**UNITED
        STATES**
 **SECURITIES
        AND EXCHANGE COMMISSION**
 **Washington,
        D.C. 20549**
 
 **FORM 10-KSB**
 **(Mark
        one)**
  **ý**  **ANNUAL
        REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
        1934.**
 **For
        the fiscal year
        ended December 31, 2006**
 **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 No: 333** **-46494**
 
 **PRIMAL
        SOLUTIONS, INC.**
 (Name
        of
        Small Business Issuer in its Charter)
  **Delaware**
              
              **36-4170318**(State
                  or Other Jurisdiction of
              
              (I.R.S.
                  Employer Identification No.)Incorporation
                  or Organization)**18881
                  Von Karman Avenue****Suite 500****Irvine,
                  California**
              
              **92612**(Address
                  of Principal Executive Offices)
              
              (Zip
                  Code)
  **(949)
        260** **-1500**
 (Issuer’s
        Telephone Number, Including Area Code)
 
  Check
        whether the issuer is not required to file reports pursuant to Section 13
        or 15(d) of the Exchange Act. o
  Check
        whether the issuer (1) filed all reports required to be filed by
        Section 13 or 15(d) of the Exchanged Act during the past 12 months (or
        for such shorter period that the registrant was required to file such reports),
        and (2) has been subject to such filing requirements for the past 90 days.
        Yes ý No o
  Check
        if
        disclosure of delinquent filers in response to Item 405 of Regulation S-B
        is not
        contained in this form, and no disclosure will be contained, to the best
        of the
        registrant’s knowledge, in definitive proxy or information statements
        incorporated by reference in Part III of this Form 10-KSB or any
        amendment to this Form 10-KSB. ý
  Indicate
        by check mark whether the registrant is a shell company (as defined in
        Rule 12b-2 of the Exchange Act). Yes o No ý
  State
                  issuer’s revenues for its most recent fiscal year:
              
              $
              5,648,000State
                  the aggregate market value of the voting and non-voting common
                  equity held
                  by non-affiliates computed by reference to the price at which the
                  common
                  equity was sold, or the average bid and asked price of such common
                  equity,
                  as of March 12, 2007:
              
              $
              3,454,000Number
                  of shares of Common Stock ($0.01 par value) outstanding as of the
                  close of
                  business on March 12, 2007:
              
              
              38,373,634
 
  Transitional
                  Small Business Disclosure Format
              Yeso
              Noý
 
 
 
 **PRIMAL
        SOLUTIONS, INC. AND SUBSIDIARY**
  **TABLE
        OF CONTENTS**
  **Page****PART I**Item
                  1.
              
              Description
                  ofBusiness
              
              3Item
                  2.
              
              Description
                  ofProperty
              
              17Item
                  3.
              
              Legal
                  Proceedings
              
              17Item
                  4.
              
              Submission
                  of Matters to a Vote of Security Holders
              
              17**PART II**Item
                  5.
              
              Market
                  for Common Equity, Related Stockholder Matters, and Small Business
                  Issuer
                  Purchases of Equity Securities
              
              18Item
                  6.
              
              Management’s
                  Discussion and Analysis
              
              18Item
                  7.
              
              Financial
                  Statements
              
              32Item
                  8.
              
              Changes
                  In and Disagreements With Accountants on Accounting and Financial
                  Disclosure
              
              32Item
                  8A.
              
              Controls
                  and Procedures
              
              33Item
                  8B.
              
              Other
                  Information
              
              33**PART III**Item
                  9.
              
              Directors,
                  Executive Officers, Promoters, Control Persons and Corporate Governance;
                  Compliance With Section 16(a) of the Exchange
                  Act
              
              34Item
                  10.
              
              Executive
                  Compensation
              
              36Item
                  11.
              
              Security
                  Ownership of Certain Beneficial Owners and Management and Related
                  Stockholder Matters
              
              45Item
                  12.
              
              Certain
                  Relationships and Related Transactions, and Director
                  Independence
              
              47Item
                  13.
              
              Exhibits
              
              47Item
                  14.
              
              Principal
                  Accountant Fees and Services
              
              52
 
  
  -2-
 **PART I**
  
 **Item
        1. Description of Business**
  **Compa** **ny
        Background**
 
 The
        Company
        was incorporated on June 28, 1996 as Primal Systems, Inc. In 1999,
        Primal Systems, Inc. was merged with and into ACI Telecommunications
        Financial Services, a wholly-owned subsidiary of Avery Communications, Inc.
        (“Avery”). The surviving company changed its name to Primal Solutions, Inc.
        In February 2001, Avery spun off Primal Solutions, Inc. and its
        wholly-owned subsidiary, Wireless Billing Systems (collectively, “Primal” or the
“Company”) as a separate public company.
  **Our
        Business Focus**
  Primal
        is
        focused on providing comprehensive solutions for streamlining and improving
        transaction management for traditional voice services as well as services
        delivered via Internet Protocol (“IP”). Our IP CorrelyticsTM (“IPC”) software
        platform and related services can help enhanced communications service providers
        and new media companies generate more revenue and launch new products and
        services more rapidly while extracting essential business intelligence from
        communications business transactions.
  Increasingly,
        our solutions are being used to enhance revenue and profitability management
        for
        complex, multi-carrier networks. The
        unique end-to-end nature of IPC’s transaction management makes it ideally suited
        for delivering carrier-grade charging and settlement management
        solutions .
        In
        2006, we sold IP Correlytics and related services both through our direct
        sales
        efforts and our partnership relationships.
 In
        addition
        to our IP Correlytics product line, we offer Connect IXCTM (“IXC”)
        and Connect CCB®
        ("CCB"), an operational support services (“OSS”) product.
        IXC is
        a robust telecommunications mediation (collecting information from various
        sources and reformatting it to a standardized form) and rating (applying
        pricing
        plans to network usage) platform. The IXC mediation and rating components
        can be
        used separately or in combination, and also can be combined with both the
        IPC
        and CCB platforms.  Our CCB software is an integrated, end-to-end customer
        care, provisioning, and billing software platform used by wireless carriers,
        cable operators, and by community broadband providers that deliver voice,
        data,
        video and other services to residential and commercial accounts. CCB’s
        features support order management, provisioning, customer service management,
        invoicing, web portal electronic bill presentment, payment processing, credit
        and collections, workforce management and management reporting. We have several
        long-time customers using this product and continue to add new customers
        both
        through our direct sales efforts and our relationship with Lucent
        Technologies.
  **Our
        Markets**
  Our
        current market focus is Tier 1 and Tier 2 communications providers offering
        services to both residential and commercial customers.  Tier
        1
        communications providers typically have revenues over $10 billion
        and Tier 2 communications providers have revenues between $250 million and
        $10 billion.These service providers offer a blend of communications,
        content and commerce in converged voice, data and video offerings. Cable
        operators, database and entertainment companies, telephone companies, municipal
        WiFi network operators, Internet service providers and Internet search engine
        providers are all potential customers.
  The
        Company’s primary focus has been Voice-over IP (“VoIP”) services which have
        gained early market momentum, while the number of new IP services offered
        continues to grow. These include: video phone, multi-line VoIP services,
        collaborative messaging, multi-player games, multi-media services, fixed-mobile
        convergence (“FMC”) services, IP Television (“IPTV”) and new forms of ad
        supported services and entertainment and interactive advertising.
  Our
        customers and partners are leading communications and technology innovators
        worldwide, including Time Warner Cable, Earthlink Networks, Lucent Technologies,
        Bright House Networks, Bresnan Communications, Telekom Malaysia and Cisco
        Systems. In September 2006, our products processed approximately 30 percent
        of all U.S. residential VoIP subscriber transaction traffic.
  -3-
 Market
          Dynamics
   As
        communications providers seek new customers, additional market share and
        sustainable revenue by accelerating the delivery of IP and other services,
        they
        are encountering numerous business and operational problems driven by the
        following market dynamics:
 interconnections
            between service providers and their internal and external networks are
            becoming increasingly complex, making settlement more involved and difficult
            to reconcile;
        rapidly
            evolving market segments require providers to be increasingly responsive
            and
            adaptable to changing conditions;
        greater
            competition from traditional and new market entrants with compelling
            new
            offerings;
        customers
            expect more services at lower prices, placing increased pressure on margins;
            and
        emerging
            business models and increasingly complex relationships are requiring
            new
            solutions and methods to ensure quality service delivery. **Our
        Solutions**
  We
        provide
        the following solutions to address the business and operational problems
        confronted by communications providers:
 Transaction
            Management - the ability to track, store, view and manage network and
            business
            events in a normalized fashion that span multiple internal and external
            systems and data structures;
        Rating
            - the ability to determine the appropriate charge for a service delivered,
            based on complex business rules;
        Mediation
            - the ability to take raw data records from a wide variety of network
            elements
            and translate them into a normalized form that can be used by downstream
            systems;
        Settlement
            - the ability to determine which parties are owed fees in complex multi-party
            network environments;
        Revenue
            Management - the ability to reconcile invoiced charges, manage costs,
            and
            maximize margins for services delivered;
        Monitoring
            and Alerting - the ability to monitor network and business systems and
            notify
            specified people and systems when a business or performance threshold
            has been
            crossed;
        Billing
            - the ability to create itemized statements of
            services offered, manage customers, provision services and the like;
            and
        Business
            Intelligence - the ability to analyze transaction data and present it
            via
            dashboards, graphs, reports and other actionable tools that enable business
            users in marketing, financial services and network operations to better
            manage
            their respective businesses.  **IP
        transaction management**
  IP
        transaction management entails managing the lifecycle of networked business
        by
        collecting session data from network devices and applications and then
        aggregating, processing and storing it. Once stored, it can be accessed for
        real-time business analysis and improved decision making. IP transaction
        management solutions embody both enabling technologies and analytical business
        services to expedite service deployments, offer greater competitive
        differentiation, assure services and revenues, derive maximum value from
        transactions and continuously adapt to the ever-changing services
        environment.
  -4-
 **IP
        Correlytics product and services-oriented architecture and open systems
        technology**
  By
        combining transaction management and correlation analytics, IP Correlytics
        helps
        simplify transaction complexities and improve business results. IP Correlytics
        enables our customers to identify, track, manage and assure transactions—from
        initiation through settlement with partners. IP Correlytics collects network
        events from any number of service providers and in varying formats which
        allows
        for the capture of transactions for greatly improved monetization, auditing
        and
        revenue assurance.
  IP
        Correlytics employs a loosely coupled, services-oriented architecture (“SOA”)
        and open systems technologies to ease service deployments, modifications
        and
        enhancements while ensuring interoperability with third-party application
        programming interfaces (“APIs”). It does not require major modifications,
        expensive upgrades or abandonment of existing business systems, which results
        in
        a lower total cost of ownership.
  **Our
        pricing and delivery models**
  We
        offer
        our software under a subscription-based pricing model or a multiple-year
        up-front fee license. The subscription-based pricing model supports delivery
        of
        services via the Software as a Service (“SaaS”) model which has the advantage of
        lowering the capital expense for customers and lowers barriers to entry for
        new
        and smaller-sized customers. The subscription-based arrangement allows customers
        to pay a monthly fee based on the then-current number of subscribers and/or
        transaction volumes associated with our products and can include software
        license and related maintenance as well as application management and hosting
        our software on the customer's hardware.  Training and professional
        services are not included in the monthly pricing and is billed
        separately.
  Up-front
        licenses are contracted to customers who intend to host and operate their
        solutions, and require payment of an annual product support and upgrades
        fee. We
        provide professional services for implementation, customization and training
        as
        well as recurring services for application management and hosting our software
        on the customer’s hardware.
  **Sales
        and Marketing**
  We
        use a
        direct sales force and channel partners to pursue sales activities. Our direct
        sales force focuses on the North America market. We manage sales, contracts
        and
        relationships directly with our clients. This approach assists us in
        establishing intimate knowledge of each client’s situation and finding the best
        solution to meet their business needs.
  Through
        our channel partners, we pursue sales opportunities inside and outside of
        North
        America. We work with our channel partners either through referrals or as
        a
        subcontractor. If through a referral, our channel partner will introduce
        us to
        its end-customer. Thereafter, we are responsible for fostering this new
        relationship and to present our products. If we are able to convert this
        introduction into an executed arrangement, we pay our channel partner a referral
        fee. If we are acting as a subcontractor, our channel partner will control
        the
        end-customer relationship and we will act as a subcontractor under the channel
        partner’s agreement with its end-customer.
  Due
        to
        the complex nature of the products and services we sell, our sales cycle
        may
        range from 60 days to over a year.
  We
        derive
        the majority of our revenues from products delivered or services performed
        in
        the United States. Products delivered or services performed outside the United
        States represented approximately 13% and 16% of our total revenues in fiscal
        years 2006 and 2005, respectively. See Note 10 of the Notes to the Consolidated
        Financial Statements included elsewhere in this Report for a summary of our
        revenue by geographic area.
 -5-
 **Competition**
  We
        compete in the VoIP, broadband, cable, commercial telecommunications, and
        municipal WiFi markets with other companies who provide solutions for
        transaction management, transaction archiving, triple-play, mediation, pricing
        and rating, partner settlement, revenue assurance, pricing plan analysis,
        business intelligence, dashboards, and analytics. We compete in markets that
        deliver solutions via customer license, application management, partner hosting
        and SaaS. We believe we differentiate ourselves by:
 our
                  IP
                  Correlytics platform, with its service-oriented architecture and
                  underlying
                  formal and rigorous definitions for what constitutes transactions
                  and how they
                  are managed;
        our
                    expertise in IP network mediation, telecommunications billing
                    and rating,
                    application and database management, correlation analytics and
                    high-volume
                    real-time business transaction
                    management;
        the
                      price/value quotient associated with the solutions we deliver;
                      and
        our
                        customer-intimate culture and our track record of quickly
                        responding and
                        delivering solutions to our customers and
                        partners. **Customers**
  We
        have
        communications service providers as customers with multiple-year
        contracts.  A significant portion of our total revenues is generated from a
        small number of customers.  During the fiscal year ended December 31, 2006,
        our three largest customers accounted for approximately 74% of total
        revenues.
  In
        December 2005, the license and services agreement with our then largest
        customer expired. After its merger with and into another wireless
        telecommunication company, the customer elected to not renew its agreement
        based
        on the decision to migrate to its merger partner’s existing billing
        system.  Revenue from this customer represented approximately 53%, or $4.5
        million, of total revenues for the fiscal year ended December 31, 2005. The
        Company has focused on converting new sales opportunities into long-term
        recurring revenue arrangements to offset the loss of this customer. During
        the
        fiscal year ended December 31, 2006, revenues from existing 2005 customers
        increased 14%, or $573,000 when compared to the revenues from the same
        customer base during fiscal year ended December 31, 2005. Additionally, we
        recognized $1.0 million, or 18% of total revenues in fiscal year 2006, from our
        new 2006 customers.
  **Research
        and Development**
  Our
        research and development team is responsible for developing new software
        products, product architecture, core technologies, product testing, quality
        assurance and ensuring the compatibility of our products with hardware, switch
        network, and software platforms. Additionally, our research and development
        team
        supports pre-sale and customer support activities, in which case, related
        costs
        are allocated to costs of revenue. Our product management, professional services
        and sales staff helps our research and development team identify potential
        new
        product features.  We spent approximately $1.5 million and $1.7 million on
        research and development efforts during the fiscal years ended December 31,
        2006
        and 2005, respectively.
  -6-
 **Intellectual
        Property**
  We
        rely
        upon a combination of U.S. patent, copyright, trade secret and trademark
        law to
        protect our intellectual property. We currently have one U.S. patent related
        to
        billing and mediation technology, four U.S. registered trademarks and two
        U.S.
        copyrights. In addition, during 2005, the Company submitted the relevant
        paperwork in order to register seven new trademarks, and in early 2007, the
        Company filed the relevant paperwork for a new patent. The table below
        summarizes our material intellectual property either currently registered
        or
        pending registration.
  **Type of**
                **Intellectual**
                **Property**
              
              **Intellectual Property Name**
              
              **Status**Patent
              
              Cellular
                  Telephone Real Time Account Administration System
              
              IssuedPatent
              
              Systems
                And Methods For Tracking State-Based Transactions
              
              PendingTrademark
              
              CONNECT
                  CCB
              
              RegisteredTrademark
              
              PRIMAL
              
              RegisteredTrademark
              
              PRIMAL
                  ACCESS IM
              
              RegisteredTrademark
              
              PRIMAL
                  CONNECT CCB
              
              RegisteredTrademark
              
              CONNECTPAK
              
              PendingTrademark
              
              CORRELYTICS
              
              PendingTrademark
              
              IP
                  CORRELYTICS
              
              PendingTrademark
              
              KPIPAK
              
              PendingTrademark
              
              NO
                  IP TRANSACTION LEFT BEHIND
              
              PendingTrademark
              
              PRIMAL
                  SOLUTIONS LOGO
              
              PendingTrademark
              
              PRIMAL
                  SOLUTIONS LOGO, NO IP TRANSACTION LEFT BEHIND
              
              PendingCopyright
              
              Access
                  IM
              
              RegisteredCopyright
              
              Connect
                  CCB
              
              Registered
  While
        we
        rely on patent, copyright, trade secret and trademark law to protect our
        technology, we believe that factors such as new product developments, frequent
        product enhancements, the technological and creative skills of our personnel,
        and reliable product maintenance are more essential to establishing and
        maintaining a technology leadership position. There can be no assurance that
        others will not develop technologies that are similar or superior to our
        technology.
  We
        generally enter into confidentiality or license agreements with employees,
        consultants and corporate partners, and generally control access to and
        distribution of our software, documentation and other proprietary information.
        Despite our efforts to protect proprietary rights, unauthorized parties may
        attempt to copy or otherwise obtain and use our products or technology or
        develop products with the same functionality as our products. Policing
        unauthorized use of our products is difficult, and we cannot be certain that
        the
        steps we have taken will prevent misappropriation of our technology,
        particularly in foreign countries where the laws may not protect proprietary
        rights as fully as do the laws of the United States of America. In addition,
        certain of our license agreements require us to place the source code for
        our
        products into escrow. Such agreements generally provide that those parties
        with
        whom we contract will have a limited, non-exclusive right to use our source
        code
        if (1) there is a bankruptcy proceeding by or against Primal, (2) we
        cease to do business without a successor or (3) we discontinue providing
        maintenance and support.
  Certain
        of our products use open source software. Open source software is software
        that
        is covered by a license agreement which permits the user to liberally use,
        copy,
        modify and distribute the software without cost. Some open source software
        licenses may require us to make part or all of the source code for our
        derivative products available to the public free of charge and/or license
        such
        derivative product under a similar open source software license.
  Our
        success and ability to compete are substantially dependent upon our internally
        developed technology. However, portions of our products incorporate software
        developed and maintained by third-party software vendors, such as operating
        systems, tools and database vendors as well as open-source
        software.
  **Employees**
  As
        of
        March 12, 2007, the Company had 25 full-time and 2 part-time employees, none
        of
        whom is represented by a union. The Company believes that its relationship
        with
        its employees is good.
  
  -7-
 **RISK
        FACTORS**
  *Investing
        in our
        common stock involves a high degree of risk.  You should carefully consider
        the material risk factors listed below and all other information contained
        in
        this prospectus before investing in our common stock.  You should also keep
        these risk factors in mind when you read the forward-looking statements. 
The risks and uncertainties described below are not the only ones facing
        us.  Additional risks and uncertainties that we are unaware of, or that we
        currently deem immaterial, also may become important factors that affect
        us.*
  *If
        any of
        the following risks occur, our business, our quarterly and annual operating
        results or our financial condition could be materially and adversely
        affected.  In that case, the market price of our common stock could decline
        or become substantially volatile, and you could lose some or all of your
        investment.*
 
 **Risks
        Related to Our Business and Our Marketplace**
 
 **We
        have not achieved profitability on an annual basis and expect to continue
        to
        incur net losses in future quarters.**
  We
        recorded
        net losses of $3.2 million and $1.4 million for the fiscal years ended
        December 31, 2006 and 2005, respectively. In
        order
        to become profitable, we will need to generate additional revenues from the
        sales of our products and services or continue to reduce operating costs
        further
        to achieve and maintain profitability, or both. We expect that we will face
        increased competition, which will make it more difficult to increase our
        revenues. Even if we are able to increase revenues, we may experience price
        competition that will lower our gross margins and our profitability. Any
        increase in the percentage of our revenues attributed to nonrecurring
        professional services which generally has lower profit margin percentages,
        will
        be less profitable. We may not be able to increase or even maintain our
        revenues and we may not achieve sufficient revenues or profitability in any
        future period.
  Our
        subscription-based pricing model for recurring software licensing and product
        support and upgrades fees for IPC and IXC customers allows them to pay a
        monthly
        fee based on the then-current number of subscribers and/or transaction volumes
        associated with our products, as compared to an up-front one-time license
        fee.
        Under this subscription-based recurring revenue model, our revenue from
        customers is expected to increase as their subscriber base and/or transaction
        volumes grow and, thus, related revenue from these customers is expected
        to be
        low in the early part of the customer contracts and higher in later years.
        If our new customers do not or are not able to increase the number of
        subscribers as they expect, our future revenues could be lower than
        anticipated.
  If
        we do
        achieve profitability, we cannot be certain we can sustain or increase
        profitability on a quarterly or annual basis. We are striving to reach
        profitability; however, we could continue to incur net losses for the
        foreseeable future.
 
 **Our
        revenues are generated from a limited number of customers, the loss of any
        of which could substantially harm our business.**
  A
        substantial
        portion of our revenue has been, and is expected to continue to be, generated
        from a limited number of customers with large financial commitments. In December
        2005, the license and services agreement with our largest customer
        expired. Revenue from this customer represented approximately 53%, or $4.5
        million, of total revenues for the fiscal year ended December 31, 2005. 
Total revenues from customers who individually account for more than 10%
        of
        total revenues during the fiscal year ended December 31, 2006 represented
        approximately 74% of total revenues, with the largest customer accounting
        for
        53% of total revenues in fiscal year 2006.
  The
        loss of
        any customer could cause our business to be harmed and, if a large contract
        is
        cancelled, deferred, or expires, or if an anticipated contract does not
        materialize, our business would be harmed. If
        we are
        unable to replace the loss of revenue associated with a large customer, we
        might
        need to reduce our operating costs, which could, among other things, cause
        difficulty in maintaining and growing the customer base, decrease our ability
        to
        attract and retain key employees and could result in a reduced stock price.
        We
        can provide no assurance that we will be able to increase our revenue or
        reduce
        our costs sufficiently to offset any future loss of revenue with a large
        customer, or at all.
 
 -8-
 **If
        we are exposed to costs beyond our expectations, or if cash flow generated
        from
        existing contracts does not meet our expectations, our business and financial
        condition could be seriously harmed.**
  We
        believe
        that existing cash balances combined with cash generated from existing and
        currently anticipated contracts will be sufficient to support our working
        capital requirements through at least the next twelve months. However, if
        these
        sources of cash are insufficient, or if we are exposed to unexpected costs,
        we
        may have to raise additional funds to pay outstanding indebtedness and fund
        our
        other liquidity needs. If we are unable to pay our indebtedness when due,
        our
        lenders may be permitted to accelerate maturity and exercise other remedies.
        There can be no assurance that we will have access to additional financing
        on
        acceptable terms, or at all, should the need arise. If we are unable to obtain
        additional financing as needed, our business and financial condition would
        be
        materially adversely affected.
  **Special
        Situations Fund III QP, L.P., Special Situations Fund III, L.P., Special
        Situations Private Equity Fund, L.P., Special Situations Technology Fund,
        L.P.
        and Special Situations Technology Fund II, L.P. (collectively
“SSF”)** **could accelerate payment of all principal and interest owed under the** **5%
        Senior Secured Convertible Notes (the “Notes”)** **and require us to pay liquidated damages owed under the Registration Rights
        Agreement.**
  As
        of March
        12, 2007, there is $1.5 million of principal and $15,000 of accrued interest
        outstanding under the Notes issued to SSF in a
        private
        placement in March 2006 ( the
        “March 2006 Private Placement”). Interest payments are payable semi-annually on
        the last day of June and December of each year, and began June 30, 2006.
        The
        principal and any accrued but unpaid interest on the Notes are due March
        31,
        2008.  In the event we fail to pay any amount due under the related
        transaction documents between the Company and SSF within five days of when
        due,
        or if we fail to make any required principal payment on indebtedness of $100,000
        or more within 10 days of when due, then SSF may elect to declare all
        unpaid principal and accrued interest under the Notes immediately due and
        payable.  Because the registration statement related to the March 2006
        Private Placement was not declared effective by July 16, 2006, we owe liquidated
        damages under the Registration Rights Agreement between the Company and SSF
        at
        the rate of $22,500 for each 30-day period or pro rata for any portion thereof
        until the registration statement was declared effective on December 22,
        2006.  As of March 12, 2007, the Company had accrued $119,000 in liquidated
        damages payable to SSF under the Registration Rights Agreement.  In the
        event SSF elects to accelerate payments under the Notes, we may not have
        sufficient cash to make such payments.  The Notes are secured by a first
        priority security interest in all of the Company's assets and failure to
        make payments under the Notes when due could materially adversely affect
        the
        Company's operations and financial condition.
 
 **If
        we are unable to attract additional customers beyond our current limited
        number,
        our future success could be limited or adversely affected.**
  Our
        future
        success will depend on our ability to attract additional customers beyond
        our
        current limited number. The growth of our customer base could be adversely
        affected by one or more of the following:
 customer
            unwillingness to implement our software products;
        any
              delays or difficulties that we may incur in completing the development
              and
              introduction of our planned products or product
              enhancements;
        our
              customers’ inability to raise capital to finance their business plans and
              capital expenditures;
        new
              product introductions by our competitors;
        any
              failure of our products to perform as expected;
        any
              difficulty we may incur in meeting customers’ delivery requirements;
              or
        the
              market perception of our financial condition and/or current stock
              price.  -9-
 **Our
        quarterly operating results may fluctuate in future periods and we may fail
        to
        meet expectations, which could cause the price of our common stock to
        fall.**
 
 Our
        revenues
        and operating results may vary significantly from quarter to quarter due
        to a
        number of factors. In future quarters, our operating results may be below
        the
        expectations of investors and the price of our common stock may fall. Factors
        that could cause quarterly fluctuations include:
 the
              timing and volume of orders for our software. Customers typically order
              our
              products and services only after other vendors have provided the
              infrastructure for their communications network. There can be delays
              in that
              process. It is therefore difficult for us to predict the timing of
              orders for
              our products and services by customers;
        the
                ability of our customers to expand their communications operations
                and
                increase their subscriber base, including their ability to obtain
                financing;
        changes
                  in our pricing policies or competitive pricing by our
                  competitors;
        the
                    timing of releases of new products by manufacturers of communications
                    equipment with which our products operate;
                    and
        the
                      timing of product introductions by
                      competitors. We
        have
        difficulty predicting the volume and timing of orders from new customers.
        For
        example, we expect an increasing percentage of our total revenues will come
        from
        software license and product support and upgrade fees for IP Correlytics
        and
        Connect IXC solutions and related services, but the markets for these products
        are in their early stages of development and are therefore unpredictable.
        Significant sales may also occur earlier than expected, which could cause
        operating results for later quarters to compare unfavorably with operating
        results from earlier quarters.
  Due
        to the
        foregoing factors, we believe that quarter-to-quarter comparisons of our
        operating results are not a good indication of our future
        performance.
  **Our
        growth depends on the commercial acceptance of our products for IP networks,
        and
        it is uncertain to what extent the market will accept these
        products.**
  Our
        future
        growth depends on the commercial success of our products. Substantially all
        of
        our revenues are derived from licenses and support and upgrades of these
        products and related services. We sell and license our software products
        primarily through our direct sales force. Our business will be harmed if
        our
        target customers do not adopt and purchase or license these software products.
        Our future financial performance will also depend on the successful development,
        introduction and customer acceptance of our software products for IP networks.
        We are not certain that our target customers will widely adopt and deploy
        our
        software products in their communications operations. Our financial success
        and
        our ability to increase revenues in the future may depend considerably on
        the
        productivity of our direct sales force. Our future revenues will also depend
        on
        our customers’ licensing software for additional billing units, such as
        increased subscribers or additional event records. Their failure to do so
        could
        harm our business.
 
 **Our
        lengthy sales cycle makes it difficult to anticipate the timing of sales,
        and
        revenue may vary from period to period.**
  The
        sales
        cycle associated with the purchase or license of our products is lengthy,
        and
        the time between the initial proposal to a prospective customer and the signing
        of a license agreement can be as long as one year. Our products involve a
        commitment of capital, time and internal resources that may be significant
        to
        the customer. In addition, market conditions have lengthened the sales cycles
        associated with our products. These delays may reduce our revenue in a
        particular period without a corresponding reduction in our costs, which could
        hurt our results of operations for that period.
  -10-
 **If
        the communications and new media markets do not expand as we anticipate,
        our
        future growth and success could be limited.**
  The
        offerings
        provided by communications service providers (“CSPs”) using IP networks are
        rapidly changing. We believe this market shows signs of growth opportunities
        for
        our products and services. However, the revenue opportunities in the market
        are
        dependent on certain factors, including the following:
 the
            adoption of IP services by the
            consumer;
        the
            timing of the providers offering IP
            services;
        our
            contracts having volume-based
            characteristics;
        our
            ability to enable our products to conform and
            comply with industry standards;
        new
            competitors we might encounter;
            and
        changes
            to technical specifications before our
            products are accepted. If
        the market
        does not grow as we expect, our future growth and success could be
        limited.
 
 **Our
        future success depends on our ability to retain and attract qualified
        personnel.**
  We
        may not be able to retain, or attract and assimilate highly qualified
        personnel in the future. In particular, our financial success and our ability
        to
        increase revenues in the future depend considerably upon the productivity
        of our
        direct sales force that has historically generated a majority of our license
        revenues, and our IP Correlytics development team. This productivity will
        depend
        to a large degree on our success to retain, recruit, and train qualified
        direct
        salespeople and technical resources. Our business will be harmed if we fail
        to
        retain or hire qualified personnel, or if newly hired employees fail to develop
        the necessary skills or develop these skills more slowly than we anticipate.
 
 **Loss
        of our senior management could harm our business if we are unable to hire
        suitable replacements.**
  We
        recently
        reduced our senior management ranks and consolidated executive responsibilities
        under our Chief Executive Officer, Chief Operating Officer, and Vice President
        of Sales. Our future success depends to a significant extent on the continued
        services of this senior management. If we lose the services of any of our
        senior
        management and are unable to hire suitable replacements, our business could
        be
        harmed. Our success also depends in large part on our ability to motivate
        and retain senior management. Significant turnover of our senior management
        could hinder our ability to serve our existing customers effectively and
        compete
        for new business, either of which could adversely affect our business and
        results of operations.
 
 **Certain
        segments of the communications industry are experiencing consolidation, which
        may reduce the number of potential clients for our
        software.**
  Certain
        segments of the communications industry continue to experience significant
        consolidation, which may result in fewer potential clients for our products
        and result in increasing the level of competition for new customers. We cannot
        be certain that we will not lose clients as a result of consolidation of
        certain
        areas of the communications industry. In addition, larger CSPs have strengthened
        their purchasing power, which could create pressure on the prices and the
        margins we could realize. These companies are also striving to streamline
        their
        operations by combining different communications systems and the related
        OSS
        into one system, reducing the number of vendors needed. We have sought to
        address this situation by continuing to market our products and services
        to new
        clients and by working with major CSPs to provide products and services that
        they need to remain competitive.
  -11-
 **If
        large CSPs consolidate their software vendors, our business may be
        harmed.**
  We
        believe
        large CSPs are seeking ways to reduce operating costs. Many CSPs have a large
        number of operating support systems from a variety of suppliers. In an effort
        to
        reduce operating costs, the CSPs could choose to reduce the number of software
        vendors they use to gain efficiencies. We could lose customers if we are
        not
        selected as a surviving incumbent software vendor. In addition, our ability
        to
        sell our products and services to the large CSPs could be limited if we had
        to
        compete directly with an incumbent software vendor with greater
        resources.
 
 **If
        our customers with multiple-year recurring revenue contracts exercise early
        termination provisions or experience a decline or lack of volume, our revenue
        could be harmed.**
  An
        increasing
        number of our contracts with new customers are multi-year agreements and
        include
        recurring license and service fees. Some of our contracts for new customers
        could include a recurring licensing and services component that may vary
        based
        on usage and volume throughout the duration of the contract. Also, some of
        our
        contracts include early termination clauses that enable customers to terminate
        those contracts without cause. If our customers exercise early termination
        or
        experience a decline or lack of volume, our revenue could be
        harmed.
 
 **If
        we do not continue to improve our products or our product is not able to
        integrate and operate successfully with the communications equipment of the
        leading manufacturers, we may be unable to maintain our existing customers
        and/or generate new sales.**
  If
        we do not
        continue to improve our software products and develop new software products
        that
        keep pace with competitive product introductions and technological developments,
        satisfy diverse and rapidly evolving customer requirements and achieve market
        acceptance, we may be unable to maintain existing customers and/or attract
        new
        customers.
  Additionally,
        the success of our software products depends upon the continued successful
        integration and operation of our software products with the communications
        equipment of the leading manufacturers. We currently target a customer base
        that
        uses a wide variety of communications network infrastructure equipment and
        software platforms, which are constantly changing. As such, we must continually
        modify our software products as new communications equipment is introduced.
        If
        our products fail to satisfy these demanding and rapidly changing technical
        challenges, our business may be harmed.
  We
        have in
        the past experienced delays in releasing new software products and product
        enhancements and may experience similar delays in the future. These delays
        or
        problems in the installation or implementation of our new releases may cause
        customers to forego purchasing or licensing our software products.
  **We
        face intense competition from companies that may have greater resources than
        we
        do and, if we are unable to compete with them effectively, then our business
        may
        suffer.**
  The
        market
        for our products is very competitive. We compete in the VoIP, broadband,
        cable,
        commercial telecommunications, and municipal WiFi markets with other companies
        that provide solutions for IP transaction management, transaction archiving,
        triple-play, mediation, pricing and rating, partner settlement, revenue
        assurance, pricing plan analysis, business intelligence, dashboards, and
        analytics. Also, the internal information technology departments of larger
        communications companies may elect to develop products in-house similar to
        those
        provided by our products.
  Many
        of our
        current and future competitors may have advantages over us,
        including:
 larger
            customer bases;
        substantially
            greater financial, technical, sales and marketing resources; and
        greater
            name recognition. Our
        current
        and potential competitors have established, and may continue to establish
        in the
        future, cooperative relationships among themselves or with third parties
        that
        would increase their ability to compete with us. In addition, competitors
        may be
        able to adapt more quickly than we can to new or emerging technologies and
        changes in customer needs, or to devote more resources to promoting and selling
        their products. If we fail to adapt to market demands and to compete
        successfully with existing and new competitors, our business and financial
        performance would suffer.
 
 -12-
 **We
        depend on our intellectual property and litigation regarding our intellectual
        property could harm our business.**
  Unauthorized
        use or misappropriation of our intellectual property could seriously harm
        our
        business. Copyrights and patents are important to the protection of our
        software, and our trademarks are important to the protection of our company
        and
        product name. These copyrights, patents and trademarks discourage unauthorized
        use of our software and our company and product names and provide us with
        a way
        to enforce our rights in the event that this unauthorized use occurs. Despite
        this protection, third parties may infringe upon our intellectual property
        rights, and we may be unable to detect this unauthorized use or effectively
        enforce our rights. Furthermore, the laws of certain countries in which we
        sell
        or license our products do not protect our software products and intellectual
        property rights to the same extent, as do the laws of the United States.
        In
        addition, any legal action that we may bring to protect our intellectual
        property rights could be expensive and distract management from the day-to-day
        operations or our business.
 
 **Some
        of our products contain open source software, which may be subject to
        restrictive open source licenses and harm our business.**
  Certain
        of
        our products use open source software. Open source software is software that
        is
        covered by a license agreement that permits the user to liberally use, copy,
        modify and distribute the software without cost. Some open source software
        licenses may require us to make all or part of the source code of our derivative
        products available to the public free of charge and/or to license such
        derivative product under a similar open source software license. If we are
        required to publicly disclose the source code for such derivative products
        or to
        license our derivative products that use an open source license, our previously
        proprietary software products may be available to others without charge.
        If this
        happens, our customers and our competitors may have access to our products
        without cost to them, which could harm our business.
 
 **Claims
        by others that we infringe on their proprietary technology could divert our
        resources, result in unexpected license fees and harm our
        business.**
  Third
        parties
        may claim that our current or future products or technology infringe their
        proprietary rights. An infringement claim against us could be costly even
        if the
        claim is invalid, and could distract our management from the operation of
        our
        business. Furthermore, a judgment against us could require us to pay substantial
        damages and could also include an injunction or other court order that could
        prevent us from selling or licensing our product offering. If we faced a
        claim
        relating to proprietary technology or information, we might seek to license
        technology or information, or develop our own, but we might not be able to
        do
        so. Our failure to obtain the necessary licenses or other rights or to develop
        non-infringing technology could prevent us from selling or licensing our
        products and could seriously harm our business.
  Because
        we
        use open source software in some of our products, we may incur expenses in
        defending claims that we did not abide by the open source software license.
        If
        we are not successful in defending against such claims, we may be subject
        to
        monetary damages or be required to remove the open source software from our
        products. Such events could disrupt our operations and the sales of our
        products, which would negatively impact our revenues and cash flow.
 
 -13-
 **If
        our software contains errors or our software product development is delayed,
        our
        business will suffer.**
  We
        face
        possible claims and higher costs as a result of the complexity of our software
        products and the potential for undetected errors. Due to the importance of
        our
        products to our customers’ operations, undetected errors are of particular
        concern. Computer software such as ours may contain undetected errors. In
        addition, the open source software that we incorporate into our products
        may
        contain undetected errors. Because this software was used pursuant to an
        open
        source license, such software is not covered by a warranty. If there are
        any
        errors in our product or the open source software that we use, we will be
        required to expend resources to correct any errors, defects or design flaws.
        The
        implementation of our products, which we accomplish through our services
        division, typically involves working with sophisticated software, computing
        and
        communications systems. If we experience difficulties with an implementation
        or
        do not meet project milestones in a timely manner, we could be obligated
        to
        devote more customer support, engineering and other resources to a particular
        project and to provide these services at reduced or no cost. If our software
        contains significant undetected errors or we fail to meet our customers’
expectations or project milestones in a timely manner, we could experience
        loss
        of or delay in revenues, loss of customers, injury to our reputation, legal
        actions by customers against us, and increased service and warranty
        costs.
  In
        general,
        we attempt to enter into license agreements with our customers that contain
        provisions designed to limit our exposure to potential product liability
        claims,
        such as disclaimers of warranties and limitations on liability for special,
        consequential and incidental damages. In addition, we attempt to enter into
        license agreements that cap the amounts recoverable for damages to the amount
        paid by the licensee to us for the product or service giving rise to the
        damages. However, all domestic and international jurisdictions may not enforce
        these limitations. Not all of our license agreements may contain such provision.
        We may encounter product liability claims in the future. Product liability
        claims, whether or not successful, brought against us could divert the attention
        of management and key personnel, could be expensive to defend and may result
        in
        adverse settlements and judgments.
 
 **Fixed-price
        services engagements can impact our profitability if we fail to complete
        them
        within the estimated budget.**
  We
        perform
        some of our professional services engagements on a fixed-price basis. If
        the
        project requires more labor or products than was estimated by us in determining
        the fixed price agreed to with the customer, our margins and profitability
        will
        be adversely affected. In addition, failure to complete services as required
        or
        to obtain written acceptance of completed milestones may result in deferral
        of
        revenue until such completion or acceptance occurs and may cause revenues
        to be
        recognized in periods other than as initially expected or forecast.
 
 **Barriers
        to international expansion could limit our future growth.**
  While
        sales
        opportunities have been available in international markets, such as Asia-Pacific
        and Europe, currently, we are not actively pursuing these geographic markets
        because of competition from larger competitors who have a local presence
        in
        these international markets, or locally based competitors in these international
        markets due to our current lack of a more fully-developed international sales
        and support capability. In the future, if we consider expansion of our
        international operations, we may face significant barriers to this expansion.
        Our failure to manage our international operations effectively could limit
        the
        future growth of our business. Our revenues attributable to international
        operations for the fiscal year ended December 31, 2006 decreased as compared
        to
        the same period last year. International customers represented approximately
        13%
        and 16% of our total revenues for the fiscal year ended December 31, 2006
        and
        2005, respectively. We conduct our international sales primarily through
        referrals from partners with operations around the world. Any expansion of
        our
        existing international operations and entry into additional international
        markets may require significant management attention and may require additional
        financing.
  To
        date, a
        majority of our international revenue and costs have been denominated in
        United
        States Dollars. However, future international revenue and costs may be
        denominated in currencies other than the United States Dollar. We have not
        engaged in any foreign exchange hedging transactions, and we are therefore
        subject to foreign currency risk.
 
 -14-
 **Governmental
        regulations that limit the growth of the Internet or the communications industry
        could limit our potential market.**
  The
        communications carriers that constitute our clients are regulated at the
        federal, state and local levels. Federal and state regulations may inhibit
        the
        growth of the Internet or communications industry, affect the development
        of
        internet enhanced services, limit the number of potential clients for our
        services, impede our ability to offer competitive services to the Internet
        and
        communications markets, or otherwise have an adverse effect on our business,
        financial condition, results of operations and cash flows.
  The
        Telecommunications Act of 1996, which in large measure deregulated the
        telecommunications industry, has caused, and is likely to continue to cause,
        significant changes in the industry, including the entrance of new competitors,
        consolidation of industry participants and the introduction of bundled services,
        such as wireless, wireline, data, and video. Those changes could in turn
        subject
        us to increased pricing pressures, decrease the demand for our products and
        services, increase our cost of doing business or otherwise have a materially
        adverse effect on our business, financial condition, results of operations
        and
        cash flows.
  **Risks
        Related to Owning Our Stock**
 
 **Future
        sales of our common stock may depress our stock price.**
  A
        significant
        number of shares of our common stock are freely tradable. If any of our
        stockholders sell substantial amounts of our common stock in the public market,
        the market price of our common stock could fall. In addition, such sales
        could
        create the perception in the public of difficulties or problems with our
        software products and services. As a result, these sales also might make
        it more
        difficult for us to sell equity or equity-related securities in the future
        at a
        time and price that we deem appropriate.
 
 **A
        related group of institutional investors beneficially owns approximately
        58.3%
        of our voting stock and possesses the right to designate one person for election
        to our Board of Directors.**
  As
        of March
        12, 2007, SSF beneficially owns approximately 58.3% of our outstanding common
        stock. As a result of such ownership, SSF may have the ability to control
        all
        matters submitted to our stockholders for approval, including the election
        and
        removal of directors and the approval of any business combination. Additionally,
        SSF has the right to designate one person for election to our Board of
        Directors. SSF’s ownership interest may delay or prevent an acquisition or cause
        the market price of our stock to decline.
  **As
        a result of the agreements related to the March 2006 Private Placement, our
        ability to engage in or enter into a variety of transactions is
        restricted.**
  Pursuant
        to
        the March 2006 Private Placement, we entered into certain agreements that
        contain various restrictive covenants that limit our discretion in operating
        our
        business. In particular, these agreements limit our ability to, among other
        things:
 make
              restricted payments (including paying dividends on, limitations on
              redeeming
              or repurchasing our capital stock);
        engage
              in sales of our assets outside of the ordinary course of our
              business;
        make
              certain investments or acquisitions;
        create
              liens on our assets to secure debt;
        engage
              in transactions with affiliates; and
        engage
              in a business other than our current
              operations. These
        restrictions may impair our ability to obtain additional financing and impact
        our liquidity.
 
 -15-
 **Since
        first trading on March 14, 2001, our common stock has experienced significant
        price and volume volatility and we expect that it will continue to do so
        in the
        future, which substantially increases the risk of loss to persons owning
        our
        common stock.**
  There
        was no
        market for our common stock prior to our initial distribution in 2001. Because
        of the limited trading market for our common stock, and because of the possible
        price volatility, you may not be able to sell your shares of common stock
        when
        you desire to do so. The inability to sell your shares in a rapidly declining
        market may substantially increase your risk of loss because of such illiquidity
        and because the price for our common stock may suffer greater declines because
        of its price volatility.
  In
        addition,
        the stock market has experienced extreme price and volume fluctuations, which
        have particularly affected the market prices of many Internet and computer
        software companies, including ours, and which we believe have often been
        unrelated to our operating performance or the performance of these
        companies.
 
 **We
        are not required to meet or maintain any listing standards for our common
        stock
        to be quoted on the OTC Bulletin Board or in the Pink Sheets, which could
        affect
        our stockholders’ ability to access trading information about our common
        stock.**
  The
        OTC
        Bulletin Board and the Pink Sheets are each separate and distinct from the
        Nasdaq Stock Market and any national stock exchange, such as the New York
        Stock
        Exchange or the American Stock Exchange. Although the OTC Bulletin Board
        is a
        regulated quotation service operated by the National Association of Securities
        Dealers (“NASD”), that displays real-time quotes, last sale prices, and volume
        information in over-the-counter (“OTC”) equity securities like our common stock,
        and although Pink Sheets’ Electronic Quotation Service is an Internet-based,
        real-time quotation service for OTC equities for market makers and brokers
        that
        provides pricing and financial information for the OTC securities markets,
        we
        are not required to meet or maintain any qualitative or quantitative standards
        for our common stock to be quoted on either the OTC Bulletin Board or in
        the
        Pink Sheets. Our common stock does not presently meet the minimum listing
        standards for listing on the Nasdaq Stock Market or any national securities
        exchange, which could affect our stockholders’ ability to access trading
        information about our common stock. Additionally, we are required to satisfy
        the
        reporting requirements under the Securities Exchange Act of 1934, as amended
        (the “Exchange Act”). If we fail to do so, our shares may no longer be quoted on
        the OTC.
 
 **We
        do not intend to pay dividends; you will not receive funds without selling
        shares.**
  We
        have never
        declared or paid any cash dividends on our capital stock and do not intend
        to
        pay dividends in the foreseeable future. We intend to invest our future
        earnings, if any, to fund our growth. Therefore, you will not receive any
        funds
        without selling your shares.
 
 **Our
        common stock may be subject to penny stock rules, which may make it more
        difficult for our stockholders to sell their common stock.**
  Broker-dealer
        practices in connection with transactions in “penny stocks” are regulated by
        certain penny stock rules adopted by the Securities and Exchange Commission
        (“SEC”). Penny stocks generally are equity securities with a price of less than
        $5.00 per share. The penny stock rules require a broker-dealer, prior to
        a
        purchase or sale of a penny stock not otherwise exempt from the rules, to
        deliver to the customer a standardized risk disclosure document that provides
        information about penny stocks and the risks in the penny stock market. The
        broker-dealer also must provide the customer with current bid and offer
        quotations for the penny stock, the compensation of the broker-dealer and
        its
        salesperson in the transaction, and monthly account statements showing the
        market value of each penny stock held in the customer’s account. In addition,
        the penny stock rules generally require that prior to a transaction in a
        penny
        stock the broker-dealer make a special written determination that the penny
        stock is a suitable investment for the purchaser and receive the purchaser’s
        written agreement to the transaction. These disclosure requirements may have
        the
        effect of reducing the level of trading activity in the secondary market
        for a
        stock that becomes subject to the penny stock rules.
  -16-
 **Item
        2.** **Description
        of Property**
  We
        do not own
        any real estate properties, but lease approximately 13,500 square feet of
        office
        space in Irvine, California. Our monthly rent obligation is approximately
        $37,000 plus utilities. Our lease expires in April 2007. We expect to enter
        into a new lease agreement for approximately 10,000 square feet of office
        space in Irvine, California beginning in May 2007. In February 2004, we
        entered into a lease agreement for an additional 7,000 square feet of office
        space in Irvine, California with a monthly rent obligation of approximately
        $9,000 plus utilities which expired May 2006. We lease an executive suite
        in Amsterdam, The Netherlands under a month-to-month arrangement for $700
        per
        month.
  **Item
        3. Legal Proceedings**
 
 We
        are not
        currently a party to any legal proceeding, other than routine litigation
        related to collections.
  **Item
        4. Submission of Matters to a Vote of Security Holders**
  None.
  
 -17-
 **PART II**
  **Item
        5. Market for Common Equity and Related Stockholder Matters**
  Our
        common
        stock has been quoted on the OTC Bulletin Board since February 2001, and
        currently is quoted on the OTC Bulletin Board and the Pink Sheets under the
        trading symbol “PSOL.” The following table sets forth the high and low bid
        prices for our common stock for the periods indicated, as reported by OTC
        Bulletin Board. Such quotations reflect inter-dealer prices, without retail
        mark-up, mark-down or commissions, and may not necessarily represent actual
        transactions.
 **Bid****High**
              
              **Low****Year
                  ended December 31, 2006:**First
                  Quarter
              
              $
              0.18
              
              $
              0.12Second
                  Quarter
              
              
              0.13
              
              
              0.07Third
                  Quarter
              
              
              0.20
              
              
              0.07Fourth
                  Quarter
              
              
              0.23
              
              
              0.07**Year
                  ended December 31, 2005:**First
                  Quarter
              
              $
              0.35
              
              $
              0.16Second
                  Quarter
              
              
              0.22
              
              
              0.08Third
                  Quarter
              
              
              0.30
              
              
              0.15Fourth
                  Quarter
              
              
              0.26
              
              
              0.12
  As
        of March
        12, 2007, there were approximately 354 holders of record of our common
        stock.
  We
        have never
        declared or paid any cash dividends on our common stock. For the foreseeable
        future, we expect to retain any earnings to finance the operation and expansion
        of our business.
  **Item
        6. Management’s Discussion and Analysis**
  This
        section
        should be read in conjunction with our Consolidated Financial Statements
        and the
        Notes thereto, which are included elsewhere in this report.
  **A
        Note About Forward-Looking Statements**
  The
        statements, other than statements of historical fact, included in this report
        are forward-looking statements. Forward-looking statements generally can
        be
        identified by the use of forward-looking terminology such as “may,” “will,”
“expect,” “intend,” “estimate,” “anticipate,” “plan,” “seek,” or “believe.” We
        believe that the expectations reflected in such forward-looking statements
        are
        accurate. However, we cannot assure you that such expectations will occur.
        Our
        actual future performance could differ materially from such statements. You
        should not unduly rely on these forward-looking statements, which speak only
        as
        of the date of this Annual Report. Except as required by law, we are not
        obligated to release publicly any revisions to these forward-looking statements
        to reflect events or circumstances occurring after the date of this report
        or to
        reflect the occurrence of unanticipated events.
   **Selected
        Financial Information Line Item Explanations**
  The
        following discussion and analysis provides information that we believe is
        relevant for an assessment and understanding of our consolidated financial
        condition and results of operations.
  -18-
 **Software
        License Revenue**
  Software
        license revenue consists of software license fees charged to our customers
        for
        their use of our software.  Software license fees include one-time and
        recurring license charges and license upgrade charges for our communications
        software products.  Under our subscriber-based recurring revenue model,
        monthly software license fees are volume sensitive and generally are based
        on
        the number of units which include subscriber count and line count. 
Software license revenue also includes revenue associated with the sales
        of
        third-party software or hardware which are not material in amount or
        frequency.
  **Product
        Support and Upgrades Revenue**
  Our
        product
        support and upgrades revenue is from providing software support and
        maintenance.  It begins after the ninety-day warranty period has expired
        and the customer has purchased software support and maintenance.  Under our
        maintenance agreement, a customer gains rights to unspecified product upgrades,
        maintenance releases, and patches released during the term of the support
        period.  Product support includes internet and telephone access to
        technical support as well as on-site visits.  In general, product support
        revenue can fluctuate with the renewal or non-renewal of maintenance contracts
        on an annual basis.
  **Services
        Revenue**
  Services
        revenue is comprised of application management and hosting our software on
        the
        customer’s hardware, delivery of recurring professional services associated with
        our existing customer base and the delivery of professional services associated
        with new customer contracts.  In general, services revenue can fluctuate
        with the volume of new customer sales as well as the renewal or non-renewal
        of
        application management and hosting contracts on an annual basis.  In
        addition, the services we provide to a customer can vary depending on the
        complexity of the customer’s information technology environment, the resources
        directed by the customers to their implementation projects, and the extent
        to
        which consulting organizations provide services directly to
        customers.
  **Sales
        and Marketing**
  Sales
        and
        marketing expenses consist primarily of sales and marketing employee salaries,
        benefits and commissions, trade show related costs, seminars, and promotional
        materials.
  **Cost
        of Revenues**
  The
        cost of
        software license revenue primarily consists of the cost of computer hardware
        and
        license fees paid to third parties under technology license arrangements
        we
        resell to customers. These costs vary depending on the customer’s
        needs.
  The
        cost of
        product support and upgrades revenue includes the costs of providing services
        such as technical support, general software maintenance, and product
        updates.
  The
        cost of
        services revenue includes the costs of providing professional services such
        as
        installation, training, applications management and hosting our software
        on the
        customer’s hardware, customization, and deployment.
  **Research
        and Development**
  Research
        and
        development expenses consist primarily of personnel and related costs associated
        with our product development efforts.
  **General
        and Administrative**
  General
        and
        administrative expenses consist primarily of public company related expenses,
        professional fees, and employee salaries and related expenses for executive,
        finance, administrative, facilities and information services
        personnel.
  -19-
 **Interest
        and Other Expense, Net**
  Interest
        and
        other expense generally consist of interest income, interest expense and
        any
        gain or loss on the sale of assets.  In 2006, interest expense also
        includes the amortization of the debt discount resulting from the initial
        recording of warrants issued in connection with the private placement in
        March
        2006 (the "March 2006 Private Placement") and the private placement in April
        2006 (the "April 2006 Private Placement" and collectively, the "2006 Private
        Placements") as liabilities, the amortization of the beneficial conversion
        feature, and the amortization of debt issuance costs.  Additionally, the
        change in the fair value of the warrants recorded as liabilities is reflected
        as
        other income or expense.
   **RESULTS
        OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 2006 AND
        2005**
 
 **Statement
                of Operations Data (in
                thousands)**
              
              **Year****Ended****December 31,**
              
              **Change****200****6**
              
              **2005**
              
              **$**
              
              **%****REVENUES**Software
                  license revenue
              
              $
              1,828
              
              $
              3,318
              
              $
              (1,490
              )
              
              (45
              )%Product
                  support and upgrades revenue
              
              
              1,236
              
              
              1,385
              
              
              (149
              )
              
              (11
              )%Services
                  revenue
              
              
              2,584
              
              
              3,864
              
              
              (1,280
              )
              
              (33
              )%Total
                  revenues
              
              
              5,648
              
              
              8,567
              
              
              (2,919
              )
              
              (34
              )%**OPERATING
                  EXPENSES**Sales
                  and marketing
              
              
              1,923
              
              
              2,397
              
              
              (474
              )
              
              (20
              )%Software
                  licenses
              
              
              122
              
              
              86
              
              
              36
              
              
              42
              %Product
                  support and upgrades
              
              
              481
              
              
              408
              
              
              73
              
              
              18
              %Services
              
              
              1,930
              
              
              3,249
              
              
              (1,319
              )
              
              (41
              )%Research
                  and development
              
              
              1,499
              
              
              1,692
              
              
              (193
              )
              
              (11
              )%General
                  and administrative
              
              
              2,263
              
              
              2,050
              
              
              213
              
              
              10
              %Total
                  operating expenses
              
              
              8,218
              
              
              9,882
              
              
              (1,664
              )
              
              (17
              )%LOSS
                  FROM OPERATIONS
              
              
              (2,570
              )
              
              (1,315
              )
              
              (1,255
              )
              
              95
              %INTEREST
                  AND OTHER EXPENSE, NET
              
              
              (590
              )
              
              (85
              )
              
              (505
              )
              
              594
              %LOSS
                  BEFORE INCOME TAXES
              
              
              (3,160
              )
              
              (1,400
              )
              
              (1,760
              )
              
              126
              %INCOME
                  TAX PROVISION
              
              
              2
              
              
              2
              
              
              —
              
              
              —NET
                  LOSS
              
              $
              (3,162
              )
              $
              (1,402
              )
              $
              (1,760
              )
              
              126
              %**Supplemental
                  data:**Depreciation
                  and Amortization
              
              $
              126
              
              $
              168
              
              $
              (42
              )
              
              (25
              )%
 
 **Overview**
  During
            2006,
            we added new customers in the cable, VoIP, and municipal WiFi markets.  We
            also released new versions of our IPC and CCB products.  We enhanced and
            expanded the capabilities of our IPC transaction management platform,
            enhanced
            the performance and capabilities of our rating engine, and introduced
            a new
            Revenue Assurance SolutionPAKTM module for revenue management, partner settlement
            and voice profitability.   For the past several years, we have
            provided revenue assurance services to a number of our largest customers
            as a
            dedicated managed service.  While to-date, we have offered our IPC product
            under a managed service model, with the release of the Revenue Assurance
            SolutionPAK, we have also begun offering the SolutionPAK revenue assurance
            and
            settlement reconciliation services under a multi-tenant SaaS delivery
            model.
 This allows customers to use our revenue assurance services on an
            outsourced basis without having to setup any infrastructure in-house.
 We
            also enhanced the capabilities of our CCB customer care and billing product
            by
            introducing expanded support for commercial voice and data
            services.
  Total
        revenues for
        the fiscal year ended December 31, 2006 were $5.6 million, a decrease of
        $2.9
        million, or 34%, from $8.6 million for the same period in 2005. The decrease
        resulted from the loss of revenue in the amount of $4.5 million from our
        then
        largest customer in 2005, whose license and services agreement expired in
        December 2005, offset by an increase in revenues of $573,000 from our existing
        customers and $1.0 million from our new 2006 customers.  During the fiscal
        year ended December 31, 2006, we had three customers who individually accounted
        for more than 10% of total revenues.  These three customers represented
        53%, 11%, and 10% of total revenues, respectively, for the fiscal year ended
        December 31, 2006.
 
 -20-
 During
        the
        fiscal year ended December 31, 2006, we focused on managing and reducing
        our
        costs in an effort to bring them in line with expected revenues. For the
        fiscal
        year ended December 31, 2006, operating expenses decreased by $1.7 million,
        or
        17%, as compared to the same period in 2005.  In January 2006, we began
        expensing stock compensation costs, as required by SFAS 123R, which totaled
        $351,000 for the fiscal year ended December 31, 2006.  During the fiscal
        year ended December 31, 2006, the decrease of $1.3 million in cost of services
        was primarily due to a decline in labor-related expenses from the same period
        in
        2005 to support our then largest customer.  As a part of accounting for the
        2006 Private Placements during the fiscal year ended December 31, 2006, we
        incurred non-cash expenses in the amount of $457,000 which we charged to
        interest expense.  We incurred interest expense of $57,000 during the same
        period for the related $1.5 million senior secured convertible
        note.
  **Total
        Revenue** **s**
  Revenues
        for
        the fiscal year ended December 31, 2006 were $5.6 million, a decrease of
        $2.9
        million, or 34%, from $8.6 million for the same period in 2005. The decrease
        resulted from the loss of revenue in the amount of $4.5 million from our
        then
        largest customer in 2005, whose license and services agreement expired in
        December 2005, and an increase in revenue of $573,000, or 14%, from our existing
        customers and $1.0 million from our new 2006 customers.  Total revenues
        from our current largest customer during the fiscal year ended December 31,
        2006
        represented approximately 53% of total revenues and accounted for 19% of
        total
        revenues for the fiscal year ended December 31, 2005.
  For
        the
        fiscal year ended December 31, 2006, total revenues of $5.6 million was
        comprised of $4.1 million of recurring revenue, or 73% of total
        revenues, and $1.5 million of nonrecurring revenue. Recurring revenue
        decreased $2.8 million, or 41%, as compared to $7.0 million for the same
        period
        in 2005.  The decrease was due to a loss of $4.2 million earned in 2005
        from our then largest customer, offset by an increase of $1.4 million from
        our
        other customers.  The increase resulted from an increase in fees from
        monthly subscription-based licenses and from three license and services
        agreements entered into during the fiscal year ended December 31, 2006. 
Total nonrecurring revenue for the fiscal years ended December 31, 2006 and
        2005
        was $1.5 million and $1.6 million, respectively.  During the fiscal year
        ended December 31, 2006, the decrease that was due to a loss of $275,000
        earned
        in 2005 from our then largest customer which was offset by an increase of
        $201,000 from our other customers.
  We
        generate
        revenue from the sale of software licenses and related maintenance arrangements,
        application management and hosting services, and subscription-based Software
        as
        a Service ("SaaS") delivery of solutions via the Internet.  Our revenue
        from professional services rendered for customization, installation,
        implementation, and training are non-recurring, while revenue for application
        management and hosting our software on the customer's hardware is recurring
        in
        nature.  We continue to shift towards multi-year, subscription-based
        recurring software and maintenance agreements, with a smaller percentage
        of our
        revenue coming from upfront license and annual maintenance agreements. 
During fiscal year ended December 31, 2006, we have increased revenues generated
        from application management and hosting services.  This overall shift has
        marked a significant change in our revenue model.  We believe this revenue
        model will provide greater long-term financial benefit to the Company as
        we
        expect increases in our customers' subscriber volumes for new IP services,
        especially in VoIP phone services and WiFi services.  Under the
        subscriber-based recurring revenue model, recurring software and
        maintenance revenues will increase over time if the customers' subscribers
        bases increase.
  We
        define
        recurring revenue as revenue derived from subscriber-based license and
        maintenance agreements, maintenance agreement renewals and application
        management and hosting of the customer equipment.  All other revenue we
        define as nonrecurring.
  -21-
 *Software
        License Revenue*
  For
        the
        fiscal year ended December 31, 2006, software license revenue was $1.8 million,
        a decrease of $1.5 million from $3.3 million of total revenues for the same
        period in the prior year. The change was the result of an increase in revenue
        of
        $645,000, or 62%, from our existing customers and an additional $146,000
        from
        our new 2006 customers, which was offset by a decrease of $2.3 million in
        revenue from our then largest customer during the same period in
        2005.
  During
        the
        fiscal year ended December 31, 2006, total software license revenue of $1.8
        million was comprised of $1.6 million of recurring revenue and $195,000 of
        nonrecurring revenue.  Recurring subscription-based license revenue
        decreased by $1.2 million, or 42%, to $1.6 million, as compared to $2.8 million
        for the same period in the prior year.  The decrease was due to a loss of
        $2.0 million earned in 2005 from our then largest customer, offset by an
        increase of $831,000 from our other customers.  Total nonrecurring license
        revenue which includes sales of third party hardware and software decreased
        by
        $314,000 for the fiscal year ended December 31, 2006, when compared to the
        same
        period in the prior year.  The decrease was due to a loss of $275,000
        earned in 2005 from our then largest customer and a decrease of $39,000 from
        our
        other customers.
  During
        the
        fiscal year ended December 31, 2006, all of our software license revenue
        resulted from subscription-based licensing and managed-services pricing
        models.  Under these models, software license revenue from customers is
        expected to grow as their subscriber bases and/or transaction volumes grow,
        having a greater impact on our license revenues in future quarters. 
Licensing revenue from our customers using the subscription-based licensing
        and
        managed-services pricing models is expected to be low in the early period
        of the
        contracts and higher in the later period.
  *Product
        Support and Upgrades Revenue*
  Product
        support and upgrades revenue of $1.2 million or 22% of total revenues, decreased
        $149,000, or 11%, for the fiscal year ended December 31, 2006, as compared
        to
        $1.4 million, or 16% of total revenues, for the same period in 2005. All
        product
        support and upgrades revenue is recurring revenue.  The net decrease was
        primarily the result of a decrease of $206,000 in revenue from our then largest
        customer for the same period 2005, offset by an increase in revenue from
        our
        other customers of $57,000.
  *Services
        Revenue*
  Services
        revenue was $2.6 million, or 46% of total revenues, for the fiscal year ended
        December 31, 2006, as compared to $3.9 million, or 45% of total revenues,
        for
        the same period last year. The net decrease was due to an increase in revenue
        of
        $860,000 from our new 2006 customers, offset by a decrease in revenue from
        our
        existing customers of $117,000, or 6%, and a loss of $2.0 million in revenue
        from our then largest customer for the same period in 2005.
  For
        the
        fiscal year ended December 31, 2006, total services revenue of $2.6 million
        was
        comprised of $1.3 million of recurring revenue and $1.3 million of nonrecurring
        revenue.  Recurring services revenue decreased $1.5 million, or 54%, as
        compared to $2.8 million for the same period last year.  The decrease was
        due to a loss of $2.0 million earned in 2005 from our then largest customer,
        offset by an increase of $502,000 from our other customers due to an increase
        in
        application management and hosting our software on customer hardware.
        Nonrecurring revenue increased $240,000, or 22%, due to an increase in
        implementation, customization, and training in connection with three new
        customers during 2006 and ongoing up-sell services to our existing customers
        when compared to the same period in 2005.
  -22-
 *Concentration
        Risk*
  For
        the
        fiscal year ended December 31, 2006, we had three customers who
        individually accounted for more than 10% of our total revenues in the amount
        of
        $3.0 million, $613,000 and $568,000, respectively. In the same period last
        year, we had two customers who individually accounted for more than 10% of
        our
        total revenues in the amount of $4.5 million and $1.6 million,
        respectively.
  In
        December 2005, the license and services agreement with our largest customer
        expired. After its merger with and into another wireless telecommunication
        company, the customer elected to not renew its agreement based on the decision
        to migrate to its merger partner’s existing billing system. During 2006, the
        Company focused on converting new sales opportunities into long-term recurring
        revenue arrangements to offset the loss of this customer.
  **Operating
        Expenses**
  *Sales
        and Marketing*
  Sales
        and
        marketing expense for the fiscal year ended December 31, 2006 was $1.9 million,
        a decrease of $474,000 from $2.4 million for the same period in 2005. 
During the fiscal year ended December 31, 2005, we embarked on a marketing
        program to rebrand the Company.  Through this program, we created a new
        image and messaging around our IP CorrelyticsTM product as well as promoted the
        Company through a new website, an industry press tour and increased
        participation at trade shows and conferences.  Marketing related costs were
        $462,000 during the fiscal year ended December 31, 2005, as compared to $109,000
        during the same period in 2006.  The overall decrease was also due to a
        decrease in travel and related expenses of $102,000 and personnel and related
        costs of $87,000 due to reduction in headcount, offset by $66,000 of non-cash
        stock compensation.
  *Cost
        of Revenues*
  The
        cost of
        software licenses increased $36,000 to $122,000 for the fiscal year ended
        December 31, 2006, as compared to $86,000 for the fiscal year ended December
        31,
        2005.  The increase primarily relates to the cost of nonrecurring third
        party software and hardware resold to a our new 2006 customers as well as
        additional third party software and hardware related to upsell revenues for
        existing customers.
  The
        cost of
        product support and upgrades increased $73,000 to $481,000 for the fiscal
        year
        ended December 31, 2006, as compared to $408,000 for the same period in
        2005.  The increase was primarily due to an increase in labor related costs
        to support new and existing customers with increasing requirements due to
        their
        growth.
  The
        cost of
        services decreased $1.3 million to $1.9 million for the fiscal year ended
        December 31, 2006, as compared to $3.2 million for the fiscal year ended
        December 31, 2005. The decrease primarily resulted from the termination of
        employees associated with the expiration of the Company’s largest customer’s
        license and services agreement in December 2005. The related severance cost
        incurred in 2005, as well as the overall reduction in the services personnel
        in
        2006, also contributed to the decrease in cost of services for the fiscal
        year
        ended December 31, 2006 compared to the same period in 2005.
  *Research
        and Development*
  Research
        and
        development expenses decreased $193,000 to $1.5 million for the fiscal year
        ended December 31, 2006, as compared to $1.7 million for the fiscal year
        ended
        December 31, 2005. The net decrease primarily resulted from a decrease in
        outside contract labor costs of approximately $274,000.  This decrease was
        offset with an overall increase in headcount which contributed to a higher
        allocation of facilities costs and other general expenses during the fiscal
        year
        ended December 31, 2006.
  -23-
 *General
        and Administrative*
  General
        and administrative expense for the fiscal year ended December 31, 2006 was
        $2.3
        million, an increase of $213,000 from $2.1 million for the same period in
        2005.
        This net increase was primarily due to higher professional services costs
        of
        $92,000, an increase in non-cash compensation expense of $97,000 related
        to the
        warrants issued to the members of the board of directors as well as the
        liquidated damages recognized in 2006 pursuant to the registration statement
        agreements related to the 2006 Private Placements. This increase was offset
        with
        an overall decrease in travel and related expenses of $33,000 and other
        administrative expenses of $46,000.
  **Interest
        and Other Expense, Net**
  Interest
        and
        other expenses, net was $590,000, an increase of $505,000 for the fiscal
        year
        ended December 31, 2006 as compared to $85,000 for the fiscal year ended
        December 31, 2005. The increase of $505,000 was primarily due to non-cash
        expenses associated with the 2006 Private Placements, consisting of the net
        gain
        from the change in the fair value of the warrants issued in the 2006 Private
        Placements of $4,000, the amortization of the capitalized debt issuance costs
        of
        $66,000, and the accretion of the debt discount totaling $395,000. Additionally,
        the interest expense associated with the senior convertible debt issued in
        the
        March 2006 private placement totaled $57,000 for the fiscal year ended December
        31, 2006.
  **Income
        Tax Provision**
  The
        income
        tax provision for the fiscal years ended December 31, 2006 and 2005
        consisted of the minimum state taxes due to the operating losses for the
        years.
  **Depreciation
        and Amortization**
  Depreciation
        and amortization expense for the fiscal year ended December 31, 2006 was
        $126,000, a decrease of $42,000 from $168,000 for fiscal year ended December
        31,
        2005. This decrease resulted from certain fixed assets acquired in previous
        years becoming fully depreciated at the beginning of 2006.
   -24-
 **Liquidity
        and Capital Resources**
 **Balance
                Sheet Data (in
                thousands)**
              
              **December****31,**
              
              **December 31,**
              
              **Change****200****6**
              
              **2005**
              
              **$**
              
              **%**Cash
                  and cash equivalents
              
              $
              382
              
              $
              711
              
              $
              (329
              )
              
              (46
              )%Restricted
                  cash
              
              
              103
              
              
              101
              
              
              2
              
              
              2
              %Accounts
                  receivable
              
              
              268
              
              
              591
              
              
              (323
              )
              
              (55
              )%Cash,
                  cash equivalents and accounts receivable
              
              
              753
              
              
              1,403
              
              
              (650
              )
              
              (46
              )%Current
                  assets
              
              
              995
              
              
              1,502
              
              
              (507
              )
              
              (34
              )%Accounts
                  payable and accrued expenses
              
              
              1,397
              
              
              1,288
              
              
              109
              
              
              8
              %Current
                  portion notes payable
              
              
              741
              
              
              288
              
              
              453
              
              
              157
              %Deferred
                  revenue
              
              
              220
              
              
              371
              
              
              (151
              )
              
              (41
              )%Warrant
                  liability
              
              
              1,015
              
              
              —
              
              
              1,015
              
              
              100
              %Current
                  liabilities
              
              
              3,373
              
              
              1,947
              
              
              1,426
              
              
              73
              %Working
                  capital deficit
              
              
              (2,378
              )
              
              (445
              )
              
              (1,933
              )
              
              434
              %Noncurrent
                  liabilities
              
              
              1,247
              
              
              1,180
              
              
              67
              
              
              6
              %
  **Overview**
  As
        of
        December 31, 2006, our working capital deficit balance increased by $1.9
        million
        to $2.4 million, as compared to a working capital deficit of $445,000 as
        of
        December 31, 2005. The overall increase was primarily due to the loss
        from operations of $3.2 million that included $351,000 for non-cash stock-based
        compensation expense, an increase in cash of $1.7 million from the 2006 Private
        Placements, less related cash and non-cash expenses that totaled $625,000,
        and
        $250,000 from a promissory note to Special Situations Private Equity Fund,
        L.P.
        executed in December 2006 (the “December Note”).  The decrease of $323,000
        in accounts receivable resulted primarily from customers taking advantage
        of
        discount terms for early payment which we began offering during 2006.  The
        increase in working capital deficit was also attributable to a note payable
        for
        $200,000 and the related accrued interest of $127,000 that will mature on
        April
        30, 2007 and was reclassified from noncurrent liabilities to current liabilities
        12 months prior to the maturity date, as well as normal fluctuations in other
        current assets and current liabilities due to changes in timing from period
        to
        period.  Of the $1.4 million increase in current liabilities, $1.0 million
        was from the warrant liability.
 We
        believe
        that existing cash balances combined with cash generated from existing and
        currently anticipated contracts will be sufficient to support our working
        capital requirements through at least the next twelve months. We are also
        focused on converting new sales opportunity to augment the cash receipts
        from
        existing contracts, which we expect to grow as our customers' subscriber
        counts
        are expected to increase. The Company continues to manage our operating costs
        in
        light of expected revenues. We anticipate savings from our move to new office
        facilities in May 2007.  In addition, management is currently exploring the
        possibilities of restructuring our current debt obligations. We
        cannot, however, be certain that cash generated from future operations will
        be
        adequate to support our working capital requirements, nor cost-reduction
        activities or debt restructuring will be adequate or possible.
  Historically,
        our sources of liquidity primarily have been cash from operations and financing
        activity. In 2007, we expect our sources of liquidity will continue to include
        cash from operations.
  -25-
 Pursuant
        to
        the 2006 Private Placements, we entered into certain agreements that contain
        various restrictive covenants that limit our discretion in operating our
        business. In particular, these agreements limit our ability to, among other
        things:
 make
            restricted payments (including paying dividends on, limitations on redeeming
            or repurchasing our capital stock);
        engage
            in sales of our assets outside of the ordinary course of our
            business;
        make
            certain investments or acquisitions;
        create
            liens on our assets to secure debt;
        engage
            in transactions with affiliates; and
        engage
            in a business other than our current operations. Thus
        our
        ability to obtain third party financing on acceptable terms will be limited.
        If
        we require additional financing, we cannot be certain that such financing
        will
        be available to us on acceptable terms, or at all.
  **Cash
        and Accounts Receivable**
  Cash
        and cash
        equivalents and accounts receivable collectively decreased by $650,000 at
        December 31, 2006 from $1.4 million at December 31, 2005, primarily due to
        the usage of cash for operating needs, offset by the net proceeds from the
        2006
        Private Placements and the December Note. On December 31, 2006 and 2005,
        we held
        restricted cash of $103,000 and $101,000, respectively, pursuant to a loan
        agreement with First Regional Bank.  On December 31, 2006, the accounts
        receivable balance was $268,000, a decrease of $323,000, or 55%, from the
        balance of $591,000 on December 31, 2005. The decrease resulted primarily
        from customers taking advantage of discount terms for early payment which
        we
        began offering during 2006.
  **Liabilities**
  Accounts
        payable and accrued expenses increased by $109,000 to $1.4 million at December
        31, 2006 from $1.3 million at December 31, 2005 largely due to timing of
        payment
        of outstanding invoices and accruals. During the fiscal year ended December
        31,
        2006, we accrued $122,000 for liquidated damages pursuant to the registration
        rights agreements related to the 2006 Private Placements and the balance
        remained outstanding as of December 31, 2006. Additionally, the total liability
        related to termination benefits as of December 31, 2006 was $29,000 higher
        than
        the total liability as of December 31, 2005. This aggregate increase was
        offset
        with a decrease in accrued incentive compensation of approximately
        $57,000.
  In
        March 2006, we restructured the Corsair Communications, Inc. note
        payable, amending the payment terms and extending the maturity date to January
        2011 from January 2010. Pursuant to the amended terms of the note, interest
        continued to accrue at the same rate, and we were required to make monthly
        interest-only payments of approximately $7,000 from January 2006 through
        December 2006 and monthly interest and principal payments of $20,000 from
        January 2007 through January 2011, until paid in full. This obligation
        was subordinated to the Notes issued in the March 2006 Private Placement.
 Effective
          January
          2 007,
          the
          payment terms for the Corsair Communications, Inc. note payable was further
          amended. Under the amended terms, the monthly interest-only payment of
          $7,000
          continues from January 2007 through June 2007. Beginning in July 2007,
          principal and interest payments of $22,000 are due monthly through November
          2011
          with a final payment of $20,000 due in December 2011. As of December 31,
          2006,
          the outstanding current liability balance was $167,000 and the outstanding
          noncurrent liability balance was $815,000.
 In
        December
        2006, we entered into the December Note with Special Situations Private Equity
        Fund, L.P., a related party, in the amount of $250,000. 
Interest accrues at a rate of 11%.  There is no principal or interest
        payment due until the maturity date of June 27, 2007.  As of December 31,
        2006, the outstanding balance was $250,000 and classified as a current
        liability.
  Also,
        during
        the second quarter of 2006, the Spieker notes payable of $200,000 and the
        related accrued interest of $127,000 was reclassified from a noncurrent
        liability to current liability based on the April 2007 maturity
        date.
  Deferred
        revenue on December 31, 2006 decreased $151,000, or 41%, to $220,000, as
        compared to $371,000 on December 31, 2005. The net decrease in deferred revenue
        is primarily due to timing difference between recognizing revenue and invoicing
        the customer for agreed-upon services, such as annual maintenance contracts
        or
        nonrecurring services.  A legacy customer’s existing contract expired at
        September 30, 2006 and we entered into a new contract with that customer
        effective October 1, 2006.  Due to changes in the customer’s business,
        software license and product support and upgrades revenues will be less than
        under the expired contract and reduced the deferred revenue liability $114,000
        on December 31, 2006 as compared to December 31, 2005. Additionally, in 2006,
        the subscriber rate for an existing contract was downwardly adjusted pursuant
        to
        the sales contract and resulted in a prepayment balance of $46,000 at December
        31, 2006. This deferred revenue will be ratably applied against the monthly
        billings in 2007.
  -26-
 The
        warrant
        liability of $1.0 million on December 31, 2006 reflects the fair value of
        the
        warrants issued as part of the 2006 Private Placements that are being accounted
        for as liabilities pursuant to Statement of Financial Accounting Standards
        No.
        133, *Accounting
        for Derivative Instruments and Hedging Activities*(“SFAS
        133”).
  **Cash
        Flows**
  Net
        cash used
        by operating activities of $2.0 million for the fiscal year ended December
        31,
        2006 resulted primarily from a net loss of $3.2 million that included non-cash
        expenses for stock-based compensation of $351,000 and non-cash expenses of
        $457,000 related to the 2006 Private Placements as well as a net decrease
        in
        operating assets over operating liabilities of $264,000.  Net cash used by
        operating activities of $1.6 million for the fiscal year ended December 31,
        2005 resulted primarily from a net loss coupled with increases in accounts
        receivable and decreases in current liabilities.
  Net
        cash used
        in investing activities decreased to $10,000 for the fiscal year ended December
        31, 2006, as compared to $61,000 for the same period in 2005, and was primarily
        due to the decrease in purchases of capital equipment.
  Net
        cash
        provided by financing activities increased to $1.6 million for the fiscal
        year
        ended December 31, 2006, a change of $1.9 million from $264,000 net cash
        used by
        financing activities for the fiscal year ended December 31, 2005. This change
        was primarily due to the March 2006 Private Placement, which provided gross
        proceeds of $1.5 million and net proceeds of $1.4 million.  In addition, we
        received $175,000 of gross proceeds from the April 2006 Private Placement
        and $250,000 from the December Note during the fiscal year ended December
        31,
        2006. Also, repayments on notes payable and capital lease obligations totaled
        $69,000 during the fiscal year ended December 31, 2006, as compared to $194,000
        during the fiscal year ended December 31, 2005.
  The
        following
        table includes all the contractual obligations, including principal and interest
        payments, as of December 31, 2006:
  **Payments****Due by Period****Contractual Obligations**
              
              **Total**
              
              **Less**
                **than 1**
                **year**
              
              **1-3**
                **years**
              
              **3-5**
                **years**
              
              **More**
                **than 5**
                **Years**Long-Term
                  Debt
              
              $
              1,963,000
              
              $
              970,000
              
              $
              519,000
              
              $
              474,000
              
              $
              —Operating
                  Lease Obligations
              
              
              252,000
              
              
              197,000
              
              
              53,000
              
              
              2,000
              
              
              —$
              2,215,000
              
              $
              1,167,000
              
              $
              572,000
              
              $
              476,000
              
              $
              —
  There
        were no
        commercial commitments outstanding as of December 31, 2006.
  **April
        2006 Private Placement**
  On
        April 27,
        2006, we sold 1,750,000 shares of our common stock and 875,000 warrants to
        purchase shares of our common stock to two accredited investors in a private
        placement, one of which is currently a member of our Board of Directors.
        The
        warrants expire March 31, 2011 and are exercisable for cash at an exercise
        price
        of $0.15 per share. The exercise price of the warrants is subject to adjustment
        in certain circumstances, including downward adjustment upon issuance by
        us of
        our common stock or securities convertible into shares of common stock at
        a per
        share price less than the exercise price of the warrants. The investors may,
        in
        limited instances, exercise the warrant through a cashless exercise. We received
        gross proceeds of $175,000 and anticipate using these proceeds to expand
        our
        sales and marketing efforts and for general working capital
        purposes.
  Pursuant
        to a
        Registration Rights Agreement entered into with the two investors, we agreed
        to
        file, and did file on May 1, 2006, a registration statement, registering
        for
        resale the shares of common stock and the shares of common stock issuable
        upon
        exercise of the warrants. Because the Company registration statement was
        not
        declared effective by July 16, 2006, the Company is required to pay
        liquidated damages at the rate of 1.5 percent of the aggregate amount invested
        by the non-director investor for each 30-day period or pro rata for any portion
        thereof until the registration statement was declared effective on December
        22,
        2006. In addition, we will be required to maintain and update it as necessary
        in
        order to keep such registration statement current so that these shares of
        common
        stock are freely tradable. If we do not keep such registration statement
        current, we may be required to pay additional liquidated damages to the
        non-director investor.
  -27-
 **March 2006
        Private Placement**
  On
        March 31, 2006, we completed a private placement of $1.5 million in
        aggregate principal amount of the Notes along with warrants to purchase 7.5
        million shares of our common stock to SSF. The Notes are due March 31, 2008
        and will pay interest semi-annually, in cash. The Notes are secured by a
        first
        priority security interest in all of the Company’s assets. Events of default
        under the Notes include failure to pay amounts due under the related private
        placement documents (including the Registration Rights Agreement described
        below) or failure to make any required principal payment on indebtedness
        of
        $100,000 or more.  Upon election of SSF, at any time, any or all of the
        outstanding principal and accrued but unpaid interest on the Notes may be
        converted into shares of our common stock at a conversion price of $0.10
        per
        share. The warrants to purchase our common stock expire March 31, 2011 and
        are exercisable for cash at an exercise price of $0.15 per share. The conversion
        price of the Notes and the exercise
        price of the warrants are subject to adjustment in certain circumstances,
        including downward adjustment upon issuance by the Company of common stock
        or
        securities convertible into shares of common stock at a per share price less
        than the conversion price or exercise price of the warrants, respectively.
        SSF
        may, in limited instances, exercise the warrant through a cashless
        exercise.
  Pursuant
        to a
        Registration Rights Agreement entered into between us and SSF as part of
        the
        March 2006 Private Placement,
        we agreed to file, and did file on May 1, 2006, a registration statement,
        registering for
        resale of the shares of common stock issuable upon conversion of the Notes
        and
        exercise of the warrants. Because the Company registration statement was
        not
        declared effective by July 16, 2006, the Company is required to pay
        liquidated damages at the rate of 1.5 percent of the aggregate amount invested
        by the investors for each 30-day period or pro rata for any portion thereof
        until the registration statement was declared effective on December 22,
        2006.  In addition, we will be required to maintain and update it as
        necessary in order to keep such registration statement current so that these
        shares of common stock are freely tradable. If we do not keep such registration
        statement current, we may be required to pay additional liquidated
        damages.
  As
        a result
        of certain anti-dilution provisions triggered by the March 2006 Private
        Placement, certain purchasers in the private placement completed in June
        2004
        (the “June 2004 Private Placement”) were issued 1,713,859 additional warrants to
        purchase shares of the our common stock and the exercise price of the 6,869,566
        outstanding warrants originally issued to these purchasers was repriced from
        $0.28 to $0.22 per share. All warrants issued pursuant to the June 2004
        Private Placement expire in June 2009.
  **June 2004
        Private Placement**
  On
        June 15,
        2004, we completed a private placement of our common stock and warrants.
        Pursuant to the June 2004 Private Placement, we issued an aggregate of
        14,284,782 shares of common stock and warrants to purchase a total of 7,142,393
        shares. The effective price was $0.23 for each unit.  We
        received gross proceeds of $3.3 million in cash from the June 2004 Private
        Placement. As a result of certain anti-dilution provisions triggered by the
        March 2006 Private Placement, certain purchasers in the June 2004 Private
        Placement are entitled to 1.7 million additional warrants to purchase shares
        of
        our common stock and the exercise price of the warrants has been adjusted
        from
        $0.28 to $0.22 per share. All warrants issued pursuant to the June 2004 Private
        Placement will also expire in June 2009.
  Additionally,
        as part of the June 2004 Private Placement, the Company and SSF and certain
        other purchasers entered into a registration rights agreement, whereby, among
        other things, we agreed to file a “resale” registration statement, covering the
        shares of common stock and the shares of common stock issuable upon the
        conversion of the warrants in connection with the June 2004 Private Placement.
        These shares of common stock are part of the subject matter of a registration
        statement on Form SB-2 filed pursuant to the Securities Act, with the SEC
        on
        July 30, 2004, as amended. Pursuant to this registration rights agreement,
        we
        have an obligation to maintain and update any such registration statement
        as
        necessary in order to keep such registration statement current so that these
        shares of common stock are freely tradable. If we do not keep such registration
        statement current, we may be required to pay liquidated damages.
  -28-
 **Critical
        Accounting Policies**
  We
        prepare
        our consolidated financial statements in conformity with accounting principles
        generally accepted in the United States. As such, we are required to make
        certain estimates, judgments and assumptions that we believe are reasonable
        based upon the information available. These estimates and assumptions affect
        the
        reported amounts of assets and liabilities at the date of the financial
        statements and the reported amounts of revenues and expenses during the periods
        presented. The significant accounting policies which we believe are the most
        critical to aid in fully understanding and evaluating our reported financial
        results include the following:
  ***Revenue
        Recognition*** —The
        Company derives revenues from the sale of software licenses, product support
        and
        upgrades fees, and professional services, which include installation, training
        and customization, application management, and hosting the Company’s software on
        the customer’s hardware. The Company enters into a multiple element arrangement
        through a license and maintenance agreement with the customer, and includes
        a
        license for the Company’s software, post-warranty maintenance fees for technical
        support and product updates over a one-year period. Although the agreement
        typically includes professional services fees for installation, training
        and
        customization, most professional services are sold separately and all are
        based
        on time spent and materials used. The Company licenses the software under
        an
        upfront fee payment, or monthly subscription that includes maintenance support,
        and both are based on the customer’s number of subscribers or similar measure.
        Customers generally subscribe to product support and upgrade, i.e.
        maintenance.
  The
        Company
        recognizes revenue using the residual method pursuant to the provisions of
        Statement of Position No. 97-2, *Software
        Revenue Recognition* (“SOP
        97-2”), as amended by Statement of Position No. 98-9, *Software
        Revenue Recognition with Respect to Certain Arrangements* (“SOP
        98-9”), and Emerging Issues Task Force Issue No. 00-21, *Revenue
        Arrangements with Multiple Deliverables* (“EITF
        00-21”). Under the residual method, revenue is recognized in a multiple element
        arrangement when vendor-specific objective evidence (“VSOE”) of fair value
        exists for all undelivered elements (i.e., maintenance) in the arrangement,
        but
        does not exist for one of the delivered elements in the arrangement (i.e.,
        software license). The Company allocates revenue to each element in the
        arrangement based on its respective fair value, with the fair value determined
        by the price historically charged if that element is sold separately. The
        Company defers revenue for the fair value of all undelivered elements and
        recognizes revenue for the remainder of the arrangement fee attributable
        to the
        delivered elements when the basic criteria in SOP 97-2 have been
        met.
  The
        Company
        determines the fair value of the maintenance portion of the arrangement based
        on
        the historical fee charged to the customer. The Company determines the fair
        value of professional services, if included in a multiple element arrangement,
        based on the hourly rates that the Company charges for these services when
        sold
        independently from a software license. If VSOE of fair value cannot be
        established for the undelivered elements of a multiple element arrangement,
        the
        entire amount of revenue is deferred and recognized ratably over the period
        that
        these elements are delivered.
  The
        Company
        also evaluates whether the elements qualify for separate accounting under
        SOP
        97-2. The more significant factors considered in determining whether the
        revenue
        should be accounted for separately include the nature of services (i.e.,
        consideration of whether the services are essential to the functionality
        of the
        licensed product), degree of risk, availability of services from other vendors,
        timing of payments and impact of milestones or acceptance criteria on the
        realizability of the software license fee.
  If
        a multiple
        element arrangement does not qualify for separate accounting, the total fee
        is
        generally recognized collectively based on contract accounting using either
        the
        percentage-of-completion or completed-contract method. Contract accounting
        is
        applied to any arrangements: (1) that include milestones or customer
        specific acceptance criteria that may affect collection of the software license
        fees; (2) where services include significant modification or customization
        of the software; (3) where significant consulting services are provided for
        in the software license contract without additional charge or are substantially
        discounted; or (4) where the software license payment is tied to the
        performance of consulting services.
  -29-
 Most
        of the
        Company’s software license arrangements do not include acceptance provisions.
        However, if acceptance provisions exist, the Company provides for a sales
        return
        allowance in accordance with Statement of Financial Accounting Standards
        No. 48, *Revenue
        Recognition when Right of Return Exists* (“SFAS
        48”). If acceptance provisions are long-term in nature or are not included as
        standard terms of an arrangement or if the Company cannot reasonably estimate
        the incidence of returns, revenue is recognized upon the earlier of receipt
        of
        written customer acceptance or expiration of the acceptance period.
  The
        Company
        assesses whether fees are fixed or determinable at the time of sale and
        recognize revenue if all other revenue recognition requirements are met.
        The
        Company’s standard payment terms are net 30. Payments that are due within six
        months are generally deemed to be fixed or determinable based on the Company’s
        successful collection history on such arrangements, and thereby satisfy the
        required criteria for revenue recognition.
  *Software
        License Revenue* —Under
        SOP 97-2, revenue is recognizable when: (1) the Company enters into a
        legally binding arrangement with a customer for the license of software;
        (2) the customer accepts delivery of the product; (3) customer payment
        is deemed fixed or determinable and free of contingencies or significant
        uncertainties; and (4) collection is probable. For software license
        arrangements that do not require significant modification or customization
        of
        the underlying software, the Company will recognize the software license
        revenue
        in this manner. Certain software license arrangements are based on monthly
        subscriber volume and the Company bills the customer on a monthly basis as
        volume varies. Under this type of arrangement, the Company recognizes the
        software license revenue in the month earned.
  *Product
        Support and Upgrades Revenue* —The
        Company’s software license arrangement includes a maintenance component, beyond
        the basic warranty period and is a separate fee. During the maintenance period,
        the customer is entitled to receive software license updates, maintenance
        releases and patches and product support and the fee is recognized ratably
        over
        the term of the maintenance period. Product support includes internet access
        to
        technical content, as well as internet and telephone access to technical
        support
        personnel. The maintenance fee is generally priced as a percentage of the
        software license fee. The Company’s customers opt to purchase a maintenance
        contract when they acquire software licenses and typically renew it
        annually.
  *Services
        Revenue* —In
        addition to the Company’s software products and the related product support
        component, the Company offers professional services, such as implementation
        services, training, hosting the Company’s software on the customer’s hardware,
        or application management. These professional services are typically sold
        under
        a separate service agreement. The revenue from these arrangements is generally
        accounted for separately from software license revenue and product support
        and
        upgrades revenue and is generally recognized as the services are performed.
        If
        there is a significant uncertainty about the project completion or receipt
        of
        payment for the related services, revenue is deferred until the uncertainty
        is
        sufficiently resolved.
  The
        Company
        recognizes revenue from contracts with fixed or “not to exceed” fees using the
        proportional performance method of accounting. The Company estimates the
        proportional performance on these contracts on a monthly basis utilizing
        hours
        incurred to date as a percentage of total estimated hours to complete the
        project. The Company recognizes no more than 90% of the milestone or total
        contract amount until acceptance is obtained. If the Company does not have
        a
        sufficient basis to measure progress towards completion, revenue is recognized
        upon the customer’s acknowledgement of final acceptance. When the total cost
        estimate exceeds revenues, the estimated loss is accrued immediately using
        cost
        estimates based upon an average fully burdened daily rate.
 
 ***Accounts
        Receivable*** *—* We
        perform ongoing credit evaluations of our customers and adjust credit limits
        based upon payment history and the customer’s current creditworthiness, as
        determined by our review of their current credit information. We continuously
        monitor collections and payments from our customers and maintain a provision
        for
        estimated credit losses based upon our historical experience and any specific
        customer collection issues that we have identified. While such credit losses
        have historically been within our expectations and the provisions established,
        we cannot guarantee that we will continue to experience the same credit loss
        rates that we have in the past. Since our accounts receivable are concentrated
        in a relatively few number of customers, a significant change in the liquidity
        or financial position of any one of these customers could have a material
        adverse impact on the collectibility of our accounts receivables and our
        future
        operating results. See Risk Factor “Our revenues are generated from a limited
        number of customers and our customer base is concentrated.”
  -30-
 ***Accounting
        for the Impairment or Disposal of Long-Lived Assets*** *—* We
        account for the impairment and disposition of long-lived assets in accordance
        with the Statement of Financial Accounting Standards No. 144, *Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets
        to
        Be Disposed Of* (“SFAS
        144”).  In accordance with SFAS 144, long-lived assets to be held are
        reviewed for events or changes in circumstances that indicate that their
        carrying value may not be recoverable. This statement addresses financial
        accounting and reporting for the impairment of long-lived assets and for
        the
        disposal of long-lived assets. We evaluate the carrying value of long-lived
        assets for impairment of value based on undiscounted future cash flows, which
        are subject to change. We cannot guarantee that there will not be impairment
        in
        the future. Any future impairment charge would negatively affect our results
        of
        operations.
  ***Change
        in Accounting for Goodwill and Other Intangible Assets*** *—* On
        January 1, 2002 we adopted SFAS 142, which requires that goodwill and intangible
        assets with indefinite useful lives no longer be amortized. It also establishes
        a new method of testing goodwill for impairment on an annual basis or on
        an
        interim basis if an event occurs or circumstances change that would reduce
        the
        fair value of a reporting unit below its carrying value. We completed our
        annual
        assessment and determined that no goodwill impairment was present as of
        September 30, 2006. We believe no events or circumstances have changed
        subsequent to September 30, 2006 that would require us to re-evaluate the
        fair
        value of our goodwill. We will continue to complete an annual testing of
        goodwill for impairment on September 30th of each year. Such fair value
        measurements involve significant estimates and assumptions, including the
        future
        cash flows, comparable market multiples and discount rates. Changes in such
        estimates and assumptions could significantly affect the fair value and
        potential impairment.
  **Recently
        Issued Accounting Pronouncements**
  In
        December
        2006, the Financial Accounting Standards Board ("FASB") issued FASB Staff
        Position EITF 00-19-2, *Accounting for Registration Payment Arrangements*
        ("FSP 00-19-2"), which addresses accounting for registration payment
        arrangements. FSP 00-19-2 specifies that the contingent obligation to make
        future payments or otherwise transfer consideration under a registration
        payment
        arrangement, whether issued as a separate agreement or included as a provision
        of a financial instrument or other agreement, should be separately recognized
        and measured in accordance with FASB Statement No. 5, *Accounting for
        Contingencies*. The
        guidance in this FSP amendsSFAS
        133,
        and Statement of Financial Accounting Standards No. 150,*Accounting
        for Certain Financial Instruments with Characteristics of both Liabilities
        and
        Equity*(“SFAS
        150”), and FASB Interpretation No. 45,*Guarantor's
        Accounting and Disclosure Requirements for Guarantees, Including Indirect
        Guarantees of Indebtedness of Others*(“FIN
        45”), to include scope exceptions for registration payment arrangements.FSP 00-19-2 further clarifies that a financial instrument subject
        to a
        registration payment arrangement should be accounted for in accordance with
        other applicable generally accepted accounting principles without regard
        to the
        contingent obligation to transfer consideration pursuant to the registration
        payment arrangement.  This
        FSP
        shall be effective immediately for registration payment arrangements and
        the
        financial instruments subject to those arrangements that are entered into
        or
        modified subsequent to the date ofissuance
        of this FSP. For registration payment arrangements and financial instruments
        subject to thosearrangements
        that were entered into prior to the issuance of this FSP, this guidance shall
        be
        effectivefor
        financial statements issued for fiscal years beginning after December 15,
        2006,
        and interim periodswithin
        those fiscal years.  The Company will adopt FSP 00-19-2 in the first
        quarter of 2007 and expects to report the change in accounting principle
        through
        a cumulative-effect adjustment to opening retained earnings and additional
        paid-in-capital related to the reclassification of the warrant
        liability currently in our consolidated financial statements.
  -31-
 In
        September
        2006, FASB issued Statement of Financial Accounting Standards No. 157, *Fair
        Value Measurements* (“SFAS
        157”) which defines fair value, establishes a framework for measuring fair value
        in generally accepted accounting principles, and expands disclosures about
        fair
        value measurements. This statement applies under other accounting pronouncements
        that require or permit fair value measurements and does not require any new
        fair
        value measurements. This statement is effective for financial statements
        issued
        for fiscal years beginning after November 15, 2007 and interim periods with
        those fiscal years. The adoption of SFAS 157 is not expected to have a material
        effect on our consolidated financial statements.
  FASB
        issued
        Interpretation No. 48, *Accounting
        for Uncertainty in Income Taxes* (“FIN
        48”) in June 2006. FIN 48 defines the threshold for recognizing the benefits
        of
        tax return positions in the financial statements as “more-likely-than-not” to be
        sustained by the taxing authority. A tax position that meet the
“more-likely-than-not” criterion shall be measured at the largest amount of
        benefit that is more than 50% likely of being realized upon ultimate settlement.
        FIN 48 applies to all tax positions accounted for under Statement of Financial
        Accounting Standards No. 109, *Accounting
        for Income Taxes* (“SFAS
        109”). FIN 48 is effective for fiscal years beginning after December 15, 2006.
        Upon adoption, we will adjust its financial statements to reflect only those
        positions that are more-likely-than-not to be sustained as of the adoption
        date.
        Any adjustment will be recorded directly to our beginning retained earnings
        balance in the period of adoption and reported as a change in accounting
        principle. The adoption of FIN 48 is not expected to have a material effect
        on
        our consolidated financial statements.
  In
        March
        2006, FASB issued Statement of Financial Accounting Standards No. 156, *Accounting
        for Servicing of Financial Assets - an Amendment to FASB Statement No.
        140* (“SFAS
        156”) with respect to the accounting for separately recognized servicing assets
        and servicing liabilities. This statement is effective as of the beginning
        of
        our first fiscal year that begins after September 15, 2006, and is not expected
        to have a material effect on our consolidated financial statements.
  FASB
        issued
        Statement of Financial Accounting Standards No. 155, *Accounting
        for Certain Hybrid Financial Instruments—an Amendment of SFAS No. 133 and
        140* (“SFAS
        155”) in February 2006. SFAS 155 amends SFAS
        133
        and Statement of Financial Accounting Standards No. 140, *Accounting
        for Transfers and Servicing of Financial Assets and Extinguishments of
        Liabilities* (“SFAS
        140”). SFAS 155 resolves issues addressed in Statement 133
        Implementation Issue No. D1, *Application
        of Statement 133 to Beneficial Interests in Securitized Financial
        Assets* .
        In
        summary, SFAS 155 permits fair value remeasurement for any hybrid financial
        instrument that contains an embedded derivative that otherwise would require
        bifurcation. It also clarifies which interest-only strips and principal-only
        strips are not subject to the requirements of SFAS 133 and establishes a
        requirement to evaluate interests in securitized financial assets to identify
        interests that are freestanding derivatives or that are hybrid financial
        instruments that contain embedded derivative requiring bifurcation.
        SFAS 155 clarifies that concentrations of credit risk in the form of
        subordination are not embedded derivatives and amends SFAS 140 to eliminate
        the prohibition of a qualifying special-purpose entity from holding a derivative
        financial instrument that pertains to a beneficial interest other than another
        derivative financial instrument. This statement is effective for all financial
        instruments acquired or issued after the beginning of an entity’s first fiscal
        year that begins after September 15, 2006. Earlier adoption is permitted as
        of the beginning of an entity’s fiscal year, provided the entity has not yet
        issued financial statements, including financial statements for any interim
        period for that fiscal year. The adoption of SFAS 155 is not expected to
        have a
        material effect on our consolidated financial statements.
  **Item
        7. Financial Statements**
  Our
        consolidated financial statements required to be included in Item 7 are set
        forth in the Index to Financial Statements set forth on page 54 of this
        report.
  **Item
        8. Changes In and Disagreements With Accountants on Accounting and Financial
        Disclosure**
  None.
  -32-
 **Item
        8A. Controls and Procedures**
  We
        maintain
        disclosure controls and procedures that are designed to ensure that information
        required to be disclosed in our Exchange Act reports is recorded, processed,
        summarized and reported within the time periods specified under the SEC’s
        rules and forms, and that such information is accumulated and communicated
        to our management, including our principal executive officer and principal
        financial officer, as appropriate, to allow timely decisions regarding required
        disclosures.  Our disclosure controls and procedures are designed to
        provide reasonable assurance of achieving their objectives. Our management,
        including our principal executive officer and principal financial officer,
        does not expect that our disclosure controls or procedures will prevent all
        error and all fraud. A control system, no matter how well conceived and
        operated, can provide only reasonable, not absolute assurance that the
        objectives of the control system are met. Further, the benefits of controls
        must
        be considered relative to their costs. Because of the inherent limitations
        in
        all control systems, no evaluation of controls can provide absolute assurance
        that all control issues and instances of fraud, if any, within Primal have
        been
        detected.
  We
        carried
        out an evaluation, under the supervision and with the participation of our
        management, including our principal executive officer and principal
        financial officer, of the effectiveness of the design and operation of our
        disclosure controls and procedures as of the end of the period covered by
        this
        report. Based on the foregoing, our principal executive officer
        and principal financial officer concluded that our disclosure controls and
        procedures were effective at the reasonable assurance level.
  There
        has
        been no change in our internal control over financial reporting during the
        Company’s most recent fiscal quarter that has materially affected, or is
        reasonably likely to materially affect, the Company’s internal control over
        financial reporting.
  **Item
        8B. Other Information**
  None.
  -33-
 **PART III**
  **Item
        9. Directors, Executive Officers, Promoters** **,
        Control Persons and Corporate Governance; Compliance with
        Section 16(a) of the Exchange Act**
  **Executive
        Officers and Directors**
  The
        following table sets forth certain information regarding our executive officers
        and directors as of March 12, 2007:
  **Name**
              
              **Age**
              
              **Position**Joseph
                  R. Simrell
              
              
              49
              
              
              Chairman
                  of the Board, Chief Executive Officer, President, Chief Financial
                  Officer
                  and SecretaryRobert
                  Richardson
              
              
              40
              
              
              Chief
                  Operating OfficerSam
                  Gilson
              
              
              42
              
              
              Senior
                  Vice President of SalesDavid
                  Haynes
              
              
              41
              
              
              DirectorJohn
                  Faltys
              
              
              43
              
              
              DirectorLouis
                  A. Delmonico, Ph.D.
              
              
              66
              
              
              DirectorJohn
                  E. Rehfeld
              
              
              66
              
              
              Director
  *Joseph
        R. Simrell, Chairman of the Board, Chief Executive Officer, President, Chief
        Financial Officer, and Secretary* .
        Mr.
        Simrell joined Primal in January 1999 as Chief Financial Officer and Vice
        President of Finance and Administration. Mr. Simrell was elected as Chief
        Executive Officer and President as of January 31, 2003 (serving those positions
        on an interim basis from January 31, 2003 to May 12, 2003, when he became
        the
        permanent Chief Executive Officer and President) and was elected Chairman
        of the
        Board as of February 3, 2003. Mr. Simrell also served as our Chief Financial
        Officer and Secretary between October 15, 2004 and March 25, 2005. Mr. Simrell
        had previously served as Secretary from August 2000 and as Chief Financial
        Officer from January 1999 until August 2003. From August 1997 to December
        1998,
        Mr. Simrell served as an outside consultant to Primal. From November 1991
        to
        July 1997, Mr. Simrell served as Executive Vice President and Chief Financial
        Officer of GDI, an information technology company. Prior to 1991, Mr. Simrell
        held various management positions at BellSouth, InteGroup, and SCI.
  *Robert
        Richardson, Chief Operating Officer* .
        Mr.
        Richardson joined Primal in August 2003 as the Senior Vice President of Services
        responsible for Customer Support and Consulting Services and launching Primal’s
        new application management and hosting services. In March 2006, Mr. Richardson
        was promoted to Chief Operating Officer. From July 2004 to March 2006, Mr.
        Richardson was the Executive Vice President of Operations. From December
        2001 to
        August 2003, Mr. Richardson was a consulting project manager for Sony Pictures
        Entertainment and responsible for the delivery of the billing and cash
        application portions of a custom accounting system. In January 1998, Mr.
        Richardson founded StrataSource, Inc. and until October 2001 served as its
        Executive Vice President, responsible for defining its strategic direction.
        Mr.
        Richardson earned his Bachelor of Science degree in computer science from
        University of Southern California.
  *Sam
        Gilson, Senior Vice President of Sales* .
        Mr.
        Gilson has 20 years of experience in the telecommunications industry that
        includes sales and technical operations management with both vendors and
        operators. Prior to joining Primal in February 2005, Mr. Gilson served as
        Vice
        President of Technology at Dalton Utilities where he was responsible for
        all
        telecommunications operations supporting the “Triple Play” of voice, TV, and
        high-speed data service deployed over their fiber-optic network. Mr. Gilson
        has
        also consulted on several rural broadband overbuild projects throughout the
        United States, as well as holding various sales management positions at Nortel
        Networks and World Wide Packets. He earned his Bachelor of Arts degree in
        Management Information Systems from James Madison University.
  -34-
 *David
        Haynes, Director* .
        Mr.
        Haynes has served as a Director since August 2000 and has served as a member
        of
        the Audit Committee and Compensation Committee since July 2002. Mr. Haynes
        joined Primal in August 1997 as Vice President of Sales and served as Vice
        President of Sales and Marketing from May 2000 until May 2002 when he resigned
        the position. From May 1997 to September 1997, Mr. Haynes served as Senior
        Business Development Manager at Deloitte & Touche Consulting Group, a
        consulting firm. From January 1995 to April 1997, Mr. Haynes was Director
        of
        Sales at GDI. From December 1988 to January 1995, Mr. Haynes was one of the
        founding associates of ITX Technologies, a software company. Mr. Haynes
        currently serves as the Executive Vice President of Fabrication Concepts
        Corporation, a high-tech equipment manufacturer. Mr. Haynes has a Masters
        in
        Business Administration degree from Pepperdine University and a bachelor’s
        degree in civil engineering from the University of Saskatchewan.
  *John
        Faltys, Director* .
        Mr.
        Faltys has served as a Director since our inception in November 1996 and
        a
        member of the Compensation Committee since July 2002. Mr. Faltys founded
        Primal
        in November 1996 and served as the Chief Technology Officer until April 2001
        when he resigned the position. In addition, Mr. Faltys served as President
        from
        inception to September 1999. Prior to founding Primal, Mr. Faltys was Vice
        President of Software Development for GDI from November 1991 to September
        1996.
        Mr. Faltys currently serves as President of PersistentWorldZ, Inc., an online
        game service provider.
  *Louis
        A. Delmonico, Ph.D, Director* .
        Dr.
        Delmonico has served as a Director of Primal since April 2001 and is Chairman
        of
        the Audit Committee and a member of the Compensation Committee since July
        2002.
        From 1999 to 2000, Dr. Delmonico served as Chairman and CEO of Motiva, a
        software company. Since September 1994, he has also served as the President
        of
        L. A. Delmonico Consulting Inc., an independent consulting firm. From September
        1994 to May 1995, Dr. Delmonico served as the Vice Chairman of the MacNeal
        Schwendler Corporation, a publicly traded NASDAQ-listed engineering software
        and
        services company. From May 1987 to August 1994, Dr. Delmonico served as the
        Chairman and CEO of PDA Engineering Inc., a publicly traded NASDAQ-listed
        engineering software and services company. In addition, he is currently an
        advisor to and a director of several private companies. Dr. Delmonico earned
        his
        bachelor degree in economics from St. John’s University in New York, his Ms.S.
        in consumer behavior from the University of Stockholm, Sweden and his Ph.D.
        in
        marketing from the University of Uppsala, Sweden.
  *John
        Rehfeld, Director* .
        Mr.
        Rehfeld is currently serving as a board member of Primal, ADC/Telecom, and
        Local.com Corporation (formerly, Interchange Corporation). Mr. Rehfeld is
        also
        lead director and chairman of the compensation committee for Local.com and
        Primal. Mr. Rehfeld has served as a Director as well as Chairman and member
        of
        both the Audit Committee and Compensation Committee since July 2002. In
        addition, Mr. Rehfeld is a CEO coach for seven different CEO’s and teaches
        marketing and strategy in the Pepperdine executive MBA program. Mr. Rehfeld
        was
        previously VP & General Manager of Toshiba’s laptop computer business where
        he launched the first commercially successful laptop computer in 1986 and
        was
        subsequently named one of the top 25 computer executives by CRN magazine.
        Then
        he became president of Seiko Instruments USA and subsequently CEO’s of three
        other technology companies in Northern and Southern California, including
        Proxima, a NASDAQ traded company. He holds a Bachelors degree in Chemical
        Engineering from the University of Minnesota and an MBA from Harvard
        University.
 
 Unless
        otherwise
        specified herein, each Director is subject to election at our annual meeting
        of
        stockholders.
  Louis
        A. Delmonico
        (Chairman), John Rehfeld and David Haynes are members of the Audit Committee
        of
        the Company’s Board of Directors. Mr. Rehfeld is an “audit committee financial
        expert” in accordance with SEC rules. Stockholders should understand that
        this designation is a disclosure requirement of the SEC related to
        Mr. Rehfeld’s experience and understanding with respect to certain
        accounting and auditing matters. The designation does not impose upon
        Mr. Rehfeld any duties, obligations, or liability that are greater than are
        generally imposed on him as a member of the Audit Committee and the Board.
        Also,
        Mr. Rehfeld’s designation as the Audit Committee financial expert pursuant
        to this SEC requirement does not affect the duties, obligations, or
        liability of any other member of the Audit Committee or the Board. Because
        we
        are not a listed issuer, the members of the Audit Committee are not subject
        to
        the independence requirements of any national securities exchange or
        association.
  -35-
 We
        do not have a
        class of equity securities registered under Section 12 of the Exchange
        Act.
  The
        Company
        has adopted a Code of Conduct, which contains general guidelines for conducting
        the Company’s business and is designed to help employees and officers resolve
        ethical issues in an increasingly complex business environment. The Code
        of
        Conduct applies to all employees, including the principal executive officer,
        the
        principal financial officer, the controller and any other employee with any
        responsibility for the preparation and filing of documents with the SEC.
        The
        Code of Conduct covers topics, including, but not limited to, conflicts of
        interest, confidentiality of information, and compliance with laws and
        regulations.  Any request for a copy of the Code of Conduct, without
        charge, should be made to:  Primal Solutions, Inc.  ATTN: 
Investor Relations, 18881 Von Karman Avenue, Suite 500, Irvine, CA 
92612.
  **Item
        10. Executive Compensation**
  The
        following
        table sets forth certain information with respect to the compensation of
        our
        principal executive officer and each of our other most highly compensated
        executive officers pursuant to Item 402(a)(2) of Regulation S-B for the fiscal
        year ended December 31, 2006.
 
 **Summary
          Compensation Table**
  **Name
                    and Principal Position**
                
                **Year**
                
                **Salary**
                  **($)**
                
                **Bonus**
                  **($)(1)**
                
                **Option
                    Awards**
                  **($)(2)**
                
                **All
                    Other Compensation**
                  **($)(3)**
                
                **Total**
                  **($)**Joseph
                  R. Simrell
                
                
                2006
                
                $
                200,000
                
                $
                71,214
                
                $
                86,368
                
                $
                16,842
                
                $
                374,424*Chief
                    Executive Officer, President, and Chief Financial
                    Officer*
                
                
                2005
                
                
                200,000
                
                
                88,662
                
                
                —
                
                
                14,693
                
                
                303,355Robert
                  Richardson
                
                
                2006
                
                
                150,000
                
                
                124,354
                
                
                23,841
                
                
                16,975
                
                
                315,170*Chief
                    Operating
                    Officer*
                
                
                2005
                
                
                150,000
                
                
                218,254
                
                
                —
                
                
                17,548
                
                
                385,802Sam
                  Gilson (4)
                
                
                2006
                
                
                150,000
                
                
                57,712
                
                
                14,585
                
                
                10,975
                
                
                233,271*Senior
                    Vice President of Sales*
                
                
                2005
                
                
                125,000
                
                
                88,273
                
                
                —
                
                
                15,554
                
                
                228,827William
                  C. Bousema (5)
                
                
                2006
                
                
                145,883
                
                
                30,762
                
                
                52,159
                
                
                157,725
                
                
                385,955*Ex-Chief
                    Financial Officer, Senior Vice President and
                    Secretary*
                
                
                2005
                
                
                160,417
                
                
                76,232
                
                
                —
                
                
                5,878
                
                
                242,527
 (1)
                  See
                      discussion below under the heading "Executive Incentive Compensation
                      Policy."
 (2)
                    The
                          value of the options granted to our named executives has
                          been estimated
                          pursuant to Statement of Financial Accounting Standards
                          No. 123R,  Share-Based
                          Payment ("SFAS 123R"), using the Black-Scholes option pricing
                          model
                          with the following weighted average assumptions: expected
                          life of 6.6
                          years, volatility of 193.11%, risk-free interest of 4.29%,
                          and no dividend
                          yield.  On August 9, 2006, the following option awards were
                          granted under our 2006 Stock Option Plan (the "2006 SOP") to the
                          named executives with an exercise price of $0.07 per share:  Joseph
                          R. Simrell - 3,973,916 shares, Robert Richardson - 1,743,809 shares,
                          and Sam Gilson - 867,579 shares.  Option awards granted under the
                          2006 SOP are nonqualified stock options.  See Note 6 of the
                          Notes to the Consolidated Financial Statements included
                          elsewhere in this
                          Report for a description of the vesting schedule of option
                          awards granted
                          under the 2006
                          SOP.
  (3)
                  Includes
                      premiums paid by Primal on certain health insurance or term-life
                      insurance
                      policies, relocation costs, or contribution paid by us on behalf
                      of the
                      individual to our Section 401(k) Plan, which matches a portion
                      of each such individual’s contributions to the same plan. Severance pay is
                      also included in this column.
  (4)
                  Mr. Gilson
                      became Senior Vice President of Sales on February 28,
                      2005.
  (5)
                  Mr. Bousema
                      became Senior Vice President, Chief Financial Officer and Secretary
                      on
                      March 25, 2005 and resigned effective October 31, 2006. The amount
                      in
                      the "All Other Compensation" column includes $154,426 that we accrued
                      as of December 31, 2006 in connection with his resignation.  See
                      "Employment Agreement with William C. Bousema"
                      below.
  -36-
 **Employment
        Agreements**
  *Employment
        Agreement with Joseph R. Simrell*
  Effective
        January 28, 2003, Mr. Simrell entered into an employment agreement with us,
        which was amended as of May 17, 2004, and then again as of December 16, 2005.
        Under the terms of the employment agreement, as amended, Mr. Simrell serves
        as
        our Chairman of the Board, Chief Executive Officer and President. The initial
        term of the employment agreement expires December 31, 2007. The Board of
        Directors is required to begin good faith negotiations with Mr. Simrell no
        later
        than October 31, 2007 for a new employment agreement, which shall contain
        a
        clause for at least 12 months of severance and benefits continuation. Mr.
        Simrell’s base annual salary is $200,000. In addition, Mr. Simrell is entitled
        to receive bonuses in an amount not less than 50% of his salary, subject
        to our
        achieving performance goals set by the Board of Directors; provided that
        any
        accrued and unpaid incentive compensation payable to Mr. Simrell shall be
        paid
        no later than two and one-half months following the close of the calendar
        year
        in which such incentive compensation was earned. Mr. Simrell is also entitled
        to
        participate in such stock option, restricted stock, pension, profit sharing,
        life insurance, hospitalization, major medical, tuition reimbursement, medical
        flexible spending accounts and other employee benefit plans provided by us
        from
        time to time.
  In
        the event
        we terminate Mr. Simrell’s employment without cause or Mr. Simrell resigns for
        good reason, Mr. Simrell shall be entitled to 12 months of severance, 100%
        of
        his incentive compensation for that year calculated assuming 100% of the
        targets
        under such bonus plans are achieved, and continuation of his medical, dental,
        life, and disability coverage for himself and his spouse and dependents for
        a
        period not to exceed 12 months, provided he signs a release in our favor.
        Additionally, any accrued and unpaid payments owed to Mr. Simrell pursuant
        to
        the terms of the employment agreement, as amended, shall be made no later
        than
        two and one-half months following the close of the calendar year in which
        Mr.
        Simrell is terminated, provided further, any such payments shall be accelerated,
        if necessary, to prevent such two and one-half month period to be exceeded.
        Notwithstanding the foregoing, in the event that Mr. Simrell terminates his
        employment for good reason, in no event will severance payments payable to
        Mr.
        Simrell commence prior to six months following such separation.
  The
        employment agreement, as amended with Mr. Simrell contains certain covenants
        by
        him not to solicit the customers and employees of Primal during his employment
        and for one year thereafter. A state court may determine not to enforce,
        or only
        to enforce partially, these covenants.
  Finally,
        the
        employment agreement, as amended, provides that if, at the time of Mr. Simrell’s
        termination of employment, Mr. Simrell is a “specified employee” as defined in
        Section 409A of the Internal Revenue Code, and one or more of the payments
        to be
        received by Mr. Simrell would constitute deferred compensation within the
        meaning of Section 409A of the Internal Revenue Code, no such payment may
        be
        provided until the earliest of (a) six months after the separation of Mr.
        Simrell’s separation from service for reasons other than death or disability,
        (b) the date of death or disability of Mr. Simrell, or (c) the effective
        date of
        a change in effective control of the Company, to the extent required to mitigate
        Mr. Simrell’s incurrence of any penalty tax or interest under Section 409A of
        the Internal Revenue Code.
  We
        have also
        entered into a Change of Control Agreement with Mr. Simrell, amended as of
        May
        16, 2004 and then again as of December 16, 2005 (the “Simrell Change
        Agreement”). The Simrell Change Agreement provides that if, within 12 months of
        a “change of control transaction,” (i) we terminate Mr. Simrell’s employment
        (except upon his death or disability, his reaching the mandatory retirement
        age,
        if any, or upon other “cause to terminate” his employment) or (ii) Mr. Simrell
        voluntarily terminates his employment for “good reason”, we will tender in a
        single lump sum cash payment (a) any accrued and unpaid salary and vacation
        through the termination date, (b) an amount equal to 150% of Mr. Simrell’s
        then-current annual salary and (c) an amount equal to 150% of Mr. Simrell’s
        incentive compensation for that year, calculated assuming 100% of the targets
        under such incentive compensation plans are achieved, payable within ten
        days of
        termination provided that any such payment must be made within two and one-half
        months following the close of the calendar year in which such termination
        occurred; provided, that, in the event Mr. Simrell terminates his employment
        with us for good reason, in no event will the lump sum payment payable to
        Mr.
        Simrell commence prior to the six months following such separation; provided
        further, within ten days after the effective date of Mr. Simrell’s resignation
        for good reason and the effective date of any release executed by Mr. Simrell,
        we shall make an irrevocable contribution to a rabbi trust in the form of
        the
        model rabbi trust described in Internal Revenue Service Revenue Procedure
        92 64.
        Moreover, any portion of said lump sum payment not subject to Internal Revenue
        Service Rule 409A shall be paid within ten days after the effective termination
        date of Mr. Simrell. Further, we are obligated to tender such payments if,
        not
        more than three months prior to the closing of a change of control transaction,
        (i) we terminate Mr. Simrell’s employment, and such termination arose in
        connection with or in anticipation of the change of control transaction or
        (ii)
        Mr. Simrell voluntarily terminates his employment for good reason. Lastly,
        in
        anticipation of a change of control transaction, the Board of Directors can
        adopt a resolution deeming that a change of control transaction has closed
        for
        purposes of activating the Simrell Change Agreement obligations.
  -37-
 The
        Simrell
        Change Agreement additionally provides that, in the event the severance payment
        is subject to excise tax, we will gross-up the severance payment to Mr. Simrell
        so that the net severance payment received shall be the equivalent to the
        severance payment that would have been received if no excise tax had been
        imposed. However, we will reduce a severance payment by the amount of any
        other
        severance or termination benefits that it is obligated to pay to Mr. Simrell.
        The Simrell Change Agreement further provides for up to 18 months following
        the
        termination of Mr Simrell’s employment, we will continue to provide Mr. Simrell
        and his spouse and dependents with uninterrupted medical, dental, life, and
        disability coverage, or a lump sum payment equal to the cost of obtaining
        substantially similar coverage.
  Additionally,
        the Simrell Change Agreement provides that if, at the time of Mr Simrell’s
        termination of employment, Mr. Simrell is a “specified employee” as defined in
        Section 409A of the Internal Revenue Code, and one or more of the payments
        to be
        received by Mr. Simrell would constitute deferred compensation within the
        meaning of Section 409A of the Internal Revenue Code, no such payment may
        be
        provided until the earliest of (a) six months after the separation of Mr.
        Simrell’s separation from service for reasons other than death or disability,
        (b) the date of death or disability of Mr. Simrell, or (c) the effective
        date of
        a change in effective control of the Company, to the extent required to mitigate
        Mr. Simrell’s incurrence of any penalty tax or interest under Section 409A of
        the Internal Revenue Code.
  Lastly,
        the
        Simrell Change Agreement provides that upon the occurrence of a change of
        control transaction, all outstanding unvested stock options and all previously
        granted unvested restricted stock awards granted to Mr. Simrell shall accelerate
        and vest.
  For
        purposes
        of the Simrell Change Agreement, a “change of control transaction” will have
        occurred if:
 an
            otherwise unaffiliated person acquires the beneficial ownership of 35%
            or more
            of the combined voting power of our then outstanding voting securities.
            The
            acquisition of the shares can be in one transaction or in a series of
            related
            transactions and the person’s ownership can be direct or
            indirect;
        an
            otherwise unaffiliated person acquires the beneficial ownership of 50%
            or more
            of the combined voting power of any of our material subsidiaries. The
            acquisition of the shares can be in one transaction or in a series of
            related
            transactions and the person’s ownership can be direct or indirect. A material
            subsidiary means a subsidiary that represents at least 50% of our combined
            revenue or assets;
        a
            change of a majority of the members of our Board of Directors during
            any 12
            consecutive months. If, by a two-thirds majority, our Board of Directors
            elected a new member or nominated a new member for election by our
            stockholders, such new member will be considered to have been an original
            member of our Board of Directors;
        our
            stockholders have approved a complete liquidation or dissolution of us
            or a
            disposition of all or substantially all of our assets;
        we,
            in
            a single transaction or series of transactions, engage in a business
            combination transaction that results in our pre-transaction stockholders
            owning less than 50% of the combined voting power of the outstanding
            voting
            securities of the resulting entity; or
        any
            other event occurs that would require disclosure of “Changes in Control of
            Registrant” through our filing of a Current Report on Form
            8-K.  -38-
 Pursuant
        to the
        Simrell Change Agreement, our “cause to terminate” Mr. Simrell means an
        intentional act by the individual that materially injures us, an intentional
        refusal or failure to follow lawful and reasonable directions of the Board
        of
        Directors or an individual to whom the individual reports (as appropriate),
        the
        willful or habitual neglect of duties, or conviction of, or the entering
        of a
        guilty plea or plea of no contest with respect to, a felony involving an
        act of
        moral turpitude.
  As
        defined in
        the Simrell Change Agreement, Mr. Simrell’s “good reason” to resign
        means:
 our
            failure to cure a material breach of its obligations under any
            employment-related agreement;
        our
            unilateral, material reduction in the individual’s title, status, overall
            position, responsibilities or duties, reporting relationship, and general
            working environment;
        our
            requirement that the individual relocate his residence outside of Orange
            County, or the relocation of the individual’s office more than 50 miles from
            its location as of the date the applicable change agreement was
            executed;
        our
            failure to obtain an assumption by our successor or assignee of substantially
            all of our business of any material written agreement between the individual
            and us; or
        any
            material change in the benefits or incentive compensation offered to
            the
            individual from those in which the individual is participating as of
            the date
            the applicable change agreement was executed. *Employment
        Agreement with Robert Richardson*
  Effective
        August 14, 2003, we entered into an at-will employment letter agreement with
        Mr.
        Richardson, in which Mr. Richardson initially agreed to serve as our Senior
        Vice
        President of Professional Services. In July 2004, Mr. Richardson was promoted
        to
        Executive Vice President of Operations, and in March 2006, Mr. Richardson
        was
        promoted to Chief Operating Officer. Under the terms of the letter agreement,
        Mr. Richardson’s base annual salary is $150,000. In addition, Mr. Richardson is
        entitled to receive incentive compensation bonuses in an amount not less
        than
        100% of his salary subject to achieving certain individual and corporate
        performance goals. Mr. Richardson is also entitled to participate in such
        stock
        option, restricted stock, pension, profit sharing, life insurance,
        hospitalization, major medical, tuition reimbursement, medical flexible spending
        accounts and other employee benefit plans provided by us from time to
        time.
  Effective
        March 25, 2005, we and Mr. Richardson agreed to amend and restate that certain
        letter agreement dated August 18, 2003 between us and Mr. Richardson to provide
        i) a 90 day period of transition assistance pay in the event Mr. Richardson’s
        employment with us is terminated without cause, and ii) that in the event
        of a
        change of control of the Company, Mr. Richardson is terminated without cause,
        or
        Mr. Richardson terminates his employment for good reason, all outstanding
        unvested stock options and all previously granted unvested restricted stock
        awards granted to Mr. Richardson shall accelerate and vest.
  On
        August 9,
        2006, the Company entered into an amendment and restatement of the Side Letter
        Agreement dated August 18, 2003 with Mr. Richardson (the “Amended Richardson
        Agreement”).  Subject to Mr. Richardson entering into a standard form of
        separation and release agreement with the Company, the Amended Richardson
        Agreement provides for 90 days of transition assistance paid in accordance
        with
        the normal payroll schedule upon involuntary termination of employment if
        other
        than for “cause.”  Additionally, the Amended Richardson Agreement provides
        that upon a “change of control,” termination without “cause,” or if Mr.
        Richardson terminates his employment for “good reason” (as such terms are
        defined in the Amended Richardson Agreement), all of his outstanding unvested
        stock options will accelerate and vest.
  -39-
 *Employment
        Agreement with Sam Gilson*
  Effective
        February 28, 2005, we entered into an at-will employment letter agreement
        with
        Mr. Gilson, in which Mr. Gilson agreed to serve as our Senior Vice President
        of
        Sales. Under the terms of the letter agreement, Mr. Gilson’s base annual salary
        is $150,000. In addition, Mr. Gilson is entitled to receive incentive
        compensation bonuses in an amount not less than 100% of his salary subject
        to
        achieving certain individual and corporate performance goals. Mr. Gilson
        is also
        entitled to participate in such stock option, restricted stock, pension,
        profit
        sharing, life insurance, hospitalization, major medical, tuition reimbursement,
        medical flexible spending accounts and other employee benefit plans provided
        by
        us from time to time.
  On
        August 9,
        2006, the Company entered into a Side Letter Agreement dated August 9, 2006
        with
        Mr. Gilson, the Company’s Senior Vice President of Sales (the “Gilson
        Agreement”).  The Gilson Agreement provides that upon a “change of
        control,” termination without “cause,” or if Mr. Gilson terminates his
        employment for “good reason,” (as such terms are defined in the Gilson
        Agreement), all of his outstanding unvested stock options will accelerate
        and
        vest.
  *Employment
        Agreement with William C. Bousema*
  Effective
        March 25, 2005, William C. Bousema entered into a letter agreement for at-will
        employment as Primal’s Senior Vice President, Chief Financial Officer and
        Secretary, which was amended as of December 16, 2005. Under the terms of
        the
        amended letter agreement, Mr. Bousema’s base annual salary was $175,000, and the
        initial term of the employment agreement would have expired on December 31,
        2007. In addition, the amended letter agreement entitled Mr. Bousema to receive
        incentive compensation bonuses in an amount not less than 35% of his salary
        subject to achieving certain individual and corporate performance goals;
        provided that any accrued and unpaid incentive compensation payable to Mr.
        Bousema shall be paid no later than two and one-half months following the
        close
        of the calendar year in which such incentive compensation was earned. Mr.
        Bousema was also entitled under the amended letter agreement to participate
        in
        such stock option, restricted stock, pension, profit sharing, life insurance,
        hospitalization, major medical, tuition reimbursement, medical flexible spending
        accounts and other employee benefit plans provided by us from time to time.
        Notwithstanding the foregoing, the amended letter agreement provided in the
        event that Mr. Bousema terminated his employment for good reason, in no event
        would severance payments payable to Mr. Bousema commence prior to six months
        following such separation.
  Under
        the
        terms of the amended letter agreement, if we had terminated Mr. Bousema’s
        employment without cause or Mr. Bousema resigned for good reason, Mr. Bousema
        would be entitled to nine-month’s severance, 75% of his incentive compensation
        for that year calculated assuming 100% of the targets under such incentive
        compensation plans were achieved (provided that any such severance payments
        be
        made within two and one-half months following the close of the calendar year
        in
        which such termination occurred), and continuation of his medical, dental,
        life,
        and disability coverage for himself and his spouse and dependents for a period
        not to exceed nine months, conditioned upon Mr. Bousema’s execution of a release
        in favor of Primal. Additionally, if Mr. Bousema’s employment had not terminated
        previously, for the sixty-day period ending December 31, 2007, we would have
        had
        to commence good faith negotiations regarding the new terms of Mr. Bousema’s
        termination and the severance section of his letter agreement. If, following
        such good faith negotiations, we were unable to reach agreement regarding
        the
        new provisions, the termination and severance section of his amended letter
        agreement would expire on their terms. If we failed to negotiate in good
        faith,
        Mr. Bousema’s amended letter agreement would expire on December 31, 2007, his
        employment with Primal would be terminated, and he would be paid the severance
        benefits provided for in the amended letter agreement, and all outstanding
        unvested stock options granted to Mr. Bousema would accelerate and vest.
        Finally, in the event, (i) Mr. Bousema was terminated without cause, or (ii)
        Mr.
        Bousema terminated his employment for good reason, all outstanding unvested
        stock options granted to him would accelerate and vest.
  Additionally,
        Mr. Bousema’s amended letter agreement contained certain covenants by him not to
        solicit the customers and employees of Primal during the course of his
        employment and for so long thereafter as he is entitled to severance benefits
        under his amended letter agreement. A state court may determine not to enforce,
        or only to enforce partially, these covenants.
  -40-
 We
        had also
        entered into a Change of Control Agreement with Mr. Bousema, as amended
        effective as of December 16, 2005 (the “Bousema Change Agreement”). The Bousema
        Change Agreement provided that if, within 12 months of a “change of control
        transaction,” (i) we terminated Mr. Bousema’s employment (except upon his death
        or disability, his reaching the mandatory retirement age, if any, or upon
        other
“cause to terminate” his employment) or (ii) Mr. Bousema voluntarily terminated
        his employment for “good reason”, we would tender in a single lump sum cash
        payment (a) any accrued and unpaid salary and vacation through the termination
        date, (b) an amount equal to 100% of Mr. Bousema’s then-current annual salary
        and (c) an amount equal to 100% of Mr. Bousema’s incentive compensation for that
        year, calculated assuming 100% of the targets under such incentive compensation
        plans were achieved, payable within ten days of termination provided that
        any
        such payment be made within two and one-half months following the close of
        the
        calendar year in which such termination occurred; provided, that, in the
        event
        Mr. Bousema terminated his employment with us for good reason, in no event
        would
        the lump sum payment payable to Mr. Bousema commence prior to the six months
        following such separation; provided further, within ten days after the effective
        date of Mr. Bousema’s resignation for good reason and the effective date of any
        release executed by Mr. Bousema, we would make an irrevocable contribution
        to a
        rabbi trust in the form of the model rabbi trust described in Internal Revenue
        Service Revenue Procedure 92 64. Moreover, any portion of said lump sum payment
        not subject to Internal Revenue Service Rule 409A would be paid within ten
        days
        after the effective termination date of Mr. Bousema. Further, we are obligated
        to tender such payments if, not more than three months prior to the closing
        of a
        change of control transaction, (i) we terminated Mr. Bousema’s employment, and
        such termination arose in connection with or in anticipation of the change
        of
        control transaction or (ii) Mr. Bousema voluntarily terminated his employment
        for good reason. Lastly, in anticipation of a change of control transaction,
        the
        Board of Directors can adopt a resolution deeming that a change of control
        transaction has closed for purposes of activating the Bousema Change Agreement
        obligations.
  The
        Bousema
        Change Agreement additionally provided that, in the event the severance payment
        is subject to excise tax, we would gross-up the severance payment to Mr.
        Bousema
        so that the net severance payment received would be the equivalent to the
        severance payment that would have been received if no excise tax had been
        imposed. However, we would reduce a severance payment by the amount of any
        other
        severance or termination benefits that it is obligated to pay to Mr. Bousema.
        The Bousema Change Agreement further provided for up to 12 months following
        the
        termination of Mr. Bousema’s employment, we would continue to provide Mr.
        Bousema and his spouse and dependents with uninterrupted medical, dental,
        life,
        and disability coverage, or a lump sum payment equal to the cost of obtaining
        substantially similar coverage.
  Additionally,
        the amended letter agreement and the Bousema Change Agreement both provided
        that
        if, at the time of Mr. Bousema’s termination of employment, Mr. Bousema was a
“specified employee” as defined in Section 409A of the Internal Revenue Code,
        and one or more of the payments to be received by such Executive would
        constitute deferred compensation within the meaning of Section 409A of the
        Internal Revenue Code, no such payment may be provided until the earliest
        of (a)
        six months after the separation of such Executive’s separation from service for
        reasons other than death or disability, (b) the date of death or disability
        of
        such Executive, or (c) the effective date of a change in effective control
        of
        the Company, to the extent required to mitigate such Executive’s incurrence of
        any penalty tax or interest under Section 409A of the Internal Revenue Code.
        Mr.
        Bousema was a “specified employee” on October 31, 2006.
  Lastly,
        the
        Bousema Change Agreement provided that upon the occurrence of a change of
        control transaction, all outstanding unvested stock options and all previously
        granted unvested restricted stock awards granted to Mr. Bousema would accelerate
        and vest.
  -41-
 For
        purposes
        of the Bousema Change Agreement, a “change of control transaction” would have
        occurred if:
 an
            otherwise unaffiliated person acquires the beneficial ownership of 35%
            or more
            of the combined voting power of our then outstanding voting securities.
            The
            acquisition of the shares can be in one transaction or in a series of
            related
            transactions and the person’s ownership can be direct or
            indirect;
        an
            otherwise unaffiliated person acquires the beneficial ownership of 50%
            or more
            of the combined voting power of any of our material subsidiaries. The
            acquisition of the shares can be in one transaction or in a series of
            related
            transactions and the person’s ownership can be direct or indirect. A material
            subsidiary means a subsidiary that represents at least 50% of our combined
            revenue or assets;
        a
            change of a majority of the members of our Board of Directors during
            any 12
            consecutive months. If, by a two-thirds majority, our Board of Directors
            elected a new member or nominated a new member for election by our
            stockholders, such new member will be considered to have been an original
            member of our Board of Directors;
        our
            stockholders have approved a complete liquidation or dissolution of us
            or a
            disposition of all or substantially all of our assets;
        we,
            in
            a single transaction or series of transactions, engage in a business
            combination transaction that results in our pre-transaction stockholders
            owning less than 50% of the combined voting power of the outstanding
            voting
            securities of the resulting entity; or
        any
            other event occurs that would require disclosure of “Changes in Control of
            Registrant” through our filing of a Current Report on Form
            8-K. Pursuant
        to
        the Bousema Change Agreement, our “cause to terminate” Mr. Bousema meant an
        intentional act by the individual that materially injured us, an intentional
        refusal or failure to follow lawful and reasonable directions of the Board
        of
        Directors or an individual to whom the individual reports (as appropriate),
        the
        willful or habitual neglect of duties, or conviction of, or the entering
        of a
        guilty plea or plea of no contest with respect to, a felony involving an
        act of
        moral turpitude.
  As
        defined in
        the Bousema Change Agreement, Mr. Bousema’s “good reason” to resign
        meant:
 our
            failure to cure a material breach of its obligations under any
            employment-related agreement;
        our
            unilateral, material reduction in the individual’s title, status, overall
            position, responsibilities or duties, reporting relationship, and general
            working environment;
        our
            requirement that the individual relocate his residence outside of Orange
            County, or the relocation of the individual’s office more than 50 miles from
            its location as of the date the applicable change agreement was
            executed;
        our
            failure to obtain an assumption by our successor or assignee of substantially
            all of our business of any material written agreement between the individual
            and us; or
        any
            material change in the benefits or incentive compensation offered to
            the
            individual from those in which the individual is participating as of
            the date
            the applicable change agreement was executed. On
        November
        2, 2006, Mr. Bousema resigned for good reason as an employee from the Company
        effective as of October 31, 2006.
  -42-
 Executive
            Incentive Compensation Policy
  In
            June
            2006, in furtherance of the Company’s policy on executive incentive
            compensation, and upon the recommendation of the Company’s Compensation
            Committee, the Company’s Board of Directors approved and established certain
            corporate performance goals for fiscal year 2006 and set the minimum
            corporate
            performance level that must be achieved before any earned incentive compensation
            awards can be paid. Because achievement of the executives’ individual
            performance goals assists the Company in meeting its short- and long-term
            business objectives, the Company’s policy on executive incentive compensation is
            intended to reward executive-level employees for their achievement of
            individual performance goals only if the Company also meets its minimum
            corporate performance level. Accordingly, no incentive compensation award
            is to
            be granted to any executive unless the minimum corporate performance
            levels have
            been achieved.
  In
          establishing the Company’s corporate performance goals, the Company’s Board of
          Directors and Compensation Committee assess both past and projected corporate
          performance levels, as well as external market-place conditions, such as
          economic outlook, competitive performance levels, projected industry volumes
          and
          projected market share. Examples of corporate performance goals include
          revenues
          and operating expenses for certain fiscal periods and cash balances at
          the end
          of those periods.
  In
          addition
          to the corporate performance goals, on a semi-annual basis and subject
          to review
          and approval or modification by the Company’s Chief Executive Officer, each
          eligible executive sets a number of individual objectives. Examples of
          objectives identified by executive officers have included achieving sales
          and
          financial targets, identifying and pursuing new business opportunities
          and
          strategic alliances, attaining product development goals, accomplishing
          sales
          training goals, and identifying and implementing cost reduction measures.
          An
          eligible executive’s incentive compensation award is based on the achievement of
          a minimum level of both corporate and individual performance goals and
          is
          expressed as a percentage of the participant’s year-end base salary, ranging in
          amount from 35% to 100% of the year-end base salary.
  **Outstanding** **Options
        at December 31, 2006**
  The
        following
        table sets forth certain information regarding unexercised options held by
        the
        officers named in the Summary Executive Compensation Table that were outstanding
        as of December 31, 2006. There were no shares of stock that had not vested
        or equity incentive plan awards outstanding as of December 31,
        2006.
 
 **Outstanding** **Option Awards at Fiscal Year-End**
  **Number
                  of Securities Underlying
                  Unexercised
                  Options****Name**
              
              **Exercisable**
                **(shares)**
              
              **Unexercisable**
                **(shares)**
              ****
              **Option
                  Exercise Price****($)**
              
              **Option**
                **Expiration**
                **Date**Joseph
                R. Simrell
              
              
              100,000
              
              
              —
              
              
              $
              0.07
              
              12/5/2011229,175
              
              
              20,825
              (1)
              
              
              0.25
              
              1/19/2014792,231
              
              
              792,232
              (2)
              
              
              0.16
              
              5/6/2015—
              
              
              3,973,916
              (3)
              
              
              0.07
              
              8/9/2011Robert
                Richardson
              
              
              360,000
              
              
              —
              
              
              
              0.08
              
              8/18/2013223,569
              
              
              223,569
              (4)
              
              
              0.16
              
              5/6/2015—
              
              
              1,743,809
              (3)
              
              
              0.07
              
              8/9/2011Sam
                Gilson
              
              
              150,000
              
              
              150,000
              (5)
              
              
              0.14
              
              4/18/2015—
              
              
              867,579
              (3)
              
              
              0.07
              
              8/9/2011William
                C. Bousema
              
              
              1,081,062
              (6)
              
              —
              
              
              
              0.14
              
              1/31/2007
 
 (1)
              20,825
                  shares vested on January 15, 2007.
  (2)
              264,130
                  shares will vest on May 6, 2007; 263,972 shares will vest on November
                  6,
                  2007; and the remaining 264,130 shares willvest
                  on May 6, 2008.
  (3)
              See Note
                  6 of the Notes to the Consolidated Financial Statements included
                  elsewhere
                  in this Report for a description of the vesting schedule of option
                  awards
                  granted under the 2006 SOP.
  (4)
              74,537
                  shares will vest on May 6, 2007; 74,494 shares will vest on November
                  6,
                  2007; and the remaining 74,538 shares willvest
                  on May 6, 2008.
  (5)
              50,010
                  shares vested on February 28, 2007; 49,980 shares will vest on
                  August 31,
                  2007; and the remaining 50,010 shareswillvest
                  on February 29, 2008.
  (6)
              1,081,062
                  shares expired on January 31, 2007.
  -43-
 **Compensation
        of Directors**
  The
        following
        table sets forth certain information regarding compensation earned during
        the
        fiscal year ended December 31, 2006 by directors, unless the director is
        also a
        named executive officer, in which case he receives no compensation for service
        as a director.
  **Compensation
        of Directors**
 **Name**
                
                **Fees
                    Earned or**
                  **Paid
                    in Cash**
                
                **Stock**
                  **Awards**
                
                **Option**
                  **Awards
                    (**1)
                
                **Total**Louis
                    A. Delmonico (2)
                
                $
                31,750
                
                $
                —
                
                $
                29,010
                
                $
                60,760John
                    Faltys (3)
                
                
                28,500
                
                
                —
                
                
                19,340
                
                
                47,840David
                    Haynes (4)
                
                
                29,500
                
                
                —
                
                
                19,340
                
                
                48,840John
                    E. Rehfeld (5)
                
                
                31,750
                
                
                —
                
                
                29,010
                
                
                60,760
 
 (1)
              The
                  value of the warrants granted to our non-employee directors has
                  been
                  estimated pursuant to SFAS 123R using the Black-Scholesoption
                  pricing model with the following weighted average assumptions:
                  expected
                  life of 10 years, volatility of 128.43%, risk-free interestof
                  5.05%, and no dividend yield.
  (2)
              180,000
                  shares of common stock underlying options and 577,174 shares of
                  common
                  stock underlying warrants were outstanding andexercisable
                  as of December 31, 2006. All option awards were granted and exercisable
                  prior to the adoption of SFAS 123R.
  (3)
              60,000
                  shares of common stock underlying options and 476,087 shares of
                  common
                  stock underlying warrants were outstanding andexercisable
                  as of December 31, 2006. All option awards were granted and exercisable
                  prior to the adoption of SFAS 123R.
  (4)
              60,000
                  shares of common stock underlying options and 504,348 shares of
                  common
                  stock underlying warrants were outstanding andexercisable
                  as of December 31, 2006. All option awards were granted and exercisable
                  prior to the adoption of SFAS 123R.
  (5)
              120,000
                  shares of common stock underlying options and 1,033,696 shares
                  of common
                  stock underlying warrants were outstanding andexercisable
                  as of December 31, 2006. All option awards were granted and exercisable
                  prior to the adoption of SFAS 123R.
  Each
        newly elected
        and re-elected non-employee member of the Board of Directors receives a grant
        of
        a warrant to purchase 50,000 shares of common stock at an exercise price
        determined by our Board at the time of issuance.
  There
        are
        currently two standing Board committees, an audit committee and a compensation
        committee. During 2006, each of our non-employee directors received an annual
        stipend of $14,000 as well as $1,750 for each Board meeting attended. Each
        non-employee member serving on a Board committee also receives compensation
        of
        $750 for each individual committee meeting attended. In addition, each
        non-employee director is entitled to reimbursement of travel expenses. In
        2007,
        the committee meetings will be scheduled on the same day as the Board meetings.
        Each of our non-employee directors will receive an annual stipend of $14,000
        and
        $2,000 for attending the Board and/or any respective committee meetings
        scheduled on the same day.
  In
        addition, Mr. Rehfeld, our Lead Director, receives a stipend of $250 per
        hour with a per day cap of $1,500. The Lead Director periodically performs
        strategic projects as requested by the Board. We periodically form and maintain
        ad hoc committees for specific and limited purposes and duration. Such ad
        hoc
        committee members may receive nominal compensation for such
        service.
  
  
  -44-
  **Item
        11. Security Ownership of Certain Beneficial Owners and Management and Related
        Stockholder Matters**
  As
        of March
        12, 2007, the Company had 38,373,634 shares of common stock
        outstanding.
  The
        table
        following sets forth information regarding the beneficial ownership of common
        stock for each person who is known by us to be the beneficial owner of more
        than
        five percent of our voting securities, for each of our directors and named
        executive officers, and all of our directors and executive officers as a
        group.
        Unless otherwise indicated in the footnotes, each person named below has
        sole
        voting and investment power over the shares indicated.
  For
        purposes
        of this table, a person is deemed to be the “beneficial owner” of the number of
        shares of common stock that such person has the right to acquire within 60
        days
        of March 12, 2007 through the exercise of any option, warrant or right, through
        the conversion of any security, through the power to revoke a trust,
        discretionary account, or similar arrangement, or through the automatic
        termination of a trust, discretionary account or similar
        arrangement.
  **Name of Beneficial Owner / Management**
              
              **Number**
                **of Shares**
              
              **Percent**
                **of Class**John
                  Faltys (1)
              
              
              2,490,541
              
              
              
              3.2
              %Joseph
                  R. Simrell (2)
              
              
              2,920,116
              
              
              
              3.7
              %David
                  Haynes (3)
              
              
              2,023,755
              
              
              
              2.6
              %John
                  E. Rehfeld (4)
              
              
              3,663,670
              
              
              
              4.7
              %Louis
                  A. Delmonico (5)
              
              
              911,522
              
              
              
              1.2
              %Robert
                  Richardson (6)
              
              
              658,106
              
              
              
              *Sam
                  Gilson (7)
              
              
              200,010
              
              
              
              *Austin
                  W. Marxe and David M. Greenhouse (8)
              
              
              45,621,163
              
              
              
              58.3
              %All
                  executive officers and directors as a group (7 persons) (9)
              
              
              12,867,720
              
              
              
              16.4
              %
 
 *  Constitutes
        less than 1%
  (1)
                  Includes1,954,454
                      shares of common stock beneficially owned by Mr. Faltys and 536,087
                      shares of commonstock
                      underlying warrants and options exercisable as of the date
                      set forth above
                      or within 60 days thereafter.The
                      business address for this person is 18881 Von Karman Avenue,
                      Suite 500, Irvine, California
                      92612.
  (2)
                  Includes1,459,407
                      shares of common stock beneficially owned by Mr. Simrell and
                      1,460,709 shares of commonstock
                      underlying warrants and options exercisable as of the date
                      set forth above
                      or within 60 days thereafter.
                      The business address for this person is 18881 Von Karman Avenue,
                      Suite 500, Irvine, California
                      92612.
  (3)
                      Includes
                          1,459,407 shares of common stock beneficially owned by
                          Mr. Haynes and
                          564,348 shares of commonstock
                          underlying warrants and options exercisable as of the date
                          set forth above
                          or within 60 days thereafter.The
                          business address for this person is 18881 Von Karman Avenue,
                          Suite 500, Irvine, California
                          92612.
  (4)
                Includes
                    2,509,974 shares of common stock beneficially owned by Mr.Rehfeld
                    and
                    1,153,696 shares of commonstock
                    underlying warrants and options exercisable as of the date set
                    forth above
                    or within 60 days thereafter.The business address for this person is 18881 Von Karman Avenue,
                    Suite 500, Irvine, California
                    92612.
  (5)
                Includes
                    154,348 shares of common stock beneficially owned by Dr. Delmonico
                    and 757,174 shares of commonstock
                    underlying warrants and options exercisable as of the date set
                    forth above
                    or within 60 days thereafter.The
                    business address for this person is 18881 Von Karman Avenue,
                    Suite 500, Irvine, California
                    92612.
  (6)
                Includes
                    658,106 shares of common stock underlying options exercisable
                    by
                    Mr. Richardson as of the dateset
                    forth above or within 60 days thereafter.The
                    business address for this person is 18881 Von Karman Avenue,Suite 500,
                    Irvine, California 92612.
  (7)
                  Includes
                      200,010 shares of common stock underlying options exercisable
                      by
                      Mr. Gilson as of the date setforth
                      above or within 60 days thereafter.The
                      business address for this person is 18881 Von Karman Avenue,
                      Suite500,
                      Irvine, California 92612.
  (8)
                  Consists
                      of: (i) 110,505 shares of common stock, 110,000 shares of common
                      stock
                      issuable upon conversion ofthe
                      outstanding principal amount of Notes and 55,000 shares of
                      common stock
                      underlying warrants held bySpecial
                      Situations Fund III, L.P. and exercisable as of the date set
                      forth above
                      or within 60 days thereafter;(ii)
                      1,260,860 shares of common stock, 1,260,000 shares of common
                      stock
                      issuable upon conversion of theoutstanding
                      principal amount of Notes and 630,000 shares of common stock
                      underlying
                      warrants held by SpecialSituations
                      Fund III QP, L.P. and exercisable as of the date set forth
                      above or within
                      60 days thereafter;(iii)
                      1,084,978 shares of common stock, 1,090,000 shares of common
                      stock
                      issuable upon conversion of theoutstanding
                      principal amount of Notes and 1,196,905 shares of common stock
                      underlying
                      warrants held bySpecial
                      Situations Technology Fund, L.P. and exercisable as of the
                      date set forth
                      above or within 60 daysthereafter;
                      (iv) 5,713,561 shares of common stock, 5,730,000 shares of
                      common stock
                      issuable upon conversionof
                      the outstanding principal amount of Notes and 6,287,504 shares
                      of common
                      stock underlying warrants heldby
                      Special Situations Technology Fund II, L.P. and exercisable
                      as of the date
                      set forth above or within 60 daysthereafter;
                      and (v) 6,802,439 shares of common stock, 6,810,000 shares
                      of common stock
                      issuable uponconversion
                      of the outstanding principal amount of Notes and 7,479,411
                      shares of
                      common stock underlyingwarrants
                      held by Special Situations Private Equity Fund, L.P. and exercisable
                      as of
                      the date set forth above orwithin
                      60 days thereafter. MGP Advisors Limited (“MGP”) is the general partner of
                      the Special Situations FundIII,
                      QP, L.P. and the general partner of and investment advisor
                      to the Special
                      Situations Fund III, L.P.  AWMInvestment
                      Company, Inc. (“AWM”) is the general partner of MGP, the general partner
                      of and investmentadvisor
                      to the Special Situations CaymanFund, L.P. and the investment adviser to the Special Situations
                      FundIII,
                      QP, L.P., the Special Situations Technology Fund, L.P., the
                      Special
                      Situations Technology Fund II, L.P., theSpecial
                      Situations Private Equity Fund, L.P. and the Special Situations
                      Life
                      Sciences Fund, L.P.  Austin W.Marxe
                      and David M. Greenhouse are the principal owners of MGP and
                      AWM. 
                      Through their control of MGPand
                      AWM, Messrs. Marxe and Greenhouse share voting and investment
                      control over
                      the portfolio securitiesof
                      each of the funds listed above.  The business address for Messrs.
                      Marxe and Greenhouse is 527 MadisonAvenue,
                      Suite 2600, New York, NY
                      10022.
  (9)
                  Includes
                      all shares, options and warrants described in Notes 1, 2, 3,
                      4, 5, 6, and
                      7 above.
 -45-
 **Special
        Situations Funds**
  It
        is our
        belief that Special Situations Fund III QP, L.P., Special Situations Fund
        III, L.P., Special Situations Private Equity Fund, L.P., Special Situations
        Technology Fund, L.P. and Special Situations Technology Fund II, L.P.
        (collectively “SSF”) may be deemed to constitute a “group” within the meaning of
        Section 13(d)(3) of the Exchange Act. As of March 12, 2007, persons
        affiliated with SSF beneficially own 58.3% of our voting stock and
        possesses the right to designate one person for election to the Board of
        Directors. As a result, if some of the persons or entities affiliated with
        SSF
        act together, they may have the ability to control all matters submitted
        to our
        stockholders for approval, including the election and removal of directors
        and
        the approval of any business combination. SSF has notified the Company that
        it
        has no present intention to exercise the right to designate one person for
        election to our Board. However, this intention may change in the
        future.
  **Securities
        Authorized for Issuance Under Equity Compensation Plans**
  The
        following
        table summarizes our equity compensation plan information as of
        December 31, 2006.
  **Equity
        Compensation Plan Information**
  **No. of****securities**
                **to be issued**
                **upon****exercise**
                **of****outstanding**
                **options,****warrants**
                **and rights**
              
              **Weighted-average**
                **exercise price**
                **of****outstanding**
                **options,****warrants**
                **and rights**
              
              **No. of securities**
                **remaining**
                **available**
                **for future**
                **issuance**
                **under equity**
                **compensation**
                **plans****excluding**
                **securities**
                **reflected in**
                **column (a))****Plan****category**
              
              **(a)**
              
              **(b)**
              
              **(c)*****Equity
                  compensation plans approved by security
                  holders***2001
                  Flexible Incentive Plan
              
              
              2,678,516
              
              $
              0.10
              
              
              535,7842004
                  Flexible Incentive Plan
              
              
              4,821,614
              
              
              0.15
              
              
              629,459***Equity
                  compensation plans not approved by security
                  holders***2006
                  Stock Option Plan (1)
              
              
              7,022,845
              
              
              0.07
              
              
              977,155Warrants
                  issued to Board Members (2)
              
              
              1,000,000
              
              
              0.10
              
              
              —Warrants
                  issued to Board of Advisors Member (3)
              
              
              25,000
              
              
              0.22
              
              
              —Warrants
                  issued to Board Members (4)
              
              
              750,000
              
              
              0.05
              
              
              —**Total**
              
              
              16,297,975
              
              $
              0.10
              
              
              2,142,398
 
 (1)
              See
                    Note 6 of the Notes to the Consolidated Financial Statements
                    included
                    elsewhere in this Report for a description of the 2006 Stock
                    Option
                    Plan.
  (2)
              Issued
                  in May 2006 to our non-employee Board members at an exercise price
                  of
                  $0.10 with a term of 10 years.
 (3)
              Issued
                  in August 2004 to a member of our Board of Advisors at an exercise
                  price of $0.22 and with a term of 10
                  years.
  (4)
              Issued
                  in April 2003 to our non-employee Board members at an exercise price
                  of $0.05, vesting over two years and with a termof
                  10 years. These warrants fully vested on June 15, 2004 as a result of
                  the June 2004 Private
                  Placement.
  -46-
 **Item
        12. Certain Relationships** **and
        Related Transactions** **,
        and Director Independence**
  Related
          Transactions
  In
          December
          2006, we issued a $250,000 note to Special Situations Private Equity Fund,
          L.P.,
          which beneficially owns 27% of our common stock and is an affiliate of
          SSF.
          Interest accrues at 11.0% per annum, and there are no principal or interest
          payments due until maturity at June 27, 2007.
  As
          part of
          our private placement on April 27, 2006, we sold 1,750,000 shares of common
          stock and 875,000 warrants to purchase shares of our common stock to two
          accredited investors, one of which is currently a member of our Board of
          Directors, for a purchase price of $175,000.  See "Item 6 - Management's
          Discussion and Analysis - April 2006 Private Placement."
  On
          March 31,
          2006, we sold $1.5 million in aggregate principal amount of Notes along
          with
          warrants to purchase 7.5 million shares of our common stock to SSF, which
          at the
          time beneficially owned approximately 62% of our outstanding common stock.
          As a
          result of certain anti-dilution provisions triggered by this issuance,
          SSF
          received an additional 1,713,859 warrants to purchase shares of our common
          stock. See "Item 6 - Management's Discussion and Analysis - March 2006
          Private
          Placement."
  Director
        Independence
  Each
        of the
        Company's Directors is "independent" with the meaning of the independence
        standards of the Nasdaq Stock Market (Marketplace Rule 4200(a)(15)), other
        than
        Mr. Simrell.
  **Item
        13. Exhibits**
  **Exhibit**
                **Number**
              
              **Description of Document**2.1
              
              
              Primal
                  Solutions, Inc. Preliminary Distribution Agreement, dated
                  July 31, 2000, by and among Avery Communications, Inc., a
                  Delaware corporation, Primal Solutions, Inc., a Delaware corporation,
                  John Faltys, Joseph R. Simrell, David Haynes, Mark J. Nielsen,
                  Arun Anand,
                  Murari Cholappadi, Sanjay Gupta, Thurston Group, Inc., a Delaware
                  corporation, Patrick J. Haynes, III and Scot M. McCormick (filed as
                  Exhibit 2.1 to the Company’s registration Statement on Form SB-2
                  filed July 30, 2004 and incorporated by reference
                  herein)3.1
              
              
              Certificate
                  of Correction to the Certificate of Amendment of the Certificate
                  of
                  Incorporation of the Company (filed as Exhibit 3.1 to the Company’s
                  registration Statement on Form SB-2 filed July 30, 2004 and
                  incorporated by reference herein)3.2
              
              
              Second
                  Amended and Restated Bylaws (filed as Exhibit 3.3 to the Company’s
                  quarterly report on Form 10-QSB filed on August 14, 2002 and
                  incorporated by reference herein)10.1
              
              
              Agreement
                  and Plan of Merger, dated as of March 19, 1999, by and among Avery
                  Communications, Inc., ACI Telecommunications Financial Services
                  Corporation, Primal Systems Inc., Mark J. Nielsen,
                  John Faltys, Joseph R. Simrell and David Haynes (filed as
                  Exhibit 10.1 to the Company’s registration Statement on
                  Form SB-2 filed July 30, 2004 and incorporated by reference
                  herein)10.2
              
              
              Primal
                  Solutions, Inc. 2001 Flexible Incentive Plan, as amended (filed as
                  Exhibit 99.1 to the Company’s registration statement on Form S-8
                  filed on May 4, 2001 (Registration No. 333-60298) and
                  incorporated by reference herein)
  -47-
 **Exhibit**
                **Number**
              
              
              **Description of Document**10.3
              
              
              Governance
                  Document, as amended (filed as Exhibit 99.2 to the Company’s
                  registration statement on Form S-8 filed on May 4, 2001
                  (Registration No. 333-60298) and incorporated by reference
                  herein)10.4
              
              
              Form of
                  Indemnification Agreement (filed as Exhibit 10.2a to the Company’s
                  annual report on Form 10-KSB filed March 27, 2002 and
                  incorporated by reference herein)10.5
              
              
              Indemnification
                  Agreement between Primal Solutions, Inc. and Louis A. Delmonico,
                  dated April 25, 2001 (filed as Exhibit 10.12 to the Company’s
                  annual report on Form 10-KSB filed March 27, 2002 and
                  incorporated by reference herein)10.6
              
              
              Employment
                  Agreement for David Haynes dated December 31, 2001 (filed as
                  Exhibit 10.6 to the Company’s annual report on Form 10-KSB filed
                  March 27, 2002 and incorporated by reference herein)10.7
              
              
              Form of
                  Master Software License Agreement (filed as Exhibit 10.7 to Amendment
                  No. 1 to the Company’s registration statement on Form SB-2 filed
                  January 8, 2001 (Registration No. 333-46494) and incorporated by
                  reference herein)10.8
              
              
              Form of
                  Change of Control Agreement, as modified on May 3, 2002 (filed as
                  Exhibit 10.8 to the Company’s quarterly report on Form 10-QSB
                  filed on May 14, 2002 and incorporated by reference
                  herein)10.9
              
              
              Form of
                  Lease between Spieker Properties, L.P. and Primal
                  Solutions, Inc. dated October 26, 2000 (filed as
                  Exhibit 10.9 to the Company’s annual report on Form 10-KSB filed
                  March 27, 2002 and incorporated by reference herein)10.10
              
              
              First
                  Amendment to Lease between Spieker Properties, L.P. and Primal
                  Solutions, Inc. dated June 13, 2001 (filed as Exhibit 10.9a
                  to the Company’s annual report on Form 10-KSB filed March 27,
                  2002 and incorporated by reference herein)10.11
              
              
              Promissory
                  Note of Primal Solutions, Inc. in favor of Spieker Properties, L.P.,
                  dated June 15, 2001 (filed as Exhibit 10.10 to the Company’s
                  annual report on Form 10-KSB filed March 27, 2002 and
                  incorporated by reference herein)10.12
              
              
              Assignment
                  of Lease between Corsair Communications and Lightbridge, Inc., dated
                  February 7, 2001 (filed as Exhibit 10.12 to the Company’s
                  registration Statement on Form SB-2 filed July 30, 2004 and
                  incorporated by reference herein)10.13
              
              
              Agreement
                  of Sublease between Primal Solutions, Inc. and
                  Lightbridge, Inc., dated January 30, 2004 (filed as
                  Exhibit 10.14 to the Company’s registration Statement on
                  Form SB-2 filed July 30, 2004 and incorporated by reference
                  herein)10.14
              
              
              Landlord
                  Consent to Sublease among CA-Tower 17 Limited Partnership,
                  Lightbridge, Inc. and Primal Solutions, dated February 27, 2004
                  (filed as Exhibit 10.15 to the Company’s registration Statement on
                  Form SB-2 filed July 30, 2004 and incorporated by reference
                  herein)10.15
              
              
              Employment
                  Agreement between Primal Solutions, Inc. and Joseph R. Simrell
                  dated January 28, 2003 (filed as Exhibit 10.14 to the Company’s
                  annual Report on Form 10-KSB filed on March 28, 2003 and
                  incorporated by reference herein)10.16
              
              
              Consolidation
                  Agreement between Wireless Billing Systems dba Primal Billing Solutions
                  and Metrocall, Inc. dated December 30, 2002 (filed as
                  Exhibit 10.15 o the Company’s annual Report on Form 10-KSB filed
                  on March 28, 2003 and incorporated by reference
                  herein)10.17
              
              
              Purchase
                  Agreement between registrant and certain institutional investors
                  and
                  accredited investors, dated June 8, 2004 (filed as exhibit 10.18
                  to the Company’s current report on Form 8-K filed June 18, 2004
                  and incorporated by reference herein)
  -48-
 **Exhibit****Number**
              
              
              **Description of Document**10.18
              
              
              Registration
                  Rights Agreement between the registrant and the institutional investors
                  and accredited investors, dated June 8, 2004 (filed as
                  exhibit 10.19 to the Company’s current report on Form 8-K filed
                  June 18, 2004 and incorporated by reference herein)10.19
              
              
              Form of
                  Warrants for the issuance of warrants to the institutional investors
                  and
                  accredited investors (filed as exhibit 10.20 to the Company’s current
                  report on Form 8-K filed June 18, 2004 and incorporated by
                  reference herein)10.20
              
              
              Purchase
                  Agreement between registrant and Management, dated June 8, 2004
                  (filed as exhibit 10.21 to the Company’s current report on
                  Form 8-K filed June 18, 2004 and incorporated by reference
                  herein)10.21
              
              
              Registration
                  Rights Agreement between registrant and Management, dated June 8,
                  2004 (filed as exhibit 10.22 to the Company’s current report on
                  Form 8-K filed June 18, 2004 and incorporated by reference
                  herein)10.22
              
              
              Form of
                  Warrants for the issuance of warrants to Management (filed as
                  exhibit 10.23 to the Company’s current report on Form 8-K filed
                  June 18, 2004 and incorporated by reference herein)10.23
              
              
              Form of
                  Lock-up Agreement, dated June 8, 2004 (filed as exhibit 10.24 to
                  the Company’s current report on Form 8-K filed June 18, 2004 and
                  incorporated by reference herein)10.24
              
              
              Amended
                  and Restated Change of Control Agreement, dated as of May 17, 2004,
                  between Joseph R. Simrell and Primal Solutions, Inc. (filed as
                  Exhibit 10.27 to the Company’s registration Statement on
                  Form SB-2 filed July 30, 2004 and incorporated by reference
                  herein)10.25
              
              
              Promissory
                  Note by Primal Solutions, Inc. in favor of Sunwest Bank, dated
                  April 8, 2002 (filed as Exhibit 10.28 to the Company’s
                  registration Statement on Form SB-2 filed July 30, 2004 and
                  incorporated by reference herein)10.26
              
              
              Commercial
                  Security Agreement, between Primal Solutions, Inc., Wireless Billing
                  Systems, and Sunwest Bank, dated April 8, 2002 (filed as
                  Exhibit 10.29 to the Company’s registration Statement on
                  Form SB-2 filed July 30, 2004 and incorporated by reference
                  herein)10.27
              
              
              Subordination
                  Agreement between Wireless Billing Systems, Corsair
                  Communication, Inc. and Sunwest Bank, dated April 8, 2002 (filed
                  as Exhibit 10.30 to the Company’s registration Statement on
                  Form SB-2 filed July 30, 2004 and incorporated by reference
                  herein)10.28
              
              
              Business
                  Loan Agreement between Primal Solutions, Inc. and Sunwest Bank, dated
                  April 8, 2002 (filed as Exhibit 10.31 to the Company’s
                  registration Statement on Form SB-2 filed July 30, 2004 and
                  incorporated by reference herein)10.29
              
              
              Change
                  in Terms Agreement between Primal Solutions, Inc. and Sunwest Bank,
                  dated March 13, 2004 (filed as Exhibit 10.32 to the Company’s
                  registration Statement on Form SB-2 filed July 30, 2004 and
                  incorporated by reference herein)10.30
              
              
              Promissory
                  Note between Primal Solutions, Inc. and Sunwest Bank, dated
                  May 13, 2002 (filed as Exhibit 10.33 to the Company’s
                  registration Statement on Form SB-2 filed July 30, 2004 and
                  incorporated by reference herein)10.31
              
              
              Letter
                  Agreement between Primal Solutions, Inc. and Robert Richardson dated
                  August 14, 2003 (filed as Exhibit 10.34 to post-effective
                  amendment no. 1 to the Company’s registration Statement on Form SB-2
                  filed March 10, 2005 and incorporated by reference
                  herein)10.32
              
              
              Letter
                  Agreement between Primal Solutions, Inc. and Robert Richardson dated
                  August 18, 2003 (filed as Exhibit 10.35 to post-effective
                  amendment no. 1 to the Company’s registration Statement on Form SB-2
                  filed March 10, 2005 and incorporated by reference
                  herein)
  -49-
   **Exhibit****Number**
              
              
              **Description of Document**10.33
              
              
              Amended
                  and Restated Letter Agreement between Primal Solutions, Inc. and
                  Robert Richardson dated March 25, 2005 (filed as Exhibit 10.36
                  to the Company’s annual report on Form 10-KSB filed March 31,
                  2005 and incorporated by reference herein)10.34
              
              
              Letter
                  Agreement dated March 25, 2005 between Primal and William C. Bousema
                  (filed as Exhibit 10.37 to the Company’s annual report on
                  Form 10-KSB filed March 31, 2005 and incorporated by reference
                  herein)10.35
              
              
              Change
                  of Control Agreement dated March 25, 2005 between Primal and William
                  C. Bousema. (filed as Exhibit 10.38 to the Company’s annual report on
                  Form 10-KSB filed March 31, 2005 and incorporated by reference
                  herein)10.36
              
              
              Form Services
                  Agreement (filed as Exhibit 10.39 to the Company’s annual report on
                  Form 10-KSB filed March 31, 2005 and incorporated by reference
                  herein)10.37
              
              
              Form Software
                  License and Services Agreement (filed as Exhibit 10.40 to the
                  Company’s annual report on Form 10-KSB filed March 31, 2005 and
                  incorporated by reference herein)10.38
              
              
              Registrant’s
                  Policy on Executive Compensation Plan (filed as Exhibit 10.1 to the
                  Company’s report on Form 8-K filed on April 20, 2005 and
                  incorporated by reference herein)10.39
              
              
              Form of
                  Executive Incentive Compensation Award (filed as Exhibit 10.2 to the
                  Company’s report on Form 8-K filed on April 20, 2005 and
                  incorporated by reference herein)10.40
              
              
              2006
                  Amended and Restated Secured Promissory Note, dated March 31, 2006
                  made by Wireless Billing Systems, a wholly-owned subsidiary of
                  Primal
                  Solutions, Inc. in favor of Lightbridge, Inc. (filed as Exhibit
                  10.40 to the Company’s annual report on Form 10-KSB filed April 17, 2006
                  and incorporated by reference herein)10.41
              
              
              Confirmation
                  of Guaranty dated March 31, 2006 by and between Primal
                  Solutions, Inc. and Lightbridge, Inc. (filed as Exhibit 10.41 to
                  the Company’s annual report on Form 10-KSB filed April 17, 2006 and
                  incorporated by reference herein)10.42
              
              
              Subordination
                  Agreement, dated as of March 31, 2006, by and among Lightbridge Inc.,
                  Wireless Billing Systems, Primal Solutions, Inc. and the senior
                  lenders whose names appear on the signature pages thereto (filed as
                  Exhibit 10.42 to the Company’s annual report on Form 10-KSB filed April
                  17, 2006 and incorporated by reference herein)10.43
              
              
              Second
                  Amended and Restated Employment Agreement, dated December 16, 2005,
                  between Primal Solutions, Inc. and Joseph R. Simrell (filed as
                  Exhibit 10.43 to the Company’s annual report on Form 10-KSB filed April
                  17, 2006 and incorporated by reference herein)10.44
              
              
              Amendment
                  No. 1 to Employment Letter Agreement, dated December 16, 2005,
                  between Primal Solutions, Inc. and William C. Bousema (filed as
                  Exhibit 10.44 to the Company’s annual report on Form 10-KSB filed April
                  17, 2006 and incorporated by reference herein)10.45
              
              
              Second
                  Amended and Restated Change of Control Agreement, dated December 16,
                  2005, between Primal Solutions, Inc. and Joseph R. Simrell
                  (filed as Exhibit 10.45 to the Company’s annual report on Form 10-KSB
                  filed April 17, 2006 and incorporated by reference herein)10.46
              
              
              Amended
                  and Restated Change of Control Agreement, dated December 16, 2005,
                  between Primal Solutions, Inc. and William C. Bousema (filed as
                  Exhibit 10.46 to the Company’s annual report on Form 10-KSB filed April
                  17, 2006 and incorporated by reference herein)10.47
              
              
              Form of
                  5% Senior Secured Convertible Note, dated March 31, 2006, issued by
                  Wireless Billings Systems to the investors under that certain Purchase
                  Agreement dated as of March 31, 2006 (filed as Exhibit 4.1 to
                  the Company’s report on Form 8-K on April 3, 2006 and
                  incorporated by reference herein)
  -50-
   **Exhibit****Number**
              
              
              **Description of Document**10.48
              
              
              Purchase
                  Agreement, dated as of March 31, 2006, by and among Primal
                  Solutions, Inc., Wireless Billing Systems and the investors whose
                  names appear on the signature pages thereto (filed as
                  Exhibit 10.1 to the Company’s report on Form 8-K on
                  April 3, 2006 and incorporated by reference herein)10.49
              
              
              Pledge
                  and Security Agreement, dated as of March 31, 2006, by and among
                  Primal Solutions, Inc., Wireless Billing Systems and the investors
                  whose names appear on the signature pages thereto (filed as
                  Exhibit 10.2 to the Company’s report on Form 8-K on
                  April 3, 2006 and incorporated by reference herein)10.50
              
              
              Form of
                  Warrant to purchase shares of Common Stock, dated March 31, 2006,
                  issued by Primal Solutions Inc. to the investors under that certain
                  Purchase Agreement dated as of March 31, 2006 (filed as
                  Exhibit 10.3 to the Company’s report on Form 8-K on
                  April 3, 2006 and incorporated by reference herein)10.51
              
              
              Registration
                  Rights Agreement, dated as of March 31, 2006, by and between Primal
                  Solutions, Inc. and the investors whose names appear on the signature
                  pages thereto (filed as Exhibit 10.4 to the Company’s report on
                  Form 8-K filed on April 3, 2006 and incorporated by reference
                  herein)10.52
              
              
              Primal
                  Solutions, Inc. 2004 Flexible Incentive Plan (filed as
                  Exhibit 99.1 to the Company’s registration Statement on Form S-8
                  (Registration No. 333-121902) (“2004 S-8”) and incorporated by
                  reference herein)10.53
              
              
              Registration
                  Rights Agreement, dated as of April 27, 2006, by and between Primal
                  Solutions, Inc. and the investors whose names appear on the signature
                  pages thereto (filed as Exhibit 10.53 to the Company’s Post-Effective
                  Amendment No. 4 on Form SB-2 (Registration Statement No. 333-117786)
                  and
                  incorporated by reference herein)10.54
              
              
              Purchase
                  Agreement, dated as of April 27, 2006, by and among Primal Solutions,
                  Inc.
                  and the investors whose names appear on the signature pages thereto
                  (filed
                  as Exhibit 10.54 to the Company’s Post-Effective Amendment No. 4 on Form
                  SB-2 (Registration No. 333-117786) and incorporated by reference
                  herein)10.55
              
              
              Form
                  of Warrant to purchase shares of Common Stock, dated April 27,
                  2006,
                  issued by Primal Solutions Inc. to the investors under that certain
                  Purchase Agreement dated as of April 27, 2006 (filed as Exhibit
                  10.55 to
                  the Company’s Post-Effective Amendment No. 4 on Form SB-2 (Registration
                  No. 333-117786) and incorporated by reference herein)10.56
              
              
              Form
                  of Warrant to purchase shares of Common Stock, dated May 19, 2006
                  (filed
                  as Exhibit 10.1 to the Company’s current report on Form 8-K on May 25,
                  2006 and incorporated by reference herein)10.57
              
              
              Primal
                  Solutions, Inc. 2006 Stock Option Plan (filed as Exhibit 10.1 to
                  the
                  Company’s current report on Form 8-K on August 15, 2006 and incorporated
                  by reference herein)10.58
              
              
              Form
                  on Non-Statutory Stock Option Agreement under Primal Solutions,
                  Inc. 2006
                  Stock Option Plan (filed as Exhibit 10.2 to the Company’s current report
                  on Form 8-K on August 15, 2006 and incorporated by reference
                  herein)10.59
              
              
              Amended
                  and Restated Side Letter, dated as of August 9, 2006, by and between
                  the
                  Company and Bob Richardson (filed as Exhibit 10.3 to the Company’s current
                  report on Form 8-K on August 15, 2006 and incorporated by reference
                  herein)10.60
              
              
              Side
                  Letter, dated as of August 9, 2006, by and between the Company
                  and Sam
                  Gilson (filed as Exhibit 10.4 to the Company’s current report on Form 8-K
                  on August 15, 2006 and incorporated by reference herein)
  -51-
   **Exhibit****Number**
              
              
              **Description of Document**10.61
              
              
              Promissory
                Note between Primal Solutions, Inc. and Special Situations Private
                Equity Fund, L.P., dated December 27, 2006(filed
                as Exhibit 4.1 to the Company’s current report on Form 8-K on December 29,
                2006 and incorporated by reference herein)10.62
              *
              
              2007
                  Amended and Restated Secured Promissory Note, dated January 1,
                  2007 made
                  by Wireless Billing Systems, a wholly-owned subsidiary of Primal
                  Solutions, Inc. in favor of Lightbridge, Inc.10.63
              *
              
              Confirmation
                  of Guaranty, dated January 1, 2007 by and between Primal
                  Solutions, Inc. and Lightbridge, Inc.10.64
              *
              
              Subordination
                Agreement, dated as of March 31, 2006 (as amended and restated as of
                March 29, 2007), by and among Lightbridge Inc., Wireless Billing
                Systems,
                Primal Solutions, Inc. and the senior lenders whose names appear on
                the signature pages thereto10.65
              *
              
              Primal
                  Solutions, Inc. Executive Incentive Compensation Policy21.1
              
              
              Subsidiaries
                  of Primal Solutions, Inc. (filed as Exhibit 21.1 to the Company’s
                  Post-Effective Amendment No. 4 on Form SB-2 (Registration No. 333-117786)
                  and incorporated by reference herein)23.1
              *
              
              Consent
                  of Haskell & White LLP31.1
              *
              
              Certification
                  pursuant to Section 302 of the Sarbanes-Oxley Act32.1
              *
              
              Certification
                  pursuant to Section 906 of the Sarbanes-Oxley Act
 
 *  Filed
        herewith
 
 **Item
        14. Principal Accountant Fees and Services**
  For
        the
        fiscal year ended December 31, 2006 and 2005, Haskell & White LLP
        audited the Company’s annual consolidated financial statements and provided tax
        return and tax related services.
  The
        aggregate
        fees billed for professional services by Haskell & White LLP in 2006
        and 2005 were as follows:
  **200****6**
              
              **2005**Audit
                  Fees (1)
              
              $
              108,000
              
              $
              75,000Audit
                  Related Fees (2)
              
              
              5,000
              
              
              2,000Tax
                  Fees (3)
              
              
              17,000
              
              
              11,000All
                  Other Fees (4)
              
              
              25,000
              
              
              16,000Total
              
              $
              155,000
              
              $
              104,000
 
 (1)
              Includes
                  audit of annual financial statements included in Form 10-KSB and
                  review of financial statements included in Form 10-QSB
                quarterly
                  reports.
  (2)
              Relates
                  to assistance addressing SEC comment
                  letters.
  (3)
              Tax
                  return and related tax services.
  (4)
              Relates
                  to registration statements on Forms SB-2 and S-8 filed by the
                  Company.
  It
        is our
        Audit Committee’s policy and procedure to approve in advance all audit
        engagement fees and terms and all permitted non-audit services provided by
        our
        independent registered accounting firm. We believe that all audit engagement
        fees and terms and permitted non-audit services provided by our independent
        registered accounting firm as described in the above table were approved
        in
        advance by our Audit Committee.
  
  -52-
   **SIGNATURES**
  In
        accordance
        with Section 13 or 15(d) of the Exchange Act, the registrant caused
        this report to be signed on its behalf by the undersigned, thereunto duly
        authorized.
  PRIMALSOLUTIONS,
                  INC.By:
              /s/Joseph
                  R. SimrellJoseph
                  R. Simrell*Chief
                  Executive Officer, President, Chief Financial Officer, and
                  Secretary*Date:
                  April 2, 2007
 
  In
        accordance
        with the Exchange Act, this report has been signed below by the following
        persons on behalf of the registrant and in the capacities and on the dates
        indicated.
  **Signature**
              
              
              
              **Title**
              
              
              **Date**/s/Joseph
                  R. Simrell
              
              Chief
                  Executive Officer, President, Chief Financial Officer, Secretary
                  and
                  Director (Principal Executive Officer, Principal
              
              April
                  2, 2007Joseph
                  R. Simrell
              
              Financial
                  Officer and Principal Accounting Officer)/s/David
                  Haynes
              
              Director
              
              April
                  2, 2007David
                  Haynes/s/John
                  Faltys
              
              Director
              
              April
                  2, 2007John
                  Faltys/s/Louis
                  A. Delmonico
              
              Director
              
              April
                  2, 2007Louis
                  A. Delmonico/s/John
                  E. Rehfeld
              
              Director
              
              April
                  2, 2007John
                  E. Rehfeld
 
  
  -53-
   **PRIMAL
        SOLUTIONS, INC.**
  **INDEX
        TO FINANCIAL STATEMENTS**
  **Page**Report
                  of Independent Registered Public Accounting Firm
              
              
              55Financial
                  Statements:Consolidated
                  Balance Sheets at December 31, 2006 and December 31,
                  2005
              
              
              56Consolidated
                  Statements of Operations for the years ended December 31, 2006 and
                  2005
              
              
              57Consolidated
                  Statements of Stockholders’ Equity (Deficit) for the years ended
                  December 31, 2006 and 2005
              
              
              58Consolidated
                  Statements of Cash Flows for the years ended December 31, 2006 and
                  2005
              
              
              59Notes
                  to Consolidated Financial Statements
              
              
              60
 
  
  -54-
  **REPORT
        OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**
  The
        Board
        of Directors and Stockholders
  Primal
        Solutions, Inc.
  We
        have
        audited the accompanying consolidated balance sheets of Primal
        Solutions, Inc. (the “Company”) as of December 31, 2006 and 2005 and
        the related consolidated statements of operations, stockholders’ equity
        (deficit) and cash flows for each of the years then ended. These financial
        statements are the responsibility of the Company’s management. Our
        responsibility is to express an opinion on these financial statements based
        on
        our audits.
  We
        conducted our audits in accordance with the standards of the Public Company
        Accounting Oversight Board (United States). Those standards require that
        we plan
        and perform the audits to obtain reasonable assurance about whether the
        financial statements are free of material misstatement. The Company is not
        required to have, nor were we engaged to perform, an audit of its internal
        control over financial reporting. Our audit included consideration of internal
        control over financial reporting as a basis for designing audit procedures
        that
        are appropriate in the circumstances, but not for the purpose of expressing
        an
        opinion on the effectiveness of the Company’s internal control over financial
        reporting. Accordingly, we express no such opinion. An audit includes examining,
        on a test basis, evidence supporting the amounts and disclosures in the
        financial statements. An audit also includes assessing the accounting principles
        used and significant estimates made by management, as well as evaluating
        the
        overall financial statement presentation. We believe that our audits provide
        a
        reasonable basis for our opinion.
  In
        our
        opinion, such consolidated financial statements present fairly, in all material
        respects, the consolidated financial position of Primal Solutions, Inc. as
        of December 31, 2006 and 2005 and the consolidated results of its
        operations and its cash flows for each of the years then ended in conformity
        with accounting principles generally accepted in the United States of
        America.
  As
        described in Note 1 to the consolidated financial statements, on January
        1,
        2006, the Company adopted Statement of Financial Accounting Standards No.
        123
        (revised 2004), “Share-Based Payment.”
  HASKELL &
                  WHITE LLPIrvine,
                  CaliforniaApril
                  2, 2007
 
  
  -55-
  **PRIMAL
        SOLUTIONS, INC.**
  **CONSOLIDATED
        BALANCE SHEETS**
  **December****31,**
                **2006**
              
              **December 31,**
                **2005*****ASSETS*****Current
                  Assets**Cash
                  and cash equivalents
              
              $
              382,000
              
              $
              711,000Restricted
                  cash
              
              
              103,000
              
              
              101,000Accounts
                  receivable, net of allowance for doubtful accounts of $0 and $72,000,
                  respectively
              
              
              268,000
              
              
              591,000Prepaid
                  expenses and other current assets
              
              
              242,000
              
              
              99,000Total
                  current assets
              
              
              995,000
              
              
              1,502,000Property
                  and equipment, net of accumulated depreciation of $1,551,000 and
                  $1,518,000, respectively
              
              
              360,000
              
              
              474,000Goodwill
              
              
              593,000
              
              
              593,000Other
                  assets
              
              
              59,000
              
              
              115,000$
              2,007,000
              
              $
              2,684,000***LIABILITIES
                  AND STOCKHOLDERS’ DEFICIT*****Current
                  Liabilities**Accounts
                  payable
              
              $
              301,000
              
              $
              230,000Accrued
                  liabilities
              
              
              463,000
              
              
              453,000Accrued
                  salaries and benefits
              
              
              633,000
              
              
              605,000Deferred
                  revenue
              
              
              220,000
              
              
              371,000Short-term
                  borrowings and current portion of long-term debt
              
              
              741,000
              
              
              288,000Warrant
                  liability
              
              
              1,015,000
              
              
              —Total
                  current liabilities
              
              
              3,373,000
              
              
              1,947,000Long-term
                  debt, net of current portion
              
              
              852,000
              
              
              1,078,000Senior
                  convertible debt, net of discount
              
              
              395,000
              
              
              —Other
                  liabilities
              
              
              —
              
              
              102,0004,620,000
              
              
              3,127,000Commitments
                  and contingencies (Note 4 and 5)**Stockholders’
                  Deficit**Preferred
                  stock, $0.01 par value; 5,000,000 shares authorized; none issued
                  and
                  outstanding
              
              
              —
              
              
              —Common
                  stock, $0.01 par value; 95,000,000 shares authorized; 38,373,634
                  and
                  36,363,641 shares issued and outstanding, respectively
              
              
              384,000
              
              
              364,000Additional
                  paid-in capital
              
              
              13,880,000
              
              
              13,249,000Warrants
                  (Note 6)
              
              
              1,558,000
              
              
              1,217,000Accumulated
                  deficit
              
              
              (18,435,000
              )
              
              (15,273,000
              )Net
                  stockholders’ deficit
              
              
              (2,613,000
              )
              
              (443,000
              )$
              2,007,000
              
              $
              2,684,000
 
   See
        accompanying notes to consolidated financial statements
 
  -56-
  **PRIMAL
        SOLUTIONS, INC.**
  **CONSOLIDATED
        STATEMENTS OF OPERATIONS**
  **For****The Year Ended December 31,****200****6**
              
              **2005****Revenues**Software
                  licenses
              
              $
              1,828,000
              
              $
              3,318,000Product
                  support and upgrades
              
              
              1,236,000
              
              
              1,385,000Software
                  revenues
              
              
              3,064,000
              
              
              4,703,000Services
                  revenue
              
              
              2,584,000
              
              
              3,864,000Total
                  revenues
              
              
              5,648,000
              
              
              8,567,000**Operating
                  Expenses**Sales
                  and marketing
              
              
              1,923,000
              
              
              2,397,000Software
                  licenses
              
              
              122,000
              
              
              86,000Product
                  support and upgrades
              
              
              481,000
              
              
              408,000Cost
                  of services
              
              
              1,930,000
              
              
              3,249,000Research
                  and development
              
              
              1,499,000
              
              
              1,692,000General
                  and administrative
              
              
              2,263,000
              
              
              2,050,000Total
                  operating expenses
              
              
              8,218,000
              
              
              9,882,000Loss
                  from operations
              
              
              (2,570,000
              )
              
              (1,315,000
              )Interest
                  and other expenses, net
              
              
              (590,000
              )
              
              (85,000
              )Loss
                  before income tax provision
              
              
              (3,160,000
              )
              
              (1,400,000
              )Income
                  tax provision
              
              
              2,000
              
              
              2,000Net
                  loss
              
              $
              (3,162,000
              )
              $
              (1,402,000
              )Basic
                  and diluted net loss per share
              
              $
              (.08
              )
              $
              (.04
              )Weighted-average
                  basic and diluted common shares outstanding
              
              
              37,733,904
              
              
              36,314,818
 
  
  See
              accompanying notes to consolidated financial statements
 -57-
   **PRIMAL
        SOLUTIONS, INC.**
  **CONSOLIDATED
        STATEMENTS OF STOCKHOLDERS’ EQUITY (DEFICIT)**
  **Common**
                **shares**
              
              **Amount**
              
              **Additional**
                **paid-in**
                **capital**
              
              **Warrants**
              
              **Accumulated**
                **deficit**
              
              **Net**
                **stockholders’**
                **equity**
                **(deficit)**BALANCE
                  AT December 31, 2004
              
              
              36,178,441
              
              $
              362,000
              
              $
              13,232,000
              
              $
              1,205,000
              
              $
              (13,871,000
              )
              $
              928,000Exercise
                  of stock options issued to employees
              
              
              185,200
              
              
              2,000
              
              
              17,000
              
              
              —
              
              
              —
              
              
              19,000Warrants
                  issued in lieu of cash payment
              
              
              —
              
              
              —
              
              
              —
              
              
              12,000
              
              
              —
              
              
              12,000Net
                  loss
              
              
              —
              
              
              —
              
              
              —
              
              
              —
              
              
              (1,402,000
              )
              
              (1,402,000
              )BALANCE
                  AT December 31, 2005
              
              
              36,363,641
              
              $
              364,000
              
              $
              13,249,000
              
              $
              1,217,000
              
              $
              (15,273,000
              )
              $
              (443,000
              )Exercise
                  of stock options issued to employees
              
              
              259,993
              
              
              2,000
              
              
              12,000
              
              
              —
              
              
              —
              
              
              14,000Warrants
                  issued in lieu of cash payment
              
              
              —
              
              
              —
              
              
              —
              
              
              97,000
              
              
              —
              
              
              97,000Warrants
                  issued as sales incentive
              
              
              —
              
              
              —
              
              
              —
              
              
              14,000
              
              
              —
              
              
              14,000Repricing
                  of warrants issued in 2004 private placement
              
              
              —
              
              
              —
              
              
              (189,000
              )
              
              189,000
              
              
              —
              
              
              —Beneficial
                  conversion feature issued as part of March 2006 private
                  placement
              
              
              —
              
              
              —
              
              
              505,000
              
              
              —
              
              
              —
              
              
              505,000Issuance
                  of stock and warrants as part of April 2006 private placements,
                  net of
                  issuance costs
              
              
              1,750,000
              
              
              18,000
              
              
              48,000
              
              
              41,000
              
              
              —
              
              
              107,000Stock
                  option compensation cost
              
              
              —
              
              
              —
              
              
              255,000
              
              
              —
              
              
              —
              
              
              255,000Net
                  loss
              
              
              —
              
              
              —
              
              
              —
              
              
              —
              
              
              (3,162,000
              )
              
              (3,162,000
              )BALANCE
                  AT December 31, 2006
              
              
              38,373,634
              
              $
              384,000
              
              $
              13,880,000
              
              $
              1,558,000
              
              $
              (18,435,000
              )
              $
              (2,613,000
              )
 
  
  See
              accompanying notes to consolidated financial statements
 -58-
   **PRIMAL
        SOLUTIONS, INC.**
  **CONSOLIDATED
        STATEMENTS OF CASH FLOWS**
  **For****The Year Ended**
                **December 31,****200****6**
              
              **2005*****Cash
                  Flows from Operating Activities***Net
                  loss
              
              $
              (3,162,000
              )
              $
              (1,402,000
              )Adjustments
                  for noncash and nonoperating activities:Depreciation
                  and amortization
              
              
              126,000
              
              
              168,000Amortization
                  ofconversion
                  featureinto
                  interest expense
              
              
              158,000
              
              
              —Amortization
                  of debt issuance cost
              
              
              66,000
              
              
              —Amortization
                  of warrant liability into interest expense
              
              
              237,000
              
              
              —Gain
                  on change in fair value of warrant liability
              
              
              (4,000
              )
              
              —Non-cash
                  stock-based compensation costs
              
              
              351,000
              
              
              —Issuance
                  of warrants as sales incentive
              
              
              14,000
              
              
              —Provision
                  for doubtful accounts
              
              
              —
              
              
              72,000(Gain)/loss
                  on disposal of equipment
              
              
              (3,000
              )
              
              1,000Changes
                  in operating assets and liabilities:Accounts
                  receivable
              
              
              323,000
              
              
              (164,000
              )Prepaid
                  expenses and other current assets
              
              
              108,000
              
              
              56,000Accounts
                  payable and other accrued liabilities
              
              
              1,000
              
              
              33,000Noncurrent
                  accrued interest
              
              
              7,000
              
              
              26,000Deferred
                  revenue
              
              
              (151,000
              )
              
              (357,000
              )Other
                  noncurrent assets and liabilities
              
              
              (24,000
              )
              
              —Net
                  cash used in operating activities
              
              
              (1,953,000
              )
              
              (1,567,000
              )***Cash
                  Flows from Investing Activities***Purchases
                  of property and equipment
              
              
              (13,000
              )
              
              (61,000
              )Proceeds
                  from sales of property and equipment
              
              
              3,000
              
              
              —Net
                  cash used in investing activities
              
              
              (10,000
              )
              
              (61,000
              )***Cash
                  Flows from Financing Activities***Increase
                  in restricted cash
              
              
              (2,000
              )
              
              (101,000
              )Payments
                  on capital lease obligations
              
              
              (22,000
              )
              
              (12,000
              )Proceeds
                  from promissory notes
              
              
              250,000
              
              
              100,000Retirement
                  of promissory note
              
              
              —
              
              
              (100,000
              )Payments
                  on notes payable
              
              
              (47,000
              )
              
              (182,000
              )Issuance
                  of warrants in lieu of cash payment
              
              
              —
              
              
              12,000Costs
                  of private placements
              
              
              (234,000
              )
              
              —Proceeds
                  from private placements
              
              
              1,675,000
              
              
              —Proceeds
                  from issuance of common stock, net
              
              
              14,000
              
              
              19,000Net
                  cash provided/(used) in financing activities
              
              
              1,634,000
              
              
              (264,000
              )Decrease
                  in cash and cash equivalents
              
              
              (329,000
              )
              
              (1,892,000
              )Cash
                  and cash equivalents, beginning of the year
              
              
              711,000
              
              
              2,603,000Cash
                  and cash equivalents, end of the year
              
              $
              382,000
              
              $
              711,000***Supplemental
                  disclosures of cash flow information***Cash
                  paid during the year for:Interest
              
              $
              111,000
              
              $
              92,000Income
                  taxes
              
              $
              2,000
              
              $
              2,000***Non-cash
                  investing and financing activities***Issuance
                  of warrants in satisfaction of liability
              
              $
              —
              
              $
              12,000Financing
                  of capital lease equipment
              
              $
              —
              
              $
              96,000Financing
                  of business insurance premiums
              
              $
              47,000
              
              $
              53,000
 
  
  See
              accompanying notes to consolidated financial statements
 -59-
   **PRIMAL
        SOLUTIONS, INC. AND SUBSIDIARY**
  **NOTES
        TO CONSOLIDATED FINANCIAL STATEMENTS**
  **1.**
              **ORGANIZATION,
                  BASIS OF PRESENTATION, AND SUMMARY OF SIGNIFICANT ACCOUNTING
                  PRINCIPLES**
 ****
 *Organization
        and Nature of Operations*
 Primal
          Systems, Inc. was incorporated on June 28, 1996. During 1999, Primal
          Systems, Inc. was merged with and into ACI Telecommunications Financial
          Services, a wholly-owned subsidiary of Avery Communications, Inc. The surviving
          company changed its name to Primal Solutions, Inc. In February 2001, Avery
          spun off Primal Solutions, Inc. and its wholly-owned subsidiary, Wireless
          Billing Systems (collectively, the “Company”), as a separate public
          company.
  *Basis
          of Presentation*
  The
          accompanying consolidated financial statements of the Company as of
          December 31, 2006 and 2005 and for the fiscal years ended December 31,
          2006 and 2005 have been prepared in accordance with accounting principles
          generally accepted in the United States.
  In
          the
          opinion of management, all adjustments, consisting of normal recurring
          adjustments, considered necessary for a fair presentation have been
          included.
  *Basis
          of Consolidation*
  The
          accompanying consolidated financial statements include the accounts of
          Primal
          Solutions, Inc. and its wholly owned subsidiary, Wireless Billing Systems.
          Intercompany accounts and transactions have been eliminated.
  *Use
          of Estimates*
  The
          preparation of financial statements in conformity with accounting principles
          generally accepted in the United States requires management to make estimates
          and assumptions that affect the reported amounts of assets and liabilities
          and
          disclosures of contingent liabilities at the date of the financial statements
          and the reported amounts of revenues and expenses during the reporting
          period.
          Actual results could differ from those estimates.
  *Recent
          Accounting Pronouncements*
 In
          December
          2006, the Financial Accounting Standards Board ("FASB") issued FASB Staff
          Position EITF 00-19-2,*Accounting
          for Registration Payment Arrangements*("FSP
          00-19-2"), which addresses accounting for registration payment arrangements.
          FSP
          00-19-2 specifies that the contingent obligation to make future payments
          or
          otherwise transfer consideration under a registration payment arrangement,
          whether issued as a separate agreement or included as a provision of a
          financial
          instrument or other agreement, should be separately recognized and measured
          in
          accordance with FASB Statement No. 5,*Accounting
          for Contingencies*.
          The
          guidance in this FSP amends Statement of Financial Accounting Standards
          No. 133,*Accounting
          for Derivative Instruments and Hedging Activities*(“SFAS
          133”), and Statement of Financial Accounting Standards No. 150,*Accounting
          for Certain Financial Instruments with Characteristics of both Liabilities
          and
          Equity*(“SFAS
          150”), and Interpretation No. 45,*Guarantor's
          Accounting and Disclosure Requirements for Guarantees, Including Indirect
          Guarantees of Indebtedness of Others*(“FIN
          45”), to include scope exceptions for registration payment arrangements. 
FSP 00-19-2 further clarifies that a financial instrument subject to a
          registration payment arrangement should be accounted for in accordance
          with
          other applicable generally accepted accounting principles without regard
          to the
          contingent obligation to transfer consideration pursuant to the registration
          payment arrangement.  This FSP shall be effective immediately for
          registration payment arrangements and the financial instruments subject
          to those
          arrangements that are entered into or modified subsequent to the date of
          issuance of this FSP. For registration payment arrangements and financial
          instruments subject to those arrangements that were entered into prior
          to the
          issuance of this FSP, this guidance shall be effective for financial statements
          issued for fiscal years beginning after December 15, 2006, and interim
          periods
          within those fiscal years.  The Company will adopt FSP 00-19-2 in the first
          quarter of 2007 and expects to report the change in accounting principle
          through
          a cumulative-effect adjustment to opening retained earnings and additional
          paid-in-capital related to the reclassification of the warrant
          liability currently in our consolidated financial
          statements.
  -60-
 In
          September
          2006,  FASB issued Statement of Financial Accounting Standards No. 157, *Fair
          Value Measurements* (“SFAS
          157”) which defines fair value, establishes a framework for measuring fair
          value
          in generally accepted accounting principles, and expands disclosures about
          fair
          value measurements. This statement applies under other accounting pronouncements
          that require or permit fair value measurements and does not require any
          new fair
          value measurements. This statement is effective for financial statements
          issued
          for fiscal years beginning after November 15, 2007 and interim periods with
          those fiscal years. The adoption of SFAS 157 is not expected to have a
          material
          effect on the Company’s consolidated financial statements.
  FASB
          issued
          Interpretation No. 48, *Accounting
          for Uncertainty in Income Taxes* (“FIN
          48”) in June 2006. FIN 48 defines the threshold for recognizing the benefits
          of
          tax return positions in the financial statements as “more-likely-than-not” to be
          sustained by the taxing authority. A tax position that meet the
“more-likely-than-not” criterion shall be measured at the largest amount of
          benefit that is more than 50% likely of being realized upon ultimate settlement.
          FIN48 applies to all tax positions accounted for under Statement of Financial
          Accounting Standards No. 109, *Accounting
          for Income Taxes* (“SFAS
          109”). FIN 48 is effective for fiscal years beginning after December 15, 2006.
          Upon adoption, the Company will adjust its financial statements to reflect
          only
          those positions that are more-likely-than-not to be sustained as of the
          adoption
          date. Any adjustment will be recorded directly to the Company’s beginning
          retained earnings balance in the period of adoption and reported as a change
          in
          accounting principle. The adoption of FIN 48 is not expected to have a
          material
          effect on the Company's consolidated financial statements.
  In
          March
          2006, FASB issued Statement of Financial Accounting Standards No. 156, *Accounting
          for Servicing of Financial Assets - an Amendment to FASB Statement No.
          140* (“SFAS
          156”) with respect to the accounting for separately recognized servicing assets
          and servicing liabilities. This statement is effective as of the beginning
          of
          its first fiscal year that begins after September 15, 2006, and is not
          expected
          to have a material effect on the Company’s consolidated financial
          statements.
  FASB
          issued
          Statement of Financial Accounting Standards No. 155, *Accounting
          for Certain Hybrid Financial Instruments—an Amendment of SFAS No. 133 and
          140* (“SFAS
          155”) in February 2006. SFAS 155 amends SFAS
          133
          and Statement of Financial Accounting Standards No. 140, *Accounting
          for Transfers and Servicing of Financial Assets and Extinguishments of
          Liabilities* (“SFAS
          140”). SFAS 155 resolves issues addressed in Statement 133
          Implementation Issue No. D1, *Application
          of Statement 133 to Beneficial Interests in Securitized Financial
          Assets* .
          In
          summary, SFAS 155 permits fair value remeasurement for any hybrid financial
          instrument that contains an embedded derivative that otherwise would require
          bifurcation. It also clarifies which interest-only strips and principal-only
          strips are not subject to the requirements of SFAS 133 and establishes a
          requirement to evaluate interests in securitized financial assets to identify
          interests that are freestanding derivatives or that are hybrid financial
          instruments that contain embedded derivative requiring bifurcation.
          SFAS 155 clarifies that concentrations of credit risk in the form of
          subordination are not embedded derivatives and amends SFAS 140 to eliminate
          the prohibition of a qualifying special-purpose entity from holding a derivative
          financial instrument that pertains to a beneficial interest other than
          another
          derivative financial instrument. This statement is effective for all financial
          instruments acquired or issued after the beginning of an entity’s first fiscal
          year that begins after September 15, 2006. Earlier adoption is permitted as
          of the beginning of an entity’s fiscal year, provided the entity has not yet
          issued financial statements, including financial statements for any interim
          period for that fiscal year. The adoption of SFAS 155 is not expected to
          have a
          material effect on the Company’s consolidated financial statements.
  -61-
 *Summary
          of Significant Accounting Policies*
  **Cash
          and Cash Equivalents** —The
          Company considers all highly liquid debt instruments purchased with an
          original
          maturity of three months or less to be cash equivalents. Cash equivalents
          are
          carried at cost, which approximates fair value.
  **Restricted
          Cash** — Pursuant to the
          secured promissory note with First Regional Bank (Note 3), the Company
          maintained a certificate of deposit of $100,000 as collateral, which matured
          in
          February 2006, concurrently with the outstanding note. The Company executed
          an
          amended and restated loan agreement for the original $100,000 principal
          balance.
          Under the amended agreement, the Company opened a savings account as collateral
          against the outstanding loan balance. The total balance held by First Regional
          Bank, which included accrued interest, was reflected as Restricted Cash
          in the
          accompanying consolidated balance sheet.
  **Fair
          Value of Financial Instruments** —The
          recorded amounts of financial assets and liabilities at December 31, 2006
          and 2005 approximate fair value, based on the Company’s incremental borrowing
          rate or due to the relatively short period of time between origination
          of the
          instruments and their expected realization.
  **Property
          and Equipment** —Property
          and equipment are stated at cost. Depreciation and amortization are provided
          on
          the straight-line method over the following estimated useful lives:
  **Estimated
                    Useful Life**Computer
                  and office equipment
                2
                  to 5 yearsFurniture
                  and fixtures
                7
                  yearsLeasehold
                  improvements
                Shorter
                  of the estimated useful life or life of leaseCapitalized
                  leases
                2
                  to 7 years
  Maintenance
          and
          repairs are charged to expense as incurred. Renewal and improvements of
          a
          significant nature are capitalized.
  **Capitalized
          Software Costs** —Costs
          incurred in the research and development of new software products and
          enhancements to existing software products are expensed as incurred until
          technological feasibility has been established. After technological feasibility
          is established, any additional costs would be capitalized in accordance
          with
          Statement of Financial Accounting Standards No. 86, Accounting
          for the Costs of Computer Software to Be Sold, Leased or Otherwise Marketed (“SFAS
          86”). Because the Company believes that its current process for developing
          software is essentially completed concurrently with the establishment of
          technological feasibility, no software development costs have been capitalized
          as of December 31, 2006 and 2005.
  **Goodwill
          and Intangible Assets** —In January 2002, the Company adopted Statement of Financial Accounting
          Standards No. 142, Goodwill
          and Other Intangible Assets, (“SFAS
          142”), which requires that goodwill and other intangible assets with indefinite
          useful lives no longer be amortized. SFAS 142 also established a new method
          of
          testing goodwill impairment on an annual basis or on an interim basis if
          an
          event occurs or circumstances change that would reduce fair value of a
          reporting
          unit below its carrying value.
  The
          Company
          records long-lived assets and definite-life intangible assets at original
          cost
          less accumulated amortization. These balances are amortized using the
          straight-line method over the estimated useful life of three to seven years.
          The
          determination whether or not these assets are impaired involves judgment
          and
          such assets are reviewed for impairment whenever events or circumstances
          indicate that the carrying amount of such assets may not be recoverable.
          The
          Company evaluates the carrying value of long-lived assets and definite
          life
          identifiable intangible assets for impairment of value based on undiscounted
          future cash flows resulting from the use of the asset and its eventual
          disposition. While the Company did not experience impairment of intangible
          assets in prior periods, it cannot guarantee that there will not be impairment
          in the future.
  -62-
 The
          Company
          reviews each of our reporting units in order to conclude if the fair value
          of
          each reporting unit exceeds its carrying value, indicating no goodwill
          impairment is present as of September 30 of each fiscal year. More frequent
          impairment tests are performed when management determines that indicators
          of
          impairment exist. In the case where goodwill appears to be impaired, the
          Company
          will write down the goodwill balance to the fair value. Such fair value
          measurements involve significant estimates and assumptions, including the
          future
          cash flows, comparable market multiples and discount rates. Changes in
          such
          estimates and assumptions could significantly affect the fair value and
          potential impairment.
  *Summary
          of Significant Accounting Policies*
  **Revenue
          Recognition** —The
          Company derives revenues from the sale of software licenses, product support
          and
          upgrades fees, and professional services, which include installation, training
          and customization, application management, and hosting the Company’s software on
          the customer’s hardware. The Company enters
          into a multiple element arrangement through a license and maintenance agreement
          with the customer, and includes a license for the Company’s software,
          post-warranty maintenance fees for technical support and product updates
          over a
          one-year period. Although the agreement typically includes professional
          services
          fees for installation, training and customization, most professional services
          are sold separately and all are based on time spent and materials used.
          The
          Company licenses the software under an upfront fee payment, or monthly
          subscription that includes maintenance support, and both are based on the
          customer’s number of subscribers or similar measure. Customers generally
          subscribe to product support and upgrade, i.e. maintenance.
  The
          Company
          recognizes revenue using the residual method pursuant to the provisions
          of
          Statement of Position No. 97-2, Software
          Revenue Recognition (“SOP
          97-2”), as amended by Statement of Position No. 98-9, Software
          Revenue Recognition with Respect to Certain Arrangements (“SOP
          98-9”), and Emerging Issues Task Force Issue No. 00-21, Revenue
          Arrangements with Multiple Deliverables (“EITF
          00-21”). Under the residual method, revenue is recognized in a multiple element
          arrangement when vendor-specific objective evidence (“VSOE”) of fair value
          exists for all undelivered elements (i.e., maintenance) in the arrangement,
          but
          does not exist for one of the delivered elements in the arrangement (i.e.,
          software license). The Company allocates revenue to each element in the
          arrangement based on its respective fair value, with the fair value determined
          by the price historically charged if that element is sold separately. The
          Company defers revenue for the fair value of all undelivered elements and
          recognizes revenue for the remainder of the arrangement fee attributable
          to the
          delivered elements when the basic criteria in SOP 97-2 have been
          met.
  The
          Company
          determines the fair value of the maintenance portion of the arrangement
          based on
          the historical fee charged to the customer. The Company determines the
          fair
          value of professional services, if included in a multiple element arrangement,
          based on the hourly rates that the Company charges for these services when
          sold
          independently from a software license. If VSOE of fair value cannot be
          established for the undelivered elements of a multiple element arrangement,
          the
          entire amount of revenue is deferred and recognized ratably over the period
          that
          these elements are delivered.
  The
          Company
          also evaluates whether the elements qualify for separate accounting under
          SOP
          97-2. The more significant factors considered in determining whether the
          revenue
          should be accounted for separately include the nature of services (i.e.,
          consideration of whether the services are essential to the functionality
          of the
          licensed product), degree of risk, availability of services from other
          vendors,
          timing of payments and impact of milestones or acceptance criteria on the
          realizability of the software license fee.
  If
          a
          multiple element arrangement does not qualify for separate accounting,
          the total
          fee is generally recognized collectively based on contract accounting using
          either the percentage-of-completion or completed-contract method. Contract
          accounting is applied to any arrangements: (1) that include milestones or
          customer specific acceptance criteria that may affect collection of the
          software
          license fees; (2) where services include significant modification or
          customization of the software; (3) where significant consulting services
          are provided for in the software license contract without additional charge
          or
          are substantially discounted; or (4) where the software license payment is
          tied to the performance of consulting services.
  -63-
 Most
          of the
          Company’s software license arrangements do not include acceptance provisions.
          However, if acceptance provisions exist, the Company provides for a sales
          return
          allowance in accordance with Statement of Financial Accounting Standards
          No. 48, Revenue
          Recognition when Right of Return Exists (“SFAS
          48”). If acceptance provisions are long-term in nature or are not included
          as
          standard terms of an arrangement or if the Company cannot reasonably estimate
          the incidence of returns, revenue is recognized upon the earlier of receipt
          of
          written customer acceptance or expiration of the acceptance period.
  The
          Company
          assesses whether fees are fixed or determinable at the time of sale and
          recognize revenue if all other revenue recognition requirements are met.
          The
          Company’s standard payment terms are net 30. Payments that are due within six
          months are generally deemed to be fixed or determinable based on the Company’s
          successful collection history on such arrangements, and thereby satisfy
          the
          required criteria for revenue recognition.
  *Software
          License Revenue* —Under
          SOP 97-2, revenue is recognizable when: (1) the Company enters into a
          legally binding arrangement with a customer for the license of software;
          (2) the customer accepts delivery of the product; (3) customer payment
          is deemed fixed or determinable and free of contingencies or significant
          uncertainties; and (4) collection is probable. For software license
          arrangements that do not require significant modification or customization
          of
          the underlying software, the Company will recognize the software license
          revenue
          in this manner. Certain software license arrangements are based on monthly
          subscriber volume and the Company bills the customer on a monthly basis
          as
          volume varies. Under this type of arrangement, the Company recognizes the
          software license revenue in the month earned.
  *Product
          Support and Upgrades Revenue* —The
          Company’s software license arrangement includes a maintenance component, beyond
          the basic warranty period and is a separate fee. During the maintenance
          period,
          the customer is entitled to receive software license updates, maintenance
          releases and patches and product support and the fee is recognized ratably
          over
          the term of the maintenance period. Product support includes internet access
          to
          technical content, as well as internet and telephone access to technical
          support
          personnel. The maintenance fee is generally priced as a percentage of the
          software license fee. The Company’s customers historically opt to purchase a
          maintenance contract when they acquire software licenses and typically
          renew it
          annually.
  *Services
          Revenue* —In
          addition to the Company’s software products and the related product support
          component, the Company offers professional services, such as implementation
          services, training, hosting the Company’s software on the customer’s hardware,
          or application management. These professional services are typically sold
          under
          a separate service agreement. The revenue from these arrangements is generally
          accounted for separately from software license revenue and product support
          and
          upgrades revenue and is generally recognized as the services are performed.
          If
          there is a significant uncertainty about the project completion or receipt
          of
          payment for the related services, revenue is deferred until the uncertainty
          is
          sufficiently resolved.
  The
          Company
          recognizes revenue from contracts with fixed or “not to exceed” fees using the
          proportional performance method of accounting. The Company estimates the
          proportional performance on these contracts on a monthly basis utilizing
          hours
          incurred to date as a percentage of total estimated hours to complete the
          project. The Company recognizes no more than 90% of the milestone or total
          contract amount until acceptance is obtained. If the Company does not have
          a
          sufficient basis to measure progress towards completion, revenue is recognized
          upon the customer’s acknowledgement of final acceptance. When the total cost
          estimate exceeds revenues, the estimated loss is accrued immediately using
          cost
          estimates based upon an average fully burdened daily rate.
  -64-
 **Income
          Taxes** —Income
          taxes are accounted for in accordance with Statement of Financial Accounting
          Standards No. 109, Accounting
          for Income Taxes (“SFAS
          109”). This statement requires the recognition of deferred tax assets and
          liabilities to reflect the future tax consequences of events that have
          been
          recognized in the Company’s financial statements or tax returns. Measurement of
          the deferred items is based on enacted tax laws. In the event the future
          consequences of differences between financial reporting bases and tax bases
          of
          the Company’s assets and liabilities result in a deferred tax asset,
          SFAS 109 requires an evaluation of the probability of being able to realize
          the future benefits indicated by such assets. A valuation allowance related
          to a
          deferred tax asset is recorded when it is more likely than not that some
          portion
          or all of the deferred tax asset will not be realized. A full valuation
          allowance for deferred tax assets has been provided at December 31, 2006
          and 2005.
  **Accounting
          for Stock-Based Compensation** — Effective January 1, 2006, the Company adopted Statement of Financial
          Accounting Standards No. 123R, Share-Based
          Payment (“SFAS 123R”).
          Under SFAS 123R, the Company is required to measure the cost of employee
          services received in exchange for an award of equity instruments based
          on the
          grant-date fair value of the award. The measured cost is recognized in
          the
          statement of operations over the period during which an employee is required
          to
          provide service in exchange for the award. Additionally, if an award of
          an
          equity instrument involves a performance condition, the related compensation
          cost is recognized only if it is probable that the performance condition
          will be
          achieved.
  Prior
          to the
          adoption of SFAS 123R, the Company followed the provisions of Statement
          of
          Financial Accounting Standards No. 123, Accounting
          for Stock-Based Compensation (“SFAS 123”)
          which allowed the Company to use the intrinsic value method set forth in
          Accounting Principles Board Opinion No. 25, Accounting
          for Stock issued to Employees (“APB 25”)
          and disclose the pro forma effects on net income (loss) had the fair value
          of
          the equity awards been expensed. Under APB 25, the Company did not recognize
          expense related to employee stock options because the exercise price of
          such
          options equaled the fair value of the underlying stock on the grant
          date.
  The
          Company
          adopted SFAS 123R using the modified prospective transition method, which
          requires the application of the accounting standard as of January 1, 2006,
          the first day of the Company’s fiscal year 2006. The Company’s financial
          statements for prior periods have not been restated to reflect, and do
          not
          include, the impact of SFAS 123R.  During the year ended December 31,
          2006, the Company recognized compensation costs of $351,000 as result of
          the adoption of SFAS 123R.
  The
          following pro forma information, as required by SFAS No. 148, Accounting
          for Stock-Based Compensation — Transition and Disclosure, an Amendment of
          FASB Statement No. 123 (“SFAS
          148”), is presented for comparative purposes and illustrates the pro forma
          effect on net loss and net loss per share for the fiscal year ended December
          31,
          2005 as if the Company had applied the fair value recognition provisions
          of
          SFAS 123 to stock-based employee compensation prior to January 1,
          2006:
    Year
                    ended December 31, 2005Net
                  loss, as reported
                
                $
                (1,402,000
                )Deduct: 
                  Total stock-based employee compensation expense determined under
                  fair
                  value based method for all awards, net of related tax effects
                
                
                (427,000
                )Pro
                  forma net loss
                
                $
                (1,829,000
                )Net
                    loss per share:Basic
                  and diluted - as reported
                
                $
                (0.04
                )Basic
                  and diluted - pro forma
                
                $
                (0.05
                )
 -65-
 **Concentration
            of Credit Risk** —The **** Company
            sells its products to large communications companies, as well as emerging
            communications carriers. Credit is extended based on an evaluation of
            the
            customer’s financial condition, and collateral is generally not required. The
            Company also evaluates its credit customers for potential credit losses.
            The
            accounts receivable balances at December 31, 2006 and 2005 are primarily
            due from the major customers indicated below.
  For
          the
          fiscal year ended December 31, 2006, the Company had three customers who
          individually accounted for more than 10% of the Company’s total revenues. In the
          same period last year, the Company had two customers who individually accounted
          for more than 10% of total revenues. At December 31, 2006, the Company
          had four
          customers who individually accounted for more than 10% of the net accounts
          receivable balance and in aggregate totaled $195,000, as compared to December
          31, 2005, when the Company had two customers who individually accounted
          for more
          than 10% of the net accounts receivable balance and in aggregate totaled
          $446,000.
  At
          times, the Company's cash balances on deposit with financial institutions
          may
          exceed federally-insured amounts.  However, management does not believe
          there is a significant credit risk associated with these financial
          institutions.
  **Comprehensive
          Loss**—There****was no difference between net loss and
          comprehensive loss for any period presented.
  **Segment
          Information** —The **** Company
          has adopted Statement of Financial Accounting Standards No. 131, Disclosures
          About Segments of an Enterprise and Related Information (“SFAS
          131”). In accordance with SFAS 131, the Company has disclosed the required
          information about the Company’s operating segments and geographic areas in Note
          10.
  **Net
          Loss Per Share** —The **** Company
          has computed net loss per share in accordance with Statement of Financial
          Accounting Standards No. 128, Earnings
          Per Share (“SFAS
          128”). Basic and diluted net loss per share was computed by dividing net loss
          by
          the weighted-average number of common shares outstanding for the
          period.
  The
          following table represents the computation of basic and diluted loss per
          common
          share for the periods presented:
 
 **Year****Ended December 31****200****6**
                
                
                **2005**Net
                    loss applicable to common stockholders
                
                $
                (3,162,000
                )
                $
                (1,402,000
                )Weighted-average
                    number of common shares outstanding
                
                
                37,733,904
                
                
                36,314,818Weighted-average
                    number of dilutive common equivalent shares outstanding
                
                
                —
                
                
                —Weighted-average
                    shares outstanding during the period
                
                
                37,733,904
                
                
                36,314,818Net
                    loss per share:Basic
                    and Diluted
                
                $
                (.08
                )
                $
                (.04
                )
  Not
          included
          in the above table is the dilutive effect of options and warrants to purchase
          1,541,236 and 2,066,173 shares of common stock for the fiscal years ended
          December 31, 2006 and 2005, respectively because they are
          anti-dilutive.
  -66-
 **2.**
              **PROPERTY
                  AND EQUIPMENT**
  Property
            and equipment consist of the following at December 31:
  **2006**
                  
                  **2005**Computer
                      and office equipment
                  
                  $
                  1,667,000
                  
                  $
                  1,748,000Furniture
                      and fixtures
                  
                  
                  97,000
                  
                  
                  97,000Capitalized
                      leases
                  
                  
                  96,000
                  
                  
                  96,000Leasehold
                      improvements
                  
                  
                  51,000
                  
                  
                  51,0001,911,000
                  
                  
                  1,992,000Less
                      accumulated depreciation and amortization
                  
                  
                  (1,551,000
                  )
                  
                  (1,518,000
                  )Property
                      and equipment, net
                  
                  $
                  360,000
                  
                  $
                  474,000
  In
            June 2005, the Company entered into a 48-month equipment lease agreement
            with CITI Capital Technology Finance, Inc. to finance the purchase of
            equipment. Amortization of equipment purchased under capitalized lease
            obligations is included in depreciation expense. The accumulated amortization
            was $28,000 and $11,000 as of December 31, 2006 and 2005,
            respectively.
 **3.**
              **BORROWINGS**
 The
          Company’s borrowings consisted of the following:
  **Current**
                
                **Noncurrent**
                
                **Total****December 31,
                    2006**Corsair
                    Communications, Inc.
                
                $
                167,000
                
                $
                815,000
                
                $
                982,000Special
                    Situations Private Equity Fund, L.P.
                
                
                250,000
                
                
                —
                
                
                250,000Spieker
                    Properties, L.P.
                
                
                200,000
                
                
                —
                
                
                200,000CITI
                    Capital.
                
                
                24,000
                
                
                37,000
                
                
                61,000First
                    Regional Bank
                
                
                100,000
                
                
                —
                
                
                100,000Total
                
                $
                741,000
                
                $
                852,000
                
                $
                1,593,000**December 31,
                    2005**Corsair
                    Communications, Inc.
                
                $
                166,000
                
                $
                816,000
                
                $
                982,000Spieker
                    Properties, L.P.
                
                
                —
                
                
                200,000
                
                
                200,000CITI
                    Capital.
                
                
                22,000
                
                
                62,000
                
                
                84,000First
                    Regional Bank
                
                
                100,000
                
                
                —
                
                
                100,000Total
                
                $
                288,000
                
                $
                1,078,000
                
                $
                1,366,000
  *Note
          Payable to Corsair Communication, Inc.*
  On
          February 4, 1999, Corsair Communications, Inc. and its wholly-owned
          subsidiary, Subscriber Computing, Inc. (collectively, "Corsair"), sold
          substantially all of the assets relating to its Communication Resource
          Manager
          billing system and Intelligent Message Router to Wireless Billing Systems,
          a
          wholly owned subsidiary of Primal Systems, Inc. As consideration for the
          assets sold, the Company executed a promissory note, payable to Corsair
          in the
          amount of $2,238,000. The note was secured by substantially all the property
          and
          equipment acquired from Corsair.  The Company recorded the assets at fair
          value of $4,582,000 and assumed liabilities of $2,344,000, in addition
          to the
          note payable to Corsair. In
          January 2001, the Company amended the original terms of the note
          payable to Corsair and refinanced the note balance to include certain other
          liabilities due to Corsair totaling $51,000. In
          December 2001, the Company paid $125,000 of the total accrued interest on
          the note, rolled the remaining unpaid accrued interest balance of $61,000
          into
          the principal balance of the note, and amended the existing terms of the
          refinance note.  The terms of the note was amended as
          of December 2002 and again in March 2004.
  -67-
  Effective
          June 2005, the Company executed another amendment to the note payable to
          Corsair. This amendment extended the maturity date to January 1, 2010 from
          the previous maturity date of December 26, 2006. Pursuant to the amended
          terms of the note, interest continued to accrue at the same interest rate
          of 8.0%, and the Company made interest-only payments of $7,000 from
          July 2005 through December 2005. The Company would also be required to
          make monthly principal and interest payments of $15,000 from January 2006
          through June 2006, $25,000 from July 2006 through December 2009,
          and a final payment of $23,000 in January 2010.
  In
          March 2006, the payment terms for the note were further amended. Under the
          amended terms, the monthly interest-only payments of $7,000 continued from
          January 2006 through December 2006. Beginning in January 2007,
          principal and interest payments of $20,000 would be due monthly until paid
          in full in December 2011. The interest remained at 8.0%. This obligation
          was subordinated to the convertible notes issued in the March 2006 private
          placement.
  Effective
          January 2007, the payment terms for the note were further amended. Under
          the
          amended terms, the monthly interest-only payments of $7,000 continue from
          January 2007 through June 2007. Beginning in July 2007, principal
          and interest payments of $22,000 are due monthly through November 2011,
          and a
          final payment of $20,000 in December 2011. The interest remains at 8.0%.
          This obligation continues to be subordinated to the convertible notes issued
          in
          the March 2006 private placement.
  The
          outstanding balance of the note was $982,000 at December 31, 2006.
  *Note
          Payable to Special Situations Private Equity Fund, L.P.*
  In
          December
          2006, the Company entered into an unsecured loan agreement with Special
          Situations Private Equity Fund, L.P., a related party, in the amount of
          $250,000. Interest accrues at an interest rate of 11.0% per annum. There
          are no
          principal or interest payments due until the maturity date of June 27,
          2007. At
          December 31, 2006, the total outstanding balance of the note was
          $250,000.
  *Note
          Payable to Spieker Properties, L.P.*
  In
          June 2001, the Company and Spieker Properties, L.P., its landlord, amended
          its occupancy lease to reduce costs related to unneeded space and corresponding
          rental payments. As part of the amendment, the Company agreed to sign a
          note in
          the amount of $200,000. Interest accrues at an interest rate of 9.0% and
          compounds monthly. There are no principal or interest payments due until
          the
          lease expiration date of April 30, 2007. At December 31, 2006, the
          total outstanding balance was $327,000 which included principal of $200,000
          and
          accrued interest expense of $127,000.
  *Line
          of Credit Facilities with Sunwest Bank*
  In
          May 2002, the Company entered into a $100,000 operating line of credit loan
          agreement with Sunwest Bank. In February 2003, the Company drew down $100,000
          on
          this line of credit to finance a portion of the annual premium for an
          insurance policy. Interest accrued monthly at a rate of prime plus 2.00%,
          with a
          floor rate of 6.50% and was payable on a monthly basis. The principal balance
          was due in full in April 2005. During February 2005, the Company
          repaid the full $100,000 outstanding balance with proceeds from a new line
          of
          credit with First Regional Bank. This line of credit has been
          cancelled.
  *Note
          Payable to First Regional Bank*
  In
          February 2005, the Company executed a secured promissory note in the amount
          of $100,000 with First Regional Bank. The proceeds of this note were used
          to pay
          down the outstanding balance of the line of credit with Sunwest Bank. The
          collateral on this secured note was a certificate of deposit in the amount
          of
          $100,000 plus any interest earned and was held with First Regional Bank.
          The
          certificate of deposit earned interest
          at 1.90% annually and matured in February 2006. The interest on the
          promissory note accrued at 3.0% over the interest rate on the certificate
          of
          deposit.
  -68-
 In
          February 2006, the Company executed an amended and restated loan agreement
          for the original $100,000 principal balance. The certificate of deposit
          related
          to the original loan agreement matured and the $100,000 plus interest earned
          was
          released as restricted cash. Under the amended agreement, the Company opened
          a
          savings account as collateral against the outstanding loan balance. The
          interest
          rate on the loan was reduced to 2% over the interest rate of the savings
          account, which is currently 3.75% annually. The loan balance was paid in
          full in
          February 2007.
  At
          December 31, 2006, the outstanding balance on this note was
          $100,000.
  *Note
          Payable to CITI Capital*
  In
          June 2005, the Company entered into a 48-month equipment lease agreement
          with CITI Capital Technology Finance, Inc. to finance the purchase of
          equipment. The total amount financed under this agreement was $96,000 with
          monthly payments including interest of $2,000 through May 2009. The
          effective interest rate was 8.25%. As of December 31, 2006, the outstanding
          balance on this lease was $61,000. This lease is accounted for as a capital
          lease.
  The
          following table represents the contractual payments associated with the
          notes
          payable as of December 31, 2006:
  **Interest**
                  **Payments**
                
                **Principal**
                  **Payments**
                
                **Total**
                  **Payments****Year
                    ending December 31:**2007
                
                $
                229,000
                
                $
                741,000
                
                $
                970,0002008
                
                
                60,000
                
                
                207,000
                
                
                267,0002009
                
                
                44,000
                
                
                208,000
                
                
                252,0002010
                
                
                27,000
                
                
                213,000
                
                
                240,0002011
                
                
                10,000
                
                
                224,000
                
                
                234,000Total
                
                $
                370,000
                
                $
                1,593,000
                
                $
                1,963,000
  **4.**
              **COMMITMENTS
                  AND CONTINGENCIES**
  The
          Company
          leases office space and certain equipment under various non-cancelable
          operating
          leases. Future minimum lease payments required under operating leases,
          net of
          sublease income, as of December 31, 2006 are as follows:
 **Sublease**
                **(Income)**
              
              **Operating**
                **Leases**
              
              **Net****Year
                  ending December 31:**2007
              
              $
              (16,000
              )
              $
              197,000
              
              $
              181,0002008
              
              
              —
              
              
              30,000
              
              
              30,0002009
              
              
              —
              
              
              23,000
              
              
              23,0002010
              
              
              —
              
              
              2,000
              
              
              2,0002011
              
              
              —
              
              
              —
              
              
              —Total
                  minimum lease payments
              
              $
              (16,000
              )
              $
              252,000
              
              $
              236,000
  Rent
          expense
          under such operating leases was $469,000 and $470,000 for the fiscal years
          ended
          December 31, 2006 and 2005, respectively. The Company’s leased office space
          included approximately 13,500 square feet of general and administrative
          office
          space in Irvine, California through April 2007. The Company expects to
          enter
          into a new lease agreement for approximately 10,000 square feet of office
          space
          in Irvine, California beginning in May 2007.  In addition, the Company
          leased approximately 7,000 square feet of office space in Irvine, California
          through May 2006.
  -69-
  The
          Company
          is subject to various legal proceedings from time to time as part of its
          business. The Company does not believe that it is currently party to any
          legal
          proceedings or threatened legal proceedings, the adverse outcome of which,
          individually or in the aggregate, would have a material adverse effect
          on its
          business, financial condition and results of operations.
 **5.**
              **GUARANTEES
                  AND INDEMNIFICATIONS**
 The
          Company
          has made guarantees and indemnities, under which it may be required to
          make
          payments to a third-party, in relation to certain transactions. In connection
          with the sales of its products, the Company provides intellectual property
          indemnities to its customers. Guarantees and indemnities to customers in
          connection with product sales generally are subject to limits based on
          the
          amount of the related product sales. The Company also indemnifies its directors
          and officers to the maximum extent permitted under applicable law in effect.
          The
          Company has not recorded any liability for these guarantees and indemnities
          in
          the accompanying consolidated balance sheets. The Company considers such
          factors
          as the degree of probability of an unfavorable outcome and the ability
          to make a
          reasonable estimate of the amount of loss. To date, the Company has not
          encountered material costs as a result of such obligations and has not
          accrued
          any liabilities related to such indemnification in its financial
          statements.
  The
          Company
          generally warrants its products for a period of 90 days from the date of
          acceptance of the product by its customers. Warranty costs have historically
          been minimal.
 **6.**
              **STOCK-BASED
                  COMPENSATION**
 *Stock
          Options*
  In
          February 2001, the Board of Directors approved the Company’s 2001 Flexible
          Incentive Plan (the “2001 FIP”) and authorized approximately 3.9 million shares
          to be reserved for issuance pursuant to the 2001 FIP. In October 2001, the
          Board of Directors approved the Company’s 2001 FIP, as amended. Under the terms
          of the 2001 FIP, as amended, employees and directors are eligible to receive
          a
          grant of incentive stock options to purchase shares of the Company’s common
          stock at their fair market value on the date of grant. Options granted
          under the
          2001 FIP vest at the minimum rate of 20% per year from the grant date,
          but could
          vest at an accelerated rate. At December 31, 2006 and 2005, options to
          purchase
          2,648,439 and 2,835,997 shares, respectively, of common stock were exercisable
          under the 2001 FIP.
  The
          Company’s stockholders approved the adoption of Primal’s 2004 Flexible Incentive
          Plan (the “2004 FIP”) at the Company’s 2004 Annual Meeting of Stockholders, held
          November 12, 2004. Pursuant to the 2004 FIP, the Company may issue up to an
          aggregate of 5,451,073 shares of the Company’s common stock, $0.01 par value per
          share. For optionees that have been with the Company for less than one
          year,
          options granted under the 2004 FIP vest one-third on the one-year anniversary
          of
          the grant date with the remaining two-thirds vesting in four equal semi-annual
          installments after the one-year anniversary date. For all other optionees,
          options granted under the 2004 FIP vest in six equal semi-annual installments
          commencing on the six-month anniversary of the grant date. At December 31,
          2006 and 2005, options to purchase 2,782,171 and 1,009,581 shares, respectively,
          of common stock were exercisable under the 2004 FIP.
  In
          August
          2006, the Board of Directors approved and adopted the Company’s 2006 Stock
          Option Plan (the "2006 SOP”), as recommended by the Board’s Compensation
          Committee. The purpose of the 2006 SOP is to assist the Company in attracting
          and retaining selected individuals to serve as officers and employees of
          the
          Company who will contribute to the Company’s success and to achieve objectives
          which will inure to the benefit of the stockholders of the Company through
          the
          additional incentive inherent in the ownership of the Company’s common stock.
          The Plan will be administered by the Board’s Compensation Committee, which will
          determine to whom options are granted, the number of options to be granted,
          the
          option price and the other terms (including vesting) of each option granted
          under the 2006 SOP. Options granted under the 2006 SOP will be nonqualified
          stock options. There have been reserved 8.0 million shares for issuance
          upon
          exercise of options granted pursuant to the 2006 SOP. Options
          granted under the 2006 SOP will vest fully upon either the sale of all
          or
          substantially all of the assets of the Company; the acquisition by any
          person or
          group of more than 50% beneficial ownership of the Company; or the merger,
          consolidation or other reorganization of the Company resulting in a more
          than
          50% change in ownership of the Company.The 2006 SOP will expire in
          July 2016. At December 31, 2006, there were no options to purchase shares
          of
          common stock exercisable under the 2006
          SOP.
  -70-
 In
          accordance with the provisions of SFAS 123R, the Company recognized stock-based
          compensation expense of $351,000 for the fiscal year ended December 31,
          2006.
          The fair value of each option granted was estimated on the date of grant
          using
          the Black-Scholes option-pricing model. The expected volatility is based
          on
          historical volatility of the Company’s stock. The risk-free rate is based on the
          U.S. Treasury yield curve in effect at the time of grant. The expected
          term of
          options granted is based on the remaining contractual life of the option.
          The
          following weighted average assumptions were used for the options granted
          during the fiscal years ended December 31, 2006 and 2005:
  **Fiscal
                    year ended December 31,****2006**
                
                **2005**Expected
                    volatility
                
                177.6%
                
                220.1%Risk-free
                    rate
                
                4.85%
                
                3.50%Expected
                    Term
                
                5.6
                    years
                
                9.0
                    years
 
 A
          summary of
          option activity under the 2001 FIP, the 2004 FIP and the 2006 SOP as of
          December
          31, 2006, and changes during the fiscal year ended December 31, 2006 is
          presented below:
  **Number of**
                  **Shares**
                
                **Weighted-**
                  **Average**
                  **Exercise**
                  **Price**
                
                **Weighted-**
                  **Average**
                  **Remaining**
                  **Contractual**
                  **Term**
                
                **Aggregate**
                  **Intrinsic Value**Outstanding
                    as of January 1, 2006
                
                
                7,566,105
                
                $
                0.13Granted
                
                
                7,907,401
                
                
                0.08Exercised
                
                
                (259,993
                )
                
                0.05Forfeited
                    or expired
                
                
                (690,538
                )
                
                0.14Outstanding
                    as of December 31, 2006
                
                
                14,522,975
                
                $
                0.10
                
                
                5.64
                
                $
                544,000Exercisable
                    as of December 31, 2006
                
                
                5,430,609
                
                $
                0.12
                
                
                5.57
                
                $
                82,000
 
 The
          weighted-average grant-date fair value of options granted during the fiscal
          years ended December 31, 2006 and 2005 was $0.07 and $0.15, respectively.
          The
          total intrinsic value of options exercised during the fiscal years ended
          December 31, 2006 and 2005 was $25,000 and $29,000, respectively.
  A
          summary of
          the status of the Company’s nonvested shares as of December 31, 2006, and
          changes during the fiscal year ended December 31, 2006 is presented
          below:
  **Number of**
                  **Shares**
                
                **Weighted-**
                  **Average**
                  **Grant Date**
                  **Fair Value**Nonvested
                    as of January 1, 2006
                
                
                3,720,529
                
                $
                0.14Granted
                
                
                7,907,401
                
                
                0.07Vested
                
                
                (2,200,625
                )
                
                0.14Forfeited
                
                
                (334,939
                )
                
                0.16Nonvested
                    as of December 31, 2006
                
                
                9,092,366
                
                $
                0.08
 
 For
          any
          option granted with a performance condition, the Company determines if
          it is
          probable that the performance condition will be achieved. Until a performance
          condition is deemed to be probable, the compensation cost of these option
          grants
          is included in the total unrecognized compensation cost. As of December
          31,
          2006, there was $597,000 of total unrecognized compensation cost related
          to
          nonvested share-based compensation arrangements granted under the 2001
          FIP, the
          2004 FIP, and the 2006 SOP. This cost is expected to be recognized over
          a period
          of 5 years.
  Cash
          received from option exercise under all share-based payment arrangements
          was
          $14,000 and $19,000 for the fiscal years ended December 31, 2006 and 2005,
          respectively.
  -71-
 *Warrants*
  In
          July
          2006, the Company issued to a new customer a five-year warrant to purchase
          up to
          1.5 million shares of the Company’s common stock at an exercise price of $0.28
          per share (subject to adjustment in certain circumstances). The warrants
          were
          issued in connection with entering into a three-year software license and
          services agreement. Upon the issuance of the warrants, the right to purchase
          300,000 shares vested and the remainder will vest in 400,000 share increments
          if
          and when stated targets of cumulative license fee and maintenance revenue
          paid
          to the Company under the license and services agreement are met. Vested
          warrants
          are exercisable for three years after the vesting date and expire immediately
          prior to a change in control of the Company.
 
 Pursuant
          to
          Emerging Issues Task Force Issue No. 01-9, Accounting
          for Consideration Given by a Vendor to a Customer (Including a Reseller
          of the
          Vendor’s Products) (“EITF
          01-9”) and Emerging Issues Task Force Issue No. 96-18, Accounting
          for Equity Instruments That Are Issued to Other Than Employees for Acquiring,
          or
          in Conjunction with Selling, Goods or Services (“EITF
          96-18”), the Company recognized the fair value of the initial 300,000 warrants
          which totaled $14,000 as a reduction against the revenue earned from this
          customer and as paid-in-capital during the quarter ended September 30,
          2006. The
          fair value of these 300,000 warrants was estimated on the vesting date
          using the
          Black-Scholes option-pricing model. For the remaining 1.2 million warrants,
          for
          each reporting period, the Company will estimate the then-current fair
          value of
          the warrants estimated to have been earned as of the period end based on
          a
          pro-rata percentage of revenue earned by the customer during that reporting
          period. If and when the stated target is met by the customer, and a measurement
          date has been established, the Company will compute the fair value of each
          additional 400,000 share increment using the Black-Scholes option-pricing
          model and record the necessary adjustment to previous estimates of the
          award
          based on this measurement date fair value.
 
 The
          fair
          value of each warrant granted was estimated on the date of grant using
          the
          Black-Scholes option-pricing model. The expected volatility is based on
          historical volatility of the Company’s stock. The risk-free rate is based on the
          U.S. Treasury yield curve in effect at the time of grant. The expected
          term of
          warrants granted is based on the remaining contractual life of the warrant.
          The
          following weighted average assumptions were used for the compensation-based
          warrants granted during the fiscal year ended December 31, 2006:
  **Fiscal
                    year ended**
                  **December 31, 2006**Expected
                    volatility
                
                128.4%Risk-free
                    rate
                
                5.05%Expected
                    Term
                
                10
                    years
  During
          the
          fiscal year ended December 31, 2005, the Company did not issue any
          compensation-based warrants.
  A
          summary of
          compensation-based warrant activity as of December 31, 2006, and changes
          during
          the fiscal year ended December 31, 2006 is presented below:
 **Number of**
                **Shares**
              
              **Weighted-**
                **Average**
                **Exercise**
                **Price**
              
              **Weighted-**
                **Average**
                **Remaining**
                **Contractual**
                **Term**
              
              **Aggregate**
                **Intrinsic**
                **Value**Outstanding
                  as of January 1, 2006
              
              
              1,427,174
              
              $
              0.14Granted
              
              
              2,500,000
              
              
              0.21Exercised
              
              
              —Canceled
              
              
              —Outstanding
                  as of December 31, 2006
              
              
              3,927,174
              
              $
              0.18
              
              
              5.63
              
              $
              108,000Exercisable
                  as of December 31, 2006
              
              
              2,727,174
              
              $
              0.14
              
              
              6.12
              
              $
              108,000
 
 -72-
 **7.**
              **PRIVATE
                  PLACEMENT**
  *April
          2006 Private Placement*
  On
          April 27,
          2006, the Company sold 1,750,000 shares of common stock and 875,000 warrants
          to
          purchase shares of the Company’s common stock to two accredited investors in a
          private placement (the “April 2006 Private Placement”), one of which is
          currently a member of the Company’s Board of Directors (“Director Investor”).
          The warrants expire March 31, 2011 and are exercisable for cash at an exercise
          price of $0.15 per share. The exercise price of the warrants is subject
          to
          adjustment in certain circumstances, including downward adjustment upon
          issuance
          by the Company of common stock or securities convertible into shares of
          common
          stock at a per share price less than the exercise price of the warrants.
          The
          investors may, in limited instances, exercise the warrant through a cashless
          exercise. The Company received gross proceeds of $175,000 and used these
          proceeds for general working capital purposes.
  Pursuant
          to
          a Registration Rights Agreement, the Company agreed to file, and did file
          on May
          1, 2006, a registration statement, registering for resale the shares of
          common
          stock and the shares of common stock issuable upon exercise of the warrants.
          Because the Company registration statement was not declared effective by
          July 16, 2006, the Company is required to pay liquidated damages at the
          rate of 1.5 percent of the aggregate amount invested by the non-director
          investor for each 30-day period or pro rata for any portion thereof until
          the
          registration statement was declared effective, on December 22, 2006. In
          addition, the Company will be required to maintain and update it as necessary
          in
          order to keep such registration statement current so that these shares
          of common
          stock are freely tradable. If the Company does not keep such registration
          statement current, the non-director investor may require that the Company
          pay
          additional liquidated damages to the non-director investor. As of December
          31,
          2006, the Company had accrued $4,000 in liquidated damages payable to the
          non-director investor.
  In
          accordance with the provisions of Accounting Principles Board Opinion No.
          14, Accounting
          for Convertible Debt and Debt Issued with Stock Purchase Warrants (“APB
          14”), the Company allocated the total proceeds received from the Director
          Investor between the shares of common stock and the warrants issued based
          on
          their relative estimated fair values on the date of issuance. The Company
          calculated the fair value of the warrants on the date of the issuance using
          the
          Black-Scholes model. As a result of this analysis, the Company allocated
          $41,000
          from the proceeds to warrants.
  Under
          the
          provisions of SFAS 133 and Emerging Issues Task Force Issue No. 00-19, Accounting
          for Derivative Financial Instruments Indexed to, and Potentially Settled
          in, a
          Company’s Own Stock (“EITF
          00-19”), the Company accounted for the warrants issued to the non-director
          investor as freestanding derivative instruments. The Company calculated
          the fair
          value of the warrants on the date of issuance using the Black-Scholes model.
          A
          liability of $24,000, which equals the fair value of the warrants on the
          date of
          issuance, was recognized with the offsetting entry as a reduction to
          paid-in-capital. Additionally, the net increase in the fair value during
          the
          fiscal year ended December 31, 2006 was recorded as a loss of $8,000. Any
          future
          change in the fair value of the warrants will be recognized during the
          current
          reporting period.
  -73-
 *March
          2006 Private Placement*
  On
          March 31, 2006, the Company completed a private placement of $1.5 million
          in aggregate principal amount of its 5% Senior Secured Convertible Notes
          (the
“Notes”) along with warrants to purchase 7.5 million shares of the Company’s
          common stock (the “March 2006 Private Placement” and, together with the
          April 2006 Private Placement, the “2006 Private Placements”) to Special
          Situations Fund III, Q.P., L.P. and four related funds (“SSF”). The Notes are
          due March 31, 2008 and will pay interest semi-annually, in cash. The Notes
          are secured by a first priority security interest in all of the Company’s
          assets. Events of default under the Notes include failure to pay amounts
          due
          under the related private placement documents (including the Registration
          Rights
          Agreement described below) or failure to make any required principal payment
          on
          indebtedness of $100,000 or more. Upon election of SSF, at any time, any
          or all
          of the outstanding principal and any accrued but unpaid interest on the
          Notes
          may be converted into shares of the Company’s common stock
          at
          a conversion price of $0.10 per share. The warrants to purchase shares
          of the
          Company’s common stock expire March 31, 2011 and are exercisable for cash
          at an exercise price of $0.15 per share. The conversion price of the Notes
          and
          the exercise price of the warrants are subject to adjustment in certain
          circumstances, including downward adjustment upon issuance by the Company
          of
          common stock or securities convertible into shares of common stock at a
          per
          share price less than the conversion price of the Notes or exercise price
          of the
          warrants, respectively. SSF may, in limited instances, exercise the warrant
          through a cashless exercise.
  Pursuant
          to
          a Registration Rights Agreement entered into between the Company and SSF
          as part
          of the March 2006 Private Placement, the Company has agreed to file, and
          did file on May 1, 2006, a registration statement, registering for resale
          of the
          shares of common stock issuable upon conversion of the Notes and exercise
          of the
          warrants. Because the Company registration statement was not declared effective
          by July 16, 2006, the Company is required to pay liquidated damages at the
          rate of 1.5 percent of the aggregate amount invested by the investors for
          each
          30-day period or pro rata for any portion thereof until the registration
          statement was declared effective, on December 22, 2006. In addition, the
          Company
          will be required to maintain and update it as necessary in order to keep
          such
          registration statement current so that these shares of common stock are
          freely
          tradable. If the Company does not keep such registration statement current,
          it
          may be required to pay additional liquidated damages. As of December 31,
          2006,
          the Company had accrued $119,000 in liquidated damages payable to
          SSF.
  Under
          the
          provisions of SFAS 133 and EITF 00-19, the Company accounted for the warrants
          as
          freestanding derivative instruments. The Company calculated the fair value
          of
          the warrants on the date of issuance using the Black-Scholes model. A liability
          of $995,000 which equals the fair value of the warrants on the date of
          issuance
          was recognized with an offsetting reduction to the carrying amount of the
          Notes.
          The resulting debt discount of $995,000 is being amortized over the life
          of the
          Notes, using the effective interest method. For the fiscal year ended December
          31, 2006, the amortization of the debt discount totaled $237,000 and was
          recorded as interest expense. Additionally, the net decrease in the fair
          value
          during the fiscal year ended December 31, 2006 was recorded as a gain of
          $12,000. Any future change in the fair value of the warrants will be recognized
          during the current reporting period.
  Pursuant
          to
          Emerging Issues Task Force Issue No. 98-5, Accounting
          for Convertible Securities with Beneficial Conversion Features or Contingently
          Adjustable Conversion Ratios (“EITF
          98-5”) and Emerging Issues Task Force Issue No. 00-27, Application
          of Issue No. 98-5 to Certain Convertible Instruments (“EITF
          00-27”), the Company calculated an effective conversion price of $0.03 per share
          for the embedded conversion option. Because the market value of the common
          stock
          was higher than the effective conversion price on the date of issuance,
          the
          conversion feature is considered to be a beneficial conversion feature.
          The
          Company recognized a beneficial conversion feature as a reduction to the
          net
          carrying amount of the Notes and an addition to paid-in-capital of $505,000,
          which is based on the effective conversion rate, capped at the net carrying
          amount of the Notes. The discount resulting from this allocation to the
          beneficial conversion feature is being amortized over the life of the Notes,
          using the effective interest method. For the fiscal year ended December
          31,
          2006, the amortization of the debt discount totaled $158,000 and was recorded
          as
          interest expense.
  -74-
 *2004
          Private Placement*
  On
          June 15, 2004, the Company completed a private placement of our common
          stock and warrants (the “June 2004 Private Placement”). Pursuant to the
          June 2004 Private Placement, the Company issued an aggregate of 14,284,782
          shares of common stock and warrants to purchase a total of 7,142,393 shares.
          The
          effective price was $0.23 for each unit. The Company received gross proceeds
          of
          $3.3 million in cash from the June 2004 Private Placement. As a result
          of certain anti-dilution provisions triggered by the March 2006 Private
          Placement, certain purchasers in the June 2004 Private Placement were issued
          1,713,859 additional warrants to purchase shares of the Company’s common stock
          (the “2004 Additional Warrants”) and the exercise price of the 6,869,566
          outstanding warrants originally issued to these purchasers (the “Repriced
          Warrants”) was repriced from $0.28 to $0.22 per share. All warrants issued
          pursuant to the June 2004 Private Placement expire in
          June 2009.
  The
          Company calculated the fair value of the Repriced Warrants just prior to
          the
          date of issuance and the aggregate fair value of the Repriced Warrants
          and the
          Additional Warrants on the date of issuance using the Black-Scholes model.
          The
          Company reclassed the increase of $189,000 from additional paid-in-capital
          to
          warrants in shareholders’ equity.
 **8.**
              **GOODWILL**
  The
          Company
          merged with Avery on October 1, 1999. In connection with the merger and
          subsequent spin-off on February 9, 2001, the Company recorded a total of
          $8.3 million in goodwill representing the difference between the purchase
          price
          Avery paid over the estimated fair market value of the net assets of the
          Company. On February 9, 2001, the Company was spun-off as a separate
          company by Avery. However, the goodwill, which was pushed-down to the Company’s
          balance sheet by the parent, Avery, at the time of the merger, remained
          on the
          Company’s balance sheet at the time it was spun-off. In September 2001, the
          Company recorded a $5.6 million charge to adjust the balance to the estimated
          recoverable value.
  As
          of
          December 31, 2006 and 2005, goodwill was $593,000.
 **9.**
              **INCOME
                  TAXES**
 For
          both of
          the fiscal years ended December 31, 2006 and 2005, the expense for income
          taxes was $2,000. The expense for income taxes for the fiscal years ended
          December 31, 2006 and 2005 mostly reflects the minimum tax due in
          California.
  A
          reconciliation of the provision for the income taxes to the amount of income
          tax
          expense that would result from applying the federal statutory rate of 34%
          to
          income before provision for income taxes is as follows:
 **2006**
              
              **2005**Benefit
                  at statutory rate
              
              $
              (1,074,000
              )
              $
              (476,000
              )State
                  taxes, net of federal benefit
              
              
              1,000
              
              
              1,000Adjustment
                  of net operating loss, credit carryforwards and
                  depreciation
              
              
              (106,000
              )
              
              (46,000
              )Change
                  in valuation allowance
              
              
              1,089,000
              
              
              515,000Other
              
              
              92,000
              
              
              8,000$
              2,000
              
              $
              2,000
  -75-
 The
        tax
        effects of temporary differences used in determining the Company’s deferred tax
        assets and liabilities are presented below at December 31, 2006 and
        2005:
  **200****6**
              
              **2005*****Deferred
                  tax assets***Net
                  operating loss carryforwards
              
              $
              2,653,000
              
              $
              1,566,000Accruals
              
              
              196,000
              
              
              145,000Credits
              
              
              585,000
              
              
              462,000State
                  taxes
              
              
              1,000
              
              
              1,000Other
              
              
              10,000
              
              
              37,000Total
                  deferred tax assets
              
              
              3,445,000
              
              
              2,211,000Less
                  valuation allowance
              
              
              (3,158,000
              )
              
              (1,904,000
              )Net
                  deferred tax assets
              
              
              287,000
              
              
              307,000***Deferred
                  tax liabilities***Basis
                  difference in fixed assets
              
              
              (280,000
              )
              
              (307,000
              )Other
              
              
              (7,000
              )
              
              —Total
                  deferred tax liabilities
              
              
              (287,000
              )
              
              (307,000
              )**Net
                  deferred tax assets**
              
              $
              —
              
              $
              —
  Based
          upon
          uncertainties related to the Company’s ability to generate sufficient taxable
          income in the future to realize its deferred tax assets, a full valuation
          allowance has been provided for the fiscal years ended December 31, 2006
          and 2005, as it is more likely than not that the Company’s deferred tax asset
          will not be realized.
  At
          December 31, 2006, the Company’s federal net operating loss carryforward
          and research and development credit carryforward were $6,767,000 and $457,000,
          respectively. Both of these carryforwards will begin to expire in 2023.
          The
          Company’s state net operating loss carryforward and research and development
          credit carryforward balances were $6,031,000 and $195,000, respectively.
          The net
          operating loss carryforward will begin to expire in 2014. However, the
          net
          operating loss and research and development credit may change due to utilization
          within the Avery consolidated group.
  As
          a result
          of the merger of Primal Systems, Inc. with and into Avery (see Note 1), the
          Company’s annual use of Primal Systems, Inc.’s net operating losses are
          limited under Section 382 of the Internal Revenue Code to approximately
          $160,000 annually
 **10.**
              **SEGMENT
                  AND GEOGRAPHIC INFORMATION**
  Operating
          segments are defined as components of an enterprise about which separate
          financial information is available that is evaluated regularly by the Company’s
          chief operating decision maker, or decision-making group, in deciding how
          to
          allocate resources and in assessing performance. The operating segments
          of the
          Company are managed separately because each segment represents a strategic
          business unit that offers different products or services.
  The
          Company’s reportable operating segments include Software Licenses, Product
          Support and Upgrades, and Services. The Software Licenses operating segment
          develops and markets the Company’s integrated suite of client/server and
          browser-based software solutions. The Product Support and Upgrades segment
          offers after-sale support and maintenance for software products, including
          software upgrades. The Services segment provides programming, customization,
          consulting, implementation services, training, application management,
          and
          hosting our software on the customer’s hardware related to the Company’s
          products and a variety of software languages and platforms.
  -76-
 The
          Company
          does not separately allocate operating expenses to these segments, nor
          does it
          allocate specific assets to these segments. Therefore, segment information
          reported includes only revenues, cost of revenues, and gross margin, as
          this
          information is the only segment-related information provided to the chief
          operating decision maker.
  Operating
          segment data for fiscal years ended December 31, 2006 and 2005 were as
          follows:
 **License**
              
              **Support**
              
              **Services**
              
              **Total****Year
                  ended December 31, 2006**Revenues
              
              $
              1,828,000
              
              $
              1,236,000
              
              $
              2,584,000
              
              $
              5,648,000Cost
                  of revenues
              
              
              122,000
              
              
              481,000
              
              
              1,930,000
              
              
              2,533,000Gross
                  margin
              
              $
              1,706,000
              
              $
              755,000
              
              $
              654,000
              
              $
              3,115,000**Year
                  ended December 31, 2005**Revenues
              
              $
              3,318,000
              
              $
              1,385,000
              
              $
              3,864,000
              
              $
              8,567,000Cost
                  of revenues
              
              
              86,000
              
              
              408,000
              
              
              3,249,000
              
              
              3,743,000Gross
                  margin
              
              $
              3,232,000
              
              $
              977,000
              
              $
              615,000
              
              $
              4,824,000
  Revenues
        are
        attributed to geographic areas based on the location of the entity to which
        the
        products or services were sold. Revenues, gross margin, loss from operations,
        and long-lived assets concerning principal geographic areas in which the
        Company
        operates are as follows:
  **North****America**
              
              **Asia / Pacific**
              
              **Europe**
              
              **Total****Year
                  ended December 31, 2006**Revenues
              
              $
              4,903,000
              
              $
              541,000
              
              $
              204,000
              
              $
              5,648,000Gross
                  margin
              
              
              2,704,000
              
              
              298,000
              
              
              113,000
              
              
              3,115,000Net
                  loss
              
              
              (2,745,000
              )
              
              (303,000
              )
              
              (114,000
              )
              
              (3,162,000
              )Property
                  and equipment, net
              
              
              360,000
              
              
              —
              
              
              —
              
              
              360,000**Year
                  ended December 31, 2005**Revenues
              
              $
              7,164,000
              
              $
              1,032,000
              
              $
              371,000
              
              $
              8,567,000Gross
                  margin
              
              
              4,034,000
              
              
              581,000
              
              
              209,000
              
              
              4,824,000Net
                  loss
              
              
              (1,172,000
              )
              
              (169,000
              )
              
              (61,000
              )
              
              (1,402,000
              )Property
                  and equipment, net
              
              
              474,000
              
              
              —
              
              
              —
              
              
              474,000


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