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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549
 FORM 10-Q þ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended March 31, 2005 o TRANSITION REPORT UNDER SECTION 13 OR 15(d)
OF THE EXCHANGE ACT For the transition period from  to Commission file number 0-22190   VERSO TECHNOLOGIES, INC.  MINNESOTA
    
    41-1484525(State or Other Jurisdiction
    
    (I.R.S. Employer Identification No.)of Incorporation or Organization)
 400 Galleria Parkway, Suite 300, Atlanta, GA 30339
(Address of Principal Executive Offices) (678) 589-3500
(Registrants Telephone Number, Including Area Code)   Indicate by check mark whether the registrant (1) has filed all reports required to be filed
by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or
for such shorter period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days.
Yes þ No o. Indicated by check mark whether registrant is an accelerated filer (as defined in Rule 12b-2 of the
Exchange Act)
Yes þ No o. Shares of the registrants common stock, par value $.01 per share, outstanding as of May 9, 2005:
134,472,641.




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VERSO TECHNOLOGIES, INC.
FORM 10-Q INDEX Page No.Part I. FINANCIAL INFORMATIONItem 1. Financial Statements (Unaudited)Condensed Consolidated Balance Sheets as of March 31, 2005 and December 31, 2004
    
    
    3Condensed Consolidated Statements of Operations for the three months ended March 31, 2005 and 2004
    
    
    4Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2005 and 2004
    
    
    5Notes to Condensed Consolidated Financial Statements
    
    
    6Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    21Item 3. Quantitative and Qualitative Disclosures about Market Risk
    
    
    31Item 4. Controls and Procedures
    
    
    32PART II. OTHER INFORMATIONItem 1. Legal Proceedings
    
    
    33Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    33Item 6. Exhibits
    
    
    33Signature Page
    
    
    34Exhibit Index
    
    
    35EX-10.32 ASSUMPTION AGREEMENT DATED APRIL 14, 2005EX-10.33 BORROWER AGREEMENT DATED APRIL 14, 2005EX-10.34 AMENDED & RESTATED SECURED PROMISSORY NOTEEX-31.1 SECTION 302, CERTIFICATION OF THE CEOEX-31.2 SECTION 302, CERTIFICATION OF THE CFOEX-32.1 SECTION 906, CERTIFICATION OF THE CEOEX-32.2 SECTION 906, CERTIFICATION OF THE CFO




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VERSO TECHNOLOGIES, INC. AND SUBSIDIARIES 
 CONDENSED CONSOLIDATED BALANCE SHEETS
 (in thousands, except share data)
 March 31,
    
    
    December 31,2005
    
    
    2004(Unaudited)ASSETS:Current assets:Cash and cash equivalents
    
    $
    14,700
    
    
    $
    4,234Restricted cash
    
    
    1,620
    
    
    
    Accounts receivable, net of allowance for doubtful accounts of $325
and $255, respectively
    
    
    3,412
    
    
    
    3,961Inventories
    
    
    4,843
    
    
    
    5,362Other current assets
    
    
    2,710
    
    
    
    1,451Current portion of note receivable
    
    
    300
    
    
    
    Assets held for sale
    
    
    
    
    
    
    8,995Total current assets
    
    
    27,585
    
    
    
    24,003Property and equipment, net of accumulated depreciation and amortization
of $6,508 and $7,047, respectively
    
    
    3,646
    
    
    
    3,879Investment
    
    
    700
    
    
    
    729Note receivable, net of current portion
    
    
    3,200
    
    
    
    Other intangibles, net of accumulated amortization of $1,049 and $921,
respectively
    
    
    3,081
    
    
    
    2,304Goodwill
    
    
    2,514
    
    
    
    2,514Total assets
    
    $
    40,726
    
    
    $
    33,429LIABILITIES AND SHAREHOLDERS EQUITY:Current liabilities:Accounts payable
    
    $
    1,643
    
    
    $
    2,095Accrued compensation
    
    
    1,050
    
    
    
    1,356Accrued expenses
    
    
    2,111
    
    
    
    1,973Current portion of liabilities of discontinued operations
    
    
    2,300
    
    
    
    1,552Liabilities held for sale
    
    
    
    
    
    
    2,001Convertible subordinated debentures
    
    
    4,322
    
    
    
    4,254Unearned revenue and customer deposits
    
    
    3,614
    
    
    
    3,157Total current liabilities
    
    
    15,040
    
    
    
    16,388Liabilities of discontinued operations, net of current portion
    
    
    1,204
    
    
    
    1,461Other long-term liabilities
    
    
    179
    
    
    
    229Notes payable, net of current portion
    
    
    2,728
    
    
    
    2,711Convertible debentures
    
    
    9,171
    
    
    
    Total liabilities
    
    
    28,322
    
    
    
    20,789Shareholders equity:Preferred
stock, no par value, 1,000,000 shares authorized;
780,000 shares issued and none outstanding
    
    
    
    
    
    
    Common stock, $.01 par value, 200,000,000 shares authorized;
13?,415,338 and 133,243,205 shares issued and outstanding
    
    
    1,344
    
    
    
    1,332Additional paid-in capital
    
    
    328,507
    
    
    
    322,971Stock payable
    
    
    28
    
    
    
    128Accumulated deficit
    
    
    (317,431
    )
    
    
    (311,931
    )Deferred compensation
    
    
    
    
    
    
    (7
    )Accumulated
other comprehensive income (loss) - foreign currency translation
    
    
    (44
    )
    
    
    147Total shareholders equity
    
    
    12,404
    
    
    
    12,640Total liabilities and shareholders equity
    
    $
    40,726
    
    
    $
    33,429
 The accompanying notes are an integral part of these condensed consolidated financial statements. 3




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VERSO TECHNOLOGIES, INC. 
 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
 (In thousands, except share data)
  For the three months ended March 31,2005
    
    
    2004Revenue:Products
    
    $
    2,738
    
    
    $
    6,614Services
    
    
    3,868
    
    
    
    4,485Total revenue
    
    
    6,606
    
    
    
    11,099Cost of revenue:Products:Product costs
    
    
    1,340
    
    
    
    2,524Amortization of intangibles
    
    
    68
    
    
    
    69Total cost of product
    
    
    1,408
    
    
    
    2,593Services
    
    
    2,335
    
    
    
    2,593Total cost of revenue
    
    
    3,743
    
    
    
    5,186Gross profit:Products
    
    
    1,330
    
    
    
    4,021Services
    
    
    1,533
    
    
    
    1,892Total gross profit
    
    
    2,863
    
    
    
    5,913Operating expenses:General and administrative
    
    
    2,586
    
    
    
    2,836Sales and marketing
    
    
    2,146
    
    
    
    1,956Research and development
    
    
    1,684
    
    
    
    1,581Depreciation and amortization
    
    
    660
    
    
    
    769Reorganization costs
    
    
    124
    
    
    
    584Reorganization
costs - stock related
    
    
    
    
    
    
    570Total operating expenses
    
    
    7,200
    
    
    
    8,296Operating loss from continuing operations
    
    
    (4,337
    )
    
    
    (2,383
    )Other income (expense), net:Other income
    
    
    6
    
    
    
    21Equity in loss of investment
    
    
    (29
    )
    
    
    (18
    )Interest expense, net
    
    
    (574
    )
    
    
    (265
    )(597
    )
    
    
    (262
    )Loss from continuing operations before income taxes
    
    
    (4,934
    )
    
    
    (2,645
    )Income taxes
    
    
    
    
    
    
    Loss from continuing operations
    
    
    (4,934
    )
    
    
    (2,645
    )Loss from discontinued operations
    
    
    (566
    )
    
    
    (1,091
    )Net loss
    
    $
    (5,500
    )
    
    $
    (3,736
    )Net loss per
common share - basic and diluted:Loss from continuing operations
    
    $
    (0.04
    )
    
    $
    (0.02
    )Loss from discontinued operations
    
    
    (0.00
    )
    
    
    (0.01
    )$
    (0.04
    )
    
    $
    (0.03
    )Weighted
average shares outstanding - basic and diluted
    
    
    133,418,567
    
    
    
    126,783,895
 The accompanying notes are an integral part of these condensed consolidated financial statements. 4




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VERSO TECHNOLOGIES, INC. AND SUBSIDIARIES 
 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
 (In thousands, except share data)
 (Unaudited)
 For the three months ended March 31,2005
    
    
    2004Operating Activities:Continuing operations:Net loss from continuing operations
    
    $
    (4,934
    )
    
    $
    (2,645
    )Adjustments to reconcile net loss from continuing operations to net
cash (used in) provided by continuing operating activities:Equity in loss of investment
    
    
    29
    
    
    
    18Depreciation and amortization
    
    
    728
    
    
    
    838Provision for doubtful accounts
    
    
    59
    
    
    
    141Amortization of loan fees and discount on convertible subordinated debentures
    
    
    349
    
    
    
    139Reorganization costs - stock related
    
    
    
    
    
    
    570Other
    
    
    (14
    )
    
    
    (34
    )Changes in current operating assets and liabilities, net of effects of acquisitions:Accounts receivable
    
    
    583
    
    
    
    1,507Inventories
    
    
    519
    
    
    
    (162
    )Other current assets
    
    
    (249
    )
    
    
    (77
    )Accounts payable
    
    
    (452
    )
    
    
    42Accrued compensation
    
    
    (306
    )
    
    
    804Accrued expenses
    
    
    (197
    )
    
    
    92Unearned revenue and customer deposits
    
    
    457
    
    
    
    (297
    )Net cash (used in) provided by continuing operating activities
    
    
    (3,428
    )
    
    
    936Discontinued operations:(Loss) income from discontinued operations
    
    
    (566
    )
    
    
    (1,091
    )Adjustment to reconcile loss from discontinued operations
to net cash used in discontinued operating activities
    
    
    (142
    )
    
    
    2,071Net cash provided by discontinued operating activities
    
    
    (708
    )
    
    
    980Net cash (used in) provided by operating activities
    
    
    (4,136
    )
    
    
    1,916Investing Activities:Continuing operations:Net cash (used in) provided by investing activities for continuing operations -Purchases of property and equipment
    
    
    (299
    )
    
    
    (339
    )Purchase of WSECI
    
    
    (244
    )
    
    
    (Increase) decrease in restricted cash
    
    
    (1,620
    )
    
    
    2,062Net cash provided by (used in) investing activities for continuing operations
    
    
    (2,163
    )
    
    
    1,723Discontinued operations:Purchases of property and equipment
    
    
    
    
    
    
    (86
    )Proceeds from sale of discontinued operations
    
    
    4,015
    
    
    
    Acquisition of MCK Communications, Inc., net of cash acquired
    
    
    
    
    
    
    (3,000
    )Net cash provided by (used in) investing activities for discontinued operations
    
    
    4,015
    
    
    
    (3,086
    )Net cash used in by investing activities
    
    
    1,852
    
    
    
    (1,363
    )Financing Activities:Proceeds from convertible debentures, net
    
    
    12,757
    
    
    
    Payments of notes payable
    
    
    
    
    
    
    (350
    )Proceeds from private placement, net
    
    
    
    
    
    
    16,601Proceeds from issuances of common stock in connection with the
exercise of options and warrants, net
    
    
    
    
    
    
    91Net cash provided by financing activities
    
    
    12,757
    
    
    
    16,342Effect of exchange rate changes on cash
    
    
    (7
    )
    
    
    3(Decrease) increase in cash and cash equivalents
    
    
    10,466
    
    
    
    16,898Cash and cash equivalents at beginning of period
    
    
    4,234
    
    
    
    7,654Cash and cash equivalents at end of period
    
    $
    14,700
    
    
    $
    24,552Supplemental disclosure of cash flow information:Cash payments during the periods for:Interest
    
    $
    177
    
    
    $
    90Income taxes
    
    $
    (70
    )
    
    $
    (1
    )Non-cash investing and financing activitiesCommon stock consideration for acquisitions:WSECI - issuance of 950,000 shares of common stock
    
    $
    331
    
    
    $
    Issuance of note receivable in disposition of MCK
    
    
    3,500Common stock and compensatory options issued in reorganization
    
    
    
    
    
    
    570Issuance of warrants in conjunction with convertible debentures
    
    
    5,084
    
    
    
    Issuance of common stock in exchange for services
    
    
    694
    
    
    
    133Assets acquired and liablities assumed in conjunction with business acquisitions:Fair value of assets acquired, excluding cash and restricted cash
    
    
    1,084
    
    
    
    Liabilities assumed
    
    $
    
    
    
    $
    
 The accompanying notes are an integral part of these condensed consolidated
financial statements. 5




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VERSO TECHNOLOGIES, INC AND SUBSIDIARIES. 
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS March 31, 2005 (Unaudited)  1.
    BASIS OF PRESENTATION Verso Technologies, Inc. and subsidiaries (the Company) is a communications technology and
solutions provider for communications service providers and enterprises seeking to implement
application-based telephony services, Internet usage management tools and outsourced
customer support services. The Companys continuing operations include two separate
business segments (i) the Packet-based Technologies Group, which includes the Companys
softswitching division and Netperformer divisions, the Companys subsidiary Telemate.Net
Software, Inc. (Telemate.Net) and the Companys I-Master division; and (ii) the Advanced
Applications Services Group, which includes the Companys technical applications support
group. The Packet-based Technologies Group includes domestic and international sales of
hardware and software, integration, applications and technical training and support. The
Packet-based Technologies Group offers hardware and software based for companies seeking to
build private, packet-based voice and data networks. Additionally, the Packet-based
Technologies Group offers software-based solutions for Internet access and usage management
that include call accounting and usage reporting for Internet protocol network devices. The
Advanced Applications Services Group includes outsourced technical application services and
application installation and training services to outside customers, as well as customers of
the Packet-based Technologies Group. In January 2005, the Company sold substantially all of the operating assets of its NACT
Telecommunications, Inc., now known as Provo Pre-Paid (Delaware) Corp. (NACT) and MCK
Communications, Inc., now known as Needham (Delaware) Corp. (MCK) businesses to better
focus the Companys capital and management resources on areas which the Company believes
have greater potential given its strategy to focus on next-generation network and solutions
to improve cash utilization. In addition, the Company disposed of its NACT business
because the Company wanted to move toward an open-standards, pre-paid next-generation
solution that could better address growing market opportunities and enable the Company to
offer a competitive product for Tier 1 and Tier 2 carriers. The Company believes that the
I-Master platform which the Company acquired from WSECI, Inc., a Delaware corporation
formerly known as Jacksonville Technology Associates, Inc. (WSECI), in March 2005 after
forming a strategic partnership with WSECI in the latter half of 2004 permits the Company to
offer a better solution. Further the Company disposed of its MCK business because the
Company intends to focus on next-generation solutions for service providers and the products
of the MCK business did not fit that profile. The operations of NACT and MCK businesses
have been reclassified as discontinued operations in the Companys consolidated financial
statements. The consolidated financial statements include the accounts of Verso Technologies, Inc. and
its wholly-owned subsidiaries, including Telemate.Net Software, Inc. (Telemate.Net); and
Clarent Canada Ltd., now known as Verso Technologies Canada Inc. (Verso Canada) and MCK
and NACT which are reflected in discontinued operations. These subsidiaries were acquired
and were all accounted for as purchases (see Note 2). Certain prior year amounts in the consolidated financial statements have been reclassified
to conform with the current year presentation. These reclassifications had no effect on
previously reported net loss. The condensed consolidated quarterly financial statements are unaudited. These statements
include all adjustments, including recurring adjustments, considered necessary by management
to present a fair statement of the results of the Companys operations, financial position
and cash flows. The results reported in these condensed consolidated financial statements
should not be regarded as necessarily indicative of results that may be expected for the
entire year. The year-end condensed consolidated balance sheet was derived from audited consolidated
financial statements. The accompanying condensed consolidated unaudited quarterly financial
statements are presented in accordance with the rules and regulations of the Securities and Exchange Commission (SEC) and do not include all
disclosures normally required by accounting principles generally accepted in the United
States of America. For further information, refer to the audited consolidated financial
statements and footnotes thereto included in the Companys Annual Report on Form 10-K for
the year ended December 31, 2004 (the Annual Report). 6




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VERSO TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) March 31, 2005 (Unaudited)  2.
    MERGERS AND ACQUISITIONS WSECI, Inc. On March 31, 2005, the Company acquired substantially all of the operating assets of WSECI
pursuant to the Asset Purchase Agreement (Asset Purchase Agreement) dated as of February
23, 2005 by and among the Company, WSECI and all of the shareholders of WSECI. WSECI is a
provider of an internet protocol-based, revenue assurance platform which enables the
deployment of multiple voice and next-generation services to the carrier market. The fair
value of the acquisition cost was approximately $1.1 million, consisting of 950,000 shares
of the Companys common stock with a fair value of $331,000, $50,000 in cash, the payment of
certain liabilities of approximately $613,000 and acquisition costs of approximately
$106,000. The acquisition is accounted for as a purchase. Pursuant to the Asset Purchase Agreement, the Company may become obligated to issue to WSECI
additional contingent consideration of up to $5.0 million based on the sales of certain
WSECI products and services. The initial $500,000 of such contingent consideration earned
by WSECI is based upon specific customer transactions the Company completes with respect to
the WSECI assets, and the remaining $4.5 million of the contingent consideration may be
earned by WSECI based on the revenue generated from the WSECI assets during the 18-month
period following the acquisition, which revenue must equal a minimum of $88.0 million during
such period in order for all of such remaining contingent consideration to be earned. The
contingent consideration is payable in cash or shares of the Companys common stock at the
election of the Company. It is not possible to estimate what, if any, payment would be due
as additional contingent consideration at this time. When the additional contingent
consideration is determined, it will increase the amount of the purchase price allocated to
other intangible assets and will be amortized over the remaining useful life of the asset. The preliminary allocation of the costs of the acquisition of WSECI are as follows (in
thousands): WSECIProperty and equipment
    
    $
    100Deferred revenue
    
    
    100Other intangibles
    
    
    900Cost of acquisition
    
    $
    1,100
 Pro Forma Effect of WSECI, Inc. The Company formed a strategic partnership with WSECI in the latter half of 2004, therefore
the results of WSECI have been included in the Companys consolidated results beginning
January 1, 2005. The following unaudited pro forma information presents the results of
continuing operations of the Company for the three months ended March 31, 2004, as if the
acquisition of substantially all of the operating assets of WSECI had taken place on January
1, 2004 (in thousands, except per share amounts): March 31, 2004Revenues
    
    $
    11,223Net loss
    
    $
    (2,622
    )Net loss per
common share - basic and diluted
    
    $
    (0.02
    )Weighted
average shares outstanding - basic and diluted
    
    
    127,733,895
 7




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VERSO TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) March 31, 2005 (Unaudited)  3.
    EQUITY INVESTMENT On October 1, 2002, the Company acquired a 51% interest in Shanghai BeTrue Infotech Co.,
Ltd. (BeTrue). The remaining 49% interest in BeTrue is owned by Shanghai Tangsheng
Investments & Development Co. Ltd (Shanghai Tangsheng). The joint venture provides the
Company with an immediate distribution channel into the China and Asia-Pacific region for
the Companys application-based Voice over Internet Protocol gateway solutions, billing
systems, value-added applications and web filtering solutions. Due to the shared decision
making between the Company and its equity partner, the results of BeTrue are treated as an
equity investment rather than being consolidated. The Company determined that since BeTrue
was a business, BeTrue did not fall under the scope of the Financial Accounting Standards
Board Interpretation No. 46 R, Consolidation of Variable Interest Entities and there was
no impact on the Companys financial position or results of operations. The Company purchased the 51% interest in BeTrue for $100,000 from NeTrue Communications,
Inc., Shanghai Tangshengs former joint venture partner. The Company also contributed to
the joint venture certain next-generation communication equipment and software valued at
approximately $236,000 and cash in the amount of $100,000. Summarized financial information reported by this affiliate for the three months ended March
31, 2005 and 2004 (in thousands) are as follows: Three months endedMarch 31,2005
    
    
    2004Operating results:Revenues
    
    $
    469
    
    
    $
    403Operating loss
    
    $
    (56
    )
    
    $
    (35
    )Net loss
    
    $
    (56
    )
    
    $
    (35
    )
 8




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VERSO TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) March 31, 2005 (Unaudited)  4.
    DISCONTINUED OPERATIONS In January 2005, the Company sold substantially all of the operating assets of its NACT and
MCK businesses to better focus the Companys capital and management resources on areas which
the Company believes have greater potential given its strategy to focus on next-generation
network and solutions to improve cash utilization. In addition, the Company disposed of
its NACT business because the Company wanted to move toward an open-standards, pre-paid
next-generation solution that could better address growing market opportunities and enable
the Company to offer a competitive product for Tier 1 and Tier 2 carriers. The Company
believes that the I-Master platform which the Company acquired from WSECI in March 2005
after forming a strategic partnership with WSECI in the latter half of 2004, permits the
Company to offer a better solution. Further, the Company disposed of its MCK business
because the Company intends to focus on next-generation solutions for service providers and
the products of the MCK business did not fit that profile. The operations of NACT and MCK
businesses have been reclassified as discontinued operations in the Companys consolidated
financial statements. The loss on the sale of the NACT business totaled $11.4 million. The loss includes a
reduction in net asset values of approximately $10.9 million and a provision for anticipated
closing costs of approximately $500,000. The loss on the sale of the MCK business totaled
$3.4 million. The loss includes a reduction in net asset values of approximately $2.9
million and a provision for anticipated closing costs of approximately $500,000. Summary operating results of the discontinued operations (in thousands) are as follows: Three months ended March 31,2005
    
    
    2004Revenue
    
    $
    212
    
    
    $
    5,462Gross (loss) profit
    
    
    (27
    )
    
    
    2,590Operating loss
    
    
    (566
    )
    
    
    (1,117
    )Loss from discontinued operations
    
    $
    (566
    )
    
    $
    (1,091
    )
 The operating loss from discontinued operations in the three months ended March 31, 2005
includes general and administrative costs of $97,000, sales and marketing costs of $104,000,
research and development costs of $275,000 and depreciation and amortization of $61,000. The operating loss from discontinued operations in the three months ended March 31, 2004
includes general and administrative costs of $926,000, sales and marketing costs of $1.2
million, research and development costs of $1.2 million, depreciation and amortization of
$337,000 and other income of $26,000. 9




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VERSO TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) March 31, 2005 (Unaudited)  4.
    DISCONTINUED OPERATIONS, Continued The assets and liabilities of NACT and MCK were classified as assets held for sale at
December 31, 2004 and the significant components (in thousands) were as follows: Accounts receivable, net
    
    $
    3,085Inventory
    
    
    2,901Other current assets
    
    
    419Furniture and equipment, net
    
    
    977Goodwill and other intangibles
    
    
    1,613Assets held for sale
    
    $
    8,995Accounts payable
    
    $
    163Accrued compensation
    
    
    465Unearned revenue and customer deposits
    
    
    1,127Other current liabilities
    
    
    246Liabilities held for sale
    
    $
    2,001
 Assets and liabilities of discontinued operations (in thousands) are as follows: March 31,
    
    
    December 31,2005
    
    
    2004Assets of discontinued operations:Notes receivable, including interest
    
    $
    3,500
    
    
    $
    Liabilities of discontinued operations:Accrued rent
    
    $
    2,164
    
    
    $
    2,384Other current liabilities
    
    
    1,340
    
    
    
    629Liabilities of discontinued operations
    
    $
    3,504
    
    
    $
    3,013
 In connection with the sale of MCK, CITEL Technologies Limited (Citel U.K.) and CITEL
Technologies, Inc. (Citel U.S.) issued to the Company a convertible secured promissory
note in principal amount of $3.5 million (the Note). The outstanding principal under the
Note accrues interest at an annual rate of 6% and is payable along with all interest accrued
thereon in fourteen monthly payments of $60,000 commencing on July 21, 2005 followed by
sixteen monthly payments of $75,000, with all remaining outstanding principal and interest
under the Note payable on January 21, 2008. Under certain circumstances described in the Note, all or any portion of the principal
outstanding under the Note may be converted at the Companys option into shares of the
capital stock of CITEL U.K. CITEL U.K.s and CITEL U.S. obligations under the Note are
secured by a security interest in certain assets sold to CITEL. Accrued rent relates primarily to several leases for buildings and equipment that are no
longer being utilized in continuing operations. The accrual is for all remaining payments
due on these leases, less estimated amounts to be paid by any sublessors. The accrual
contains one lease with total payments remaining through January 31, 2010 of $2.0 million
and assumes that the building will be sub-leased for approximately 57% of the total lease
liability over the remaining term of the lease and one lease with total payments remaining
through March 31, 2007 of $2.8 million, discounted at 6%, which has been sub-leased for
approximately 64% of the total lease liability over the remaining term of the lease. 10




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VERSO TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) March 31, 2005 (Unaudited)  4.
    DISCONTINUED OPERATIONS, Continued The activity in the liabilities of discontinued operations (in thousands) for the three
months ended March 31, 2005 and 2004 was as follows: 2005
    
    
    2004Balance beginning of period
    
    $
    3,013
    
    
    $
    4,579Lease payments, net of sublease receipts
    
    
    (219
    )
    
    
    (102
    )Other payments
    
    
    (111
    )
    
    
    (82
    )Estimated costs of disposal of discontinued operations
    
    
    1,000
    
    
    
    Legal and other costs of disposal
    
    
    (179
    )
    
    
    Balance March 31
    
    $
    3,504
    
    
    $
    4,395
  5.
    INVENTORIES Inventories consist primarily of purchased electronic components, and are stated at the
lower of cost or market. Cost is determined by using average cost. Inventories as of March 31, 2005 and December 31, 2004 are comprised of the following (in
thousands): March 31,
    
    
    December 31,2005
    
    
    2004Raw materials
    
    $
    4,007
    
    
    $
    3,315Work in process
    
    
    23
    
    
    
    9Finished goods
    
    
    813
    
    
    
    2,038Total inventories
    
    $
    4,843
    
    
    $
    5,362
 The inventory amounts noted are net of allowance of $739,000 and $2.7 million for at March
31, 2005 and December 31, 2004, respectively. 11




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VERSO TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) March 31, 2005 6. GOODWILL AND OTHER INTANGIBLES Intangible assets represent the excess of cost over the fair value of net tangible assets
acquired and identified other intangible assets which consist of current technology and a
customer relationship. The current technology is amortized on a straight-line basis over
its estimated useful life of three years. The customer relationship is amortized on a
straight-line basis over its estimated useful life of ten years. Goodwill associated with
acquisitions is not being amortized in accordance with Statement of Financial Accounting
Standards (SFAS) No. 142, Goodwill and Other Intangible Assets (SFAS No. 142). Goodwill and other intangible assets consist of the following (in thousands): Amortization
    
    
    March 31,
    
    
    December 31,Period in months
    
    
    2005
    
    
    2004Intangibles subject to amortization:Current technology
    
    36 months
    
    $
    1,727
    
    
    $
    821Customer relationship
    
    120 months
    
    
    2,403
    
    
    
    2,403Weighted average months
    
    85 months
    
    
    4,130
    
    
    
    3,224Accumulated amortization:Current technology
    
    
    
    
    
    
    (508
    )
    
    
    (440
    )Customer relationship
    
    
    
    
    
    
    (541
    )
    
    
    (480
    )Net intangibles subject to amortization
    
    
    
    
    
    
    3,081
    
    
    
    2,304Goodwill
    
    
    
    
    
    
    2,514
    
    
    
    2,514Total goodwill and other intangibles
    
    
    
    
    
    $
    5,595
    
    
    $
    4,818
 12




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VERSO TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) March 31, 2005 (Unaudited)  7.
    LOAN FACILITY WITH SILICON VALLEY BANK In March 2005, the Company and Silicon renewed and further amended the credit facility in
connection with the disposition of the MCK and NACT businesses (as amended, the Amended
Credit Agreement). The Amended Credit Agreement provides for a credit line of $7.5 million
through September 30, 2005 at which time it will increase to $10.0 million subject to the
Company meeting certain financial criteria. The working capital line includes an
export-import (EX-IM) facility that will provide for working capital based on the
Companys international accounts receivable and inventories related to export sales. The
Companys borrowings under the Amended Credit Agreement are secured by substantially all of
the assets of the Company. Interest on borrowings under the Amended Credit Agreement is
computed at 2.0% above Silicons Base Rate, with a minimum Base Rate of 4.25% (6.75% at
March 31, 2005). The Amended Credit Agreement provides for up to $2.5 million in letters of
credit. Advances are limited by a formula based on eligible receivables, inventories,
certain cash balances, outstanding letters of credit and certain subjective limitations.
Interest payments are due monthly, and the Amended Credit Agreement expires in March 2006.
The Amended Credit Agreement includes a loan fee of $130,000 and .375% per annum on unused
available borrowings. The loan fees will be amortized to interest expense over the term of
the Amended Credit Agreement. Under the terms of the Amended Credit Agreement, the Company
must maintain a minimum cash and excess availability covenant, computed monthly, and may not
declare dividends or incur any additional indebtedness without the consent of Silicon, and
must comply with other financial covenants, as defined in the Amended Credit Agreement. The
Company was in compliance with these covenants as of March 31, 2005. The Company had no borrowings under the Amended Credit Agreement as of March 31, 2005. The
availability under the Amended Credit Agreement at March 31, 2005 was $3.4 million. The
Company has outstanding letters of credit in the amount of $1.6 million at March 31, 2005,
which would reduce borrowing capacity under the Amended Credit Agreement.  8.
    SENIOR UNSECURED CONVERTIBLE DEBENTURES On February 4, 2005, the Company completed a private placement of senior unsecured
convertible debentures and warrants pursuant to a securities purchase agreement with certain
institutional investors. The Company issued $13.5 million of senior unsecured convertible
debentures, Series A warrants exercisable for 10.8 million shares of the Companys common
stock and Series B warrants exercisable for 10.0 million shares of the Companys common
stock. The Company has allocated $5.1 million to the value of the warrants which is being
amortized over the life of the senior unsecured convertible debentures. The senior
unsecured convertible debentures bear interest at a rate of 6% per annum and are due
February 2009 and are convertible into approximately 27.0 million shares of the Companys
common stock at an initial conversion price of $0.50 per share, subject to anti-dilution
adjustments and certain limitations. Interest is payable on a quarterly basis beginning
April 2005 and principal is payable on a quarterly basis beginning August 2006. The Series
A warrants issued in connection with the private placement are exercisable for a period of
five years commencing on February 4, 2005 and at an exercise price of $0.72 per share. The
Series B warrants issued in connection with the private placement are exercisable for a
period of 90 days after the date on which the Company obtains shareholder approval of
proposals to increase the number of shares of the Companys authorized common stock and to
approve the issuance of more than 20% of the Companys common stock to comply with the rules
of The Nasdaq Stock Market, Inc. The Series B warrants have an exercise of $0.78 per share.
In connection with the private placement, the Company expects to net approximately $12.5
million, including $1.6 million in restricted cash, net of expenses. 13




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VERSO TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) March 31, 2005 (Unaudited)  9.
    OTHER COMPREHENSIVE LOSS Comprehensive loss for the three months ended March 31, 2005 and 2004 is shown in the
following table (in thousands): Three months ended March 31,2005
    
    
    2004Net loss
    
    $
    (5,500
    )
    
    $
    (3,736
    )Other comprehensive loss:Foreign currency translation
    
    
    (191
    )
    
    
    (59
    )Comprehensive loss
    
    $
    (5,691
    )
    
    $
    (3,795
    )
  10.
    SEGMENT INFORMATION The Company reports information for two segments, the Packet-based Technologies Group and
the Advanced Applications Services Group. Previously the Company reported two segments, the
Carrier Solutions Group and the Enterprise Solutions Group. Following the dispositions of
the NACT and MCK businesses, the Company re-evaluated its internal reporting and
decision-making and segregated the activity of the Advanced Applications Services Group and
combined the remaining operations of the Carrier Solutions Group and Enterprise Solutions
Group into the Packet-based Technologies Group. Management evaluates the business segment
performance based on contributions before unallocated items. Inter-segment sales and
transfers are not significant. Packet-based
TechnologiesGroup:
    
    The Companys Packet-based Technologies Group consists of the operations of the
Companys softswitching division and Netperformer divisions and the Companys subsidiary
Telemate.Net. The Packet-based Technologies Group includes domestic and international
sales of hardware and software, integration, applications and technical training and
support. The Packet-based Technologies Group offers hardware and software based
solutions for companies seeking to build private, packet-based voice and data networks.
Additionally, the Packet-based Technologies Group offers software-based solutions for
Internet access and usage management that include call accounting and usage reporting for
Internet protocol network devices.Advanced Applications
ServicesGroup:
    
    The Companys Advanced Applications Services Group, consists of the Companys
technical applications support group which was previously included as part of the
Enterprise Solutions Group, and includes outsourced technical application services and
application installation and training services to outside customers, as well as
customers of the Companys Packet-based Technologies Group segment.
 14




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VERSO TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) March 31, 2005 (Unaudited)  10.
    SEGMENT INFORMATION, Continued Summarized financial information concerning the Companys reportable segments is shown in
the following table (in thousands): Packet-based
    
    
    AdvancedTechnologies
    
    
    ApplicationGroup
    
    
    Services Group
    
    
    TotalFor the Three Months Ended March 31,
2005Revenue
    
    $
    4,071
    
    
    $
    2,535
    
    
    $
    6,606(Loss) contribution before unallocated items
    
    
    (2,275
    )
    
    
    592
    
    
    
    (1,683
    )At March 31, 2005Goodwill
    
    
    1,061
    
    
    
    1,453
    
    
    
    2,514Total assets
    
    
    10,889
    
    
    
    3,936
    
    
    
    14,825For the Three Months Ended March 31,
2004Revenue
    
    $
    7,953
    
    
    $
    3,146
    
    
    $
    11,099Contribution before unallocated items
    
    
    701
    
    
    
    784
    
    
    
    1,485At December 31, 2004Goodwill
    
    
    1,061
    
    
    
    1,453
    
    
    
    2,514Total assets
    
    
    11,104
    
    
    
    4,027
    
    
    
    15,131
 The following table reconciles the contribution before unallocated items to the loss before
discontinued operations (in thousands): Three months ended March 31,2005
    
    
    2004(Loss) contribution before unallocated items, per above
    
    $
    (1,683
    )
    
    $
    1,485Corporate general and administrative expenses
    
    
    (1,813
    )
    
    
    (1,899
    )Corporate research and development
    
    
    (57
    )
    
    
    (46
    )Depreciation and amortization
    
    
    (660
    )
    
    
    (769
    )Reorganization costs
    
    
    (124
    )
    
    
    (584
    )Reorganization costs-stock related
    
    
    
    
    
    
    (570
    )Other
    
    
    (597
    )
    
    
    (262
    )Income taxes
    
    
    
    
    
    
    Loss from continuing operations
    
    $
    (4,934
    )
    
    $
    (2,645
    )
 15




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VERSO TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONDENSED
CONSOLIDATED FINANCIAL STATEMENTS (Continued)
March 31, 2005 (Unaudited)  10.
    SEGMENT INFORMATION, Continued  March 31,
    
    
    December 31,2005
    
    
    2004Total assets before unallocated items, per above
    
    $
    14,825
    
    
    $
    15,131Corporate assets:Cash and cash equivalents
    
    
    14,700
    
    
    
    4,234Restricted cash
    
    
    1,620
    
    
    
    Current portion of notes receivable
    
    
    300
    
    
    
    Other current assets
    
    
    2,382
    
    
    
    1,253Assets held for sale
    
    
    
    
    
    
    8,995Property and equipment, net
    
    
    2,999
    
    
    
    3,087Investment
    
    
    700
    
    
    
    729Notes receivable, net of current portion
    
    
    3,200
    
    
    
    $
    40,726
    
    
    $
    33,429
 Following the acquisition of substantially all the operating assets along with certain
liabilities of Clarent Corporation in February 2003, the Company began conducting research
and development in Canada. International sales of the Companys products and services
continue to originate only from the United States. The geographic distribution of the
Companys revenue and contribution before unallocated items (in thousands) are as follows: Canada
    
    
    United States
    
    
    TotalFor the Three Months Ended March 31,
2005Revenue
    
    $
    
    
    
    $
    6,606
    
    
    $
    6,606Loss before unallocated items
    
    
    (1,025
    )
    
    
    (658
    )
    
    
    (1,683
    )At March 31, 2005Total Assets
    
    
    582
    
    
    
    40,144
    
    
    
    40,726For the Three Months Ended March 31,
2004Revenue
    
    $
    
    
    
    $
    11,099
    
    
    $
    11,099(Loss) contribution before unallocated items
    
    
    (941
    )
    
    
    2,426
    
    
    
    1,485At December 31, 2004Total Assets
    
    
    704
    
    
    
    32,725
    
    
    
    33,429
 16




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VERSO TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONDENSED
CONSOLIDATED FINANCIAL STATEMENTS (Continued)
March 31, 2005 (Unaudited)  11.
    REORGANIZATION COSTS In January 2005, the Company sold substantially all of the operating assets of NACT and MCK,
which resulted in six corporate positions being eliminated. The Company recorded
reorganization costs of $124,000 during the three months ended March 31, 2005. In the first quarter of 2004, the Company terminated a senior executive. As a result of
this action, the Company recorded reorganization costs of $1.2 million during the three
months ended March 31, 2004. The reorganization costs consist of severance costs of
$584,000 and non-cash stock compensation of $570,000 related to the write-off of unamortized
deferred compensation.  12.
    STOCK OPTIONS AND WARRANTS The Company has a stock option plan for employees, board of directors, consultants, and
other individual contributors to the Company. In addition, in connection with various
financing and acquisition transactions, and for services provided to the Company, the
Company has issued warrants to purchase the Companys common stock. A summary of stock
options and warrants outstanding at March 31, 2005 is as follows: OPTIONS AND WARRANTS ISSUED TO EMPLOYEES Options and Warrants Outstanding
    
    
    Options and Warrants ExercisableRange of Exercise
    
    Outstanding at
    
    
    Weighted Average
    
    
    Exercisable at
    
    
    Weighted AveragePrices
    
    March 31, 2005
    
    
    Exercise Price
    
    
    March 31, 2005
    
    
    Exercise Price$0.19-$0.50
    
    
    2,896,516
    
    
    $
    0.42
    
    
    
    2,570,641
    
    
    $
    0.42$0.51-$1.00
    
    
    1,963,953
    
    
    $
    0.64
    
    
    
    697,579
    
    
    $
    0.65$1.01-$1.50
    
    
    1,089,350
    
    
    $
    1.28
    
    
    
    728,615
    
    
    $
    1.31$1.51-$2.13
    
    
    806,605
    
    
    $
    1.69
    
    
    
    222,355
    
    
    $
    1.81$2.14-$2.14
    
    
    3,762,500
    
    
    $
    2.14
    
    
    
    3,762,500
    
    
    $
    2.14$2.15-$3.05
    
    
    273,095
    
    
    $
    2.76
    
    
    
    272,345
    
    
    $
    2.76$3.06-$4.00
    
    
    1,477,359
    
    
    $
    3.43
    
    
    
    1,254,984
    
    
    $
    3.44$4.01-$5.00
    
    
    1,164,880
    
    
    $
    4.21
    
    
    
    1,162,630
    
    
    $
    4.21$5.01-$18.00
    
    
    663,455
    
    
    $
    6.76
    
    
    
    663,455
    
    
    $
    6.76Total
    
    
    14,097,713
    
    
    $
    2.02
    
    
    
    11,335,104
    
    
    $
    2.24
 Options and warrants issued to employees generally terminate ten years from the date of
grant. Termination dates on the options and warrants listed above range from April 1, 2005
to March 22, 2015. 17




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]

VERSO TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) March 31, 2005 (Unaudited)  12.
    STOCK OPTIONS AND WARRANTS, Continued A summary of the status of stock options and warrants granted to employees as of March 31,
2005, and the changes during the three months ended March 31, 2005 is presented below : Number ofShares of
    
    
    WeightedUnderlying
    
    
    AverageOptions
    
    
    Exercise PricesOutstanding at beginning of the period
    
    
    16,210,941
    
    
    $
    2.04Granted
    
    
    179,750
    
    
    
    0.70Exercised
    
    
    (24,530
    )
    
    
    0.20Forfeited
    
    
    (2,268,448
    )
    
    
    2.14Expired
    
    
    
    
    
    
    Outstanding at end of period
    
    
    14,097,713
    
    
    $
    2.02Exercisable at end of period
    
    
    11,335,104
    
    
    $
    2.24
 A summary of warrants issued primarily in connection with financing is as follows: Number of
    
    
    Weighted AverageExercise Price
    
    Outstanding Warrants
    
    
    Exercise Price
    
    
    Expiration Date$0.01
    
    
    37,532
    
    
    $
    0.01
    
    
    September 2005-October 2006$0.72
    
    
    12,312,000
    
    
    $
    0.72
    
    
    February 2010$0.78
    
    
    10,000,000
    
    
    $
    0.78
    
    
    *$1.34-$1.50
    
    
    1,491,432
    
    
    $
    1.35
    
    
    January 2006$1.81-$2.81
    
    
    3,119,961
    
    
    $
    2.02
    
    
    July 2005-February 2011$4.03-$5.25
    
    
    2,120,374
    
    
    $
    4.13
    
    
    November 2005-October 2006$5.65
    
    
    4,502,811
    
    
    $
    5.65
    
    
    August 2005-September 2005$6.00
    
    
    150,000
    
    
    $
    6.00
    
    
    October 2006Total
    
    
    33,734,110
    
    
    $
    1.78
    All warrants are vested. The exercise price and number of outstanding warrants for certain warrants previously issued
have been adjusted according to their antidilution provisions. 18




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VERSO TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) March 31, 2005 (Unaudited)  12.
    STOCK OPTIONS AND WARRANTS, Continued A summary of the status of warrants issued primarily in connection with financing as of
March 31, 2005, and the changes during the three months ended March 31, 2005 is presented
below: Number of
    
    
    WeightedShares of
    
    
    AverageUnderlying
    
    
    ExerciseWarrants
    
    
    PricesOutstanding at beginning of period
    
    
    10,551,807
    
    
    $
    4.25Granted
    
    
    22,312,000
    
    
    
    0.75Exercised
    
    
    
    
    
    
    Expired
    
    
    (37,364
    )
    
    
    5.26Effects of anti-dilutive provisions
    
    
    907,667Outstanding and exercisable at end of period
    
    
    33,734,110
    
    
    $
    1.78
 If the Company had used the fair value-based method of accounting for its stock option and
incentive plans and charged compensation cost against income, over the vesting period, based
on the fair value of options at the date of grant, then the pro-forma net loss and net loss
per common share would have been as follows (in thousands, except for per share amounts): Three months ended March 31,2005
    
    
    2004Net loss, as reported
    
    $
    (5,500
    )
    
    $
    (3,736
    )Add: Stock-based compensation
expense included in net loss
    
    
    7
    
    
    
    166Less: Total stock-based employee
compensation expense determined
under fair value based method
for all awards
    
    
    278
    
    
    
    (653
    )Pro forma net loss
    
    $
    (5,215
    )
    
    $
    (4,223
    )Net loss per common shareAs reported
    
    $
    (0.04
    )
    
    $
    (0.03
    )Pro forma
    
    
    (0.04
    )
    
    
    (0.03
    )
 19




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VERSO TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) March 31, 2005 (Unaudited)  13.
    NET LOSS PER SHARE Basic and diluted net loss per share are computed in accordance with SFAS No. 128, Earnings
Per Share, using the weighted average number of common shares outstanding. The diluted net
loss per share for the three months ended March 31, 2005 does not include the effect of the
common stock equivalents, calculated by the treasury stock method, as their impact would be
antidilutive. Using the treasury stock method, common stock equivalents are as follows: For the three months endedMarch 31,2005
    
    
    2004Shares issuable under stock options
    
    
    290,493
    
    
    
    3,944,394Shares issuable pursuant to warrants
to purchase common stock
    
    
    36,716
    
    
    
    271,363327,209
    
    
    
    4,215,757
  14.
    LITIGATION Except for the pending matters described in Note 16 to the Companys audited consolidated
financial statements included in the Annual Report, the Company is not a party to any
material legal proceedings other than ordinary routine claims and proceedings incidental to
its business, and the Company does not expect these ordinary routine claims and proceedings,
either individually or in the aggregate, to have a material adverse effect on the Company.
There have been no material developments regarding the pending matters described in Note 16
to the Companys audited consolidated financial statements included in the Annual Report
during the three months ended March 31, 2005. 20




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##### Table of Contents



ITEM 2: MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Certain statements in this Quarterly Report on Form 10-Q for the quarter ended March 31, 2005
(the Quarterly Report) and in future filings by the Company with the SEC and in the Companys
written and oral statements that are not statements of historical facts are forward-looking
statements within the meaning of the Private Securities Litigation Reform Act of 1995. The words
believe, expect, anticipate, intend, will and similar expressions are examples of words
that identify forward-looking statements. Forward-looking statements include, without limitation,
statements regarding our future financial position, business strategy and expected cost savings.
These forward-looking statements are based on our current beliefs, as well as assumptions we have
made based upon information currently available to us. Each forward-looking statement reflects our current view of future events and is subject to
risks, uncertainties and other factors that could cause actual results to differ materially from
any results expressed or implied by our forward-looking statements. Important factors that could
cause actual results to differ materially from the results expressed or implied by any
forward-looking statements include:  
    the price of the Companys common stock has been volatile;
    the Company may be unable to fund future growth;
    the Company has a history of losses and may not be profitable in the future;
    the Companys common stock may be delisted from The Nasdaq SmallCap Market;
    the Companys growth could be limited if it is unable to attract and retain qualified
personnel;
    the Company is exposed to the general condition of the telecommunications market;
    the Companys need to invest in research and development could harm the Companys operating results;
    the market for converged communications solutions is still in its infancy and rapidly evolving.
If this market does not develop and grow as expected, then it could have a material
adverse effect on the Companys business;
    intellectual property infringement claims against the Company, even those without merit, could
require the Company to enter into costly licenses or deprive the Company of the technology it needs;
    failure to protect the Companys intellectual property rights could have a material adverse
effect on the Companys business;
    if the Companys products contain defects, then the Companys sales are likely to suffer, and
the Company may be exposed to legal claims;
    the Company may be obligated to indemnify customers who purchase equipment from the Company
against claims of patent infringement;
    the new softswitch and VoIP routers which the Company intends to offer may not achieve
acceptance in the marketplace;
    sales to customers based outside the United States have accounted for a significant portion of
the Companys revenues, which exposes the Company to risks inherent in international operations;
    the Companys dependence on contract manufacturers and suppliers could result in product
delivery delays;
    the Company may be subject to litigation;
    the Company derives a substantial amount of its revenue from channel distribution partners, and
such revenues may decline significantly if any major partner cancels or delays a purchase of
the Companys products; 21




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##### Table of Contents




    the Companys inability to develop and maintain relationships with key technology suppliers
could harm its ability to sustain and grow its business; and
    other risks and uncertainties disclosed in the Annual Report and in the Companys other filings with the SEC. All subsequent forward-looking statements relating to the matters described in this document
and attributable to us or to persons acting on our behalf are expressly qualified in their entirety
by such factors. We have no obligation to publicly update or revise these forward-looking
statements to reflect new information, future events, or otherwise, except as required by
applicable Federal securities laws, and we caution you not to place undue reliance on these
forward-looking statements. Overview The Company is a communications technology and solutions provider for communications service
providers and enterprises seeking to implement application-based telephony services, Internet usage
management tools and outsourced customer support services. The Companys continuing operations
include two separate business segments: (i) the Packet-based Technologies Group, which includes the
Companys softswitching and Netperformer divisions (the two businesses acquired from Clarent
Corporation in February 2003), the Companys subsidiary Telemate.Net and the Companys I-Master
division (acquired from WSECI in March 2005); (ii) the Advanced Applications Services Group, which
includes the Companys technical applications support group. The Packet-based Technologies Group
includes domestic and international sales of hardware and software, integration, applications and
technical training and support. The Packet-based Technologies Group offers hardware-based
solutions (which include software) for companies seeking to build private, packet-based voice and
data networks, and software-based solutions for Internet access and usage management that include
call accounting and usage reporting for IP network devices. The Advanced Applications Services
Group includes outsourced technical application services and application installation and training
services to outside customers, as well as customers of the Companys Packet-based Technologies
Group. Since 2001, the Company has been selling products to the carrier market and focusing its
strategic direction on developing and marketing next-generation communications products. The
Companys current business was built on acquisitions made by the Company by leveraging the economic
downturn in the telecommunications area. In the first quarter of 2003, the Company acquired
substantially all of the operating assets of Clarent Corporation, which provided the Company with
patented VoIP technologies for both the carrier and enterprise markets (primarily serving international markets) and significantly
increased the Companys market share in the worldwide softswitch market. The Companys strategy through 2003 was to add next-generation communications products to its
suite of products through strategic acquisitions and to leverage these operations through cost
reductions to enhance cash flow. With the acquisition of substantially all of the operating assets
of Clarent Corporation, the Company moved its growth strategy toward international markets. As the
acquisition of substantially all of the operating assets of Clarent Corporation was funded
primarily by short-term seller financing, generating cash flow from operations during 2003 was
required to meet the debt repayment obligations. As such, the Company leveraged its combined
operations, reducing sales, general and administrative costs (as compared to costs prior to the
acquisition), while preserving the research and development expenditures, which are vital to the
Companys long-term growth and viability. In 2004, the Company began moving towards an open standards platform. In 2004, the Company
significantly increased its expenditures for sales and marketing to focus on long-term sustainable
revenue growth. In the first quarter of 2004, the Company completed a private placement raising
approximately $16.5 million, net of expenses, to fund the expanded sales and marketing programs.
As expected, these additional expenditures significantly increased the operating loss from
continuing operations in 2004. In January 2005, the Company sold substantially all of the operating assets of its NACT and
MCK businesses to better focus the Companys capital and management resources on areas which the
Company believes have greater potential given its strategy to focus on next-generation network and
solutions to improve cash utilization. In addition, the Company disposed of its NACT business
because the Company wanted to move toward an open-standards, pre-paid next-generation solution that
could better address growing market opportunities and enable the Company to offer a competitive
product for Tier 1 and Tier 2 carriers. The Company believes that the I-Master platform, which the
Company acquired from WSECI in March 2005 after forming a strategic partnership with WSECI in the
latter half of 2004, permits the Company to offer a better solution. Further, the Company
disposed of its MCK business because the Company intends to focus on next-generation solutions for
service providers and the products of the MCK business did not fit that profile. The operations of
the NACT and MCK businesses have been reclassified as discontinued operations in the Companys
consolidated financial statements. The Company believes that the foregoing events significantly affect the comparability of the
Companys results of operations from year to year. You should read the following discussion of the
Companys results of operations and financial 22




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##### Table of Contents



condition in conjunction with the Companys consolidated financial statements and related notes thereto included in Item 15 of this Annual
Report. Results of Operations Three Months Ended March 31, 2005, compared to Three Months Ended March 31, 2004 For the three months ended March 31, 2005, the Companys net loss totaled $5.5 million, or
$0.04 per share, compared with a net loss of $3.7 million, or $0.03 per share, for the same period
in 2004. The 2005 results included $124,000 in reorganization costs and a loss from discontinued
operations of $566,000. The 2004 results included $1.2 million in reorganization costs and a loss
from discontinued operations of $1.1 million. Continuing Operations For the three months ended March 31, 2005, the Companys net loss from continuing operations
totaled $4.9 million, or $0.04 per share, compared with a net loss of $2.6 million, or $0.02 per
share, for 2004. The 2005 results included $124,000 in reorganization costs. The 2004 results
included $1.2 million in reorganization. Total revenue was $6.6 million in the three months ended March 31, 2005, reflecting a 40%
decrease from the same period in 2004. Products revenue decreased from $6.6 million in the three
months ended March 31, 2004, to $2.7 million in the three months ended March 31, 2005. During the
three months ended March 31, 2004, the Companys Packet-Based Technologies Group had a large
softswitch sale that represented in excess of $4.0 million in revenue, but did not receive such an
order in the first quarter of 2005. Services revenue was $3.9 million for the three months ended
March 31, 2005, reflecting a 14% decrease from the same period in 2004, primarily due to revenue
from the Advanced Application Services Group and the Telemate products. The decrease in revenue
from the Advanced Application Services Group was attributable primarily to a decline in revenue
from its largest customer due to that customers conversion to a new software platform, the support
of which is primarily handled by the software vendor, net of new customers added. Gross profit
was 43% of revenue in the three months ended March 31, 2005, compared with 53% of revenue for the
same period in 2004. The decrease in gross profit dollars resulted primarily from the decrease in revenues. The decrease in gross profit percentage is due to a decline in revenues
across all product lines in relation to fixed departmental costs (primarily personnel and related
costs) related to the production and support departments. Total operating expenses incurred for the three months ended March 31, 2005, were $7.2
million, a decrease of $1.1 million compared to the same period in 2004. The decrease is primarily
attributable to the following items: a decrease in reorganization costs of $1.0 million, decreases
in general and administrative expenses of $250,000 and depreciation and amortization of $109,000
offset by increases in sales and marketing expenses of $190,000 and research and development
expenses of $103,000. The decrease in general and administrative expenses resulted from a decrease in personnel and
related costs due to the sale of NACT and MCK resulting in the consolidation of some corporate
functions as well as a decrease in bad debt expense during the three months ended March 31, 2005. The increase in sales and marketing and research and development expenses resulted from the
Companys intention to expand its sales and marketing programs in 2004 and the addition of
personnel and related costs related to the acquisition of substantially all of the operating assets
of WSECI in March 2005, which the Company formed a strategic partnership with in the latter half of
2004. The decrease in depreciation and amortization expense is primarily related to a decrease in
amortization of deferred compensation offset by and increase in depreciation. The decrease in
amortization of deferred compensation is primarily related to the full vesting of options
outstanding since the Companys acquisitions of Telemate.Net in November 2001 and Cereus Technology
Partners, Inc. (Cereus) in September 2000. The deferred compensation represents the intrinsic
value of the Telemate.Net and Cereus unvested options outstanding at the date of the acquisitions
of Telemate.Net and Cereus that was amortized over the remaining vesting period of the options.
The deferred compensation became fully-amortized in the first quarter of 2005. The increase in
depreciation expense is related to the purchase of furniture and equipment of approximately $1.7
million and $299,000 during the last nine months of 2004 and the first three months of 2005,
respectively, offset by fully depreciated assets. Capital expenditures are primarily depreciated
on a straight-line basis over their estimated useful lives of three years. 23




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##### Table of Contents



In the first quarter of 2005, the Company initiated a reorganization as a result of the sale
of MCK and NACT and eliminated six corporate positions. As a result of these actions, the Company
recorded reorganization costs of $124,000 during the three months ended March 31, 2005. In the
first quarter of 2004, the Company terminated a senior executive. As a result of this action, the
Company recorded reorganization costs of $1.2 million during the three months ended March 31, 2004.
The reorganization costs consist of severance costs of $584,000 and non-cash stock compensation of
$570,000 related to the write-off of unamortized deferred compensation. As a percent of revenue, operating expenses were 109% during the three months ended March 31,
2005 as compared to 75% for the same period in 2004. Other income was $6,000 during the three months ended March 31, 2005 compared with $21,000 for
the same period in 2004. Equity in loss of investment was $29,000 during the three months ended March 31, 2005,
compared to $18,000 for the same period in 2004. This amount represents the Companys portion of
BeTrues income or losses. Due to the shared decision making between the Company and its equity
partner, the results of BeTrue are treated as an equity investment rather than being consolidated. Net interest expense was $574,000 during the three months ended March 31, 2005, an increase of
$309,000 compared to the same period in 2004. The increase was attributable to interest and
amortization of the discount and loan origination fees on the $13.5 million of senior unsecured
convertible debentures issued in February 4, 2005. Business Unit Performance Packet-based
    
    
    AdvancedTechnologies
    
    
    ApplicationsDollars in thousands
    
    Group
    
    
    Services Group
    
    
    ConsolidatedFor the Three MonthsEnded March 31,
    
    2005
    
    
    2004
    
    
    2005
    
    
    2004
    
    
    2005
    
    
    2004Revenue
    
    $
    4,071
    
    
    $
    7,953
    
    
    $
    2,535
    
    
    $
    3,146
    
    
    $
    6,606
    
    
    $
    11,099Gross profit
    
    
    2,035
    
    
    
    4,848
    
    
    
    828
    
    
    
    1,065
    
    
    
    2,863
    
    
    
    5,913Gross margin
    
    
    50
    %
    
    
    61
    %
    
    
    33
    %
    
    
    34
    %
    
    
    43
    %
    
    
    53
    %General and administrative
    
    
    561
    
    
    
    693
    
    
    
    212
    
    
    
    244
    
    
    
    773
    
    
    
    937Sales and marketing
    
    
    2,122
    
    
    
    1,919
    
    
    
    24
    
    
    
    37
    
    
    
    2,146
    
    
    
    1,956Research and development
    
    
    1,627
    
    
    
    1,535
    
    
    
    
    
    
    
    
    
    
    
    1,627
    
    
    
    1,535(Loss) contribution before
unallocated items
    
    $
    (2,275
    )
    
    $
    701
    
    
    $
    592
    
    
    $
    784
    
    
    $
    (1,683
    )
    
    $
    1,485Unallocated items:Corporate general and administrative
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,813
    
    
    
    1,899Corporate research and development
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    57
    
    
    
    46Depreciation and amortization
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    660
    
    
    
    769Reorganization costs
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    124
    
    
    
    584Reorganization costs-stock related
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    570Operating loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (4,337
    )
    
    
    (2,383
    )Other
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (597
    )
    
    
    (262
    )Loss before income taxes
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    (4,934
    )
    
    $
    (2,645
    )
 24




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##### Table of Contents



Packet-based Technologies Group Total revenue from the Companys Packet-based Technologies Group revenue was $4.1 million in
the three months ended March 31, 2005, a 49% decrease from the same period in 2004. During the
three months ended March 31, 2004, the Companys Packet-Based Technologies Group had a large
softswitch sale that represented in excess of $4.0 million in revenue, but did not receive such an
order in the first quarter of 2005. Gross profit decreased by $2.8 million in the three months ended March 31, 2005, and was 50%
percent of revenue, compared to 61% in the same period in 2004. The decrease in gross profit
dollars is attributable to the decrease in revenue. The decrease in gross margin is due to a
decline in revenues in relation to fixed departmental costs (primarily personnel and related costs)
related to the production and support departments. Allocated operating expenses incurred in the Carrier Solutions Group for the three months
ended March 31, 2005, were $4.3 million, an increase of $163,000 compared to the same period in
2004. The decrease in general and administrative expenses is attributable to a reduction in bad
debt expense. The increase in sales and marketing and research and development expenses during the
three months ended March 31, 2005, reflects increased personnel costs related to additional
personnel and the acquisition of substantially all of the operating assets of WSECI. As a percent
of revenue, operating expenses for the Carrier Solutions Group were 106% during the three months
ended March 31, 2005, up from 52% during the same period in 2004. Advanced Applications Services Group Total revenue for the Companys Advanced Applications Services Group was $2.5 million in the
three months ended March 31, 2005, a 19% decrease from the same period in 2004. The decrease in
revenue is related to a decrease in installation services, rebillable travel and outsourced
services for hospitality related customers. Gross profit decreased by $237,000 in the three months ended March 31, 2005, and was 33% of
revenue, compared with 34% of revenue in the same period in 2004. The decrease in gross profit
dollars was attributable primarily to a decline in revenue from the Companys Advanced Applications
Services Groups largest customer due to that customers conversion to a new software platform, the
support of which is primarily handled by the software vendor, net of new customers added. Allocated operating expenses incurred in Advanced Applications Services Group for the three
months ended March 31, 2005, were $236,000, a decrease of $45,000 compared to the same period in
2004. The decrease in general and administrative expenses primarily relate to a decrease in
personnel and related costs and a reduction in bad debt expense. Discontinued Operations In January 2005, the Company sold substantially all of the operating assets of its NACT and
MCK businesses to better focus the Companys capital and management resources on areas which the
Company believes have greater potential given its strategy to focus on next-generation network and
solutions to improve cash utilization. In addition, the Company disposed of its NACT business
because the Company wanted to move toward an open-standards, pre-paid next-generation solution that
could better address growing market opportunities and enable the Company to offer a competitive
product for Tier 1 and Tier 2 carriers. The Company believes that the I-Master platform, which the
Company acquired in March 2005 after forming a strategic partnership with WSECI in the latter half
of 2004, permits the Company to offer a better solution. Further, the Company disposed of its MCK
business because the Company intends to focus on next-generation solutions for service providers
and the products of the MCK business did not fit that profile. The operations of the NACT and MCK
businesses have been reclassified as discontinued operations in the Companys consolidated
financial statements. Summary operating results of the discontinued operations (in thousands) are as follows: 2005
    
    
    2004Revenue
    
    $
    212
    
    
    $
    5,462Gross (loss) profit
    
    
    (27
    )
    
    
    2,590Operating loss
    
    
    (566
    )
    
    
    (1,117
    )Loss from discontinued operations
    
    $
    (566
    )
    
    $
    (1,091
    )
 25




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##### Table of Contents



The operating loss from discontinued operations in the three months ended March 31, 2005
includes general and administrative costs of $97,000, sales and marketing costs of $104,000,
research and development costs of $275,000, depreciation and amortization of $61,000. The
operating loss from discontinued operations in the three months ended March 31, 2004 includes
general and administrative costs of $926,000, sales and marketing costs of $1.2 million, research
and development costs of $1.2 million, depreciation and amortization of $337,000 and other income
of $26,000. 26




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##### Table of Contents



Critical Accounting Policies The preparation of financial statements and related disclosures in conformity with accounting
principles generally accepted in the United States of America requires management to make
judgments, assumptions and estimates that affect the amounts reported in the consolidated financial
statements and accompanying notes. Factors that could affect the Companys future operating
results and cause actual results to vary from expectations include, but are not limited to, lower
than anticipated growth from existing customers, an inability to attract new customers, an
inability to successfully integrate acquisitions and technology changes, or a decline in the
financial stability of the Companys customers. Negative developments in these or other risk
factors could have a material adverse affect on the Companys financial position and results of
operations. A summary of the Companys critical accounting policies follows: Allowance for Doubtful Accounts The Company is required to estimate the collectibility of its trade receivables. Considerable
judgment is required in assessing the ultimate realization of these receivables, including the
creditworthiness of each customer. The evaluation is based on credit information and collection
history concerning the customer up and through the determination date. The Company determines the
allowance for doubtful accounts based on a specific review of outstanding customer balances and a
general reserve based upon aging of customer accounts and write-off history. Significant changes
in required reserves have been recorded in recent periods and may occur in the future due to the
current telecommunications and general economic environments and updates to customer credit
information and collection activity. Inventory Obsolescence The Company is required to state its inventories at the lower of cost or market. In assessing
the ultimate realization of inventories, the Company makes judgments as to future demand
requirements and compares that with the current and committed inventory levels. The Company has
recorded changes in net realizable values in recent periods due to the impact of current and future
technology trends and changes in strategic direction, such as discontinuances of product lines, as
well as, changes in market conditions due to changes in demand requirements. Estimates of the
future demand for inventory are based on historical usage for different products, as well as
estimates of inventory required to fulfill maintenance requirements for products previously sold.
It is possible that changes in the net realizable value of inventory may continue to occur in the
future due to the current market conditions. Liabilities of Discontinued Operations In January 2005, the Company sold substantially all of the operating assets of its NACT and
MCK businesses. As a result of these sales, certain liabilities of MCK are now classified as
discontinued operations, including a liability for one lease with total payments remaining through
March 31, 2007 of $2.8 million, discounted at 6%, which has been sub-leased for approximately 64%
of the total lease liability over the remaining term of the lease. During 2001, the Company initiated certain restructuring plans and discontinued operations of
its legacy VAR business. In conjunction with these restructuring plans, the Company established a
restructuring reserve account for the estimated costs related to the plans. These costs primarily
related to facilities closings, severance costs and other businesses exiting costs. For the
facilities closings cost, a reserve was established for all remaining lease payments due on
buildings and equipment that were no longer being utilized in continuing operations, less
assumptions for sub-leases. The accrual for one of the leases with total payments remaining
through January 31, 2010 of $2.0 million is offset by sublease receipts totaling $875,000 through
the end of the lease term and assumes an amount of $240,000 for the extension of one of the
subleases through the end of the lease term. As of March 31, 2005, the Company had a remaining balance of approximately $3.5 million in
liabilities of discontinued operations. The Company currently believes that this remaining
estimated balance is appropriate to cover future obligations associated with the restructurings;
however, changes in these estimates could occur based on changes in the financial condition of the
subleases. 27




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##### Table of Contents



Deferred Tax Asset Valuation Allowance The Company currently has significant deferred tax assets, which are subject to periodic
recoverability assessment. Realization of the Companys deferred tax assets is principally
dependant upon achievement of projected future taxable income. The Companys judgments regarding
future profitability may change due to market conditions, its ability to continue to successfully
execute its strategic plan and other factors. These changes, if any, may require possible material
adjustments to these deferred tax asset balances. Due to the uncertainty of the Companys ability
to recognize the entire tax benefit, the Company established an offsetting provision for the tax
assets. Litigation and Related Contingencies The Company is subject to proceedings, lawsuits and other claims related to labor, product and
other matters. The Company is required to assess the likelihood of any adverse judgments or
outcomes to these matters, as well as, potential ranges of probable losses. A determination of the
amount of reserves required, if any, for these contingencies is made by the Company with assistance
of its legal counsel after careful analysis of each individual issue based upon the then-current
facts and circumstances. The required reserves may change in the future due to new developments in
each matter or changes in approach such as a change in settlement strategy in dealing with these
matters. Goodwill, Intangible Assets and Long-Lived Assets Goodwill represents the excess of costs over the fair value of net assets of businesses
acquired. Goodwill and intangible assets acquired in a purchase business combination and
determined to have an indefinite useful life are not amortized, but instead are tested for
impairment at least annually in accordance with provisions of SFAS No. 142. Significant estimates
are made with respect to the impairment testing. SFAS No. 142 also requires that intangible assets
with estimable useful lives be amortized over their respective estimated useful lives to their
estimated residual values, and reviewed for impairment in accordance with SFAS No. 144. In accordance with SFAS No. 144, long-lived assets, such as property, plant and equipment and
purchased assets subject to amortization, are reviewed for impairment whenever events or changes in
circumstances indicate that the carrying amount of the asset may not be recoverable.
Recoverability of assets to be held and used is measured by a comparison of the carrying amount of
an asset to estimated undiscounted future cash flows expected to be generated by the asset. If the
carrying amount of an asset exceeds its estimated future cash flows, an impairment charge is
recognized by the amount by which the carrying amount of the asset exceeds the fair value of the
asset. Significant estimates are made with respect to recoverability and fair value assessments. 28




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##### Table of Contents



Liquidity and Capital Resources Summary Liquidity is the measurement of the Companys ability to have adequate cash or access to cash
at all times in order to meet financial obligations when due, as well as to fund corporate
expansion and other activities. For the last three years, the Company has met its liquidity
requirements through a combination of cash provided by debt from third party lenders, issuances of
debt and equity securities and purchases and divestitures of other businesses. At March 31, 2005, the Company had a positive working capital position (excess of current
assets over current liabilities) of $12.5 million compared to a positive working capital position
of $7.6 million at December 31, 2004. The Companys cash and cash equivalents totaled $14.7
million at March 31, 2005, and $4.2 million at December 31, 2004. Total long-term debt, net of
discount, was $11.9 million at March 31, 2005 and $2.7 million at December 31, 2004. At March 31,
2005 and December 31, 2004, the Company had no borrowings under its credit facility with Silicon.
The Companys borrowing availability under the Amended Credit Agreement at March 31, 2005 was $3.4
million. The Company has outstanding stand-by letters of credit in the amount of $1.6 million at
March 31, 2005, which reduce borrowing capacity under the Amended Credit Agreement. In March 2005, the Company and Silicon renewed and further amended the credit facility in
connection with the disposition of the MCK and NACT businesses. The Amended Credit Agreement
provides for a credit line of $7.5 million through September 30, 2005 at which time it will
increase to $10.0 million subject to the Company meeting certain financial criteria. The working
capital line includes an EX-IM facility that will provide for working capital based on the
Companys international accounts receivable and inventories related to export sales. Under the
terms of the Amended Credit Agreement, the Company must maintain a minimum cash and excess
availability covenant, computed monthly, and may not declare dividends or incur any additional
indebtedness without the consent of Silicon, and must comply with other financial covenants, as
defined in the Amended Credit Agreement. The Company was in compliance with these covenants as of
March 31, 2005. On February 12, 2003, the Company acquired substantially all the business assets and assumed
certain related liabilities of Clarent Corporation for $9.8 million in notes. At March 31, 2005, a
$3.0 million secured note due February 12, 2008, which bears interest at 5% per annum, remains
outstanding. The assets the Company purchased from Clarent Corporation secure the note. On February 4, 2005, the Company completed a private placement of senior unsecured convertible
debentures and warrants pursuant to a securities purchase agreement with certain institutional
investors. The Company issued $13.5 million of senior unsecured convertible debentures, Series A
warrants exercisable for 10.8 million shares of the Companys common stock and Series B warrants
exercisable for 10.0 million shares of the Companys common stock. The senior unsecured
convertible debentures bear interest at 6% per annum and are due February 2009 and are convertible
into approximately 27.0 million shares of the Companys common stock at an initial conversion price
of $0.50 per share, subject to anti-dilution adjustments and certain limitations. Interest is
payable on a quarterly basis beginning April 2005 and principal is payable on a quarterly basis
beginning August 2006. The Series A warrants issued in connection with the private placement are
exercisable for a period of five years commencing on February 4, 2005 and at an exercise price of
$0.72 per share. The Series B warrants issued in connection with the private placement are
exercisable for a period of 90 days after the date on which the Company obtains shareholder
approval of proposals to increase the number of shares of the Companys authorized common stock and
to approve the issuance of more than 20% of the Companys common stock to comply with the rules of
The Nasdaq Stock Market, Inc. The Series B warrants have an exercise price of $0.78 per share.
The Company expects to net approximately $12.5 million, including $1.6 million in restricted cash,
net of expenses. Cash Flow Cash used in the Companys continuing operations in the three months ended March 31, 2005
totaled approximately $3.4 million compared with cash provided by continuing operations of $936,000
in the same period in 2004. The cash used in continuing operations during the three months ended
March 31, 2005 resulted primarily from cash used by continuing operations of $3.7 million (net loss
from continuing operations of $4.9 million reduced by non-cash charges totaling $1.2 million,
including depreciation and amortization of $728,000, amortization of loan fees and discount on
convertible subordinated debentures of $349,000, provision for doubtful accounts of $59,000 and
equity in loss of investment of $29,000) which was offset by changes in current operating assets
and liabilities of approximately $355,000. Cash used in the Companys discontinued operations in the three months ended March 31, 2005
totaled $708,000 compared to cash provided of $980,000 in the same period in 2004. 29




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##### Table of Contents



The Company used cash in investing activities in the three months ended March 31, 2005 of
approximately $2.2 million, compared to cash provided by investing activities of $1.7 million in
the same period of 2004. In the three months ended March 31, 2005, the Company used $244,000 in cash related to the acquisition of WSECI. During the three
months ended March 31, 2005, restricted cash increased by $1.6 million compared to a decrease of
$2.1 million in the same period in 2004. The Company spent $299,000 and $339,000 on capital
expenditures in the three months ended March 31, 2005 and 2004, respectively. Cash provided by investing activities for discontinued operations totaled approximately $4.0
million in the three months ended March 31, 2005, compared to cash used by investing activities for
discontinued operations of $3.1 million in the same period of 2004. For the three months ended
March 31, 2005, the Company received proceeds of $4.0 million for the sale of NACT and MCK. During
the three months ended March 31, 2004, the Company spent $86,000 on capital expenditures and $3.0
million in cash related to the acquisition of MCK. Cash provided by financing activities totaled approximately $12.8 million in the three months
ended March 31, 2005 compared to $16.3 million in the same period of 2004. For the three months
ended March 31, 2005, the Company received proceeds from the issuance of convertible debentures,
net of associated fees of $12.8 million. For the three months ended March 31, 2004, the Company
received proceeds from a private placement, net of associated fees of $16.6 million and $91,000
from the exercise of options and warrants which was offset by a payment of $350,000 on the notes
payable for the purchase of substantially all of the operating assets of Clarent Corporation. Contractual Obligations and Commercial Commitments The following summarizes the Companys future contractual obligations at March 31, 2005 (in
thousands): Less than
    
    
    
    
    
    
    
    
    
    
    AfterContractual Obligations
    
    Total
    
    
    1 year
    
    
    1-3 years
    
    
    4-5 years
    
    
    5 yearsLine of credit
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    Additional payments for the acquisition of
Encore Group
    
    
    419
    
    
    
    240
    
    
    
    179
    
    
    
    
    
    
    
    Notes payable for the purchase of Clarent
    
    
    3,000
    
    
    
    
    
    
    
    3,000
    
    
    
    
    
    
    
    Convertible subordinated debentures
    
    
    4,500
    
    
    
    4,500
    
    
    
    
    
    
    
    
    
    
    
    Senior unsecured convertible debentures
    
    
    13,500
    
    
    
    
    
    
    
    6,187
    
    
    
    7,313
    
    
    
    Operating leases:Continuing operations
    
    
    7,902
    
    
    
    2,090
    
    
    
    3,140
    
    
    
    2,672
    
    
    
    Discontinued operations
    
    
    4,568
    
    
    
    1,736
    
    
    
    2,117
    
    
    
    715
    
    
    
    Total contractual cash obligations
    
    $
    33,889
    
    
    $
    8,566
    
    
    $
    14,623
    
    
    $
    10,700
    
    
    $
    
 Note, this table excludes interest expense and sublease rentals and assumes that leases are
not renewed. The Company has outstanding stand-by letters of credit in the amount of $1.6 million
at March 31, 2005. Sources of Cash For the remainder of 2005, the Company expects that its primary sources of cash will be from
cash on hand, interst and principal payment on its note receivable from the sale of MCK and
borrowings under the Companys Amended Credit Agreement with Silicon. The Company expects that its
current operations will not generate positive income from operations before interest, taxes,
depreciation, amortization of intangibles and amortization of deferred compensation for 2005. The
Company is currently working on several initiatives to significantly reduce the cash used in
continuing operations and to ensure that is has sufficient liquidity to cover its needs for the
next twelve months. 30




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The Amended Credit Agreement with Silicon, however, is subject to certain financial covenants
(including a minimum tangible net worth covenant) and limitations on the Companys ability to
access funds under the Amended Credit Agreement. If the Company is in violation of the Amended
Credit Agreement, or does not have sufficient eligible accounts receivable and inventories to
support the level of borrowings it may need, then the Company may be unable to draw on the Amended
Credit Agreement to the extent necessary. To the extent the Company does not have borrowing
availability under the Amended Credit Agreement, the Company may be required to obtain additional sources of capital, sell assets, obtain an
amendment to the Amended Credit Agreement or otherwise restructure its outstanding indebtedness.
Additional borrowings other than pursuant to the Amended Credit Agreement must be approved by
Silicon and may have to be approved by the holders of the Clarent secured note due in 2008 and the
holders of the $13.5 million convertible debentures. If the Company is unable to obtain additional
capital, sell assets, obtain an amendment to the Amended Credit Agreement or otherwise restructure
its outstanding indebtedness, then the Company may not be able to meet its obligations. The Companys short-term cash needs are for working capital, including cash operating losses,
capital expenditures, payments on the convertible subordinated debentures due November 2005
totaling $4.5 million, interest payments on debt outstanding and payments related to discontinued
operations. At December 31, 2004, liabilities of discontinued operations included $2.2 million in
lease payments related to discontinued operations. The Company expects to pay out approximately
$656,000 related to lease payments, net of sublease rentals for discontinued operations in the next
twelve months. The Companys long-term cash needs are related to the costs of growing its current business as
well as prospective businesses to be acquired, including capital expenditures and working capital.
In addition, the Company will begin payment of the senior unsecured convertible debentures in
August 2006 and the secured note payable made by the Company in connection with the acquisition of
substantially all of the operating assets of Clarent Corporation in February 2008. The Company
expects to meet these cash needs through cash from operations, if any, cash on hand, borrowings
under the credit facility or other debt facilities, if available, as well as through possible
issuances of equity or debt securities. If sufficient borrowing capacity under a working capital
line of credit is unavailable (or if the Company is unable to restructure its existing credit
facility in the event that the Company requires additional borrowing capacity), or if the Company
is otherwise unable to obtain additional capital or sell assets, then the Company may not be able
to meet its obligations and growth plans. 
 ITEM 3: QUANTATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Market Risk The Company is exposed to various market risks, including changes in interest rates and foreign
currency exchange rates. Market risk is the potential loss arising from adverse changes in market
rates and prices, such as interest rates and foreign currency exchange rates. The Company does not
enter into derivatives or other financial instruments for trading or speculative purposes. The
Company has also not entered into financial instruments to manage and reduce the impact of changes
in interest rates and foreign currency exchange rates although the Company may enter into such
transactions in the future. Interest Rate Risks The Companys notes payable and convertible subordinated debentures at March 31, 2005, carry
interest rates, which are fixed. The Companys line of credit with Silicon carries interest rates,
which vary with the prime rate. Accordingly, if the Company has any indebtedness outstanding under
its line of credit with Silicon, then any increases in Silicons prime rate will reduce the
Companys earnings. At March 31, 2005, the Company did not have any indebtedness outstanding under
its line of credit with Silicon. Foreign Currency Risks Products sold outside of the United States of America are transacted in U.S. dollars and,
therefore, the Company is not exposed to foreign currency exchange risk. Transactions with Verso
Technologies Canada Inc. and Verso Technologies (UK) Limited, an indirect, wholly owned subsidiary
of the Company, present foreign currency exchange risk. The principal transactions are personnel
and related costs. The intercompany balance is denominated in U.S. dollars and changes in foreign
currency rates would result in foreign currency gains and losses. Using the intercompany balance
at March 31, 2005, a 10% strengthening of the U.S. dollar against the Canadian dollar and the
British pound would result in a foreign currency transaction loss of approximately $19,000. To
date, foreign exchange gains and losses have not been significant. 31




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ITEM 4: CONTROLS AND PROCEDURES The Companys Chief Executive Officer and Chief Financial Officer have evaluated the
effectiveness of the Companys disclosure controls and procedures (as such term is defined in Rules
13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the Exchange Act))
as of the end of the period covered by this report, as required by paragraph (b) of Rules 13(a)-15 or 15(d)-15 of the Exchange Act. Based on such evaluation, such officers have
concluded that, as of the end of the period covered by this report, the Companys disclosure
controls and procedures are effective. During the quarter ended March 31, 2005, there was not any change in the Companys internal
control over financial reporting identified in connection with the evaluation required by paragraph
(d) of Rules 13a-15 or 15d-15 of the Exchange Act that has materially affected, or is reasonably
likely to materially affect, the Companys control over financial reporting. 32




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##### Table of Contents



PART II - OTHER INFORMATION 
 ITEM 1. LEGAL PROCEEDINGS Except for the pending matters described in Note 16 to the Companys Consolidated Financial
Statements included in the Companys Annual Report on Form 10-K for the year ended December 31,
2004, the Company is not a party to any material legal proceedings other than ordinary routine
claims and proceedings incidental to its business, and the Company does not expect these ordinary
routine claims and proceedings, either individually or in the aggregate, to have a material adverse
effect on the Company. There has been no material developments regarding the pending matters
described in Note 16 to the Companys audited consolidated financial statements included in the
Annual Report during the three months ended March 31, 2005. 
 ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS On January 21, 2005 the Company issued 95,030 shares of its common stock to Clunet R. Lewis as
compensation pursuant to that certain Consulting Agreement between Mr. Lewis and the Company dated
as of March 14, 2003. The shares issued to the Mr. Lewis were issued without registration under the
Securities Act of 1933, as amended (the Securities Act), in reliance upon the exemptions from
registration set forth in Section 4(2) of the Securities Act and Regulation D promulgated pursuant
thereto (Regulation D). The Company based such reliance upon factual representations made to the
Company by Mr. Lewis as to such investors investment intent, sophistication, and status as an
accredited investor, among other things. On January 21, 2005, the Company issued 102,572 shares of its common stock to William P.
OReilly as compensation pursuant to that certain Consulting Agreement between Mr. OReilly and the
Company dated as of March 14, 2003. The shares issued to the Mr. Lewis were issued without
registration under the Securities Act in reliance upon the exemptions from registration set forth
in Section 4(2) of the Securities Act and Regulation D. The Company based such reliance upon
factual representations made to the Company by Mr. Lewis as to such investors investment intent,
sophistication, and status as an accredited investor, among other things. 
 ITEM 6. EXHIBITS The exhibits required to be furnished with this quarterly Report are listed on the exhibit index
attached hereto. 33




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##### Table of Contents



SIGNATURE Pursuant to the requirements of the Securities Exchange Act of 1934 the registrant has duly caused
this report to be signed on its behalf by the undersigned thereunto duly authorized. VERSO TECHNOLOGIES, INC.Date: May 9, 2005
    
    /s/ Juliet M. ReisingExecutive Vice President and Chief Financial Officer(duly authorized signatory andPrincipal Financial and Accounting Officer)
 34




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##### Table of Contents



EXHIBIT INDEX Exhibit No.
    
    Exhibit
    
    Method of Filing2.1
    
    Asset Purchase Agreement
dated as of January 21,
2005 with respect to the
Registrants disposition
of its MCK business. (The
schedules to the Asset
Purchase Agreement have
been omitted from this
Report pursuant to Item
601(b)(2) of Regulation
S-K, and the Registrant
agrees to furnish copies
of such omitted schedules
supplementally to the SEC
upon request.)
    
    Incorporated by reference
to Exhibit 2.1 to the
Registrants Current
Report on Form 8-K filed
on January 27, 2005.2.2
    
    Asset Purchase Agreement
dated as of January 21,
2005 with respect to the
Registrants disposition
of its NACT business.
(The schedules to the
Asset Purchase Agreement
have been omitted from
this Report pursuant to
Item 601(b)(2) of
Regulation S-K, and the
Registrant agrees to
furnish copies of such
omitted schedules
supplementally to the SEC
upon request.)
    
    Incorporated by reference
to Exhibit 2.2 to the
Registrants Current
Report on Form 8-K filed
on January 27, 2005.2.3
    
    Securities Purchase
Agreement dated as of
February 4, 2005, among
the Registrant and each
of the Investors
signatory thereto. (The
schedules to the
Securities Purchase
Agreement have been
omitted from this Report
pursuant to Item
601(b)(2) of Regulation
S-K, and the Registrant
agrees to furnish copies
of such omitted schedules
supplementally to the SEC
upon request.)
    
    Incorporated by reference
to Exhibit 2.1 to the
Registrants Current
Report on Form 8-K filed
on February 8, 2005.2.4
    
    Asset Purchase Agreement
dated as of February 23,
2005 by and among the
Registrant, WSECI, Inc.
and the shareholders of
WSECI, Inc. (The
schedules to the Asset
Purchase Agreement have
been omitted from this
Report pursuant to Item
601(b)(2) of Regulation
S-K, and the Registrant
agrees to furnish copies
of such omitted schedules
supplementally to the SEC
upon request.)
    
    Incorporated by reference
to Exhibit 2.1 to the
Registrants Current
Report on Form 8-K filed
on March 1, 2005.3.1
    
    Amended and Restated
Articles of Incorporation
of the Registrant.
    
    Incorporated by reference
to Exhibit 3.1 to the
Registrants Registration
Statement on Form S-18
(File No. 33-51456).3.2
    
    Amendment to the Amended
and Restated Articles of
Incorporation of the
Registrant, as amended.
    
    Incorporated by reference
to Exhibit 3.1 to the
Registrants Current
Report on Form 8-K filed
October 2, 2000.
 35




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##### Table of Contents



Exhibit No.
    
    Exhibit
    
    Method of Filing3.3
    
    Amendment to the Amended and Restated
Articles of Incorporation of the
Registrant, as amended.
    
    Incorporated by
reference to Exhibit
4.1 to the Registrants
Current Report on Form
8-K filed November 19,
2001.3.4
    
    Bylaws of the Registrant, as amended.
    
    Incorporated by
reference to Exhibit
3.2 to the Registrants
Registration Statement
on Form S-4 filed
August 7, 2000 (File
No. 333-43224).3.5
    
    Amendment to the Bylaws of the
Registrant, as amended.
    
    Incorporated by
reference to Exhibit
4.2 to the Registrants
Current Report on Form
8-K filed November 19,
2001.3.6
    
    Amendment to the Bylaws of the
Registrant, as amended.
    
    Incorporated by
reference to Exhibit
3.1 to the Registrants
Current Report on Form
8-K filed November 9,
2004.3.7
    
    Bylaws of the Registrant, as amended and
currently in effect.
    
    Incorporated by
reference to Exhibit
3.2 to the Registrants
Current Report on Form
8-K filed November 9,
2004.4.1
    
    Form of 6% Senior Unsecured Convertible
Debenture dated February 4, 2005 issued
in connection with the Registrants
February 2005 private placement.
    
    Incorporated by
reference to Exhibit
4.1 to the Registrants
Current Report on Form
8-K filed on February
8, 2005.4.2
    
    Form of Series A Warrant dated February
4, 2005 to purchase shares of the
Registrants common stock issued in
connection with the Registrants
February 2005 private placement.
    
    Incorporated by
reference to Exhibit
4.2 to the Registrants
Current Report on Form
8-K filed on February
8, 2005.4.3
    
    Form of Series B Warrant dated February
4, 2005 to purchase shares of the
Registrants common stock issued in
connection with the Registrants
February 2005 private placement.
    
    Incorporated by
reference to Exhibit
4.3 to the Registrants
Current Report on Form
8-K filed on February
8, 2005.4.4
    
    Form of Registration Rights Agreement
among the Registrant and the investors
signatory thereto entered into in
connection with the Registrants
February 2005 private placement.
    
    Incorporated by
reference to Exhibit
4.4 to the Registrants
Current Report on Form
8-K filed on February
8, 2005.
 36




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##### Table of Contents



Exhibit No.
    
    Exhibit
    
    Method of Filing4.5
    
    Form of warrant to purchase the
Registrants common stock
issued to certain placement
agents in connection with the
Registrants February 2005
private placement.
    
    Incorporated by reference to
Exhibit 4.61 to the
Registrants Annual Report on
Form 10-K for the year ended
December 31, 2004.4.6
    
    Form of warrant to purchase the
Registrants common stock which
may become issuable to certain
placement agents in connection
with the Registrants February
2005 private placement.
    
    Incorporated by reference to
Exhibit 4.62 to the
Registrants Annual Report on
Form 10-K for the year ended
December 31, 2004.4.7
    
    Form of Registration Rights
Agreement executed in
connection with the closing of
the transactions contemplated
by the Asset Purchase Agreement
dated as of February 23, 2005
by and among the Registrant,
WSECI, Inc. and the
shareholders of WSECI, Inc.
    
    Incorporated by reference to
Exhibit 4.1 to the Registrants
Current Report on Form 8-K
filed on March 1, 200510.1
    
    Assignment and Assumption
Agreement dated January 21,
2005 entered into in connection
with the Registrants
disposition of its MCK business
with respect to the U.K.
assets.
    
    Incorporated by reference to
Exhibit 99.1 to the
Registrants Current Report on
Form 8-K filed on January 27,
2005.10.2
    
    Assignment and Assumption
Agreement dated January 21,
2005 entered into in connection
with the Registrants
disposition of its MCK business
with respect to the U.S.
assets.
    
    Incorporated by reference to
Exhibit 99.2 to the
Registrants Current Report on
Form 8-K filed on January 27,
2005.10.3
    
    Assignment and Assumption
Agreement dated January 21,
2005 entered into in connection
with the Registrants
disposition of its MCK business
with respect to the Canadian
assets.
    
    Incorporated by reference to
Exhibit 99.3 to the
Registrants Current Report on
Form 8-K filed on January 27,

2005.10.4
    
    Bill of Sale dated January 21,
2005 entered into in connection
with the Registrants
disposition of its MCK business
with respect to the U.K.
assets.
    
    Incorporated by reference to
Exhibit 99.4 to the
Registrants Current Report on
Form 8-K filed on January 27,
2005.10.5
    
    Bill of Sale dated January 21,
2005 entered into in connection
with the Registrants
disposition of its MCK business
with respect to the U.S.
assets.
    
    Incorporated by reference to
Exhibit 99.5 to the
Registrants Current Report on
Form 8-K filed on January 27,
2005.10.6
    
    Bill of Sale dated January 21,
2005 entered into in connection
with the Registrants
disposition of its MCK business
with respect to the Canadian
assets.
    
    Incorporated by reference to
Exhibit 99.6 to the
Registrants Current Report on
Form 8-K filed on January 27,
2005.
 37




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##### Table of Contents



Exhibit No.
    
    Exhibit
    
    Method of Filing10.7
    
    Secured Convertible Promissory
dated January 21, 2005 issued
to the Registrant in principal
amount of $3.5 million in
connection with the
Registrants disposition of
its MCK business.
    
    Incorporated by reference to
Exhibit 99.7 to the
Registrants Current Report on
Form 8-K filed on January 27,
2005.10.8
    
    Security Agreement dated
January 21, 2005 entered into
in connection with the
Registrants disposition of
its MCK business.
    
    Incorporated by reference to
Exhibit 99.8 to the
Registrants Current Report on
Form 8-K filed on January 27,
2005.10.9
    
    Copyright Assignment Agreement
dated January 21, 2005 entered
into in connection with the
Registrants disposition of
its MCK business.
    
    Incorporated by reference to
Exhibit 99.9 to the
Registrants Current Report on
Form 8-K filed on January 27,
2005.10.10
    
    Domain Name Assignment
Agreement dated January 21,
2005 entered into in
connection with the
Registrants disposition of
its MCK business.
    
    Incorporated by reference to
Exhibit 99.10 to the
Registrants Current Report on
Form 8-K filed on January 27,
2005.10.11
    
    Patent Assignment Agreement
dated January 21, 2005 entered
into in connection with the
Registrants disposition of
its MCK business.
    
    Incorporated by reference to
Exhibit 99.11 to the
Registrants Current Report on
Form 8-K filed on January 27,
2005.10.12
    
    Trademark Assignment Agreement
dated January 21, 2005 entered
into in connection with the
Registrants disposition of
its MCK business.
    
    Incorporated by reference to
Exhibit 99.12 to the
Registrants Current Report on
Form 8-K filed on January 27,
2005.10.13
    
    Bill of Sale dated January 21,
2005 entered into in
connection with the
Registrants disposition of
its NACT business.
    
    Incorporated by reference to
Exhibit 99.13 to the
Registrants Current Report on
Form 8-K filed on January 27,
2005.10.14
    
    Copyright Assignment Agreement
dated January 21, 2005 entered
into in connection with the
Registrants disposition of
its NACT business.
    
    Incorporated by reference to
Exhibit 99.14 to the
Registrants Current Report on
Form 8-K filed on January 27,
2005.10.15
    
    Trademark Assignment Agreement
dated January 21, 2005 entered
into in connection with the
Registrants disposition of
its NACT business.
    
    Incorporated by reference to
Exhibit 99.15 to the
Registrants Current Report on
Form 8-K filed on January 27,
2005.10.16
    
    Patent Assignment Agreement
dated January 21, 2005 entered
into in connection with the
Registrants disposition of
its NACT business.
    
    Incorporated by reference to
Exhibit 99.16 to the
Registrants Current Report on
Form 8-K filed on January 27,
2005.10.17
    
    License Agreement dated
January 21, 2005 entered into
in connection with the
Registrants disposition
    
    Incorporated by reference to
Exhibit 99.17 to the
 38




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##### Table of Contents



Exhibit No.
    
    Exhibit
    
    Method of Filingof its NACT business.
    
    Registrants Current Report on Form 8-K filed on January 27, 2005.10.18
    
    Reciprocal Reseller Agreement
dated January 21, 2005 entered
into in connection with the
Registrants disposition of
its NACT business.
    
    Incorporated by reference to
Exhibit 99.18 to the
Registrants Current Report on
Form 8-K filed on January 27,
2005.10.19
    
    Call Center Services Agreement
dated January 21, 2005 entered
into in connection with the
Registrants disposition of
its NACT business.
    
    Incorporated by reference to
Exhibit 99.19 to the
Registrants Current Report on
Form 8-K filed on January 27,
200510.20
    
    Instrument of Assignment,
Agreement and Consent dated
January 21, 2005 entered into
in connection with the
Registrants disposition of
its NACT business.
    
    Incorporated by reference to
Exhibit 99.20 to the
Registrants Current Report on
Form 8-K filed on January 27,
2005.10.21
    
    Cash Collateral Agreement
dated as of February 4, 2005
between the Registrant, the
investors signatory thereto
and Wachovia Bank, National
Association.
    
    Incorporated by reference to
Exhibit 99.1 to the
Registrants Current Report on
Form 8-K filed on February 8,
2005.10.22
    
    Form of Seller Non-competition
Agreement executed in
connection with the closing of
the transactions contemplated
by the Asset Purchase
Agreement dated as of February
23, 2005 by and among the
Registrant, WSECI, Inc. and
the shareholders of WSECI,
Inc.
    
    Incorporated by reference to
Exhibit 99.1 to the
Registrants Current Report on
Form 8-K filed on March 1,
2005.10.23
    
    Bill of Sale, Assignment and
Assumption Agreement Seller
executed in connection with
the closing of the
transactions contemplated by
the Asset Purchase Agreement
dated as of February 23, 2005
by and among the Registrant,
WSECI, Inc. and the
shareholders of WSECI, Inc.
    
    Incorporated by reference to
Exhibit 99.2 to the
Registrants Current Report on
Form 8-K filed on March 1,
2005.10.24
    
    Non-qualified Stock Option
entered into March 15, 2005
and effective November 3, 2004
to purchase 500,000 shares of
the Registrants common stock
granted to Lewis Jaffe.
Represents an executive
compensation plan or
arrangement.
    
    Incorporated by reference to
Exhibit 99.5 to the
Registrants Current Report
filed on March 21, 2005 and
amended on April 28, 2005.10.25
    
    Non-qualified Stock Option
entered into March 15, 2005
and effective November 3, 2004
to purchase 250,000 shares of
the Registrants common stock
granted to Lewis Jaffe.
Represents an executive
compensation plan or
arrangement.
    
    Incorporated by reference to
Exhibit 99.6 to the
Registrants Current Report
filed on March 21, 2005 and
amended on April 28, 2005.10.26
    
    Non-qualified Stock Option
entered into March 15, 2005
and effective November 3, 2004
to purchase 250,000 shares of
the Registrants common stock
granted to Lewis Jaffe.
Represents an executive
compensation plan or
arrangement.
    
    Incorporated by reference to
Exhibit 99.7 to the
Registrants Current Report
filed on March 21, 2005 and
amended on April 28, 2005.10.27
    
    Non-qualified Stock Option
entered into March 15,
    
    Incorporated by reference to
 39




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##### Table of Contents



Exhibit No.
    
    Exhibit
    
    Method of Filing2005 and effective November 19,
2004 to purchase 250,000
shares of the Registrants
common stock granted to
Montgomery Bannerman.
Represents an executive
compensation plan or
arrangement.
    
    Exhibit 99.8 to the Registrants Current Report
filed on March 21, 2005 and
amended on April 28, 2005.10.28
    
    Amendment to Loan Documents
dated March 15, 2005, among
the Registrant, Provo Prepaid
(Delaware) Corp., Telemate.Net
Software, Inc., Needham
(Delaware) Corp. and Silicon
Valley Bank.
    
    Incorporated by reference to
Exhibit 99.1 to the
Registrants Current Report
filed on March 21, 2005 and
amended on April 28, 2005.10.29
    
    Amendment to Loan Documents
(Exim Program) dated March 15,
2005, among the Registrant,
Provo Prepaid (Delaware)
Corp., Telemate.Net Software,
Inc. and Silicon Valley Bank.
    
    Incorporated by reference to
Exhibit 99.2 to the
Registrants Current Report
filed on March 21, 2005 and
amended on April 28, 2005.10.30
    
    Borrower Agreement dated March
15, 2005, among the
Registrant, Provo Prepaid
(Delaware) Corp., Telemate.Net
Software, Inc. and Silicon
Valley Bank.
    
    Incorporated by reference to
Exhibit 99.3 to the
Registrants Current Report
filed on March 21, 2005 and
amended on April 28, 2005.10.31
    
    Amended and Restated Secured
Promissory Note dated March
15, 2005, in principal amount
of $10.0 million, made by the
Registrant, Provo Prepaid
(Delaware) Corp. and
Telemate.Net Software, Inc. in
favor of Silicon Valley Bank.
    
    Incorporated by reference to
Exhibit 99.4 to the
Registrants Current Report
filed on March 21, 2005 and
amended on April 28, 2005.10.32
    
    Assumption Agreement dated
April 14, 2005, among the
Registrant, Needham (Delaware)
Corp., Provo Prepaid
(Delaware) Corp., Telemate.Net
Software, Inc. and Silicon
Valley Bank.
    
    Filed herewith.
 40




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##### Table of Contents



Exhibit No.
    
    Exhibit
    
    Method of Filing10.33
    
    Borrower Agreement dated April 14, 2005, among
the Registrant, Needham (Delaware) Corp., Provo
Prepaid (Delaware) Corp., Telemate.Net
Software, Inc. and Silicon Valley Bank.
    
    Filed herewith.10.34
    
    Amended and Restated Secured Promissory Note
dated April 14, 2005, in principal amount of
$10.0 million, made by the Registrant, Needham
(Delaware) Corp., Provo Prepaid (Delaware)
Corp. and Telemate.Net Software, Inc. in favor
of Silicon Valley Bank.
    
    Filed herewith.31.1
    
    Rule 13a-14(a)/15d-14(a) Certification by the
Registrants Chief Executive Officer.
    
    Filed herewith.31.2
    
    Rule 13a-14(a)/15d-14(a) Certification by the
Registrants Chief Financial Officer.
    
    Filed herewith.32.1
    
    Section 1350 Certification by the Registrants
Chief Executive Officer.
    
    Filed herewith.32.2
    
    Section 1350 Certification by the Registrants
Chief Financial Officer.
    
    Filed herewith.
 41