financial statements, the Company is required to estimate its income taxes in each of the tax jurisdictions in which the Company operates. This process involves management’s estimation of the Company’s actual current tax exposure 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. The Company must then assess the likelihood that the deferred tax assets will be recovered from future taxable income and to the extent the Company believes that recovery is not

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likely, the Company must establish a valuation allowance. To the extent the Company establishes a valuation allowance or adjusts this allowance in a period, the Company must include a tax benefit or expense 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. The Company has a valuation allowance of $84 million as of March 31, 2003, due to uncertainties related to the Company’s ability to utilize all of its deferred tax assets, primarily consisting of certain net operating losses carried forward and research tax credits, before they expire. The valuation allowance is based on estimates of taxable income by jurisdiction in which the Company operates and the period over which the deferred tax assets will be recoverable. In the event that actual results differ from these estimates or the Company adjusts these estimates in future periods, the Company may need to adjust its valuation allowance, which could materially impact its financial position and results of operations.

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

     Impairment of long-lived assets: The Company’s long-lived assets include property and equipment, long term investments, goodwill and other intangible assets. The fair value of the long-term investments is dependent on the performance of the companies in which the Company has invested, as well as volatility inherent in the external markets for these investments. In assessing potential impairment for these investments, the Company considers these factors as well as the forecasted financial performance of its investees. The Company records an investment impairment charge when it believes an investment has experienced a decline in value that is other than temporary. During 2002, the Company recognized $9 million of impairment losses related to its long-term investments. As of March 31, 2003, the carrying value of the Company’s long-term investment was $150,000.

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

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

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

     During the third quarter of 2002, the Company identified indicators of impairment of acquired assets relating to previous acquisitions. These indicators included the deterioration in the business outlook, recent changes in strategic plans and revised future net cash flow for certain acquired intangible assets. Therefore, the Company compared these future net cash flows to the respective carrying amounts attributable to the acquired intangible assets and determined that an impairment existed. As a result, during the third quarter of 2002, the Company recorded a total impairment charge of $39 million. Of this charge, $38 million related to acquired technology and was recorded within cost of revenues, while approximately $1 million related to customer base and sales channels acquired and was recorded within selling, general and administrative expenses.

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Results of Operations

     The following table sets forth statements of operations data for the three months ended March 31, 2003 and 2002 expressed as a percentage of total revenues: