**SECURITIES AND EXCHANGECOMMISSION**

**Washington,D.C. 20549**

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**FORM 10-Q**
| **x**                                                                                                                                                                                  | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**  |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|---------------------------------------------------------------------------------------------------------|
| ** **                                                                                                                                                                             | ** **                                                                                              |
| **For the  quarterly period ended March 31, 2007**                                                                                                                                |
| ** **                                                                                                                                                                             | ** **                                                                                              |
| **OR**                                                                                                                                                                                 |
| ** **                                                                                                                                                                             | ** **                                                                                              |
| **o**                                                                                                                                                                                  | **TRANSITION REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
| ** **                                                                                                                                                                             | ** **                                                                                              |
| **For the  transition period  from             to           ** |
| ** **                                                                                                                                                                             | ** **                                                                                              |
| **Commission  file number 000-29335**                                                                                                                                                  |

 

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**WITNESS SYSTEMS, INC.**

(Exact Name of Registrant as Specified in Its Charter)
| **Delaware**                              | ** ** | **23-2518693**       |
|-------------------------------------------|------------|----------------------|
| (State or Other  Jurisdiction             |       | (I.R.S. Employer     |
| of Incorporation  or Organization)        |       | Identification  No.) |
| ** **                                | ** ** | ** **           |
| **300  Colonial Center Parkway**          | ** ** | ** **           |
| **Roswell,  Georgia**                     | ** ** | **30076**            |
| (Address of  Principal Executive Offices) |       | (Zip Code)           |

 

Registrant’s telephone number, including area code **770-754-1900**

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Securities registered pursuant toSection 12(b) of the Act:**None**
| **Title of each class**                 | ** ** | **Name of  each exchange on which registered** |
|-----------------------------------------|------------|------------------------------------------------|
| Common Stock,  par value $.01 per share |       | Nasdaq                                         |

 

Securities registered pursuant toSection 12(g) of the Act: **None**

Indicateby check mark whether the registrant (1) has filed all reports required tobe filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject tosuch filing requirements for the past 90 days. Yes x  No o

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer, or a non- accelerated filer (as defined in Exchange ActRule 12b-2).
| Large accelerated filer o |   | Accelerated filer x |   | Non-accelerated filer o |
|--------------------------------|--------|---------------------|--------|-------------------------|

 

Indicateby check mark whether the registrant is a shell company (as defined inRule 12b-2 of the Exchange Act). Yes o   No x

As ofApril 30, 2007, 34,923,407 shares of the registrant’s common stock wereoutstanding.

 

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**WITNESS SYSTEMS, INC.**

**FORM 10-Q**

**INDEX**
| PART I.  |   | FINANCIAL INFORMATION                                                                                                 |   |   |
|---------------|--------|-----------------------------------------------------------------------------------------------------------------------|--------|--------|
|          |   |                                                                                                                  |   |   |
| Item 1.       |   | Financial Statements:                                                                                                 |   |   |
|          |   |                                                                                                                  |   |   |
|          |   | Condensed  Consolidated Balance Sheets at March 31, 2007 and December 31, 2006  (unaudited)                 |   |   |
|          |   |                                                                                                                  |   |   |
|          |   | Condensed  Consolidated Statements of Operations for the three months ended  March 31, 2007 and 2006 (unaudited) |   |   |
|          |   |                                                                                                                  |   |   |
|          |   | Condensed  Consolidated Statements of Cash Flows for the three months ended  March 31, 2007 and 2006 (unaudited) |   |   |
|          |   |                                                                                                                  |   |   |
|          |   | Notes to the  Condensed Consolidated Financial Statements (unaudited)                                                 |   |   |
|          |   |                                                                                                                  |   |   |
| Item 2.       |   | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                           |   |   |
|          |   |                                                                                                                  |   |   |
| Item 3.       |   | Quantitative  and Qualitative Disclosures About Market Risk                                                           |   |   |
|          |   |                                                                                                                  |   |   |
| Item 4.       |   | Controls and  Procedures                                                                                              |   |   |
|          |   |                                                                                                                  |   |   |
| PART II. |   | OTHER INFORMATION                                                                                                     |   |   |
|          |   |                                                                                                                  |   |   |
| Item 1.       |   | Legal Proceedings                                                                                                     |   |   |
|          |   |                                                                                                                  |   |   |
| Item  1A      |   | Risk  factors                                                                                                         |   |   |
|          |   |                                                                                                                  |   |   |
| Item  6.      |   | Exhibits                                                                                                              |   |   |
|          |   |                                                                                                                  |   |   |
| SIGNATURES    |   |                                                                                                                  |   |   |

 

2

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**PART I.FINANCIAL INFORMATION**

**Item 1.   Financial Statements**

**WITNESS SYSTEMS, INC. ANDSUBSIDIARIES**

**CONDENSED CONSOLIDATED BALANCE SHEETS**

**(in thousands, except share data)**

**(unaudited)**
| ** **                                                                                                                                                                                             | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                                             | ** ** | **2007**           | ** ** | **2006**              | ** ** |
| ** **                                                                                                                                                                                             | ** ** | ** **         | ** ** | ** **            | ** ** |
| **ASSETS**                                                                                                                                                                                             | ** ** | ** **         | ** ** | ** **            | ** ** |
| Current assets:                                                                                                                                                                                        |       |               |       |                  |       |
| Cash and cash  equivalents                                                                                                                                                                             |       | $                  | 114,052    |                  | $          | 73,888 |   |
| Investments  available for sale, at fair market value                                                                                                                                                  |       | 30,493             |       | 57,640                |       |
| Accounts  receivable, net of allowance of $4,279 at March 31, 2007 and $2,990 at  December 31, 2006                                                                                          |       | 53,073             |       | 59,668                |       |
| Prepaid and  other current assets                                                                                                                                                                      |       | 8,403              |       | 7,361                 |       |
| Total current  assets                                                                                                                                                                                  |       | 206,021            |       | 198,557               |       |
| Intangible assets, net  of accumulated amortization of $47,448 at March 31, 2007 and $43,179 at  December 31, 2006                                                                                     |       | 36,098             |       | 41,282                |       |
| Goodwill                                                                                                                                                                                               |       | 59,987             |       | 59,130                |       |
| Property and equipment,  net of accumulated depreciation and amortization of $21,549 at March 31, 2007  and $19,718 at December 31, 2006                                                               |       | 10,883             |       | 10,207                |       |
| Deferred income tax  assets                                                                                                                                                                            |       | 5,229              |       | 5,233                 |       |
| Other assets                                                                                                                                                                                           |       | 10,283             |       | 10,184                |       |
|                                                                                                                                                                                                   |       | $                  | 328,501    |                  | $          | 324,593 |   |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                                                                                         | ** ** | ** **         | ** ** | ** **            | ** ** |
| Current liabilities:                                                                                                                                                                                   |       |               |       |                  |       |
| Accounts payable                                                                                                                                                                                       |       | $                  | 9,597      |                  | $          | 10,005 |   |
| Accrued expenses                                                                                                                                                                                       |       | 22,327             |       | 24,256                |       |
| Deferred revenue                                                                                                                                                                                       |       | 37,173             |       | 38,799                |       |
| Total current  liabilities                                                                                                                                                                             |       | 69,097             |       | 73,060                |       |
| Other long-term  liabilities                                                                                                                                                                           |       | 5,349              |       | 5,418                 |       |
| Deferred income tax  liabilities                                                                                                                                                                       |       | 436                |       | 638                   |       |
| Total  liabilities                                                                                                                                                                                     |       | 74,882             |       | 79,116                |       |
| Commitments and  contingencies                                                                                                                                                                         |       |               |       |                  |       |
| Stockholders’ equity:                                                                                                                                                                             |       |               |       |                  |       |
| Preferred stock,  $.01 par value; 10,000,000 shares authorized; (50,000 shares of which have  been designated as Series A Junior Participating Preferred Stock), no  shares issued or outstanding |       | —             |       | —                |       |
| Common stock,  $.01 par value; 50,000,000 shares authorized; 34,771,167 and 34,122,704  shares issued and outstanding at March 31, 2007 and December 31,  2006, respectively                 |       | 348                |       | 341                   |       |
| Additional  paid-in capital                                                                                                                                                                            |       | 295,428            |       | 282,594               |       |
| Accumulated  deficit                                                                                                                                                                                   |       | (49,328            | )          | (43,971               | )          |
| Accumulated  other comprehensive income                                                                                                                                                                |       | 7,171              |       | 6,513                 |       |
| Total  stockholders’ equity                                                                                                                                                                       |       | 253,619            |       | 245,477               |       |
|                                                                                                                                                                                                   |       | $                  | 328,501    |                  | $          | 324,593 |   |

 

See accompanying Notes to Condensed ConsolidatedFinancial Statements.

3

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**WITNESS SYSTEMS, INC. ANDSUBSIDIARIES**

**CONDENSED CONSOLIDATED STATEMENTS OFOPERATIONS**

**(in thousands, except per share data)**

**(unaudited)**
| ** **                                      | ** ** | **Three Months Ended March 31,** | ** ** |
|-------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                      | ** ** | **2007**                                             | ** ** | **2006** | ** ** |
| Revenue:                                        |       |                                                 |       |   |   |
| Product                                         |       | $                                                    | 20,157     |   | $ | 19,839 |   |
| Services                                        |       | 41,111                                               |       | 31,627 |   |
| Total revenue                                   |       | 61,268                                               |       | 51,466 |   |
| Cost of revenue:                                |       |                                                 |       |   |   |
| Product                                         |       | 4,068                                                |       | 4,578 |   |
| Services                                        |       | 15,556                                               |       | 11,755 |   |
| Total cost of revenue                           |       | 19,624                                               |       | 16,333 |   |
| Gross profit                                    |       | 41,644                                               |       | 35,133 |   |
| Operating  expenses:                            |       |                                                 |       |   |   |
| Selling, general and administrative             |       | 36,289                                               |       | 25,209 |   |
| Research and development                        |       | 10,051                                               |       | 7,978 |   |
| Merger-related and integration costs            |       | 963                                                  |       | 2,091 |   |
| Operating loss                                  |       | (5,659                                               | )          | (145 | ) |
| Interest and  other income, net                 |       | 1,506                                                |       | 1,271 |   |
| (Loss) income before provision for income taxes |       | (4,153                                               | )          | 1,126 |   |
| Provision for  income taxes                     |       | 1,204                                                |       | 177 |   |
| Net (loss) income                               |       | $                                                    | (5,357     | ) | $ | 949 |   |
| Net (loss)  income per share:                   |       |                                                 |       |   |   |
| Basic                                           |       | $                                                    | (0.16      | ) | $ | 0.03 |   |
| Diluted                                         |       | $                                                    | (0.16      | ) | $ | 0.03 |   |
| Weighted-average  common shares outstanding:    |       |                                                 |       |   |   |
| Basic                                           |       | 34,359                                               |       | 32,871 |   |
| Diluted                                         |       | 34,359                                               |       | 36,648 |   |

 

See accompanying Notes to Condensed ConsolidatedFinancial Statements.

4

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**WITNESS SYSTEMS, INC. ANDSUBSIDIARIES**

**CONDENSED CONSOLIDATED STATEMENTS OFCASH FLOWS**

**(in thousands)**

**(unaudited)**
| ** **                                                                         | ** ** | **Three Months Ended March 31,** | ** ** |
|------------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                                         | ** ** | **2007**                                             | ** ** | **2006** | ** ** |
| Cash flows from  operating activities:                                             |       |                                                 |       |   |   |
| Net (loss) income                                                                  |       | $                                                    | (5,357     | ) | $ | 949 |   |
| Adjustments to reconcile net income to net cash  provided by operating activities: |       |                                                 |       |   |   |
| Amortization of intangible assets                                                  |       | 4,842                                                |       | 3,964 |   |
| Stock-based compensation expense                                                   |       | 5,863                                                |       | 3,146 |   |
| Depreciation and amortization of property and  equipment                           |       | 1,799                                                |       | 1,134 |   |
| Provision for accounts receivable                                                  |       | 3,106                                                |       | 747 |   |
| Deferred income taxes                                                              |       | (51                                                  | )          | (11 | ) |
| Other non-cash items, net                                                          |       | (186                                                 | )          | 1,200 |   |
| Changes in operating assets and liabilities:                                       |       |                                                 |       |   |   |
| Accounts receivable                                                                |       | 2,863                                                |       | (3,960 | ) |
| Prepaid and other assets                                                           |       | (1,680                                               | )          | (1,875 | ) |
| Accounts payable                                                                   |       | (398                                                 | )          | 2,545 |   |
| Accrued expenses                                                                   |       | (1,392                                               | )          | 225 |   |
| Deferred revenue                                                                   |       | (1,261                                               | )          | 10,416 |   |
| Net cash provided by operating activities                                          |       | 8,148                                                |       | 18,480 |   |
| Cash flows from  investing activities:                                             |       |                                                 |       |   |   |
| Capital expenditures                                                               |       | (2,622                                               | )          | (1,973 | ) |
| Purchases of investments                                                           |       | (17,924                                              | )          | (62,557 | ) |
| Proceeds from maturities of investments                                            |       | 44,490                                               |       | — |   |
| Proceeds from sales of investments                                                 |       | 888                                                  |       | 6,668 |   |
| Restricted cash held in escrow                                                     |       | —                                               |       | 4,000 |   |
| Others                                                                             |       | (218                                                 | )          | — |   |
| Net cash provided by (used in) investing activities                                |       | 24,614                                               |       | (53,862 | ) |
| Cash flows from  financing activities:                                             |       |                                                 |       |   |   |
| Proceeds from exercise of stock options and Employee  Stock Purchase Plan          |       | 6,954                                                |       | 5,251 |   |
| Others                                                                             |       | (5                                                   | )          | (105 | ) |
| Proceeds from sale of common stock, net                                            |       | —                                               |       | 3,723 |   |
| Excess tax benefits from stock-based compensation                                  |       | —                                               |       | 76 |   |
| Net cash provided by financing activities                                          |       | 6,949                                                |       | 8,945 |   |
| Effect of exchange rate changes on cash                                            |       | 453                                                  |       | 196 |   |
| Net increase (decrease) in cash and cash equivalents                               |       | 40,164                                               |       | (26,241 | ) |
| Cash and cash  equivalents at beginning of period                                  |       | 73,888                                               |       | 111,751 |   |
| Cash and cash  equivalents at end of period                                        |       | $                                                    | 114,052    |   | $ | 85,510 |   |
| Supplemental  cash flow information:                                               |       |                                                 |       |   |   |
| Cash paid for interest                                                             |       | $                                                    | —     |   | $ | 5 |   |
| Cash paid for  income taxes                                                        |       | $                                                    | 431        |   | $ | 95 |   |

 

See accompanying Notes to Condensed ConsolidatedFinancial Statements.

5

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**WITNESS SYSTEMS, INC. ANDSUBSIDIARIES**

**NOTES TO CONDENSED CONSOLIDATEDFINANCIAL STATEMENTS**

**March 31, 2007**

**(unaudited)**

**1.                     Pending Acquisition ofWitness Systems by Verint Systems Inc.**

On February 11, 2007, we entered into anAgreement and Plan of Merger with Verint Systems Inc. (“Verint”), whichprovides that we will be acquired by Verint and thus no longer be a publiccompany. If the merger contemplated by that agreement is completed, we willbecome a wholly-owned subsidiary of Verint. Except as otherwise expresslynoted, all statements and information in this filing presume our continuation asan independent company, which will not be the case if we are acquired byVerint.

**2.****                    ****Basis of Presentation**

***Business***—WitnessSystems, Inc. (“Witness”) is a publicly traded company that providesworkforce optimization software and services that help businesses capturecustomer intelligence and optimize their work performance. Our Impact 360solution features quality monitoring, compliance and IP recording, workforcemanagement, performance management and e-learning. Our quality monitoringproducts record multimedia interactions, including traditional voice, Web chatand email, based on user-defined business rules to enable our customers toevaluate the performance of their customer service representatives (“CSRs”),wherever they may be located in the enterprise. Our complianceapplications are designed to record high volume voice conversations betweenCSRs and customers for purposes such as compliance recording and salesverification. Our workforce management products enable our customers to developstrategic staffing plans, deploy skilled resources and evaluate productivity ofCSRs in a contact center, branch bank or back office operations. Our performancemanagement applications provide comprehensive analytics, including performancescorecards, and reports of customer interaction and CSR performance. Oure-learning applications deliver ongoing training tailored to CSR needs andcompetencies. We also provide consulting and implementation services, trainingand support to customers that use our software products. Primarily deployed incontact centers as well as the remote, branch and back offices of globalorganizations, the workforce optimization solution captures, analyzes andenables users to share and act on cross-functional information across theenterprise. With Impact 360, organizations can improve interactions and theunderlying back-office processes that enhance the customer experience and buildcustomer loyalty.

We are headquartered in Roswell, Georgia withoperations in the United States, Australia, Brazil, Canada, China, Germany,India, Japan, Mexico, the Netherlands, Singapore, South Africa and the UnitedKingdom. We were originally incorporated in 1988 in Georgia and werereincorporated in Delaware in 1997.

***Principles of Consolidation*** - The unaudited interim CondensedConsolidated Financial Statements include the financial statements of WitnessSystems, Inc. and its wholly-owned subsidiaries. All significantintercompany balances and transactions have been eliminated in consolidation.

The Condensed Consolidated Financial Statementsherein have been prepared in accordance with the requirements of Form 10-Qand, therefore, do not include all information and footnotes required byaccounting principles generally accepted in the United States of America.However, in the opinion of management, all adjustments necessary for a fairpresentation of the results of operations for the relevant periods have beenmade. All adjustments were of a normal recurring nature. Results for theinterim periods are not necessarily indicative of the results to be expectedfor the year. These Condensed Consolidated Financial Statements should be readin conjunction with the summary of significant accounting policies and thenotes to the Consolidated Financial Statements included in our Annual Report onForm 10-K for the fiscal year ended December 31, 2006, filed with theU.S. Securities and Exchange Commission.

***Use of Estimates***— The Condensed Consolidated Financial Statements have been prepared inaccordance with accounting principles generally accepted in the United States.The preparation of these Condensed Consolidated Financial Statements requiresus to make certain estimates and judgments that affect our reported assets,liabilities, revenues and expenses, and our related disclosure of contingentassets and liabilities. We base our estimates on historical experience and onvarious assumptions that we believe to be reasonable under the circumstances.Actual results may differ from these estimates under different assumptions orconditions.

6

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**3.****                    ****Revenue Recognition and Deferred Revenue**

We recognize revenue in accordance with the AmericanInstitute of Certified Public Accountants’ Statement of Position (“SOP”)No. 97-2,*Software RevenueRecognition,* and SOP No. 98-9*, Modification of SOP 97-2, Software RevenueRecognition, With Respect to Certain Transactions**and* Emerging Issues Task Force (“EITF”) No. 00-21,*Revenue Arrangements with Multiple Deliverables*.Revenue is primarily derived from licensing software and providing relatedservices including maintenance. We also derive a relatively small portion ofproduct revenue by selling hardware to customers. Product revenue, whichincludes software and hardware, is recognized when persuasive evidence of anarrangement exists, delivery of the product has occurred, the fee is fixed ordeterminable, collection is probable and vendor specific objective evidence offair value (“VSOE”) exists to allocate revenue to the undelivered elements ofthe arrangement. We report hardware revenue gross in accordance with EITFNo. 99-19,*Reporting RevenueGross as a Principal versus Net as an Agent,* because the factorsindicating gross reporting outweigh the factors indicating net reporting. Werecognize revenue using the residual method of accounting since we generallyhave VSOE for maintenance and professional services, but not for the softwareand hardware elements of the order. Under the residual method, servicesrevenue, including maintenance and professional services, is deferred at anamount equal to its fair value until those elements are delivered.Consequently, product revenue for the software and hardware is recognized(i) upon delivery of those products when we have VSOE for the relatedmaintenance and professional services sold and (ii) at an amountrepresenting the difference between the total order amount and the amountdeferred. For customer orders that include hardware, hardware revenue isaccounted for as a separate unit of accounting in accordance with guidanceprovided in EITF 00-21.

Services revenue includes installation, training,consulting, maintenance and reimbursable travel expenses. Revenue frominstallation, training and consulting services is recognized upon performanceof the related services and is offered and billed as separate elements ofcontracts. Reimbursable travel expenses revenue is recognized upon incurrenceof the related expenses. The functionality of the software and any hardwaresold is not dependent on installation and training services and customizationis not required to enable our customers to use our products. Maintenance isoffered as a separate element and the majority of contracts include the rightto unspecified upgrades on a when-and-if available basis. Maintenance revenueis deferred and recognized ratably over the term of the related maintenancecontract.

Our revenue recognition policy is significant becauseour revenues are a key component of our results of operations. We follow veryspecific and detailed guidelines in measuring revenues; however, certainjudgments and estimates affect the application of our revenue policy describedabove. Further, assessment of collectibility is particularly critical indetermining whether or not revenues should be recognized. We also recordprovisions for estimated sales allowances on product and service relatedrevenues at the time the related revenues are recorded. These estimates arebased on historical sales and services allowances, analysis of customer creditsand other known factors. If future sales credits prove to be greater than thehistorical data and the estimates we used to calculate these provisions, ourrevenues could be overstated.

Deferred revenue consists primarily of amountscollected from customers for products and services that have not met thecriteria for revenue recognition.

**4.****                    ****Blue Pumpkin Acquisition**

On January 24, 2005, we acquired Blue PumpkinSoftware, Inc. (“Blue Pumpkin”), a privately held California corporation.Pursuant to our Merger Agreement and Plan of Reorganization, datedDecember 16, 2004, with Blue Pumpkin (the “Blue Pumpkin Merger Agreement”),we paid $36 million in cash which was funded from our existing cash and investmentsand issued 1.9 million shares of Witness’ common stock valued at$33.5 million (measured based on the date the stock consideration becamefixed pursuant to the application of a formula specified in the Blue PumpkinMerger Agreement). Pursuant to the Blue Pumpkin Merger Agreement, cash of $4.0million and 210,000 shares of common stock valued at approximately $3.7 millionon the date of acquisition were placed into an escrow fund to compensateWitness, subject to certain limitations, for potential losses that could resultfrom, among other things, the IEX litigation and other specified litigations,and breaches of Blue Pumpkin’s representations, warranties or covenants in theBlue Pumpkin Merger Agreement.

7

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On December 15, 2005, Tekelec, IEX’s parent company,and Witness reached a tentative agreement to settle all claims asserted betweenthem. As part of the final settlement entered into in April 2006,Witness made payment of $8.25 million to Tekelec, and agreed to make six annualpayments of $0.5 million ($3.0 million in total) from April 2007 through2012. In accordance with Accounting Principles Board (“APB”) No. 21, *Interest on Receivables and Payables,* we recorded a $0.7 million discountrepresenting the difference between the face value and the present value of the$3.0 million. The escrow fund was released to Witness during March 2006 insatisfaction and settlement of claims that Witness brought against the escrowfund, including claims for losses resulting from the settlement of the IEX litigation.As part of the agreement to release the escrow, Witness issued shares of commonstock for proceeds of approximately $3.1 million. These shares were issued at adiscount of approximately $1.35 million, which was recorded as a charge toearnings in our Condensed Consolidated Statement of Operations for the threemonths ended March 31, 2006.

**5.****                    ****Merger-Relatedand Integration Costs**

During the three months ended March 31, 2007, merger-related andintegration costs were $1.0 million, comprised primarily of legal andother costs associated with the pending merger with Verint. During thethree months ended March 31, 2006, merger-related and integration costs of$2.1 million pertained primarily to legal,professional fees and a discount on shares sold to the Blue Pumpkinshareholders.

**6.****                     Net (Loss) Income Per Share**

The following is a reconciliation of the numerator anddenominator used in the calculation of basic and diluted net (loss) income pershare (in thousands, except per share data):
| ** **                                                                         | ** ** | **Three Months Ended March 31,** | ** ** |
|------------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                                         | ** ** | **2007**                                             | ** ** | **2006** | ** ** |
| Net (loss)  income                                                                 |       | $                                                    | (5,357     | ) | $ | 949 |   |
| Weighted average  shares of common stock and common stock equivalents outstanding: |       |                                                 |       |   |   |
| Basic                                                                              |       | 34,359                                               |       | 32,871 |   |
| Dilutive effect of stock options computed using the  treasury stock method         |       | —                                               |       | 3,777 |   |
| Diluted common  shares and share equivalents outstanding                           |       | 34,359                                               |       | 36,648 |   |
| Net (loss)  income per share:                                                      |       |                                                 |       |   |   |
| Basic                                                                              |       | $                                                    | (0.16      | ) | $ | 0.03 |   |
| Diluted                                                                            |       | $                                                    | (0.16      | ) | $ | 0.03 |   |

 

8

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We have excluded all outstanding stock options fromthe calculation of diluted net loss per common share for the three months endedMarch 31, 2007 because we reported a loss in this period. The total numberof share equivalents excluded from the calculation of historical diluted netloss per common share for the three months ended March 31, 2007 was3,384,062 calculated using the treasury stock method. In the first quarter of 2006, 4,200 stockoptions were excluded from the computation of diluted earnings per sharebecause they had exercise prices that exceeded the average fair market value ofour common stock for those periods, and therefore, had an anti-dilutive effect.

**7.****                    ****Comprehensive (Loss) Income**

Totalcomprehensive (loss)income and accumulated other comprehensive income consisted of the following(in thousands):
| ** **                                                               | ** ** | **Three Months Ended  March 31,** | ** ** |
|--------------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                               | ** ** | **2007**                                         | ** ** | **2006** | ** ** |
|                                                                     |       |                                             |       |   |   |
| Net (loss)  income                                                       |       | $                                                | (5,357     | ) | $ | 949 |   |
| Other  comprehensive income:                                             |       |                                             |       |   |   |
| Foreign currency translation adjustments                                 |       | 646                                              |       | 1,241 |   |
| Change in unrealized net holding gain (loss) on  investments, net of tax |       | 12                                               |       | (83 | ) |
| Total comprehensive  (loss) income                                       |       | $                                                | (4,699     | ) | $ | 2,107 |   |

 
| ** **                                           | ** ** | **March 31,  2007** | ** ** | **December 31,  2006** | ** ** |
|------------------------------------------------------|------------|--------------------------|------------|-----------------------------|------------|
| ** **                                           | ** ** | ** **               | ** ** | ** **                  | ** ** |
| Cumulative  foreign currency translation adjustments |       | $                        | 7,170      |                        | $          | 6,524 |   |
| Unrealized net  holding gain (loss) on investments   |       | 1                        |       | (11                         | )          |
| Total accumulated other  comprehensive income        |       | $                        | 7,171      |                        | $          | 6,513 |   |

 

**8.****                    ****Line of Credit**

In March 2007, in anticipation of the completionof our acquisition by Verint, we reduced our line of credit from $15.0 millionto $2.0 million and extended the maturity date on the $2.0 million line ofcredit to March 2008. At our election, borrowings under the line of creditbear interest at the bank’s prime rate, which was 8.25% on March 31, 2007,or LIBOR plus 300 basis points. Borrowings under the revolving line ofcredit is limited to 85% of eligible accounts receivable, as defined by theagreement. The revolving line of credit is secured by all of our assets andrequires compliance with various covenants, including liquidity ratios andEBITDA requirements, among others. As of March 31, 2007, we were incompliance with all bank covenants.

**9.****                    ****Segment and Geographic Information**

We consider ourselves to bein a single industry segment, specifically licensing and servicing of softwareapplications to the customer interaction recording and analysis market. Ourchief operating decision maker receives financial information by geographicregion; however, our operating segments are aggregated into one reportablesegment based upon similar economic characteristics, products, services anddelivery methods.

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World-wide revenue based oncustomer location is as follows (in thousands):
| ** **     | ** ** | **Three Months Ended  March 31,** | ** ** |
|----------------|------------|--------------------------------------------------|------------|
| ** **     | ** ** | **2007**                                         | ** ** | **2006** | ** ** |
|           |       |                                             |       |   |   |
| United States  |       | $                                                | 35,436     |   | $ | 27,669 |   |
| United Kingdom |       | 14,612                                           |       | 13,297 |   |
| Rest of world  |       | 11,220                                           |       | 10,500 |   |
| Total          |       | $                                                | 61,268     |   | $ | 51,466 |   |

 

The rest of world revenuewas derived primarily from customers located in Australia, Canada, China, Indiaand Japan. No individual customer accounted for more than 10% of consolidatedrevenue during the three months ended March 31, 2007 or 2006.

Long-lived assets, includinggoodwill and intangible assets, by geography are as follows (in thousands):
| ** **     | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|----------------|------------|--------------------|------------|-----------------------|------------|
| ** **     | ** ** | **2007**           | ** ** | **2006**              | ** ** |
| ** **     | ** ** | ** **         | ** ** | ** **            | ** ** |
| United States  |       | $                  | 95,502     |                  | $          | 99,028 |   |
| United Kingdom |       | 9,312              |       | 9,386                 |       |
| Rest of world  |       | 2,154              |       | 2,205                 |       |
| Total          |       | $                  | 106,968    |                  | $          | 110,619 |   |

 

**10.****                  Income Taxes**

***In***June 2006, the FinancialAccounting Standard Board (“FASB”) issued FIN No. 48, *Accountingfor Uncertainty in Income Taxes—an interpretation of FASB StatementNo. 109*, which provides criteria for the recognition,measurement, presentation and disclosure of uncertain tax positions. We aresubject to the provisions of FIN 48 as of January 1, 2007 and have analyzedfiling positions in all federal, state and foreign filing jurisdictions wherewe are required to file income tax returns as well as all open years in thosejurisdictions. The adoption of FIN 48 did not have a material impact on ourresults of operations and financial position, and we believe that we haveadequate support for the income tax positions taken on filed tax returns.Further, there have been no significant changes to our FIN 48 positions duringthe quarter ended March 31, 2007.

The Company andits subsidiaries have no U.S. federal or state income tax examinationscurrently in progress. We are under examination in the United Kingdom, Canada,and New Zealand for the period ended December 31, 2003, tax years 2003 and2004, and tax years 2003 through 2005, respectively. We anticipate all suchexaminations will close before the end of 2007 and do not anticipate anyadditional tax liability as a result of these examinations. For domesticjurisdictions, our tax returns remain open for periods 1997 to 2006 as a resultof net operating loss carryovers. Foreign jurisdiction tax years also remainopen for examination under various foreign regulations.

Due to the natureof our tax positions and the results of recent examinations, we do not believethat any material tax benefit that will have a material impact on our effectivetax rate, will be derecognized during the next 12 months. It is our policy torecord interest and penalties related to income tax matters, if any, in incometax expense.

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**11.****                  Legal Proceedings**

***On*********December 11,2002, we filed in the United States District Court for the Northern District ofGeorgia, Atlanta Division, a lawsuit against Knowlagent, Inc. (“Knowlagent”),which is the assignee of United States (“U.S.”) Patent Nos. 6,324,282 B1 and6,459,787 B2. Knowlagent has accused our eQuality Now software of infringingthe above patents. We filed suit seeking a declaration that we did not and donot infringe either of the two patents listed above, as well as a declarationthat the above patents are invalid and unenforceable. We also filed a claimrequesting that if the patents are found to be valid, that one of our ownemployees be named the rightful inventor of the patents. We also requestedmonetary damages in an amount equal to the amount that Knowlagent has receivedfrom its use of the above patents. On December 31, 2002, Knowlagent filedits answer to our complaint as well as two counterclaims, alleging that weinfringe and contribute to the infringement by others of the above patents;Knowlagent seeks both monetary damages and an injunction in connection with itscounterclaim. On June 6, 2005, the Court held a claim construction hearingand issued a claim construction order on June 8, 2005. The case is nowproceeding to expert discovery and summary judgment phases.

On July 20, 2004, STS Software Systems Ltd. (“STSSoftware”), a wholly-owned subsidiary of NICE Systems, Ltd. (“NICE Ltd.”),filed a patent infringement suit in the U.S. District Court for the SouthernDistrict of New York against us (“New York Action”). The New York Actionasserts that our products, including eQuality ContactStore for IP, infringeUnited States (“U.S.”). Patent No. 6,122,665 (“the ‘665 patent”) and seeksonly injunctive, not monetary, relief. On the same day, we filed a declaratoryjudgment action against STS Software in the U.S. District Court for theNorthern District Georgia (“Georgia Action”). We seek a declaration from thecourt that we have not infringed any valid claim of the ‘665 patent. By Orderentered December 16, 2004, Judge Koeltl of the U.S. District Court for theSouthern District of New York granted our motion to transfer the New YorkAction to the Northern District of Georgia, which has now consolidated theformer New York Action with the Georgia Action. On July 7, 2005, the Courtalso granted STS leave to amend its complaint to add three patents to thedispute, namely: U.S. Patent Nos. 6,865,604; 6,871,229; and 6,880,004(respectively, “the ‘604 patent,” “the ‘229 patent,” and “the ‘004 patent”;collectively, “the STS patents”), again seeking solely injunctive relief. Weanswered the first amended complaint and asserted counterclaims onJuly 29, 2005, collectively, through which we deny infringement of anyvalid claim of the STS patents and seek a declaration to that effect. The Courtentered its claim construction ruling on January 16, 2007, and the case isprogressing through its remaining discovery phases.

On August 30, 2004, we filed in the United StatesDistrict Court for the Northern District of Georgia, Atlanta Division, alawsuit against NICE Systems, Inc. (“NICE Inc.”), a wholly-ownedsubsidiary of NICE Ltd., alleging patent infringement. Specifically, wehave alleged that NICE products, including the NiceUniverse products thatinclude screen capture and synchronized screen and voice capture technologies,infringe claims of U.S. Patent Nos. 5,790,798 (“the ‘798 Patent”) and 6,510,220(“the ‘220 Patent”), both entitled “Method and Apparatus for SimultaneouslyMonitoring Computer User Screen and Telephone Activity from a Remote Location.”We have sought an injunction and money damages for NICE’s infringement of thesetwo patents. NICE Inc. has answered and counterclaimed for declaratoryjudgments of non-infringement and invalidity. Since then, on February 24,2005, we filed suit against NICE Ltd. because of its infringing activitiesin violation of the ‘798 and ‘220 patents, including importation of the accusedNICE products. By order dated April 5, 2005, the court has consolidatedthe NICE Inc. and NICE Ltd. actions. The Court entered its claim constructionruling on January 5, 2007, and the case is progressing through itsremaining discovery phases.

On January 19, 2006, we filed in the UnitedStates District Court for the Northern District of Georgia, Atlanta Division, alawsuit against NICE Systems, Inc. and NICE Systems, Ltd. (collectively “NICE”),alleging patent infringement. Specifically, we have alleged that NICE products,including NicePerform and related products that include the ability tomonitor communications to detect the presence of at least one predeterminedparameter, infringe claims of U.S. Patent No. 6,404,857 B1 (“the ‘857Patent”), entitled “Signal Monitoring Apparatus for Analyzing Communications.”We have sought an injunction and money damages for NICE’s infringement of the ‘857patent. On March 6, 2006, NICE answered and counterclaimed, alleging thatthe ‘857 patent is not infringed and is invalid. The case has been set on adiscovery calendar and is at a preliminary stage.

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On May 10, 2006, NICE Systems, Inc. and NICESystems Ltd. (collectively “NICE”), filed a patent infringement suit seekingmonetary damages and injunctive relief in the U.S. District Court for theDistrict of Delaware against us (“Delaware Action”). The Delaware Actionasserts that our products, including ContactStore, ContactStore for IP,ContactStore for Communications Manager, Quality for Communications Manager,and eQuality Balance, infringe one or more claims of ten U.S. Patents:  U.S. Patent Nos. 5,274,738; 5,396,371;5,819,005; 6,249,570; 6,728,345; 6,775,372; 6,785,370; 6,870,920; 6,959,079;and 7,010,109 (“the Delaware Patents”). We answered NICE’s complaint onJune 30, 2006, through which we deny infringement of any valid claim ofany of the Delaware Patents. The case has been set on a discovery calendar andis at a preliminary stage.

On December 27, 2006, NICE Systems, Inc. andNICE Systems Ltd. (collectively, “NICE”), filed a declaratory judgment actionagainst us in the U.S. District Court for the Northern District Georgia,relating to U.S. Patent No. 6,757,361 (“the ‘361 Patent”), entitled “SignalMonitoring Apparatus Analyzing Voice Communication Content.”  NICE seeks a declaration from the court thatthe claims of the ‘361 Patent are invalid, and that NICE has not infringed anyvalid claim of the ‘361 Patent. The company has moved to dismiss or stay thecase while a previously filed reissue proceeding remains pending in the PatentOffice. The motion remains pending.

On August 29, 2006, A. Edward Miller filed ashareholder derivative lawsuit in the United States District Court for theNorthern District of Georgia (Atlanta Division) naming WitnessSystems, Inc. (the “Company”) as a nominal defendant and naming all of ourcurrent Board of Directors and a number of our current officers as defendants.Miller v. Gould, et al., Civil Action No. 1:06-CV-2039 (N.D. Ga.).The complaint alleges purported violations of federal and state law, includingbreaches of fiduciary duty, abuse of control, constructive fraud, corporatewaste, unjust enrichment, gross mismanagement and violations of certainantifraud provisions of the federal securities laws (including Sections10(b) and 14(a) of the Securities Exchange Act of 1934 andRules 10b-5 and 14a-9 thereunder) in connection with certain stock optiongrants made by the Company. The complaint seeks monetary damages in unspecifiedamounts, disgorgement of profits, an accounting, rescission of stock optiongrants, imposition of a constructive trust over the defendants’ stock optionsand proceeds derived therefrom, punitive damages, reimbursement of attorneys’fees and other costs and expenses, an order directing the Company to adopt orput to a stockholder vote various proposals relating to corporate governance,and other relief as determined by the court. Plaintiffs filed an AmendedComplaint on January 9, 2007. Defendants moved to dismiss the Amended Complainton March 9, 2007, arguing, *inter alia*,that the case should be stayed or dismissed because the Company’s announcedcash-out merger with Verint Systems Inc. (expected to close during the secondquarter of 2007) would eliminate plaintiff’s standing to pursue a derivativeaction on behalf of the Company’s shareholders. Plaintiffs responded by filing,on April 6, 2007 a motion for leave to file a proposed Second AmendedComplaint, which purports to bring four new direct claims as a putative classaction for breach of fiduciary duty, abuse of control, gross mismanagement, andconstructive fraud. Defendants filed an opposition to the motion for leave toamend on May 4, 2007.

On August 14, 2006, aputative class action securities lawsuit was filed by an individual claiming tobe a stockholder of the Company and naming the Company and certain of its Boardof Directors and officers as defendants in connection with certain stock optiongrants made by the Company. *Rosenberg v.Gould, et al.*, Civil Action No. 1:06-CV-1894 (N.D. Ga.). Thecomplaint, filed in the United States District Court for the Northern Districtof Georgia, alleges violations of Section 10(b) of the Securities Exchange Actof 1934 (“Exchange Act”) and Rule 10b-5 thereunder and seeks unspecifieddamages, attorneys’ fees and other costs and expenses, unspecifiedextraordinary, equitable and injunctive relief, and other relief as determinedby the court. On January 25, 2007, the Court granted an unopposed motion by “WitnessSystems Investor Group” for an order consolidating all later-filed securitiesclass actions, appointing the Group as Lead Plaintiff, and approving itsselection of Motley Rice LLC and Kahn Gauthier Swick LLC as Co-Lead Counsel. AConsolidated Amended Complaint was filed on April 6, 2007, adding a claim underSection 20(a) of the Exchange Act and naming the Company’s auditor, KPMG LLP,as an additional defendant. The Company and its Board of Directors intend toreview the allegations of the Consolidated Amended Complaint and respond whenappropriate.

On October 27, 2006, the Company received anotice of informal nonpublic inquiry from the Securities and ExchangeCommission requesting certain documents and information relating to the company’sstock option grant practices from February 2000 to the present. We intendto cooperate fully with all matters related to this request.

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On March 14, 2007, the Company was served with acomplaint by Doron Aspitz, the former chief executive officer of Blue PumpkinSoftware, Inc., in California Superior Court for the County of Santa Clara(Case No. 107CV078480). The complaint names the Company as defendant andpurports to assert eight causes of action, for promissory estoppel, promissoryfraud, negligent misrepresentation, breach of fiduciary duty, vote buying,violation of Section 17200 of the California Business and Professions Code,violation of Section 1101 of the California General Corporation Law, and unjustenrichment. The complaint purports to seek over $5.0 million in compensatorydamages as well as other unquantified punitive and exemplary damages,disgorgement, and attorneys’ fees and costs. The complaint was filed on orabout January 19, 2007, but no effort was made to serve the complaint untilapproximately mid-March 2007. On April 12, 2007, the Company removed the actionto the United States District Court for the Northern District of California.The Company subsequently filed a motion to dismiss the claims against it. Afterthe motion to dismiss was filed, the plaintiff moved to amend the complaint toadd as a defendant a resident of California and on that basis has challengedthe removal and sought to have the matter remanded to California state court.The Company intends to oppose the remand and to seek dismissal. The Companyintends to continue to contest the complaint vigorously.

From time to time we may be involved in other legalproceedings and/or litigation arising in the ordinary course of our businessthat might impact on our financial position, our results of operations, or ourcash flows.

***Indemnificationsand Warranties—******We***moreoften than not indemnify our customers against damages and costs resulting fromclaims of patent, copyright, or trademark infringement associated with use ofour software in its software licensing agreements. We have historically notmade any payments under such indemnifications. However, we continue to monitorthe conditions that are subject to the indemnifications to identify whether itis probable that a loss has occurred, and would recognize any such losses underthe indemnifications when those losses are probable and estimable. In addition,we warrant to customers that our software products operate substantially inaccordance with the software product’s specifications. Historically, nomaterial costs have been incurred related to software product warranties and nosignificant costs are expected in the future.

We have entered into indemnification agreements witheach of our present and former directors and officers. Under those agreements,we are (with certain exceptions) required to indemnify each such director orofficer against expenses, including attorneys’ fees, judgments, fines andsettlements, paid by such individual in connection with the pending litigationrelating to our stock option granting practices.

**12.****                  Recent Accounting Pronouncements**

In June 2006, the FASB issued EITF No. 06-3,*How Taxes Collected from Customers and Remitted toGovernmental Authorities Should Be Presented in the Income Statement (That is,Gross versus Net Presentation)*. This EITF requires disclosure of theaccounting policy of any tax assessed by a governmental authority that isdirectly imposed on a revenue-producing transaction (i.e., sales, use, valueadded) on a gross (included in revenue and costs) or net (excluded from revenue)basis. This EITF is effective for us as of January 1, 2007. Our policy isto record any tax assessed by a governmental authority on revenue-producingtransactions on a net basis. Our adoption of EITF No. 06-3 did not havematerial impact on our results of operations and financial position.

In September 2006, the FASB issued SFASNo. 157, *Fair Value Measurements*, whichbecomes effective beginning on January 1, 2008. SFAS No. 157addresses the definition of fair value, the methods used to measure fair valueand the expanded disclosures about fair value measurement of a company’s assetsand liabilities. SFAS No. 157 requires that the fair value measurementshould be determined based on the assumptions that market participants woulduse in pricing the asset or liability. We are currently assessing the impact ofthe SFAS No. 157 on our results of operations and financial position.

In February 2007, the FASB issued SFAS No. 159, *The Fair Value Option for Financial Assets and Financial Liabilities,*whichbecomes effective beginning on January 1, 2008. SFAS No. 159 requires companiesto display the fair value of assets and liabilities on the face of the balancesheet when a company elects to use fair value. We are currently assessing theimpact of the SFAS No. 159 on our results of operations and financialpositions.

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**13.                  SubsequentEvents**

On April 6, 2007, the plaintiffs in the shareholderderivative lawsuit filed a motion for leave to file a proposed Second AmendedComplaint, which purports to bring four new direct claims as a putative classaction for breach of fiduciary duty, abuse of control, gross mismanagement, andconstructive fraud. Defendants filed an opposition to the motion for leave toamend on May 4, 2007.

In the putative classaction securities lawsuit, the plaintiffs filed a Consolidated AmendedComplaint on April 6, 2007, adding a claim under Section 20(a) of the ExchangeAct and naming the Company’s auditor, KPMG LLP, as an additional defendant. TheCompany and its Board of Directors intend to review the allegations of theConsolidated Amended Complaint and respond when appropriate.

On May 1, 2007, our stockholders voted to adopt theAgreement and Plan of Merger pursuant to which Verint will acquire Witness.Completion of the merger remains subject to the receipt of regulatory approvalin the United Kingdom and the continued satisfaction or waiver of the otherconditions set forth in the merger agreement.

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**Item 2.Management’s Discussion and Analysis of Financial Condition and Results ofOperations**

The following Management’sDiscussion and Analysis of Financial Condition and Results of Operations shouldbe read in conjunction with the Condensed Consolidated Financial Statements andNotes thereto included elsewhere in this report. Investors should carefullyreview the information contained in this report under the caption “Risk Factors”beginning on page 27. The following will be discussed and analyzed:

·                  PendingAcquisition of Witness Systems by Verint Systems Inc.

·                  Overview

·                  CriticalAccounting Policies and Estimates

·                  Resultsof Operations

·                  Liquidityand Capital Resources

**PendingAcquisition of Witness Systems by Verint Systems Inc.**

On February 11, 2007, we entered into anAgreement and Plan of Merger (the “Merger Agreement”) with Verint, a Delawarecorporation pursuant to which Witness expects to merge with a wholly-ownedsubsidiary of Verint, and thereby become a wholly-owned subsidiary of Verint (“theMerger”). At the effective time of the Merger, each outstanding share of ourcommon stock will be converted into the right to receive $27.50 in cash, lessany applicable withholding taxes.. The Merger is expected to close in thesecond quarter of 2007.

Except as otherwise expressly noted, all statementsand information in this filing presume our continuation as an independentpublic company, which will not be the case if the Merger is completed.

**Overview**

We are a leading provider of workforce optimizationsoftware and services that help businesses capture customer intelligence andoptimize their work performance. Our Impact 360 solution features qualitymonitoring, compliance and IP recording, workforce management, performancemanagement and e-learning. Our quality monitoring products record multimediainteractions, including traditional voice, Web chat and email, based onuser-defined business rules to enable our customers to evaluate theperformance of their customer service representatives (“CSRs”) wherever theymay be located in the enterprise. Our full-time compliance applicationsare designed to record high volume voice conversations between CSRs andcustomers for purposes such as compliance recording and sales verification. Ourworkforce management products enable our customers to develop strategicstaffing plans, deploy skilled resources and evaluate productivity of CSRs in acontact center, branch bank or back office operations. Our performancemanagement applications provide comprehensive analytics, including performancescorecards, and reports of customer interaction and CSR performance. Oure-learning applications deliver ongoing training tailored to CSR needs andcompetencies. We also provide consulting and implementation services, trainingand support to customers that use our software products. Primarily deployed incontact centers—as well as the remote, branch and back offices of globalorganizations, the workforce optimization solution captures, analyzes andenables users to share and act on cross-functional information across theenterprise. With Impact 360, organizations can improve interactions and theunderlying back-office processes that enhance the customer experience and buildcustomer loyalty.

Our Impact 360 solution is an integrated offering ofsoftware products that provide comprehensive workforce optimizationfunctionality, including quality monitoring and high-volume compliancerecording, workforce management, performance management and electroniclearning, or e-learning. Our quality monitoring products record multimediainteractions, including traditional voice, Web chat and email, based onuser-defined business rules to enable our customers to evaluate theperformance of their CSRs wherever they may be located in the enterprise. Ourhigh-volume compliance applications are designed to record high volume,full-time performance of the voice conversations between CSRs and 

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customers for purposessuch as compliance recording and sales verification. Our workforce managementproducts enable our customers to develop strategic staffing plans, deployskilled resources and evaluate productivity of CSRs. Our performance managementapplications provide comprehensive analytics, including performance scorecards,and reports of customer interaction and CSR performance. Our e-learningapplications deliver ongoing training tailored to CSR needs and competencies.We also provide consulting and implementation services, training and support tocustomers that use our software products.

We derive product revenue by licensing software andderive services revenue by providing related installation, training,consulting, and maintenance services. We also derive a relatively small portionof product revenue by selling hardware to customers. The majority of ourproduct revenue is derived from recording, quality monitoring (“QM”) andworkforce management (“WFM”) software. We sell our products through our directsales force and through our indirect sales channels. Our indirect saleschannels consist of distributors, resellers, systems integrators and OriginalEquipment Manufacturers (“OEM”). Distributors and resellers purchase productfrom us at a discount and then resell our products to end-users (or, in thecase of distributors, to other resellers) and referral partners are paid a feefor referring sales leads to us or for assisting us in a sales order. Systemsintegrators are information technology (“IT”) consulting service companies whorecommend our products during client engagements. Through OEM agreements, weco-develop products, which are sold by the OEM as part of their portfolio ofproducts.

We intend to continue to expand our global saleschannels by entering into new reseller, distributor, OEM and similararrangements with key vendors in the contact center workforce optimizationmarket. During first quarter of 2007 and 2006, approximately 51% and 31%,respectively**,**of our license revenue has beenderived from the indirect sales channel.

We plan to grow our product revenue and maintain our competitiveposition from a technology perspective through the timely introduction of newproducts, such as pre-packaged solutions, which add capabilities such asperformance analysis and e-learning management to our core qualitymonitoring and workforce management solutions. We also believe the market shiftfrom traditional hardware based recording to VoIP represents a significantgrowth opportunity and our software solutions support both of these recordingenvironments. In addition, we believe our product offerings can be marketedtoward branch-office and back-office initiatives for business processmonitoring, which represents a new market for us. Factors that may impact ourability to grow our product revenue, however, include our ability to remaincompetitive from a technology perspective; market acceptance of our newproducts; our ability to maintain our product pricing integrity; and ourability to expand our global sales channels.

We also plan to grow our services revenue in concertwith our product revenue. When our customers license our products, theygenerally purchase installation, training and one year of support services.Therefore, as we generate product revenue, we also generate related servicesrevenue. In addition, our customers generally renew their maintenance contractswith us each year. Therefore, our maintenance revenue increases as our customerbase increases. Factors that may influence our ability to grow our servicesrevenue, however, include our ability to continue to increase product revenues,provide services that enable and enhance our customers’ ability to improve theefficiency and effectiveness of their call center operations and our ability tomaintain a high level of customer success and satisfaction.

We are headquartered in Roswell, Georgia withoperations in the United States, Australia, Brazil, Canada, China, Germany,India, Japan, Mexico, the Netherlands, Singapore, South Africa and the UnitedKingdom. During the three months ended March 31, 2007 and 2006,approximately 42% and 46%, respectively, of our revenue was derived fromoperations outside the United States. We had****851****full-time employees**,** excludingapproximately 110 contractors located in the Asia-Pacific region, atMarch 31, 2007, compared to 668 employees, excluding approximately 164contractors, at March 31, 2006. As of March 31, 2007, 312 of the 851full-time employees were located outside the United States compared to 229employees at March 31, 2006.

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**Critical Accounting Policies andEstimates**

The discussion and analysis of our financial conditionand results of operations is based upon our Condensed Consolidated FinancialStatements, which have been prepared in accordance with accounting principlesgenerally accepted in the United States of America. The preparation of thesefinancial statements requires us to make certain estimates and judgments thataffect our reported assets, liabilities, revenue and expenses, and our relateddisclosure of contingent assets and liabilities. On an on-going basis, were-evaluate our estimates, accounting policies and judgments including thoserelated to revenue recognition, the collectibility of receivables, accountingfor acquisitions, impairment of long-lived assets, income taxes and stock-basedcompensation to ensure that our financial statements are presented fairly andin accordance with Generally Accepted Accounting Principles (“GAAP”). We baseour estimates on historical experience and on various assumptions that webelieve to be reasonable under the circumstances. However, because futureevents and their effects cannot be determined with certainty, actual resultsmay differ from these estimates under different assumptions or conditionsand such differences could be material. Management believes that the followingaccounting policies and estimates are critical to understanding and evaluatingour reported financial results. Management has reviewed these criticalaccounting policies and estimates with the Audit Committee of our Board ofDirectors.

*Revenue Recognition.*Werecognize revenue in accordance with the American Institute of Certified PublicAccountants’ Statement of Position (“SOP”) No. 97-2,*Software Revenue Recognition,* andSOP No. 98-9*, Modificationof SOP 97-2, Software Revenue Recognition, With Respect to Certain Transactions**and* Emerging Issues Task Force (“EITF”) No. 00-21,*Revenue Arrangements with Multiple Deliverables*.Revenue is primarily derived from licensing software and providing relatedservices including maintenance. We also derive a relatively small portion ofproduct revenue by selling hardware to customers. Product revenue, whichincludes software and hardware, is recognized when persuasive evidence of anarrangement exists, delivery of the product has occurred, the fee is fixed ordeterminable, collection is probable and vendor specific objective evidence offair value (“VSOE”) exists to allocate revenue to the undelivered elements ofthe arrangement. We report hardware revenue gross in accordance with EITFNo. 99-19,*Reporting RevenueGross as a Principal versus Net as an Agent,* because the factorsindicating gross reporting outweigh the factors indicating net reporting. Werecognize revenue using the residual method of accounting since we generallyhave VSOE for maintenance and professional services, but not for the softwareand hardware elements of the order. Under the residual method, servicesrevenue, including maintenance and professional services, is deferred at anamount equal to its fair value until those elements are delivered.Consequently, product revenue for the software and hardware is recognized(i) upon delivery of those products when we have VSOE for the relatedmaintenance and professional services sold and (ii) at an amountrepresenting the difference between the total order amount and the amountdeferred. For customer orders that include hardware, hardware revenue isaccounted for as a separate unit of accounting in accordance with guidanceprovided in EITF 00-21.

Services revenue includes installation, training,consulting, maintenance and reimbursable travel expenses. Revenue frominstallation, training and consulting services is recognized upon performanceof the related services and is offered and billed as separate elements ofcontracts. Reimbursable travel expenses revenue is recognized upon incurrenceof the related expenses. The functionality of the software and any hardwaresold is not dependent on installation and training services and customizationis not required to enable our customers to use our products. Maintenance isoffered as a separate element and the majority of contracts include the rightto unspecified upgrades on a when-and-if available basis. Maintenance revenueis deferred and recognized ratably over the term of the related maintenancecontract.

Our revenue recognition policy is significant becauseour revenues are a key component of our results of operations. We follow veryspecific and detailed guidelines in measuring revenues; however, certainjudgments and estimates affect the application of our revenue policy describedabove. Further, assessment of collectibility is particularly critical indetermining whether or not revenues should be recognized. We also recordprovisions for estimated sales allowances on product and service relatedrevenues at the time the related revenues are recorded. These estimates arebased on historical sales and services allowances, analysis of customer creditsand other known factors. If future sales credits prove to be greater than thehistorical data and the estimates we used to calculate these provisions, ourrevenues could be overstated.

Deferred revenue consists primarily of amountscollected from customers for products and services that have not met thecriteria for revenue recognition.

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*Allowance for Doubtful Accounts.*We perform ongoing evaluations of ourcustomers and continuously monitor collections and payments and estimate anallowance for doubtful accounts based on the aging of the underlyingreceivables, our historical experience with write-offs and any specificcustomer collection issues that we have identified. While such credit losseshave historically been within our expectations and we believe appropriatereserves have been established, we cannot assure that we will continue toexperience the same credit loss rates that we have experienced in the past oradequately predict future credit losses. If the financial condition of ourcustomers were to deteriorate and result in an impairment of their ability tomake payments, additional allowances may be required which would result inan additional selling, general and administrative expense in the period suchdetermination is made.

*Accounting for Acquisitions.*Accounting for acquisitions requiresmanagement to make judgments and estimates in determining the purchase price,the fair value of the assets and liabilities acquired and merger-related andintegration costs. In recording acquisitions, significant judgment is requiredin estimating:

·                  valuationof deferred revenue,

·                  valuationof intangible assets and acquired in-process research and development,

·                  otherliabilities existing at the time of acquisition.

Changes to estimates of acquired identifiable assetsand liabilities are reflected as adjustments to goodwill or intangibles to theextent such changes were based on conditions that existed at the acquisitiondate but the information was subsequently received and evaluated. Otheradjustments are reflected in our results of operations. In accordance withStatement of Financial Accounting Standards (“SFAS”) No. 142,*Goodwill and Other Intangible Assets*,goodwill and intangible assets with indefinite useful lives are not amortized,but are tested for impairment annually or more frequently if circumstancesindicate their value may no longer be recoverable.

*Impairmentof Long-Lived Assets.*  Long-livedassets, such as property and equipment and intangible assets, are accounted forin accordance with SFAS No. 144*,Accounting for Impairment or Disposal of Long-lived Assets* and arereviewed for impairment whenever events or changes in circumstances indicatethat the carrying amount of an asset may not be recoverable. All of ouridentifiable intangible assets are amortized using the straight-line method.Useful lives of amortizable intangible assets are reviewed annually with anychanges in estimated useful lives being accounted for prospectively over therevised remaining useful life. Recoverability of assets to be held and usedwould be measured by a comparison of the carrying amount of an asset to theestimated undiscounted future cash flows expected to be generated by the asset.If the carrying amount of an asset exceeds its estimated undiscounted futurecash flows, an impairment charge is recognized in the amount by which thecarrying amount of the asset exceeds the fair value of the asset. Thedetermination of estimated future cash flows, however, requires management tomake estimates. Future events and changes in circumstances may require us torecord a significant impairment charge in the period in which such events orchanges occur. Impairment testing requires considerable analysis and judgmentin determining the results. If other assumptions and estimates were used in ourevaluations, the results could differ significantly.

*Accountingfor Income Taxes.* Weaccount for income taxes in accordance with SFAS No. 109,*Accounting for Income Taxes*, whichrequires recognition of deferred income tax assets and liabilities fortemporary differences between the financial reporting and tax bases of recordedassets and liabilities and the expected benefits of net operating loss andcredit carry forwards. SFAS No. 109 requires that deferred income taxassets be reduced by a valuation allowance if it is more likely than not thatsome portion or all of the deferred income tax assets will not be realized.Historically, we have provided a complete valuation allowance against thedeferred income tax asset. We evaluate the realizability of our deferred incometax assets, primarily resulting from net operating loss and credit carryforwards, and adjust our valuation allowance, if necessary. In 2006, weeliminated $7.3 million of the valuation allowance related to deferred incometax assets in the UK.

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The utilization of deferred tax assets, primarily netoperating loss carry forwards arising from acquisitions, generally results in areduction in goodwill and the recognition of tax expense associated with thepurchased deferred tax assets. The utilization of net operating loss carryforwards generated by the tax deduction for stock option exercises may result inan increase to additional-paid-in capital and the recognition of tax expense.Under SFAS No. 123(R), *Share-Based Payment*,the realization of tax benefits resulting from stock option exercises mayresult in an increase to additional-paid-in capital and the recognition of taxexpense. Under SFAS No. 123(R), we will continue to follow the with-and-withoutapproach and consider the impact of excess stock option deductions last whencomputing our income tax provision. Due to the existence of net operating losscarry forwards, $7.5 million of income tax benefits originating from stockoption deductions have not reduced taxes payable and, therefore, have not beenrealized or recorded in 2007.

***On January 1, 2007, we adopted Financial Interpretation (“FIN”)***No. 48, *Accounting for Uncertaintyin Income Taxes—an interpretation of FASB Statement No. 109,*whichprescribes a recognition threshold and measurement attribute for the financialstatement recognition and measurement of a tax position taken or expected to betaken in a tax return, and provides guidance on derecognition, classification,interest and penalties, accounting in interim periods, disclosure, andtransition. The adoption of FIN No. 48 did not have material impact on ourresults of operations and financial position.

Estimates and judgmentsare required in determining our worldwide income tax provision. In the ordinarycourse of conducting business globally, there are many transactions andcalculations whose ultimate tax outcome cannot be certain. Although we believeour estimates and judgments are reasonable, no assurance can be given that thefinal tax outcome of these matters will not be different from what is reflectedin our historical income tax provisions and accruals. Such differences couldhave a material impact on our income tax provision and operating results in theperiod in which such a determination is made.

*Stock-BasedCompensation.* OnJanuary 1, 2006, we adopted SFAS No.123(R) which requires the measurementand recognition of compensation expense for all share-based payment awards madeto employees including employee stock options and employee stock purchase planbased on the grant date fair value of those awards. We determine the fair valueof share-based payment awards on the date of grant using Black-Scholesoption-pricing model. The fair value of share-based awards is affected by stockprice as well as assumptions regarding a number of highly complex andsubjective variables. These variables include, but are not limited to, ourexpected stock price volatility over the term of the awards, and actual andprojected employee stock option exercise behavior. SFAS No. 123(R) alsorequires that forfeitures be estimated over the vesting period of an award,rather than being recognized as a reduction of compensation expense when theforfeiture actually occurs. We adopted SFAS No. 123(R) using the modifiedprospective transition method, which requires the application of SFAS No.123(R) as of January 1, 2006. Our Condensed Consolidated Financial Statementsas of and for the three months ended March 31, 2007 and 2006 reflect theimpact of SFAS No. 123(R).

SFAS No. 123(R) requires us to estimate the fair value of share-basedpayment awards on the date of grant using an option-pricing model. The value ofthe portion of the award that is ultimately expected to vest is recognized asexpense over the requisite service periods in our Consolidated Statement ofOperations. Stock-based compensation expense recognized under SFAS No. 123(R)for the three months ended March 31, 2007 and 2006 were $5.9 million and$3.1 million, respectively,  whichconsisted of stock-based compensation expense related to employee stock optionsgranted during the last four years (vesting period). Prior to the adoption ofSFAS No. 123(R), we accounted for stock-based awards to employees using theintrinsic value method in accordance with Accounting Principles Board (“APB”)No. 25, *Accounting for Stock Issued to Employees*,as allowed under SFASNo. 123, *Accounting for Stock-Based Compensation*.

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**Results of Operations**

The table below showsoperating data as a percentage of total revenue for the three months endedMarch 31, 2007 and 2006.
| ** **                                      | ** ** | **Three Months Ended** | ** ** |
|-------------------------------------------------|------------|----------------------------------|------------|
| ** **                                      | ** ** | **March 31,**               | ** ** |
| ** **                                      | ** ** | **2007**                         | ** ** | **2006** | ** ** |
| Revenue:                                        |       |                             |       |   |   |
| Product                                         |       | 33                               | %          | 39 | % |
| Services                                        |       | 67                               |       | 61 |   |
| Total revenue                                   |       | 100                              |       | 100 |   |
| Cost of revenue:                                |       |                             |       |   |   |
| Product                                         |       | 7                                |       | 9 |   |
| Services                                        |       | 25                               |       | 23 |   |
| Total cost of revenue                           |       | 32                               |       | 32 |   |
| Gross profit                                    |       | 68                               |       | 68 |   |
| Operating  expenses:                            |       |                             |       |   |   |
| Selling, general and administrative             |       | 59                               |       | 49 |   |
| Research and development                        |       | 16                               |       | 15 |   |
| Merger-related and integration costs            |       | 2                                |       | 4 |   |
| Operating (loss) income                         |       | (9                               | )          | 0 |   |
| Interest and  other income, net                 |       | 2                                |       | 2 |   |
| (Loss) income before provision for income taxes |       | (7                               | )          | 2 |   |
| Provision for  income taxes                     |       | 2                                |       | 0 |   |
| Net (loss)  income                              |       | (9                               | )%         | 2 | % |

 

*Total revenue*

Totalrevenue increased 19% in the first quarter of 2007, as compared to the firstquarter of 2006, to $61.3 million. The increase in total revenue can beattributed to the Demos and Exametric acquisitions, and the continued growth ofour business. Effective April 1, 2006, we began recognizing revenue fromone OEM partner upon receipt of valid purchase orders versus royalty reportsbecause it was determined, based on the Company’s historical experience withthis particular partner, that fixed and determinable pricing exists at the timethe order is placed by the partner. The number of installed customer sites grew to 4,802 as ofMarch 31, 2007 from 4,330 sites as of March 31, 2006.

*Product revenue*

Product revenue includes hardware and softwarerevenue. Although hardware sales are incidental to our business, we expect thatwe will continue to sell hardware to our existing customers as well as to newcustomers whose preference is to make joint purchases of hardware and software.It is difficult to estimate future hardware revenue due to its incidentalnature.

Product revenue of $19.2million, excluding hardware revenue of $1.0 million in the first quarter of2007 (and $1.6 million in the same period in 2006), increased $0.9 million, or5% in the first quarter of 2007. The increase in software revenue growthduring the first quarter of 2007 is largely attributed to the Demos andExametric acquisitions and our expanded product line, particularly Impact 360. Our Impact 360 solution consists of softwareproducts and services designed to optimize the workforce, processes andtechnology involved in the customer service function.

New customers accounted for17% and 15%, respectively, of product revenue, excluding hardware revenue,during the first quarters of 2007 and 2006. We receive follow-on revenuefrom our customers when they purchase additional user licenses or licenseadditional applications at existing sites and when they license our products atnew sites. We expect to generate the majority of our product revenue from existingcustomers during 2007.

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*Services revenue*

Services revenue, consisting of installation,training, consulting, maintenance support and reimbursable travel expenses,increased 30% to $41.1 million in the first quarter of 2007 compared to thefirst quarter of 2006. The increase was primarily due to installation andtraining services related to new product sales and to customers renewing theirmaintenance contracts with us thereby increasing our recurring maintenancerevenue stream. The percentage of Witness customers that have renewed theirmaintenance contracts with us has historically exceeded 90%. We believe thatmaintenance contracts will be renewed at a comparable rate during 2007. Weexpect services revenue, in absolute dollars, to increase over time due to thecompounding effect of renewals of annual maintenance contracts from existingcustomer sites and to remain relatively constant as a percentage of totalrevenue, excluding hardware revenue, in 2007.

*Total cost ofrevenue*

Total cost of revenue increased20% to $19.6 million in the first quarter of 2007 compared to the first quarterof 2006. Expressed as a percent of revenue, gross profit margin remainedconstant at 68% in the first quarter of 2007 and 2006. Excluding hardware costof revenue and the amortization of intangible assets resulting fromacquisitions, gross profit margins decreased slightly to 73% in the firstquarter of 2007 from 75% in the first quarter of 2006. We expect our grossprofit margin, excluding hardware and amortization of intangible assets, toremain relatively constant throughout 2007.

*Cost of productrevenue*

Cost of product revenueconsists of amortization of acquired technology, hardware costs, royalties dueto third parties for software components that are embedded in our softwareapplications, amortization of capitalized software development costs andpackaging costs. Amortization of acquired technology was $2.3 million in thefirst quarter of 2007 and 2006.

 Cost of hardware revenue was $1.0 million inthe first quarter of 2007 and $1.7 million in the same period of 2006. Cost ofsoftware, increased 17% in the first quarter of 2007 compared to the sameperiod in 2006. The quarter-over-quarter cost of software revenuefluctuation results from the royalties due to third parties for softwareincluded in our product offerings which vary period-over-period in proportionto the sales of certain software products.

*Cost of servicesrevenue*

 Cost of services revenue for installation,training, consulting and maintenance services include personnel costs andrelated expenses and allocated overhead. Personnel costs include salaries,bonuses and benefits. Cost of services revenue increased 32% to $15.6 millionin the first quarter of 2007 compared to the same period in 2006, due primarilyto an increase in the number of employees engaged in customer support services.Cost of services revenue as a percentage of services revenue remained constantat 37% of total services revenue in the first quarter of 2007 and 2006. We anticipate that our services margins willremain relatively consistent throughout 2007. We expect our customer serviceorganization to continue to grow over time and, therefore, we anticipate thatour cost of services revenue, in absolute dollars, will increase as we grow ourcustomer base.

*Operating Expenses*

*Selling,General and Administrative.*Selling, general and administrative (“SG&A”) expense consistsprimarily of personnel costs, sales commissions, marketing programs,professional fees, the amortization of certain intangible assets and provisionsfor bad debt expense. SG&A expense increased 44% to $36.3 million in thefirst quarter of 2007 compared to the same period in 2006 due primarily to$3.1 million increase in legal expense,$2.7 million in bad debt expense, higher professional and personnel costs, andthe inclusion of $1.9 million stock-based compensation expense resulting fromthe cancellation and de facto modification of certain stock options granted toour former CEO. Legal and professional fees during the first quarter of2007 include $1.4 million related to the stock option review matter initiallydisclosed in 2006. We have Directors and Officers insurance coverage that isprovided for defense fees and costs incurred in connection with the classaction and derivative action made against Witness as a result of our stockoption review and related restatement. We record an insurance reimbursementreceivable in accordance with SFAS No. 5, *Accounting forContingencies*, as amounts

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become probable and estimable.We expect SG&A expense to vary throughout 2007 in absolute dollars butdecrease as a percentage of total revenue due to anticipated revenue growth.

*Researchand Development.*Research and development (“R&D”) expenses consist primarily of personneland consulting costs to support product development, and allocated overhead.R&D costs are expensed as incurred and include software development costsincurred prior to the establishment of technological feasibility. Costsincurred subsequent to establishing technological feasibility are capitalizedand amortized over the asset’s estimated useful life to cost of productrevenue. Cost of product revenue during the three months ended March 31,2007 and 2006 includes amortization of capitalized software development costsof $0.2 million and $0.1 million, respectively. R&D expenses increased26% to $10.1 million in the first quarter of 2007 compared to the same periodin 2006, primarily due to the increased number of employees engaged in researchand development activities. We expect total R&D expense to increasequarterly in absolute dollars but decrease as a percentage of total revenueduring 2007.

*Merger-relatedand Integration Costs*.During the first quarter of 2007, merger-related and integration costs comprisedprimarily of legal and other costs associated with the pending merger withVerint.

During the first quarter of2006, merger-related and integration costs pertained primarily to legal,professional fees and a discount on shares sold to the Blue Pumpkinshareholders.

*Interest and Other Income, Net*

Interest and other income, net for the three monthsended March 31, 2007 and 2006, respectively is as follows (in thousands):
| ** **                    | ** ** | **Three Months Ended  March 31,** | ** ** |
|-------------------------------|------------|--------------------------------------------------|------------|
| ** **                    | ** ** | **2007**                                         | ** ** | **2006** | ** ** |
| Interest income,  net         |       | $                                                | 1,445      |   | $ | 1,408 |   |
| Foreign currency  gain (loss) |       | 61                                               |       | (137 | ) |
|                          |       | $                                                | 1,506      |   | $ | 1,271 |   |

 

*Provision for Income Taxes*

We recorded a provision for income taxes of $1.2million and $0.2 million, respectively, in the first quarter of 2007 and 2006.The increase in tax expense primarily relates to an increase in tax provisionfor Witness Systems Ltd resulting from an increased pre-tax income, and therelease of valuation allowance in the fourth quarter of 2006 which resulted inrecognition of deferred tax expense. As of December 31, 2006, we had netoperating loss carry forwards aggregating $78.1 million for U.S. income taxpurposes and $31.0 million for foreign income tax purposes. We expect thatthe provision for income taxes in 2007 will benefit from the utilization of thesenet operating loss carry forwards. However, the utilization of certain netoperating loss carry forwards arising from acquisitions may result in therecognition of deferred income tax expense.

**Liquidity and Capital Resources**

In March 2007, in anticipation of the completionof our acquisition by Verint, we reduced our line of credit from $15.0 millionto $2.0 million and extended the maturity date on the $2.0 million line ofcredit to March 2008. At our election, borrowings under the line of creditbear interest at the bank’s prime rate, which was 8.25% on March 31, 2007,or LIBOR plus 300 basis points. Borrowings under the revolving line ofcredit is limited to 85% of eligible accounts receivable, as defined by theagreement. The revolving line of credit is secured by all of our assets andrequires compliance with various covenants, including liquidity ratios andEBITDA requirements, among others. As of March 31, 2007, we were incompliance with all bank covenants.

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We anticipate spending at least $8.0 million incapital expenditures in 2007 primarily for computer equipment and software. Webelieve that our capital expenditures may increase over the next several yearsas we expand our facilities and acquire equipment to support the expansion ofour research and development activities and internal management and informationsystems. We believe that our existing cash and investment balances, togetherwith our anticipated cash flows from operations, will be sufficient to meet ourworking capital and capital expenditures for at least the nexttwelve months.

On February 11, 2007, we entered into adefinitive agreement under which Verint will acquire Witness for $27.50 pershare in cash, less any applicable withholding taxes. The Merger is expected toclose in the second quarter of 2007.

*Market Risk*

Market risk represents therisk of loss that may affect us due to adverse changes in financial marketprices and rates. Our market risk exposure primarily relates to fluctuations inforeign exchange rates and interest rates. We have not entered into derivativeor hedging transactions to manage risk in connection with foreign exchangefluctuations and have not engaged in any interest rate hedging transactions.

Within our foreign-basedoperations, where transactions may be denominated in foreign currencies,we are subject to market risk with respect to fluctuations in the relativevalue of currencies. Currently, we have foreign-based operations in Australia,Brazil, Canada, China, Germany, India, Japan, Mexico, the Netherlands, Singapore,South Africa and the United Kingdom that conduct transactions in either thelocal currency of the location or the U.S. dollar. We are exposed to adversemovements in foreign currency exchange rates because we translate foreigncurrencies into U.S. dollars for reporting purposes. Historically, these riskshave been minimal, but as our international operations continue to grow,adverse currency fluctuations could have a material adverse impact on ourfinancial results. Net foreign exchange gains (losses) were $0.1 million and($0.1) million in the three months ended March 31, 2007 and 2006,respectively.

Exposure to market rate risk for changes in interestrates relates to our investment portfolio and any potential borrowing. Ourinvestments are made with capital preservation and liquidity as our primaryobjectives. We generally hold only high-grade investments such as commercialpaper, corporate bonds, auction rate securities and U.S. government agencysecurities. To reduce our Balance Sheet exposure to variations in asset values,our investment policy guidelines specify that we invest in the highestinvestment grade securities and maintain a weighted average maturity of ninemonths or less for our entire portfolio. Our investment portfolio may containsecurities with maturities of up to three years. While this minimizes ourinterest rate risk to asset values, our results are exposed to fluctuations ininterest income due to changes in market rates.

**Item 3.Quantitative and Qualitative Disclosures About Market Risk**

Information concerning market risk is included inManagement’s Discussion and Analysis of Financial Condition and Results ofOperations, Item 2 of Part I of this Report.

**Item 4.Controls and Procedures**

***Evaluation ofDisclosure Controls and Procedures***

We conducted an evaluationof the effectiveness of our disclosure controls and procedures (as defined inRules 13a-14 and 15d-14 under the Securities Exchange Act of 1934), as ofthe end of the period covered by this quarterly report. This evaluation wasconducted under the supervision and with the participation of our management,including the Chief Executive Officer and Chief Financial Officer. Based onthis evaluation, as of the quarter ended March 31, 2007, our ChiefExecutive Officer and Chief Financial Officer concluded that our disclosurecontrols and procedures are not effective due to the material weaknessesdiscussed below.

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The following werethe material weaknesses, as originally reported in our Annual Report onForm 10-K for the year ended December 31, 2006:

(1)                                  Wedid not have effective policies and procedures to provide for appropriateconsideration of all payments made to the selling shareholders in a businesscombination. This deficiency resulted in a material error in our preliminary2006 Consolidated Financial Statements.

(2)                                  Wedid not have policies and procedures sufficiently detailed to ensureappropriate accounting for the reduction of deferred income tax asset valuationallowances established as part of a business combination. As a result, therewere material errors in goodwill and income tax expense in our preliminary 2006Consolidated Financial Statements.

(3)                                  Ourevaluation and review of the allowance for uncollectible accounts receivablewas not sufficiently thorough and objective to ensure accounts receivable wererecorded at their net realizable value. Specifically, our evaluation and reviewof the allowance for uncollectible accounts receivable did not adequatelyconsider the aging of certain receivables and specific customer collectionissues that existed at December 31, 2006. As a result, there were errors inaccounts receivable and operating expenses in our preliminary 2006 ConsolidatedFinancial Statements.

(4)                                  Ourpolicies and procedures over the recognition of deferred revenue frommaintenance and other service contracts were not sufficient to ensure thatrevenue was recognized in the appropriate period in accordance with U.S.generally accepted accounting principles. Specifically, our policies andprocedures did not provide for sufficient analysis of contracts included indeferred revenue to determine the timing of recognition. This deficiencyresulted in errors in revenue and deferred revenue in our preliminary 2006Consolidated Financial Statements.

In the quarter endedMarch 31, 2007, management has made progress in remediating the materialweaknesses by:

·       Creating a detailedacquisition accounting checklist in order to ensure purchase priceconsideration is properly measured and recorded;

·       Revising our policies andprocedures related to our review of the income tax provision to provide forsufficient analysis of the accounting for valuation allowances established in abusiness combination.  Specifically,revising the review procedures performed by our tax professionals and outsideconsultants to ensure applicable issues are appropriately considered;

·       Formalizing our reviewprocedures over the allowance for uncollectible accounts to ensure agedreceivables and specific customer collection issues are appropriately consideredwhen estimating and recording the allowance for uncollectible accounts; and

·       Formalizing our policiesand procedures related to the recognition of deferred revenue, includingenhanced monitoring of aged deferred revenues associated with certain serviceprojects, as well as certain accounting policies related to maintenancecontracts.

Since this is the firstquarter of remediation, it is too early to conclude that the materialweaknesses have been remediated. Management believes that the above new policiesand procedures, when fully implemented, will be effective in remediating thesematerial weaknesses.

A material weakness ininternal control over financial reporting is defined by the Public CompanyAccounting Oversight Board (“PCAOB”) Auditing Standard No. 2 as asignificant deficiency, or combination of significant deficiencies, that resultin a more than remote likelihood that a material misstatement of the annual orinterim financial statements will not be prevented or detected.

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There were no changes, otherthan as discussed above, in our internal controls over financial reporting thatoccurred during the period covered by this quarterly report that havematerially affected, or that are reasonably likely to materially affect, our internalcontrols over financial reporting.

**PART II.OTHER INFORMATION**

**Item 1.Legal Proceedings**

***On*********December 11,2002, we filed in the United States District Court for the Northern District ofGeorgia, Atlanta Division, a lawsuit against Knowlagent, Inc. (“Knowlagent”),which is the assignee of United States (“U.S.”) Patent Nos. 6,324,282 B1 and6,459,787 B2. Knowlagent has accused our eQuality Now software of infringingthe above patents. We filed suit seeking a declaration that we did not and donot infringe either of the two patents listed above, as well as a declarationthat the above patents are invalid and unenforceable. We also filed a claimrequesting that if the patents are found to be valid, that one of our ownemployees be named the rightful inventor of the patents. We also requestedmonetary damages in an amount equal to the amount that Knowlagent has receivedfrom its use of the above patents. On December 31, 2002, Knowlagent filedits answer to our complaint as well as two counterclaims, alleging that weinfringe and contribute to the infringement by others of the above patents;Knowlagent seeks both monetary damages and an injunction in connection with itscounterclaim. On June 6, 2005, the Court held a claim construction hearingand issued a claim construction order on June 8, 2005. The case is nowproceeding to expert discovery and summary judgment phases.

On July 20, 2004, STS Software Systems Ltd. (“STSSoftware”), a wholly-owned subsidiary of NICE Systems, Ltd. (“NICE Ltd.”),filed a patent infringement suit in the U.S. District Court for the SouthernDistrict of New York against us (“New York Action”). The New York Actionasserts that our products, including eQuality ContactStore for IP, infringeUnited States (“U.S.”). Patent No. 6,122,665 (“the ‘665 patent”) and seeksonly injunctive, not monetary, relief. On the same day, we filed a declaratoryjudgment action against STS Software in the U.S. District Court for theNorthern District Georgia (“Georgia Action”). We seek a declaration from thecourt that we have not infringed any valid claim of the ‘665 patent. By Orderentered December 16, 2004, Judge Koeltl of the U.S. District Court for theSouthern District of New York granted our motion to transfer the New YorkAction to the Northern District of Georgia, which has now consolidated theformer New York Action with the Georgia Action. On July 7, 2005, the Courtalso granted STS leave to amend its complaint to add three patents to thedispute, namely: U.S. Patent Nos. 6,865,604; 6,871,229; and 6,880,004(respectively, “the ‘604 patent,” “the ‘229 patent,” and “the ‘004 patent”;collectively, “the STS patents”), again seeking solely injunctive relief. Weanswered the first amended complaint and asserted counterclaims onJuly 29, 2005, collectively, through which we deny infringement of anyvalid claim of the STS patents and seek a declaration to that effect. The Courtentered its claim construction ruling on January 16, 2007, and the case isprogressing through its remaining discovery phases.

On August 30, 2004, we filed in the United StatesDistrict Court for the Northern District of Georgia, Atlanta Division, alawsuit against NICE Systems, Inc. (“NICE Inc.”), a wholly-ownedsubsidiary of NICE Ltd., alleging patent infringement. Specifically, wehave alleged that NICE products, including the NiceUniverse products thatinclude screen capture and synchronized screen and voice capture technologies,infringe claims of U.S. Patent Nos. 5,790,798 (“the ‘798 Patent”) and 6,510,220(“the ‘220 Patent”), both entitled “Method and Apparatus for SimultaneouslyMonitoring Computer User Screen and Telephone Activity from a Remote Location.”We have sought an injunction and money damages for NICE’s infringement of thesetwo patents. NICE Inc. has answered and counterclaimed for declaratoryjudgments of non-infringement and invalidity. Since then, on February 24,2005, we filed suit against NICE Ltd. because of its infringing activitiesin violation of the ‘798 and ‘220 patents, including importation of the accusedNICE products. By order dated April 5, 2005, the court has consolidatedthe NICE Inc. and NICE Ltd. actions. The Court entered its claim constructionruling on January 5, 2007, and the case is progressing through itsremaining discovery phases.

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On January 19, 2006, we filed in the UnitedStates District Court for the Northern District of Georgia, Atlanta Division, alawsuit against NICE Systems, Inc. and NICE Systems, Ltd. (collectively “NICE”),alleging patent infringement. Specifically, we have alleged that NICE products,including NicePerform and related products that include the ability tomonitor communications to detect the presence of at least one predeterminedparameter, infringe claims of U.S. Patent No. 6,404,857 B1 (“the ‘857Patent”), entitled “Signal Monitoring Apparatus for Analyzing Communications.”We have sought an injunction and money damages for NICE’s infringement of the ‘857patent. On March 6, 2006, NICE answered and counterclaimed, alleging thatthe ‘857 patent is not infringed and is invalid. The case has been set on adiscovery calendar and is at a preliminary stage.

On May 10, 2006, NICE Systems, Inc. and NICESystems Ltd. (collectively “NICE”), filed a patent infringement suit seekingmonetary damages and injunctive relief in the U.S. District Court for theDistrict of Delaware against us (“Delaware Action”). The Delaware Actionasserts that our products, including ContactStore, ContactStore for IP,ContactStore for Communications Manager, Quality for Communications Manager,and eQuality Balance, infringe one or more claims of ten U.S. Patents:  U.S. Patent Nos. 5,274,738; 5,396,371;5,819,005; 6,249,570; 6,728,345; 6,775,372; 6,785,370; 6,870,920; 6,959,079;and 7,010,109 (“the Delaware Patents”). We answered NICE’s complaint on June 30,2006, through which we deny infringement of any valid claim of any of theDelaware Patents. The case has been set on a discovery calendar and is at apreliminary stage.

On December 27, 2006, NICE Systems, Inc. andNICE Systems Ltd. (collectively, “NICE”), filed a declaratory judgment actionagainst us in the U.S. District Court for the Northern District Georgia,relating to U.S. Patent No. 6,757,361 (“the ‘361 Patent”), entitled “SignalMonitoring Apparatus Analyzing Voice Communication Content.”  NICE seeks a declaration from the court thatthe claims of the ‘361 Patent are invalid, and that NICE has not infringed anyvalid claim of the ‘361 Patent. The company has moved to dismiss or stay thecase while a previously filed reissue proceeding remains pending in the PatentOffice. The motion remains pending.

On August 29, 2006, A. Edward Miller filed ashareholder derivative lawsuit in the United States District Court for theNorthern District of Georgia (Atlanta Division) naming WitnessSystems, Inc. (the “Company”) as a nominal defendant and naming all of ourcurrent Board of Directors and a number of our current officers as defendants.Miller v. Gould, et al., Civil Action No. 1:06-CV-2039 (N.D. Ga.). Thecomplaint alleges purported violations of federal and state law, includingbreaches of fiduciary duty, abuse of control, constructive fraud, corporatewaste, unjust enrichment, gross mismanagement and violations of certainantifraud provisions of the federal securities laws (including Sections 10(b) and14(a) of the Securities Exchange Act of 1934 and Rules 10b-5 and14a-9 thereunder) in connection with certain stock option grants made by theCompany. The complaint seeks monetary damages in unspecified amounts,disgorgement of profits, an accounting, rescission of stock option grants,imposition of a constructive trust over the defendants’ stock options andproceeds derived therefrom, punitive damages, reimbursement of attorneys’ feesand other costs and expenses, an order directing the Company to adopt or put toa stockholder vote various proposals relating to corporate governance, andother relief as determined by the court. Plaintiffs filed an Amended Complainton January 9, 2007. Defendants moved to dismiss the Amended Complaint on March9, 2007, arguing, *inter alia*,that the case should be stayed or dismissed because the Company’s announcedcash-out merger with Verint Systems Inc. (expected to close during the secondquarter of 2007) would eliminate plaintiff’s standing to pursue a derivativeaction on behalf of the Company’s shareholders. Plaintiffs responded by filing,on April 6, 2007 a motion for leave to file a proposed Second AmendedComplaint, which purports to bring four new direct claims as a putative classaction for breach of fiduciary duty, abuse of control, gross mismanagement, andconstructive fraud. Defendants filed an opposition to the motion for leave toamend on May 4, 2007.

On August 14, 2006, aputative class action securities lawsuit was filed by an individual claiming tobe a stockholder of the Company and naming the Company and certain of its Boardof Directors and officers as defendants in connection with certain stock optiongrants made by the Company. *Rosenberg v.Gould, et al.*, Civil Action No. 1:06-CV-1894 (N.D. Ga.). Thecomplaint, filed in the United States District Court for the Northern Districtof Georgia, alleges violations of Section 10(b) of the Securities Exchange Actof 1934 (“Exchange Act”) and Rule 10b-5 thereunder and seeks unspecified damages,attorneys’ fees and other costs and expenses, unspecified extraordinary,equitable and injunctive relief, and other relief as determined by the court.On January 25, 2007, the Court granted an unopposed motion by “Witness SystemsInvestor Group”

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for an order consolidating all later-filed securitiesclass actions, appointing the Group as Lead Plaintiff, and approving itsselection of Motley Rice LLC and Kahn Gauthier Swick LLC as Co-Lead Counsel. AConsolidated Amended Complaint was filed on April 6, 2007, adding a claim underSection 20(a) of the Exchange Act and naming the Company’s auditor, KPMG LLP,as an additional defendant. The Company and its Board of Directors intend toreview the allegations of the Consolidated Amended Complaint and respond whenappropriate.

On October 27, 2006, the Company received anotice of informal nonpublic inquiry from the Securities and ExchangeCommission requesting certain documents and information relating to the company’sstock option grant practices from February 2000 to the present. We intendto cooperate fully with all matters related to this request.

On March 14, 2007, the Company was served with acomplaint by Doron Aspitz, the former chief executive officer of Blue PumpkinSoftware, Inc., in California Superior Court for the County of Santa Clara(Case No. 107CV078480). The complaint names the Company as defendant andpurports to assert eight causes of action, for promissory estoppel, promissoryfraud, negligent misrepresentation, breach of fiduciary duty, vote buying,violation of Section 17200 of the California Business and Professions Code,violation of Section 1101 of the California General Corporation Law, and unjustenrichment. The complaint purports to seek over $5.0 million in compensatorydamages as well as other unquantified punitive and exemplary damages,disgorgement, and attorneys’ fees and costs. The complaint was filed on orabout January 19, 2007, but no effort was made to serve the complaint untilapproximately mid-March 2007. On April 12, 2007, the Company removed the actionto the United States District Court for the Northern District of California.The Company subsequently filed a motion to dismiss the claims against it. Afterthe motion to dismiss was filed, the plaintiff moved to amend the complaint toadd as a defendant a resident of California and on that basis has challengedthe removal and sought to have the matter remanded to California state court.The Company intends to oppose the remand and to seek dismissal. The Companyintends to continue to contest the complaint vigorously.

From time to time we may be involved in other legalproceedings and/or litigation arising in the ordinary course of our businessthat might impact on our financial position, our results of operations, or ourcash flows.

**Item 1A Risk Factors**

Our future operating results may varysubstantially from period to period. The price of our common stock willfluctuate in the future, and an investment in our common stock is subject to avariety of risks, including, but not limited to, the specific risks identifiedbelow. Inevitably, some investors in our securities will experience gains whileothers will experience losses depending on the prices at which they purchaseand sell our securities. Prospective and existing investors should consider thefollowing factors in evaluating our business or an investment in oursecurities. If any of the following or other risks actually occurs, ourbusiness, financial condition and results of operations could be adverselyaffected. In that case, the trading price of our common stock could decline.

*Our business andoperating results may be adversely affected by our proposed acquisition byVerint.*

On February 11, 2007, we signed an Agreement andPlan of Merger with Verint. Pursuant to the merger agreement, we expect tomerge with a wholly owned subsidiary of Verint. If the merger contemplated bythat agreement is completed Witness Systems will become a wholly ownedsubsidiary of Verint and we will no longer be a public company. At theeffective time of the merger, each outstanding share of our common stock willbe exchanged for the right to receive $27.50 in cash, less any applicablewithholding taxes and without interest.

On May 1, 2007, our stockholders voted to adopt theAgreement and Plan of Merger. The Merger is subject to the receipt ofregulatory approval in the United Kingdom and the continued satisfaction orwaiver of the other conditions set forth in the Merger Agreement. We have madecustomary representations and warranties and covenants in the Merger Agreement,including covenants relating to the conduct of our business between the date ofthe signing of the Merger Agreement and the closing of the Merger. Weanticipate that the Merger will be consummated in the second quarter of 2007.

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The continued passage of time since the announcementof the merger could have an adverse effect on our revenue if customers delay,defer or cancel purchases pending consummation of the planned merger. Currentand prospective customers could be reluctant to purchase our products andservices due to potential uncertainty about the combined company’s productofferings and its support and servicing of our existing products. If thecontinued passage of time since our announcement of the merger causes ourcustomers to delay purchase decisions pending consummation of the planned merger,our business and operating results could be materially and adversely affected. Anyuncertainty surrounding the proposed merger may also cause employee turnover orimpair our ability to add new employees. Any significant employee turnover ordelays in hiring forecasted positions could have an adverse effect on ourbusiness and operating results.

*If our planned acquisition by Verint is not completed,our business, operating results and stock price may be adversely affected.*

If the plannedMerger with Verint is not completed, we could suffer a number of consequencesthat could adversely affect our business, operating results and stock price,including the following:

·       the market price of ourcommon stock could decline following an announcement that the Merger has beenabandoned, to the extent that the current market price reflects a marketassumption that the Merger will be completed;

·       we could, under certaincircumstances, be required to pay Verint a termination fee of approximately$35.5 million;

·       we would remain liable forour costs related to the transaction, such as legal, accounting and certain investmentbanking fees, and we expect these costs to be significant; and

·       activities relating to theMerger may divert our management’s attention from our business and causedisruptions among our employees and our relationships with customers andbusiness partners, thus detracting from our ability to grow revenue andminimize costs and possibly leading to a loss of revenue and market positionthat we may not be able to regain if the transaction does not occur.

*An SEC inquiry and litigation relating to certain ofour stock option grants remain pending and could have an adverse effect on ourbusiness, operating results and stock price and may divert the attention of ourmanagement and other key employees.*

An informal inquiry by the SEC relating to our stock optiongranting practices remains pending, as does derivative and class actionlitigation against the Company and certain of our Board of Directors andofficers. Although we believe that we have made appropriate corrections to ourprior years Consolidated Financial Statements for matters relating to stockoptions, we cannot rule out the possibility that these proceedings mayrequire further adjustments to the Condended Consolidate Financial Statementsand other disclosures set forth in this Quarterly Report on Form 10-Q.In addition, these proceedings are likely to result in additional legal expensethat may affect our results in future periods, and may also result in diversionof management attention and other resources, as well as fines, penalties,damages and other sanctions. The U.S. Attorney’s Office for the NorthernDistrict of Georgia has also been given access to the documents and informationprovided by us to the SEC. Action by the SEC, the U.S. Attorney’s Office orother governmental agencies could result in civil or criminal actions againstus and/or certain of our former officers, directors and/or employees and mightresult in monetary and other sanctions.

As discussed in Item 1, “Legal Proceedings’, of PartII of this Report, civil litigation described in the preceding paragraphincludes allegations, among other, that certain of our current and formerdirectors and officers improperly dated stock option grants to enhance theirown profits on the exercise of such options or for other improper purposes.Although we and the other defendants intend to defend these claims vigorously,there are many uncertainties associated with any litigation, and we cannotassure you that these actions will be resolved without substantial costs and/orsettlement charges. We have entered into indemnification agreements with eachof our present and former directors and officers. Under those agreements, weare (with certain exceptions) required to indemnify each such director orofficer against expenses, including attorneys’ fees, judgments, fines andsettlements, paid by such individual in connection with the pending litigation.

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The resolution of the pending investigations by theSEC and U.S. Attorney’s Office, the defense of our pending civil litigation,and the defense of any additional litigation relating to our past stock optionpractices or the February 2007 restatement of our prior ConsolidatedFinancial Statements could result in significant costs and diversion of theattention of management and other key employees.

*If we fail to protect our intellectual property, thirdparties may use our technology for their own benefit.*

Our success and ability to compete depends to asignificant degree upon our proprietary technology. We rely on a combination ofpatent, trade secret, copyright and trademark laws and confidentialityagreements with employees and third parties to establish and protect ourproprietary rights. These measures may not be sufficient to protect ourproprietary rights, and we cannot be certain that third parties will notmisappropriate our technology and use it for their own benefit. Also, most ofthese protections do not preclude our competitors from independently developingproducts with functionality or features substantially equivalent or superior toour software. Any infringement of our proprietary rights could negativelyaffect our future operating results.

As of March 31, 2007, we had 11 registeredtrademarks in the U.S. and 13 U.S. and 3 non-U.S patents. We cannot assure youthat we will file new patent or trademark applications, that any futureapplications will be approved, that any existing or future patents, trademarksor copyrights will adequately protect our intellectual property or that anyexisting or future patents, trademarks or copyrights will not be challenged bythird parties.

We are aware of certain uses, U.S. trademarkregistrations, and U.S. trademark applications for our “eQuality” trademark andits variations that predate our use, and the April 2002 issuance of theU.S. registration for our trademark eQuality®. It is possible that an owner oflegal rights resulting from prior use, registrations, or applications willbring legal action to challenge our registration of and/or our use of thetrademark eQuality®, and may also seek compensation for damages resulting fromour use this trademark. As a result, we cannot assure you that our registrationof this trademark will be undisturbed, or that this use will not result inliability for trademark infringement, trademark dilution, and/or unfair competition.

Moreover, the laws of certain foreign countries do notprotect our intellectual property rights to the same extent as do the laws ofthe United States. Furthermore, policing the unauthorized use of our productsis difficult, and litigation may be necessary in the future to enforce ourintellectual property rights, to protect our trade secrets or to determine thevalidity and scope of the proprietary rights of others. Litigation could resultin substantial costs and diversion of resources and could negatively affect ourfuture operating results.

*Claims by other companies that our software infringestheir intellectual property could require us to incur substantial costs orprevent us from selling our software or services.*

Third parties have in the past claimed, and it ispossible that third parties will in the future claim, that we have infringedtheir current or future intellectual property. We expect that we and otherparticipants in our industry will be increasingly subject to infringement claimsas the number of competitors and products grows. Any claims, with or withoutmerit, which are generally uninsurable, could be time-consuming, result incostly litigation, require us to reengineer or redevelop our software, causeproduct shipment delays or require us to enter into royalty or licensingagreements, any of which could negatively affect our operating results. Anyefforts to reengineer our software or obtain licenses from third partiesmay not be successful, could be extremely costly and would likely divertvaluable management and product development resources.

For example, claims have been asserted against us inlawsuits involving Knowlagent, STS and NICE (as described in Item 1, “LegalProceedings”, of Part II). We cannot assure you that we will be successfulin defending against the claims that have been asserted or any other claimsthat may be asserted. We also cannot assure you that such claims will nothave a material adverse effect on our business, financial condition, oroperations. Defending infringement claims or other claims involves substantialcosts and diversion of management resources. In addition, to the extent we arenot successful in defending such claims, we may be subject to injunctionswith respect to the use or sale of certain of our products or to liabilitiesfor damages to the claimants or to customers to whom we have indemnificationcommitments, and we may be required to obtain licenses which may notbe available on reasonable terms. In addition, we cannot assure you that legalaction claiming patent infringement will not be commenced against us, or thatwe would prevail in litigation given the complex technical issues and inherentuncertainties in patent litigation. In addition, users of our softwaremay become subject to claims if our software is alleged to infringe theintellectual property rights of others. These software users could attempt to 

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hold us responsible forthese claims and any resulting harm they suffer. If a patent claim against uswere to be successful and we could not obtain a license on acceptable terms orlicense a substitute technology or redesign to avoid infringement, wemay be prevented from distributing our software or required to incursignificant expense and delay in developing non-infringing software. Such aresult could have a material adverse effect on our business, financialcondition and results of operations.

*Because our products have a long sales cycle, it ismore difficult to plan our expenses and forecast our results; and our operatingresults may fail to meet investor expectations and may fluctuatematerially from period to period, which may adversely affect our stockprice.*

It typically takes three to nine months from the timewe qualify a sales lead until we sign a sales contract with the customer. As aresult, it is difficult for us to predict the quarter in which a particularsale will occur. If our sales cycle unexpectedly lengthens for one or morelarge orders or a significant number of small orders, it would delay the timingof our revenue, but not the timing of most of our corresponding expenses.Lengthening of our sales cycle could also increase the total cost of a sale dueto additional employee time and costs associated with the sale. Materialchanges in our sales cycle could cause our quarterly revenue or operatingresults to be below the expectations of investors, and the price of our commonstock could fall substantially.

Our customers’decision process regarding their purchase of our products and services isrelatively long due to several factors, including:

·       the complex nature of ourproducts, requiring our need to educate potential customers about the uses andbenefits of our products;

·       competition for thecorporate resources necessary to finance the purchase and implementation of ourproducts;

·       customers’ budgeting andpurchasing cycles;

·       general economicconditions;

·       the extent of customers’evaluation and internal approval process often required before purchasing ourproducts and services; and

·       delayed purchases due toannouncements of new products or enhancements by our competitors or us.

*If our products and services are not used and acceptedby existing and prospective customers, our business and results of operationswill be adversely affected.*

The market forworkforce optimization software, including software that records and analyzescustomer interactions and that forecast and schedules employees, is stilldeveloping. Our success depends on the use and acceptance of our software andservices by existing and prospective customers. In addition, demand for oursoftware remains uncertain because our existing and potential customers may:

·       not understand the benefitsof using workforce optimization software generally or, more specifically,software which records and analyzes the interactions between a business and itscustomers or which optimizes the forecasting and scheduling of employees;

·       not achieve favorableresults using our software;

·       experience technicaldifficulty in implementing our software;

·       use alternative methodssuch as online self-help to solve the same business problems our software isintended to address; or

·       close contact centers.

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*Our quarterly results are difficult to predict andadverse fluctuations in operating results could cause our stock price to fall.*

Our quarterlyrevenue and operating results are difficult to predict and could fluctuatesignificantly from period to period. In particular, we typically derive asignificant portion of our software product revenue toward the end of eachquarter and from a small number of relatively large orders. The delay orfailure to close anticipated sales in a particular quarter could reduce ourrevenue in that quarter and subsequent quarters over which revenue for the salecould be recognized. In addition, because our revenue from installation andtraining services largely correlates with our product revenue, a decline inproduct revenue could also cause a decline in our professional services revenuein the same quarter or in subsequent quarters. Our quarterly revenue isdifficult to forecast for several reasons, including the following:

·       changes in demand for ourproducts and services;

·       the tendency of customersto delay software purchases until the end of the fiscal quarter;

·       lengthening of ourcustomers’ budgeting and purchasing cycles;

·       timing of any acquisitionsand related costs;

·       delays in installations ofour software;

·       varying sales andimplementation cycles for our products and services from customer to customer;

·       the failure of ourcustomers to renew their maintenance service agreements;

·       the timing of hiring newservices employees and the rate at which these employees become productive; and

·       the development andperformance of our distribution channels.

As a result of these and other factors, we believethat quarter-to-quarter comparisons of our operating results may not be agood indicator of our future performance, and you should not rely on them topredict our future performance or the performance of our stock price. If ourrevenue or operating results fall below the expectations of investors orsecurities analysts, the price of our common stock would likely decline.

*We may be unable to manage and expand ourinternational operations, which may adversely affect our business andoperating results.*

We derived revenues of $25.8 million and$23.8 million in the first quarter of 2007 and 2006, respectively, fromcustomers located outside the United States. Our operations outside of theUnited States at March 31, 2007, consisted of operations located inAustralia, Brazil, Canada, China, Germany, India, Japan, Mexico, theNetherlands, Singapore, South Africa and the United Kingdom. We have alsoestablished relationships with a number of international resellers.

We intend toexpand our international operations through acquisitions, internal businessexpansion and strategic business relationships. These efforts requiresignificant management attention and financial resources. We may not beable to successfully penetrate international markets or, if we do, wemay not be able to grow or to maintain adequate profit margins in thesemarkets. Because of the complex nature of our international expansion, itmay adversely affect our business and operating results. Internationalexpansion and sales are subject to many risks, including the following:

·       limited development of aninternational market for our software and services;

·       expanding and training ourinternational sales force and support operations;

·       higher costs of employmentin certain international locations;

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·       difficulties in producinglocalized versions of our products;

·       political and economicinstability;

·       potentially adverse taxconsequences of operating in foreign countries;

·       international laws andregulations, including trade restrictions, local labor ordinances, changes intariff rates and import and export licensing requirements;

·       longer payment cycles anddifficulties in collecting accounts receivable;

·       currency fluctuations;

·       cultural differences whichmay affect workforce performance and sales processes;

·       difficulties and expensesassociated with complying with a variety of foreign laws; and

·       unexpected changes inregulatory requirements.

As we further expand our operations outside the UnitedStates, we will also face new competitors and competitive environments. Inaddition to the risks associated with our domestic competitors, foreigncompetitors may pose an even greater risk, because they may possess abetter understanding of their local markets and have better working relationshipswith local infrastructure providers and others. In particular, becausetelephone protocols and standards are unique to each country, local competitorswill have more experience with, and may have a competitive advantage in,these markets. We may not be able to obtain similar levels of knowledge,which could place us at a significant competitive disadvantage. In addition, wehave limited experience in developing local language versions of our productsor in marketing our products to international customers. We may not beable to successfully translate, market, sell and deliver our productsinternationally.

*If we are unable to maintain a productive direct salesforce, our business and operating results could be adversely affected.*

We believe that our future success will depend onmaintaining a productive direct sales force. Historically, it has taken us upto six months to train new sales personnel before they reach an acceptablelevel of productivity. We have also experienced difficulty in recruiting salespersonnel with experience in computer and telephone integration technologies.We cannot assure you that we will be able to continue to manage turnover andhire new sales personnel to meet our needs. If the personnel we hire are lessqualified than we expect, it may take us more time to train them beforethey reach an acceptable level of productivity, which could increase our costsand reduce our revenue.

*If we are unable to expand the distribution of ourproducts through indirect sales channels, our business and operating resultscould be materially adversely affected.*

Our strategy is to continue to increase the proportionof customers served through indirect sales channels, such as select resellersand a variety of strategic marketing alliances. Product revenue, excludinghardware revenue, from our indirect sales channel represented approximately 51%and 31% of total product revenue in 2007 and 2006, respectively. We expectrevenue from our indirect sales channel and, accordingly, our dependence ondistribution partners, to increase as we establish relationships with companiesto resell our software worldwide. We cannot assure you that we will be able tomaintain productive relationships with our current partners, or that we will beable to establish similar relationships with additional resellers on a timelybasis, if at all.

Some resellers with which we do business have similar,and often more established, relationships with our competitors, andmay recommend the products and services of our competitors to customersinstead of our software and services. We cannot provide assurance that thesedistribution partners will devote adequate resources to selling our softwareand services or that our resellers may not learn about our products andthe market for our software and services and develop and sell competingproducts and services. As a result, our relationships with resellers could leadto increased competition for us.

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*Competition in our business could adversely affect ourrevenue, profitability and market share.*

The market forproducts that record customer interactions, forecast andschedule employees, analyze performance and/or provide electronic learningis intensely competitive, evolving and is subject to rapid changes intechnology. We believe our principal competitors include, but are not limitedto:

·       traditional call-loggingvendors;

·       quality monitoringsuppliers to the contact center industry;

·       workforce management,forecasting and scheduling vendors to the call center, branch banking and backoffice operations industries;

·       electronic learningvendors;

·       business analytics vendors;

·       large telecom solutionproviders;

·       enterprise softwarevendors;

·       systems integrators andconsulting firms; and

·       new, larger and moreestablished entities that may acquire, invest in or form jointventures with providers of recording or performance enhancing softwaresolutions.

Many of our current and potential competitors havelonger operating histories, more established business relationships, largercustomer bases, a broader range of products and services, greater namerecognition and substantially greater financial, technical, marketing,personnel, management, service, support and other resources than we do. As aresult, our current and potential competitors may be able to respond morequickly to new or emerging technologies and changes in customer requirements,take better advantage of acquisitions and other opportunities, devote greaterresources to marketing and selling their products and services and adopt moreaggressive pricing policies. We cannot assure you that our current or potentialcompetitors will not develop products comparable or superior in terms of priceand performance features to those developed by us.

In addition, many of our competitors market their productsthrough resellers and companies that integrate their technology and productswith those of the competitor. These resellers and technology partners oftenhave strong business relationships with our customers and potential customers.For example, some of our competitors have better and more long standingrelationships than we do with telephone switch vendors. Our competitorsmay use these business relationships to market and sell their products andcompete for potential customers. It is also possible that resellers ortechnology partners may acquire or be acquired by one or more of ourcompetitors, which would further solidify their business relationships.

We expect that competition will increase as otherestablished and emerging companies enter our market and as new products,services and technologies are introduced. Increased competition may resultin price reductions, lower gross margins and loss of market share, any of whichcould materially and adversely affect our business, financial condition and resultsof operations.

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*Our heavy reliance on sales of our recording, qualitymonitoring and workforce management software exposes us to risks ofobsolescence due to changes in competitive product offerings.*

We have derived a substantial portion of our productrevenues from sales of our recording, quality monitoring and workforcemanagement software products. We expect revenue from these products to continueto account for a significant portion of our revenue for the foreseeable future.As a result, any factors affecting the markets for these products couldmaterially and adversely affect our business, financial condition and resultsof operations. We cannot assure you that the market will continue to demand ourcurrent products or those we will be successful in marketing any new orenhanced products. If our competitors release new products that are superior toour products in performance or price, demand for our products may decline.A decline in demand for our products as a result of competition, technologicalchange or other factors would reduce our total revenues and adversely affectprofitability.

*If we fail to develop new software or improve ourexisting software, we may not remain competitive.*

The markets for ourproducts are characterized by rapidly changing technology, frequent new productintroductions and enhancements, changes in customer demands and evolvingindustry standards. Our existing products could be rendered obsolete if we failto continue to advance our technology. We have also found that thetechnological life cycles of our products are difficult to estimate, partiallybecause of changing demands of our customers. We believe that our futuresuccess will depend on our ability to continue to enhance our current productline while we concurrently develop and introduce new products that keep pacewith competitive and technological developments. These developments require usto anticipate customers’ future needs and to continue to make substantialproduct development investments. Although we are presently developing a numberof product enhancements to our product suites, we cannot assure you that theseenhancements will be completed on a timely basis or gain customer acceptance.In addition, failure to develop new software or improve existing softwareproducts may adversely affect our ability to maintain our maintenancerenewal rate which could adversely affect our revenue.

*Our liability to customers may be substantial ifour products fail to perform properly.*

Our software is used in a complex operatingenvironment that requires its integration with computer and telephone networksand other business software applications. If our products fail to function asrequired, we may be subject to claims for substantial damages. Courtsmay not enforce provisions in our contracts that would limit our liabilityor otherwise protect us from liability for damages. Although we maintaingeneral liability insurance coverage, including coverage for errors oromissions, this coverage may not continue to be available on reasonableterms or in sufficient amounts to cover claims against us. In addition, ourinsurer may disclaim coverage as to any future claim. If claims exceedingthe available insurance coverage are successfully asserted against us, or ourinsurer imposes premium increases, large deductibles or co-insurancerequirements on us, our business, financial position, and results of operationscould be adversely affected.

*If an original equipment manufacturer that ispart of our indirect sales channel experiences technical difficulties, ourproduct sales through that channel may be adversely affected.*

When we sell our software through an originalequipment manufacturer, or OEM, our software is embedded in the OEM’s product,which we sometimes refer to as the “environment” for our software. When the OEM’sproduct uses our software, there is a risk that the “environment” will fail orthat it will not achieve the compatibility with our product that we and the OEMseek. If this happens, our software might not function properly, or the OEMmight sell less of it, or both, which could have a material adverse effecton our revenues, operating cash flows and the growth of our business.

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*Our software may contain undetected errors or “bugs,”resulting in harm to our reputation and operating results.*

Software products as complex as those offered by usmight contain undetected errors or failures when first introduced or when newversions are released. We cannot assure you, despite testing by us and bycurrent and prospective customers that errors will not be found in new productsor product enhancements after commercial release. Any errors foundmay cause substantial harm to our reputation and result in a loss inrevenue and additional unplanned expenses to remedy any defects.

*If our advanced compliance recording applications failto record our customers’ interactions, we may be subject to liability andour reputation may be harmed.*

Many of our customers use our advanced compliancerecording applications to record and store interactions with customers toprovide back-up and verification of transactions and to guard against risksposed by lost or misinterpreted voice communications. These customers rely onour applications to record, store and retrieve voice data in a timely, reliableand efficient manner. If our applications fail to record our customers’interactions or our customers are unable to retrieve the recordings whennecessary, we may be subject to liability and our reputation may beharmed.

*If we are unable to maintain the security of oursystems, our business, financial condition and operating results could beharmed.*

The occurrence orperception of security breaches in the operation of our business or suffered bythird parties using our products could harm our business, financial conditionand operating results. Our customers use our products to compile and analyzehighly sensitive or confidential information. We may come into contactwith such information or data when we perform support or maintenancefunctions for our customers. While we have internal policies and procedures foremployees performing these functions, the perception that we have improperlyhandled sensitive, confidential information could have a negative effect on ourbusiness. If, in handling this information, we fail to comply with privacy orsecurity laws, we could incur civil liability to government agencies, customersand individuals whose privacy is compromised. If personal information isreceived or used from sources outside the U.S., we could be subject to civil,administrative or criminal liability under the laws of other countries. Inaddition, while we implement sophisticated security measures, third partiesmay attempt to breach our security or inappropriately use our productsthrough computer viruses, electronic break-ins and other disruptions. Ifsuccessful, confidential information may be improperly obtained and wemay be subject to lawsuits and other liability. Any internal or externalsecurity breaches could harm our reputation, and even the perception ofsecurity risks, whether or not valid, could inhibit market acceptance of ourproducts.

*Fluctuations in foreign currency exchange rates couldaffect our financial results.*

We may experience gains and losses resulting fromfluctuations in currency exchange rates. Moreover, in locations where we priceour products in U.S. dollars, our sales could be affected adversely by declinesin foreign currencies relative to the dollar, thereby making our products moreexpensive in local currencies. In locations where we sell our products in localcurrencies, we could be competitively unable to increase our prices to reflectfluctuations in exchange rates. We do not use derivative instruments to manageour foreign exchange risk, and we cannot predict the impact that futureexchange rate fluctuations may have on our results.

*Certain provisions in agreements that we have enteredinto may expose us to liability for breach that is not limited in amountby the terms of the contract.*

Certain contract provisions, principallyconfidentiality and indemnification obligations in certain of our licenseagreements, could expose us to risks of loss that, in some cases, are notlimited by contract to a specified maximum amount. If we fail toperform to the standards required by these contracts, we could be subjectto additional liability and our business, financial condition and results ofoperations could be materially and adversely affected.

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*If we are unable to maintain the compatibility of oursoftware with certain other products and technologies, our future businesswould be adversely affected.*

Our software mustintegrate with software and hardware solutions provided by a number of ourexisting and potential competitors. For example, our products must integratewith phone switches made by the telephone switch vendors and computer telephonysoftware applications offered by other software providers. These competitors ortheir business partners could alter their products so that our software nolonger integrates well with them, or they could delay or deny our access tosoftware releases that allow us to timely adapt our software to integrate withtheir products. If we cannot adapt our software to changes in necessarytechnology, it may significantly impair our ability to competeeffectively, particularly if our software must integrate with the software andhardware solutions of our competitors.

*If our professional services employees do not provideinstallation services effectively and efficiently, our customers may notuse our installation services or may stop using our software.*

Our customers ordinarilypurchase installation, training and maintenance services together with ourproducts. The functionality of our products is not dependent on ourinstallation and training services. We believe that the speed and quality ofinstallation services are competitive factors in our industry. If ourinstallation services are not satisfactory to our customers, the customersmay choose not to use our installation services or they may notlicense our software in the future. As a result, we would lose licensing andservices revenue, and it could harm our reputation. In addition, our revenuesrealized from the performance of maintenance services are material to ouroperating results, and a failure to provide adequate maintenance support to ourcustomers would result in reduced maintenance revenues and have an adverseeffect on our operating results.

*We may make acquisitions or investments that arenot successful and that adversely affect our ongoing operations.*

We may acquire ormake investments in companies, products, services and technologies that webelieve complement our business and assist us in quickly bringing new productsto market. We have limited experience in making acquisitions and investments.As a result, our ability to identify and evaluate prospects, completeacquisitions and properly manage the integration of businesses is relativelyunproven. If we fail to properly evaluate and execute acquisitions orinvestments, it may have a material adverse effect on our business andoperating results. In making or attempting to make acquisitions or investments,we face a number of risks, including:

·       identifyingsuitable candidates, performing appropriate due diligence, identifyingpotential liabilities and negotiating acceptable terms;

·       reducingour working capital and hindering our ability to expand or maintain ourbusiness, if we make acquisitions using cash;

·       thepotential distraction of our management, diversion of our resources anddisruption of our business;

·       retainingand motivating key employees of the acquired companies;

·       managingoperations that are distant from our current headquarters and operations;

·       enteringinto geographic markets in which we have little or no prior experience;

·       competingfor acquisition opportunities with competitors that are larger than we are orhave greater financial and other resources than we have;

·       accuratelyforecasting the financial impact of a transaction;

·       assumingliabilities of acquired companies, including litigation related to theoperation of the business prior to the acquisition;

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·       maintaininggood relations with the customers and suppliers of the acquired company;

·       potentiallydilutive issuances of securities as consideration for an acquisition;

·       effectivelyintegrating acquired companies and achieving expected synergies; and

·       theimpairment of the value of the assets acquired in any corporate acquisition.

*If we need additional financing to maintain or expandour business, it may not be available on favorable terms, if at all.*

Although we believe ourcurrent cash and borrowing capacity will be sufficient to meet our anticipatedcash needs for at least the next 12 months and the foreseeable future, wemay need additional funds to expand or meet all of our operating needs. Ifwe need additional financing, we cannot be certain that it will be available tous on favorable terms, or at all. If we raise additional funds by issuingequity securities or convertible debt, the ownership interest of ourstockholders could be significantly diluted, and any additional equitysecurities we issue may have rights, preferences or privileges senior tothe rights of our stockholders. Also, the terms of any additional financing weobtain may significantly limit our future financing and operatingactivities. If we need funds and cannot obtain them on acceptable terms, wemay be unable to:

·       developand enhance our software to remain competitive;

·       takeadvantage of future opportunities, such as acquisitions;

·       respondto changing customer needs and our competitors’ innovations; or

·       attractand retain qualified key personnel.

Any of these events couldsignificantly harm our business and financial condition and limit our growth.

*Our inability to source hardware could harm ourbusiness.*

A number of customersexpect us to source hardware to support the implementation of our software. Weseek to reduce the amount of hardware sales in the future and have transferredthe fulfillment of hardware orders to third-party distributors. Thus, we arelargely dependent on third parties for the supply of hardware components to ourcustomers. If these hardware distributors experience financial, operational orquality assurance difficulties, or if there is any other disruption in ourrelationships, we may be required to locate alternative hardware sources.We are subject to the following risks due to our hardware distribution system:

·       cancellationsof orders due to unavailability of hardware;

·       increasedhardware prices, which may make our products less attractive; and

·       additionaldevelopment expense to modify our products to work with new hardwareconfigurations.

Even if we and/or ourdistributors are successful in locating alternative sources of supply,alternative suppliers could increase prices significantly. In addition,alternative components may malfunction or interact with existingcomponents in unexpected ways. The use of new suppliers and the modification ofour products to function with new systems would require testing andmay require further modifications, which may result in additionalexpense, diversion of management attention and other resources, inability tofulfill customer orders or delay in fulfillment, reduction in quality andreliability, customer dissatisfaction, and other adverse effects on ourreputation, business and operating results.

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*We have reported material weaknesses in internalcontrols over financial reporting and cannot assure you that additionalmaterial weaknesses will not be identified in the future. If our internalcontrols over financial reporting or disclosure controls and procedures are noteffective, there may be errors in our Consolidated Financials Statements thatcould require a restatement or our filings may not be timely and investors maylose confidence in our reported financial information, which could lead to adecline in our stock price.*

The Sarbanes-Oxley Act of2002 imposes certain duties on us and our executives, Board of Directors andattorneys. Our efforts to comply with the requirements of Section 404 haveresulted in increased general and administrative expense and a diversion ofmanagement time and attention from revenue-generating activities to complianceactivities, and we expect these efforts to require the continued commitment ofsignificant resources. We have reported material weaknesses in internal controlover financial reporting which we found in connection with our evaluation ofcontrols and procedures as of December 31, 2006. If we fail to maintainthe adequacy of our internal controls, we may not be able to ensure thatwe can conclude on an ongoing basis that we have effective internal controlsover financial reporting. Failure to maintain effective internal controls overfinancial reporting could result in investigation and/or sanctions byregulatory authorities, and could have a material adverse effect on ourbusiness and operating results, investor confidence in our reported financial information,and the market price of our common stock.

*Our stock price has been volatile.*

The market price of ourcommon stock has historically been subject to significant fluctuations inresponse to variations in quarterly operating results and other factors. Inaddition, the stock market has experienced significant volatility that hasparticularly affected the market prices of equity securities of many technologycompanies and that often has been unrelated or disproportionate to theoperating performance of these companies. Any announcement with respect to anyadverse variance in revenue or earnings from levels generally expected bysecurities analysts or investors could have a significant adverse effect on thetrading price of our common stock. In addition, factors such as announcementsof technological innovations or new products by us, our competitors or thirdparties, changing conditions in the customer relationship management softwaremarket, changes in the market valuations of similar companies, loss of a majorcustomer, additions or departures of key personnel, changes in estimates bysecurities analysts, announcements of extraordinary events, such asacquisitions or litigation, or general economic conditions may have anadverse effect on the market price of our common stock. With the announcementof our pending Merger with Verint pursuant to which our stockholders wouldreceive a fixed cash price of $27.50 per share of our common stock (less anyapplicable withholding taxes and without interest), the market price of ourcommon stock may depend more on developments and expectations relating to theprobability and timing of completion of the Merger and may be less subject tofluctuation resulting from other changes.

*Government regulation of telephone and Internetmonitoring could cause a decline in the use of our software, result inincreased expenses for us or subject our customers and us to liability.*

As the telecommunicationsindustry continues to evolve, state, federal and foreign governments (includingsupranational governmental organizations such as the European Union) andindustry associations may increasingly regulate the monitoring oftelecommunications and telephone and Internet monitoring and recordingproducts, such as our software. We believe that increases in regulation couldcome in a number of different forms, including regulations regarding privacy,protection of personal information such as Social Security numbers, credit cardinformation and employment. For example, the State of California enacted theDatabase Security Breach Act, which requires any business that suffers acomputer security breach to immediately notify customers in California ifpersonal information has been compromised, and the payment card industry hasadopted regulations that require additional security regarding the storage ofconsumers’ credit card numbers. The adoption of any new regulations or changesto existing regulations could cause a decline in the use of our software andcould result in increased expense for us as we modify our software toaccommodate these regulations. Moreover, these regulations could subject ourcustomers or us to liability. Whether or not these regulations are adopted, ifwe do not adequately address the privacy concerns of consumers, companiesmay be hesitant to use our software. If any of these events occur, itcould materially and adversely affect our business.

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*If we are unable to attract and retain key personnel,our ability to effectively manage and grow our business would suffer.*

Our success greatlydepends on our ability to hire, train, retain and motivate qualified personnel,particularly in sales, marketing, research and development, service andsupport. We face significant competition for individuals with the skillsrequired to perform the services we offer. If we are unable to attract andretain qualified personnel or if we experience high personnel turnover, itcould prevent us from effectively managing and expanding our business.

Our success also dependsupon the continued service of our executive officers. Any of our executiveofficers and other employees could terminate his or her relationship with us atany time. The loss of the services of our executive officers or other keypersonnel, particularly if lost to competitors, could materially and adverselyaffect our business.

*Our certificate of incorporation and bylaws, as wellas Delaware law, may inhibit a takeover of our company, which could limitthe price investors might be willing to pay for our securities.*

Should our proposed Mergerwith Verint not be consummated our amended and restated certificate ofincorporation and bylaws, as well as Delaware law, contain provisions thatmight enable our management to resist a takeover of our company by some otherperson or entity. For example, our stockholders cannot take action by writtenconsent or call a special meeting to remove our Board of Directors. Inaddition, our directors serve for staggered terms, which makes it difficult toremove all our directors at once. Further, in October 2002, our Board ofDirectors approved, and we implemented, a stockholder rights plan which has theeffect of causing substantial dilution to a person or group that attempts toacquire us on terms not approved by the Board of Directors.

These anti-takeover provisionsmight discourage, delay or prevent a change in the control of our company or achange in our management. These provisions could also discourage proxy contestsand make it more difficult for you and other shareholders to elect directorsand take other corporate actions. The existence of these provisions could alsolimit the price that investors might be willing to pay in the future for oursecurities.

**Item 6. Exhibits**
| (a)     | ** ** | **Exhibits**                                                                                                                                      |
|---------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------|
| 2.1(1)  |       | Agreement and  Plan of Merger, dated as of February 11, 2007, among Verint Systems Inc.,  White Acquisition Corporation and Witness Systems, Inc. |
| 4.1(1)  |       | Amendment to  Rights Agreement, dated as of February 11, 2007, between the Company and  Compushare Trust Company, N.A.                            |
| 10.1(2) |       | Separation and  Release Agreement between the Company and David Gould, dated January 3, 2007                                                      |
| 10.2(1) |       | First Amendment  to Separation and Release Agreement, dated February 9, 2007, between the  Company and David Gould                                |
| 31.1*   |       | Certification of  Chief Executive Officer                                                                                                         |
| 31.2*   |       | Certification of  Chief Financial Officer                                                                                                         |
| 32.1*   |       | Certifications  Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002                                                                    |

 

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*Filed herewith

(1)             Incorporatedby reference to exhibits previously filed with the Company’s Current Report onForm 8-K on February 15, 2007.

(2)             Incorporatedby reference to exhibits previously filed with the Company’s Current Report onForm 8-K on January 10, 2007.

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**(1) ****  SIGNATURES**

Pursuant to the requirements of the SecuritiesExchange Act of 1934, the registrant has duly caused this report to be signedon its behalf by the undersigned thereunto duly authorized.

 
| Dated: May 8, 2007 |   | WITNESS SYSTEMS, INC. |
|-------------------------|--------|----------------------------|
|                    |   |                       |
|                    |   |                       |
|                    |   | BY:                        | /s/   Nicholas Discombe |
|                    |   |                       | NICHOLAS DISCOMBE |
|                    |   |                       | CHIEF EXECUTIVE OFFICER |
|                    |   |                       | *(PRINCIPAL EXECUTIVE OFFICER)* |
|                    |   |                       | * * |
|                    |   |                       | * * |
|                    |   | BY:                        | /s/   William F. Evans |
|                    |   |                       | WILLIAM F. EVANS |
|                    |   |                       | EXECUTIVE VICE PRESIDENT AND |
|                    |   |                       | CHIEF FINANCIAL OFFICER |
|                    |   |                       | *(PRINCIPAL FINANCIAL AND ACCOUNTING OFFICER)* |

 

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