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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549



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FORM 10-Q

(Mark One)

|x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- | ---------------------------------------------------------------------------------------



| | For the quarterly period ended March 31, 2007
| | ---------------------------------------------

or



| ̈ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- | ----------------------------------------------------------------------------------------



| | For the transition period from 
to
| | ----------------------------------

Commission File Number 000-19462



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VERTICAL COMMUNICATIONS, INC.

(Exact Name of Registrant as Specified in
Its Charter)



|                                                              |  |                                    
|------------------------------------------------------------- |  | -----------------------------------
|Delaware                                                      |  | 86-0446453                         
|(State or other jurisdictionof incorporation or organization) |  | (I.R.S. EmployerIdentification No.)



|                                             |  |           
|-------------------------------------------- |  | ----------
|One Memorial Drive, Cambridge, Massachusetts |  | 02142     
|(Address of Principal Executive Offices)     |  | (Zip Code)

Registrant's telephone number, including area code:    (617) 354-0600



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Indicate by check
mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to
file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No ̈

Indicate by check mark whether the registrant is a large
accelerated filer, an accelerated filer or a non-accelerated filer. See definition of accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act.)



|                         |  |                    |  |                          
|------------------------ |  | ------------------ |  | -------------------------
|Large Accelerated Filer ̈ |  | Accelerated Filer ̈ |  | Non accelerated Filer  x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the
Exchange Act.)    Yes ̈No  x

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.



|                                        |  |                                     
|--------------------------------------- |  | ------------------------------------
|Title of Class of Common Stock          |  | Shares Outstanding as of May 7, 2007
|Common Stock, $0.01 par value per share |  | 52,084,483                          



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##### Table of Contents

VERTICAL COMMUNICATIONS, INC.

FORM 10-Q

TABLE OF CONTENTS



|        |  |                                                                                                                        |  |     
|------- |  | ---------------------------------------------------------------------------------------------------------------------- |  | ----
|        |  |                                                                                                                        |  | Page
|PART I  |  | FINANCIAL INFORMATION                                                                                                  |  | 3   
|        |  |                                                                                                                       
|        |  | Item 1. Condensed Consolidated Financial Statements                                                                    |  | 3   
|        |  |                                                                                                                       
|        |  | Condensed Consolidated Balance Sheets as of March 31, 2007 (unaudited) and June 30, 2006                               |  | 3   
|        |  |                                                                                                                       
|        |  | Condensed Consolidated Statement of Operations for the three and nine months ended March 31, 2007 and 2006 (unaudited) |  | 4   
|        |  |                                                                                                                       
|        |  | Condensed Consolidated Statement of Cash Flows for the nine months ended March 31, 2007 and 2006 (unaudited)           |  | 5   
|        |  |                                                                                                                       
|        |  | Notes to Condensed Consolidated Financial Statements (unaudited)                                                       |  | 7   
|        |  |                                                                                                                       
|        |  | Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations                          |  | 22  
|        |  |                                                                                                                       
|        |  | Item 3. Quantitative and Qualitative Disclosures about Market Risk                                                     |  | 29  
|        |  |                                                                                                                       
|        |  | Item 4. Controls and Procedures                                                                                        |  | 29  
|        |  |                                                                                                                       
|PART II |  | OTHER INFORMATION                                                                                                      |  | 30  
|        |  |                                                                                                                       
|        |  | Item 1. Legal Proceedings                                                                                              |  | 30  
|        |  |                                                                                                                       
|        |  | Item 1A. Risk Factors                                                                                                  |  | 30  
|        |  |                                                                                                                       
|        |  | Item 6. Exhibits                                                                                                       |  | 42  
|        |  |                                                                                                                       
|        |  | Signature                                                                                                              |  | 43  



2



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##### Table of Contents

PART I  FINANCIAL INFORMATION

Item 1.  FINANCIAL STATEMENTS

VERTICAL COMMUNICATIONS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except share and per share amounts)



|                                                                                                                                                                                          |  |                          |         |   |               |   |         |  
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------------------ | ------- | - | ------------- | - | ------- | -
|                                                                                                                                                                                          |  | March 31,2007(Unaudited) |         |   | June 30, 2006 |  
|ASSETS                                                                                                                                                                                    |  |                          |         |   |               |   |         |  
|Current assets:                                                                                                                                                                           |  |                          |         |   |               |   |         |  
|Cash and cash equivalents                                                                                                                                                                 |  | $                        | 14,546  |   |               | $ | 4,726   |  
|Trade receivables, net of allowances of $297 and $322, respectively                                                                                                                       |  |                          | 11,146  |   |               |   | 10,510  |  
|Inventories, net                                                                                                                                                                          |  |                          | 14,986  |   |               |   | 6,071   |  
|Prepaid expenses                                                                                                                                                                          |  |                          | 2,119   |   |               |   | 2,855   |  
|Deferred costs                                                                                                                                                                            |  |                          | 4,289   |   |               |   | 4,120   |  
|Restricted cash                                                                                                                                                                           |  |                          | 1,273   |   |               |   | 389     |  
|                                                                                                                                                                                          |  |                          |         |   |               |   |         |  
|Total current assets                                                                                                                                                                      |  |                          | 48,359  |   |               |   | 28,671  |  
|                                                                                                                                                                                          |  |                          |         |   |               |   |         |  
|Property and equipment                                                                                                                                                                    |  |                          | 10,359  |   |               |   | 5,460   |  
|Less accumulated depreciation and amortization                                                                                                                                            |  |                          | (7,879  | ) |               |   | (3,259  | )
|                                                                                                                                                                                          |  |                          |         |   |               |   |         |  
|Net property and equipment                                                                                                                                                                |  |                          | 2,480   |   |               |   | 2,201   |  
|                                                                                                                                                                                          |  |                          |         |   |               |   |         |  
|Goodwill                                                                                                                                                                                  |  |                          | 40,040  |   |               |   | 25,759  |  
|Intangible assets, net of accumulated amortization                                                                                                                                        |  |                          | 16,968  |   |               |   | 6,567   |  
|Deferred costs, net of current portion                                                                                                                                                    |  |                          | 4,231   |   |               |   | 6,777   |  
|Other assets                                                                                                                                                                              |  |                          | 480     |   |               |   | 104     |  
|                                                                                                                                                                                          |  |                          |         |   |               |   |         |  
|Total assets                                                                                                                                                                              |  | $                        | 112,558 |   |               | $ | 70,079  |  
|                                                                                                                                                                                          |  |                          |         |   |               |   |         |  
|LIABILITIES, CONVERTIBLE REDEEMABLE PREFERRED STOCK AND SHAREHOLDERS' EQUITY                                                                                                              |  |                          |         |   |              
|Current liabilities:                                                                                                                                                                      |  |                          |         |   |               |   |         |  
|Accounts payable                                                                                                                                                                          |  | $                        | 7,787   |   |               | $ | 4,964   |  
|Accrued liabilities                                                                                                                                                                       |  |                          | 11,039  |   |               |   | 8,752   |  
|Trade accounts payable to a stockholder                                                                                                                                                   |  |                          | 2,125   |   |               |   |        |  
|Deferred revenue                                                                                                                                                                          |  |                          | 10,087  |   |               |   | 10,409  |  
|Customer deposits                                                                                                                                                                         |  |                          | 175     |   |               |   | 175     |  
|Current portion of long term debt                                                                                                                                                         |  |                          | 9,173   |   |               |   | 10,805  |  
|                                                                                                                                                                                          |  |                          |         |   |               |   |         |  
|Total current liabilities                                                                                                                                                                 |  |                          | 40,386  |   |               |   | 35,105  |  
|                                                                                                                                                                                          |  |                          |         |   |               |   |         |  
|Deferred revenue, net of current portion                                                                                                                                                  |  |                          | 7,761   |   |               |   | 12,196  |  
|Deferred tax liability                                                                                                                                                                    |  |                          | 6,056   |   |               |   | 883     |  
|Long term debt, net of current portion                                                                                                                                                    |  |                          | 15,584  |   |               |   | 416     |  
|                                                                                                                                                                                          |  |                          |         |   |               |   |         |  
|Total liabilities                                                                                                                                                                         |  |                          | 69,787  |   |               |   | 48,600  |  
|                                                                                                                                                                                          |  |                          |         |   |               |   |         |  
|Series D convertible, redeemable preferred stock, $1.00 par value, 5,000 shares authorized, issued and outstanding at March 31, 2007 and
June 30, 2006; liquidation preference of $5,455. |  |                          | 965     |   |               |   | 3,555   |  
|Series E convertible, redeemable preferred stock, $1.00 par value, 30,000 shares authorized, 27,400 shares issued and outstanding at
March 31, 2007; liquidation preference of $28,308.   |  |                          |        |   |               |   |        |  
|                                                                                                                                                                                          |  |                         
|Shareholders' equity:                                                                                                                                                                     |  |                          |         |   |               |   |         |  
|Preferred stock, $1.00 par value; authorized 30,000,000 shares.                                                                                                                           |  |                          |        |   |               |   |        |  
|Common stock, $.01 par value per share; authorized 250,000,000 shares; issued and outstanding 52,084,483 shares at March 31, 2007 and
47,016,918 shares at June 30, 2006.                 |  |                          | 521     |   |               |   | 470     |  
|Accumulated other comprehensive income (loss)                                                                                                                                             |  |                          | (19     | ) |               |   | (15     | )
|Additional paid-in capital                                                                                                                                                                |  |                          | 128,328 |   |               |   | 93,389  |  
|Accumulated deficit                                                                                                                                                                       |  |                          | (86,579 | ) |               |   | (75,410 | )
|Deferred Toshiba equity cost                                                                                                                                                              |  |                          | (445    | ) |               |   | (510    | )
|                                                                                                                                                                                          |  |                          |         |   |               |   |         |  
|Net shareholders' equity                                                                                                                                                                  |  |                          | 41,806  |   |               |   | 17,924  |  
|                                                                                                                                                                                          |  |                          |         |   |               |   |         |  
|Total liabilities, convertible redeemable preferred stock and shareholders equity                                                                                                         |  | $                        | 112,558 |   |               | $ | 70,079  |  
|                                                                                                                                                                                          |  |                          |         |   |               |   |         |  

See notes to condensed consolidated financial statements.



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VERTICAL COMMUNICATIONS, INC. AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share amounts)



|                                                                       |  |                             |        |   |                            |   |        |      |  |   |         |   |  |   |         |  
|---------------------------------------------------------------------- |  | --------------------------- | ------ | - | -------------------------- | - | ------ | ---- |  | - | ------- | - |  | - | ------- | -
|                                                                       |  | Three Months EndedMarch 31, |        |   | Nine Months EndedMarch 31, |  
|                                                                       |  | 2007                        |        |   | 2006                       |   |        | 2007 |  |   | 2006    |  
|Net revenue                                                            |  | $                           | 22,683 |   |                            | $ | 14,388 |      |  | $ | 56,632  |   |  | $ | 40,581  |  
|Cost of sales                                                          |  |                             | 12,225 |   |                            |   | 6,579  |      |  |   | 29,401  |   |  |   | 18,666  |  
|                                                                       |  |                             |        |   |                            |   |        |      |  |   |         |   |  |   |         |  
|Gross profit                                                           |  |                             | 10,458 |   |                            |   | 7,809  |      |  |   | 27,231  |   |  |   | 21,915  |  
|                                                                       |  |                             |        |   |                            |   |        |      |  |   |         |   |  |   |         |  
|Operating expenses:                                                    |  |                             |        |   |                            |   |        |      |  |   |         |   |  |   |         |  
|Sales and marketing                                                    |  |                             | 4,677  |   |                            |   | 4,193  |      |  |   | 11,952  |   |  |   | 12,845  |  
|Product development                                                    |  |                             | 3,573  |   |                            |   | 2,889  |      |  |   | 9,706   |   |  |   | 8,812   |  
|General and administrative                                             |  |                             | 3,945  |   |                            |   | 4,105  |      |  |   | 11,972  |   |  |   | 11,362  |  
|Amortization of intangible assets                                      |  |                             | 619    |   |                            |   | 308    |      |  |   | 1,290   |   |  |   | 789     |  
|                                                                       |  |                             |        |   |                            |   |        |      |  |   |         |   |  |   |         |  
|Total operating expenses                                               |  |                             | 12,814 |   |                            |   | 11,495 |      |  |   | 34,920  |   |  |   | 33,808  |  
|                                                                       |  |                             |        |   |                            |   |        |      |  |   |         |   |  |   |         |  
|Loss from operations                                                   |  |                             | (2,356 | ) |                            |   | (3,686 | )    |  |   | (7,689  | ) |  |   | (11,893 | )
|Interest expense                                                       |  |                             | (1,670 | ) |                            |   | (229   | )    |  |   | (3,073  | ) |  |   | (472    | )
|Other income (expense), net                                            |  |                             | 151    |   |                            |   | 15     |      |  |   | 239     |   |  |   | (9      | )
|                                                                       |  |                             |        |   |                            |   |        |      |  |   |         |   |  |   |         |  
|Loss before provision for income tax                                   |  |                             | (3,875 | ) |                            |   | (3,900 | )    |  |   | (10,523 | ) |  |   | (12,374 | )
|Provision for income taxes                                             |  |                             | (298   | ) |                            |   | (139   | )    |  |   | (644    | ) |  |   | (382    | )
|                                                                       |  |                             |        |   |                            |   |        |      |  |   |         |   |  |   |         |  
|Net loss                                                               |  |                             | (4,173 | ) |                            |   | (4,039 | )    |  |   | (11,167 | ) |  |   | (12,756 | )
|                                                                       |  |                             |        |   |                            |   |        |      |  |   |         |   |  |   |         |  
|Series D preferred stock accretion and dividends                       |  |                             | (213   | ) |                            |   | (78    | )    |  |   | (580    | ) |  |   | (78     | )
|                                                                       |  |                             |        |   |                            |   |        |      |  |   |         |   |  |   |         |  
|Net loss applicable to common shareholders                             |  | $                           | (4,386 | ) |                            | $ | (4,117 | )    |  | $ | (11,747 | ) |  | $ | (12,834 | )
|                                                                       |  |                             |        |   |                            |   |        |      |  |   |         |   |  |   |         |  
|Net loss applicable to common shareholders per sharebasic and diluted |  | $                           | (0.09  | ) |                            | $ | (0.09  | )    |  | $ | (0.25   | ) |  | $ | (0.31   | )
|Weighted average common shares outstandingbasic and diluted           |  |                             | 49,178 |   |                            |   | 45,809 |      |  |   | 47,727  |   |  |   | 42,082  |  

The accompanying notes are an integral part of the unaudited condensed consolidated financial
statements.



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VERTICAL COMMUNICATIONS, INC. AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)



|                                                                                       |  |                            |         |   |      |   |         |  
|-------------------------------------------------------------------------------------- |  | -------------------------- | ------- | - | ---- | - | ------- | -
|                                                                                       |  | Nine Months EndedMarch 31, |        
|                                                                                       |  | 2007                       |         |   | 2006 |  
|Cash flows from operating activities:                                                  |  |                            |         |   |      |   |         |  
|Net loss                                                                               |  | $                          | (11,167 | ) |      | $ | (12,756 | )
|Adjustments to reconcile net loss to net cash used by operating activities:            |  |                            |         |   |      |   |         |  
|Depreciation and amortization                                                          |  |                            | 2,617   |   |      |   | 2,040   |  
|Amortization of deferred Toshiba equity costs                                          |  |                            | 65      |   |      |   | 113     |  
|Non-cash interest                                                                      |  |                            | 1,494   |   |      |   |        |  
|Non-cash compensation                                                                  |  |                            | 3,354   |   |      |   | 3,126   |  
|Deferred tax provision                                                                 |  |                            | 644     |   |      |   | 382     |  
|Non-cash changes in accounts receivable allowances                                     |  |                            | 52      |   |      |   | (171    | )
|Changes in assets and liabilities, net of acquisitions:                                |  |                            |         |   |      |   |         |  
|Trade accounts receivables                                                             |  |                            | 2,033   |   |      |   | (1,483  | )
|Inventories                                                                            |  |                            | (1,826  | ) |      |   | 770     |  
|Prepaid expenses                                                                       |  |                            | 3,055   |   |      |   | (154    | )
|Deferred costs                                                                         |  |                            | 2,377   |   |      |   | 372     |  
|Other assets                                                                           |  |                            | (50     | ) |      |   | (2      | )
|Accounts payable                                                                       |  |                            | (1,468  | ) |      |   | (1,513  | )
|Accrued liabilities                                                                    |  |                            | (1,029  | ) |      |   | 2,324   |  
|Deferred revenue                                                                       |  |                            | (4,757  | ) |      |   | 1,285   |  
|                                                                                       |  |                            |         |   |      |   |         |  
|Net cash used in operating activities                                                  |  |                            | (4,606  | ) |      |   | (5,667  | )
|                                                                                       |  |                            |         |   |      |   |         |  
|Cash flows from investing activities:                                                  |  |                            |         |   |      |   |         |  
|Cash used for acquisitions, net of cash acquired                                       |  |                            | (24,665 | ) |      |   | (19,249 | )
|Purchases of property and equipment                                                    |  |                            | (267    | ) |      |   | (838    | )
|Increase in restricted cash                                                            |  |                            | (885    | ) |      |   | (101    | )
|                                                                                       |  |                            |         |   |      |   |         |  
|Net cash used in investing activities                                                  |  |                            | (25,817 | ) |      |   | (20,188 | )
|                                                                                       |  |                            |         |   |      |   |         |  
|Cash flows from financing activities:                                                  |  |                            |         |   |      |   |         |  
|Payments of capital lease obligations                                                  |  |                            | (16     | ) |      |   | (10     | )
|(Payments of)/proceeds from SVB term note                                              |  |                            | (2,000  | ) |      |   | 2,000   |  
|Payment of Comdial note                                                                |  |                            | (2,575  | ) |      |   |        |  
|Net change in SVB revolver facility                                                    |  |                            | (6,533  | ) |      |   | 5,092   |  
|Proceeds from issuance of Columbia debt, net of issuance costs                         |  |                            | 24,440  |   |      |   |        |  
|Proceeds from issuance of Series E preferred stock, net of issuance costs              |  |                            | 26,926  |   |      |   |        |  
|Proceeds from issuance of common stock, net of issuance costs                          |  |                            | 5       |   |      |   | 12,869  |  
|Proceeds from issuance of Series D preferred stock and warrants, net of issuance costs |  |                            |        |   |      |   | 4,847   |  
|                                                                                       |  |                            |         |   |      |   |         |  
|Net cash provided by financing activities                                              |  |                            | 40,247  |   |      |   | 24,798  |  
|                                                                                       |  |                            |         |   |      |   |         |  
|Effect of foreign currency exchange rates                                              |  |                            | (4      | ) |      |   | (52     | )
|                                                                                       |  |                            |         |   |      |   |         |  
|Net increase (decrease) in cash and cash equivalents                                   |  |                            | 9,820   |   |      |   | (1,109  | )
|Cash and cash equivalents at beginning of period                                       |  |                            | 4,726   |   |      |   | 4,880   |  
|                                                                                       |  |                            |         |   |      |   |         |  
|Cash and cash equivalents at end of period                                             |  | $                          | 14,546  |   |      | $ | 3,771   |  
|                                                                                       |  |                            |         |   |      |   |         |  
|SUPPLEMENTAL CASH FLOW INFORMATION:                                                    |  |                            |         |   |      |   |         |  
|Non cash dividend to series D preferred shareholders                                   |  |                            | 580     |   |      |   | 78      |  
|Restricted cash released to Vertical Networks shareholders                             |  |                            |        |   |      |   | 416     |  
|Cash paid for taxes                                                                    |  |                            |        |   |      |   |        |  
|Cash paid for interest                                                                 |  |                            | 604     |   |      |   | 342     |  



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On December 1, 2006, the Company acquired Vodavi Technology, Inc. and on September 28, 2005, the Company
acquired Comdial Corporation (see Note 3) as follows:



|                                                |  |                            |         |   |      |   |         |  
|----------------------------------------------- |  | -------------------------- | ------- | - | ---- | - | ------- | -
|                                                |  | Nine months endedMarch 31, |        
|                                                |  | 2007                       |         |   | 2006 |  
|Accounts receivable                             |  | $                          | 2,721   |   |      | $ | 3,158   |  
|Inventory                                       |  |                            | 7,089   |   |      |   | 4,540   |  
|Other current assets                            |  |                            | 2,319   |   |      |   | 2,248   |  
|Property and equipment                          |  |                            | 1,058   |   |      |   | 1,285   |  
|Other assets                                    |  |                            | 12      |   |      |   | 150     |  
|Intangible assets                               |  |                            | 11,950  |   |      |   | 4,300   |  
|Goodwill                                        |  |                            | 14,152  |   |      |   | 9,190   |  
|Deferred tax liability                          |  |                            | (4,529  | ) |      |   |        |  
|Cash used in acquisitions, net of cash acquired |  |                            | (24,665 | ) |      |   | (19,249 | )
|                                                |  |                            |         |   |      |   |         |  
|                                                |  |                            | 10,107  |   |      |   | 5,622   |  
|Note payable to Comdial Corporation             |  |                            |        |   |      |   | (2,500  | )
|Accrued direct acquisition costs                |  |                            | (81     | ) |      |   |        |  
|Liabilities assumed                             |  | $                          | 10,026  |   |      | $ | 3,122   |  
|                                                |  |                            |         |   |      |   |         |  

The accompanying notes are an integral part of the unaudited condensed consolidated financial
statements.



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VERTICIAL COMMUNICATIONS, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS

(1) BASIS OF PRESENTATION

Vertical Communications, Inc. (formerly Artisoft, Inc) (the "Company", we, our, us or the "Registrant"), develops, markets and sells business phone systems, software, hardware and associated services. We
sell our products through distributors, resellers and system integrators such as AT&T, Fujitsu, IBM and Graybar, and we engage in alliances with those parties and other technology vendors to assist us in selling and marketing our products. Most
of our end user customers rely upon resellers or systems integrators to implement our products, and these resellers and systems integrators can significantly influence our customers purchasing decisions. We market and sell our products in the
United States, Europe and Latin America. We also have distributor relationships in Africa, Asia, Australia and the Middle East.

The
accompanying unaudited condensed consolidated financial statements include the accounts of the Company and our wholly owned subsidiaries. All material intercompany balances and transactions have been eliminated in consolidation.

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in
the United States of America and pursuant to the rules and regulations of the Securities and Exchange Commission (the "SEC"). The balance sheet amounts at June 30, 2006 in this report were derived from our audited financial statements included
in our Annual Report on Form 10-K for the fiscal year ended June 30, 2006. In the opinion of management, the accompanying financial statements include all adjustments of a normal recurring nature which are necessary for a fair presentation
of the financial results for the interim periods presented. Certain information and footnote disclosures normally included in financial statements have been condensed or omitted pursuant to such rules and regulations. Although we believe that the
disclosures are adequate to make the information presented not misleading, we recommend that these financial statements be read in conjunction with the consolidated financial statements and the notes thereto included in our Annual Report on
Form 10-K for the fiscal year ended June 30, 2006 on file with the SEC. The results of operations for the three and nine months ended March 31, 2007 are not necessarily indicative of the results to be expected for the full year or any
other future periods.

The preparation of these financial statements requires us to make estimates and judgments that affect the reported
amount of assets and liabilities at the date of the financial statements and revenues and expenses during the reported period. Areas where significant judgments are made include, but are not limited to, revenue recognition, as well as the accounting
for our acquisition of Vodavi Technology, Inc. as discussed below. Actual results could differ materially from these estimates. The accounting policies applied are consistent with those disclosed in our Annual Report on Form 10-K as disclosed in
Note 2.

Acquisition of Vodavi Technology, Inc.

On December 1, 2006, we completed the acquisition of all of the outstanding securities of Vodavi Technology, Inc. (Vodavi) pursuant to an Agreement and Plan of Merger dated as of October 18, 2006 (the Merger
Agreement), by and among the Company, Vodavi and Vertical Acquisition Sub Inc., a Delaware corporation and wholly-owned subsidiary of the Company (MergerSub). MergerSub was merged with and into Vodavi (the Merger), with
Vodavi continuing its corporate existence as a wholly-owned subsidiary of the Company. Pursuant to the Merger Agreement, each issued and outstanding share of common stock of Vodavi was converted into the right to receive $7.50 in cash, without
interest, on the terms specified in the Merger Agreement. Immediately prior to the effective time of the Merger, all outstanding options to purchase shares of Vodavi capital stock, whether vested or not vested, were exercised pursuant to a cashless
exercise procedure and all equity incentive plans administered by Vodavi were terminated.

Vodavi is a provider of traditional and
next-generation business telecommunications solutions, targeted to small and medium-sized business, primarily in the United States. The aggregate consideration paid by the Company to the stockholders of Vodavi was approximately $31.1 million in cash
(the Merger Consideration). In addition, the Company incurred approximately $0.5 million in transaction costs related to the merger.

The operational results of this acquisition are included in all periods since December 1, 2006, the date that the merger was consummated.

(2) SIGNIFICANT ACCOUNTING POLICIES

Stock-Based Compensation

On July 1, 2005, we adopted the provisions of FASB Statement No. 123 (revised 2004) Accounting for Stock-Based Compensation(SFAS
No. 123R) and elected to use the modified prospective transition method as permitted under SFAS 123R. Under SFAS 123R, compensation cost recognized includes compensation cost for all share-based payments, based on the grant date fair
value estimated in accordance with the provisions of SFAS 123R.



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Stock Options

The Company currently grants stock options under one plan. Generally, options become exercisable over a four-year period commencing on the date of the grant. Options granted prior to and after September 28, 2004 vest 25% at the first
anniversary of the grant date with the remaining 75% vesting in equal monthly increments over the remaining three years of the vesting period. Options granted on September 28, 2004 vest 2.08% monthly. In computing stock based compensation, we
apply an estimated forfeiture rate based on actual forfeitures in our recent history. The fair value of options granted was calculated using the Black-Scholes option-pricing model with the following weighted average assumptions:



|                        |  |                            |   |  |         |  
|----------------------- |  | -------------------------- | - |  | ------- | -
|                        |  | Nine Months EndedMarch 31, |  
|                        |  | 2007                       |   |  | 2006    |  
|Expected dividend yield |  | 0                          | % |  | 0       | %
|Volatility factor       |  | 116.5                      | % |  | 114     | %
|Risk free interest rate |  | 4.87                       | % |  | 4.71    | %
|Expected life           |  | 6 Years                    |   |  | 6 Years |  

The risk-free interest rate is based upon the U. S. Treasury securities yield. The term of the
options grant is derived from historical data. The expected volatility is based upon the historical volatility of the Companys common stock over the period of time. The Company recognizes expense using the straight-line attribution method for
both pre- and post-adoption grants. The amount of option expense recognized during a period is based on the value of the portion of the awards that are ultimately expected to vest. SFAS 123R requires forfeitures to be estimated at the time of grant
and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. The Company currently expects, based on analysis of its historical forfeitures, a forfeiture rate of approximately 4%.

The following summarizes stock option activity for the three month period ended March 31, 2007:



|                                 |  |            |   |  |                                |      |                                                   |    
|-------------------------------- |  | ---------- | - |  | ------------------------------ | ---- | ------------------------------------------------- | ---
|Stock Options                    |  | Shares     |   |  | Weighted AverageExercise Price |      | Weighted AverageRemaining Contractual Term(years)
|Outstanding at December 31, 2006 |  | 8,702,971  |   |  | $                              | 1.75 |                                                   |    
|Granted                          |  | 11,723,028 |   |  | $                              | 0.85 |                                                   |    
|Exercised                        |  |           |   |  |                                |     |                                                   |    
|Cancelled                        |  | (507,829   | ) |  | $                              | 8.13 |                                                   |    
|Forfeited                        |  | (308,282   | ) |  | $                              | 2.06 |                                                   |    
|Outstanding at March 31, 2007    |  | 19,609,888 |   |  | $                              | 0.99 |                                                   | 9.0
|Exercisable at March 31, 2007    |  | 3,720,242  |   |  | $                              | 1.48 |                                                   | 8.0

The following summarizes stock option activity for the nine month period ended March 31,
2007:



|                              |  |            |   |  |                                |      |                                                   |    
|----------------------------- |  | ---------- | - |  | ------------------------------ | ---- | ------------------------------------------------- | ---
|Stock Options                 |  | Shares     |   |  | Weighted AverageExercise Price |      | Weighted AverageRemaining Contractual Term(years)
|Outstanding at June 30, 2006  |  | 8,216,803  |   |  | $                              | 1.90 |                                                   |    
|Granted                       |  | 12,724,528 |   |  | $                              | 0.82 |                                                   |    
|Exercised                     |  |           |   |  |                                |     |                                                   |    
|Cancelled                     |  | (507,829   | ) |  | $                              | 8.13 |                                                   |    
|Forfeited                     |  | (823,614   | ) |  | $                              | 1.72 |                                                   |    
|Outstanding at March 31, 2007 |  | 19,609,888 |   |  | $                              | 0.99 |                                                   | 9.0
|Exercisable at March 31, 2007 |  | 3,720,242  |   |  | $                              | 1.48 |                                                   | 8.0

In February 2007, the Company modified certain previously issued option grants with exercise
prices greater than $2.50 by cancelling the original grant and granting new options, on a one for three basis, with an exercise price equal to the market value of the Companys common shares as of the grant date. The Company cancelled 507,829
options and issued 169,276 new options. The new options become exercisable over a four year period beginning on the date of the new grant, with 25% vesting at the first anniversary of the grant date and the remaining 75% vesting in equal monthly



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increments over the remaining three years of the vesting period. The Company recognized no incremental cost related to the modification of these options and
elected to recognize the remaining unrecognized expense of the original grants over the original vesting period of the cancelled options.

Restricted
Stock

In February 2007, the Company granted restricted stock to certain key executives. This restricted stock program is a performance
based plan that awards shares of common stock of the Company at the end of a four year, one month measurement period. Awards associated with this program cliff vest at the end of the measurement period subject to attainment of the defined
performance measures associated with the performance of the Companys common stock and operations.

The Company will recognize
compensation expense on these awards ratably over the vesting period. The fair value of the awards was determined based on the market value of the underlying stock price at the grant date. The Company estimated a forfeiture rate of 20% based on
projections related to whether the performance measures are likely to be achieved and the probability of all awards vesting. The amount of compensation expense ultimately recognized will depend on whether the performance measures are met and all of
the restricted stock awards vest. The Company will assess its projections at each reporting period and, as a result, the amount of expense recorded from period to period may change.

The Company granted restricted stock awards for 4.6 million shares for the three and nine months ended March 31, 2007.

Total stock-based compensation for both options and restricted stock awards increased loss from operations and net loss for the three and nine months
ended March 31, 2007 by $1.3 million ($0.03 per basic and diluted share) and $3.4 million ($0.07 per basic and diluted share), respectively. As of March 31, 2007, $18.1 million of unvested stock-based compensation has not yet been
recognized by the Company. The unvested stock-based compensation balance is expected to be expensed over a weighted average period of 3.6 years.

The following table summarizes the allocation of stock-based compensation included in operating expenses by line item in the Unaudited Consolidated Condensed Statements of Operations for the periods indicated (in thousands):



|                           |  |                             |       |                            |   |      |  |      |       |  |   |      
|-------------------------- |  | --------------------------- | ----- | -------------------------- | - | ---- |  | ---- | ----- |  | - | -----
|                           |  | Three MonthsEnded March 31, |       | Nine Months EndedMarch 31,
|                           |  | 2007                        |       | 2006                       |   | 2007 |  | 2006
|Sales and marketing        |  | $                           | 504   |                            | $ | 214  |  | $    | 1,198 |  | $ | 720  
|Product development        |  | $                           | 385   |                            | $ | 306  |  | $    | 968   |  | $ | 1,030
|General and administrative |  | $                           | 425   |                            | $ | 410  |  | $    | 1,188 |  | $ | 1,376
|                           |  |                             |       |                            |   |      |  |      |       |  |   |      
|Total                      |  | $                           | 1,314 |                            | $ | 930  |  | $    | 3,354 |  | $ | 3,126

Goodwill

The Company accounts for its goodwill in accordance with the provisions of FASB Statement No. 142, Goodwill and Other Intangible Assets. This statement requires that goodwill be periodically tested
for impairment, with impaired assets written down to fair value. As of September 1, 2006, the Company conducted its annual impairment test of goodwill by comparing fair value to the carrying amount of its underlying assets and
liabilities. The Company determined that the fair value exceeded the carrying amount of the assets and liabilities, therefore no impairment existed as of the testing date.

(3) ACQUISITIONS

Vertical Networks, Inc.

On September 28, 2004, we acquired substantially all of the assets, other than patents and patent rights, and most of the liabilities of Vertical
Networks, Inc. (Vertical Networks). Vertical Networks was a leading provider of distributed IP-PBX software and communications solutions to large enterprises. We also received a patent license for the use of all of Vertical
Networks patents and patent applications other than Vertical Networks rights under specified patents that do not relate to the business we purchased. In addition, we assumed specific liabilities of Vertical Networks.

The purchase price for Vertical Networks consisted of: $12.5 million in cash, paid at closing, with an additional $1.0 million held in escrow to secure
Vertical Networks indemnification obligations to us, $1.0 million in transaction costs, the assumption of most liabilities of Vertical Networks and an earnout provision of up to $4.3 million. The earnout obligation is equal to the first $4.3
million of non-refundable software license revenues collected by us from CVS Pharmacy, Inc. (CVS) in connection with a specific contract. We have paid $2.0 million of the earn-out provision and accrued an additional $0.6 million of the
earn-out provision through March 31, 2007. As of September 30, 2006, the entire $1.0 million in escrow has been released to Vertical Networks.



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Comdial Corporation

On September 28, 2005, we completed the acquisition of substantially all of the assets (the Comdial Assets) of Comdial Corporation (Comdial) pursuant to the terms of an asset purchase
agreement entered into on September 1, 2005. The Comdial Assets included all of Comdials intellectual property, fixed assets, equipment, inventories, accounts receivable, rights under contracts and leases, cash and other current assets.

In exchange for the acquired assets, we (i) delivered $14.5 million in cash, (ii) executed an 8% secured promissory note in the
aggregate principal amount of $2.5 million to Comdial (see Note 6), (iii) repaid $1.7 million of debtor-in-possession financing incurred to fund operations of Comdial prior to the closing, (iv) repaid an amended and restated note dated
May 25, 2005, issued by Comdial to Dialcom Acquisition, LLC, in the principal amount of $1.9 million and (v) paid $0.4 million and assumed $0.2 million of Comdials remaining obligations under a key employee retention plan with
Comdials employees, as approved by an order of the Bankruptcy Court. In addition, we incurred approximately $0.8 million in transaction costs related to the acquisition.

We also assumed certain liabilities of Comdial such as post-petition ordinary course trade payables outstanding as of the acquisition date, certain
employee related obligations, and certain customer related obligations and liabilities related to certain assumed executory contracts. In addition, we assumed pre-petition and post-petition obligations under remaining unfulfilled purchase orders
outstanding as of the closing date. The amount of the liabilities we assumed as of September 28, 2005 was approximately $8.9 million, which included $6.0 million in open purchase order obligations.

Vodavi Technology, Inc.

On December 1, 2006, we
completed the acquisition of all of the outstanding securities of Vodavi pursuant to the Merger Agreement by and among the Company, Vodavi and MergerSub wherein MergerSub was merged with and into Vodavi, with Vodavi continuing its corporate
existence as a wholly-owned subsidiary of the Company.

Pursuant to the Merger Agreement, each issued and outstanding share of common stock
of Vodavi was converted into the right to receive $7.50 in cash, without interest, on the terms specified in the Merger Agreement. Immediately prior to the effective time of the Merger, all outstanding options to purchase shares of Vodavi capital
stock, whether vested or not vested, were exercised pursuant to a cashless exercise procedure and all equity incentive plans administered by Vodavi were terminated. The aggregate consideration paid by the Company to the stockholders of Vodavi was
approximately $31.1 million in cash. In addition, the Company incurred approximately $0.5 million in transaction costs related to the merger.

The Company obtained the Merger Consideration (a) through the sale of 27,400 shares of its newly designated Series E convertible preferred stock, par value $1.00 per share, at a purchase price of $1,000 per share to certain
investors pursuant to a Securities Purchase Agreement, as amended and restated (the Amended and Restated Securities Purchase Agreement), and (b) by entering into a Credit Agreement (the Credit Agreement) dated as of
October 18, 2006, by and among the Company, Vertical Communications Acquisition Corp., a Delaware corporation (VCAC), Columbia Partners, L.L.C. Investment Management (Investment Manager), and NEIPF, L.P.
(Lender), pursuant to which the Company issued (i) a senior secured promissory note payable to Lender in the principal amount of $10.0 million; and (ii) a senior secured promissory note payable to Lender in the principal amount
of $15.0 million.

The following table represents the estimated allocation of the purchase price for our acquisition of Vodavi over the
estimated fair value of the assets acquired and liabilities assumed at the date of acquisition.



|                              |  |                                                  |         |  
|----------------------------- |  | ------------------------------------------------ | ------- | -
|                              |  | EstimatedFair Values atMarch 31,2007 (thousands) |        
|Cash                          |  | $                                                | 6,881   |  
|Accounts Receivable, net      |  |                                                  | 2,721   |  
|Inventory, net                |  |                                                  | 7,089   |  
|Other Current Assets          |  |                                                  | 2,319   |  
|Property and Equipment        |  |                                                  | 1,058   |  
|Other Long Term Assets        |  |                                                  | 12      |  
|Intangible Assets             |  |                                                  | 11,950  |  
|Goodwill                      |  |                                                  | 14,152  |  
|                              |  |                                                  |         |  
|Total assets acquired         |  |                                                  | 46,182  |  
|Accounts Payable              |  |                                                  | (6,416  | )
|Accrued Expenses              |  |                                                  | (3,610  | )
|Deferred income tax liability |  |                                                  | (4,529  | )
|                              |  |                                                  |         |  
|Total liabilities assumed     |  |                                                  | (14,555 | )
|                              |  |                                                  |         |  
|Total purchase price          |  | $                                                | 31,627  |  
|                              |  |                                                  |         |  



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The estimated values of current assets, excluding inventory, and liabilities were based upon their
historical costs on the date of acquisition due to their short-term nature. Inventory was valued at estimated selling prices less the sum of (i) the cost of disposal and (ii) a reasonable profit allowance for the selling effort. Property
and equipment was also estimated based upon its historical cost as there was no appreciated real estate and the historical costs of the office equipment, furniture and machinery most closely approximated fair value. The identified intangible assets
were valued at their fair value as of the acquisition date. The associated deferred income tax liability is preliminary and also subject to change pending the Companys analysis of its ownership changes and the impact on the availability of the
Companys deferred tax assets. The residual purchase price was recorded as goodwill.

The following are the identifiable intangible
assets acquired and the respective periods over which the assets will be amortized on a straight-line basis:



|                               |  |                |        |            |  
|------------------------------ |  | -------------- | ------ | ---------- | -
|                               |  | AMOUNT         |        | LIFE      
|                               |  | (IN THOUSANDS) |        | (IN YEARS)
|Trade names/Trademarks         |  | $              | 690    |            | 4
|Customer relationships         |  |                | 10,440 |            | 9
|Customer relationships - other |  |                | 600    |            | 8
|Existing technology            |  |                | 220    |            | 4
|                               |  |                |        |            |  
|                               |  | $              | 11,950 |            |  

The amounts assigned to identifiable intangible assets acquired was based on their respective fair
values determined as of the acquisition date using a discounted cash flow analysis and relief from royalty methodology. The excess of the purchase price over the tangible and identifiable intangible assets was recorded as goodwill and amounted to
approximately $14.2 million. In accordance with current accounting standards, the goodwill is not being amortized and will be tested for impairment annually in the first quarter of our fiscal year, as required by SFAS No. 142 or more often if
impairment indicators arise.

The following unaudited pro forma condensed financial information gives effect to our acquisition of Vodavi
as if it had occurred on July 1, of each period presented. The unaudited pro forma condensed financial information is presented for illustrative purposes only and is not necessarily indicative of the consolidated financial position or
consolidated results of operations of the Company that would have been reported had the merger occurred on the date indicated, nor does it represent a forecast of the consolidated results of the operations of the Company for any future period.
Furthermore, no effect has been given in the unaudited pro forma combined statements of income for operating benefits that may be realized through the combination of the entities.



|                                                        |  |                                          |        |   |                                  |   |        |        |  |                     |        |  |                              |        |   |  |   |        |  
|------------------------------------------------------- |  | ---------------------------------------- | ------ | - | -------------------------------- | - | ------ | ------ |  | ------------------- | ------ |  | ---------------------------- | ------ | - |  | - | ------ | -
|                                                        |  |                                          |        |   | Three Months EndedMarch 31, 2006 |  
|                                                        |  | Three MonthsEnded March 31,2007 Combined |        |   | Vertical                         |   |        | Vodavi |  | Pro FormaAdjustment |        |  | CombinedPro Forma asAdjusted |       
|Net product revenue                                     |  | $                                        | 22,683 |   |                                  | $ | 7,809  |        |  | $                   | 10,005 |  |                              |       |   |  | $ | 17,814 |  
|Net (loss)/income                                       |  |                                          | (4,173 | ) |                                  |   | (4,039 | )      |  |                     | 204    |  | $                            | (2,177 | ) |  |   | (6,012 | )
|Net (loss)/income applicable to common shareholders     |  |                                          | (4,386 | ) |                                  |   | (4,117 | )      |  |                     | 204    |  |                              | (2,177 | ) |  |   | (6,090 | )
|Net loss applicable to common stock  Basic and Diluted |  | $                                        | (0.09  | ) |                                  |   | (0.09  | )      |  |                     |        |  |                              |        |   |  | $ | (0.13  | )



|                                                    |  |                                  |         |   |                                  |   |        |                      |  |   |                      |   |  |          |         |   |        |   |                      |   |  |                      |        |  |   |        |   |  |   |         |  
|--------------------------------------------------- |  | -------------------------------- | ------- | - | -------------------------------- | - | ------ | -------------------- |  | - | -------------------- | - |  | -------- | ------- | - | ------ | - | -------------------- | - |  | -------------------- | ------ |  | - | ------ | - |  | - | ------- | -
|                                                    |  | Nine Months Ended March 31, 2007 |         |   | Nine Months Ended March 31, 2006 |  
|                                                    |  | Vertical                         |         |   | Vodavi                           |   |        | Pro FormaAdjustments |  |   | Pro Forma asAdjusted |   |  | Vertical |         |   | Vodavi |   | Pro FormaAdjustments |   |  | Pro Forma asAdjusted |       
|Net product revenue                                 |  | $                                | 56,632  |   |                                  | $ | 13,066 |                      |  |   |                     |   |  | $        | 69,698  |   |        | $ | 26,193               |   |  | $                    | 33,216 |  |   |        |   |  | $ | 59,409  |  
|Net (loss)/income                                   |  |                                  | (11,167 | ) |                                  |   | (2,601 | )                    |  | $ | (6,532               | ) |  |          | (20,300 | ) |        |   | (8,717               | ) |  |                      | 894    |  | $ | (6,532 | ) |  |   | (14,355 | )
|(Loss)/income applicable to common shareholders     |  |                                  | (11,747 | ) |                                  |   | (2,601 | )                    |  |   | (6,532               | ) |  |          | (20,300 | ) |        |   | (8,717               | ) |  |                      | 894    |  |   | (6,532 | ) |  |   | (14,355 | )
|Loss applicable to common stock  Basic and Diluted |  | $                                | (0.25   | ) |                                  |   |        |                      |  |   |                      |   |  | $        | (0.44   | ) |        | $ | (0.18                | ) |  |                      |        |  |   |        |   |  | $ | (0.30   | )



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The pro forma adjustments include the amortization expense for the acquired identifiable intangible
assets of approximately $0.4 million per quarter and the interest expense for the amounts borrowed to finance the acquisition of approximately $1.7 million per quarter. Income tax expense has been recorded on the goodwill valuation of $14.2 million
over a 15 year life. All periods presented include this tax charge.

Pursuant to EITF 95-3, Recognition of Liabilities in Connection
with a Purchase Business Combination,the Company recorded a liability of $0.4 million related to the planned employee involuntary termination costs as a result of the acquisition. The Companys management began the assessment and
formulation of a plan as of the acquisition date and is in the process of completing the assessment of the number of employees, their job classifications and their locations that will be affected. The liability recorded includes the anticipated
severance and benefits costs that the Company will pay to the involuntarily terminated employees. The Company expects to complete the planned actions prior to October 2007.

(4) INVENTORIES

Inventories, net, at March 31, 2007 and June 30, 2006 are $15.0 million
and $6.1 million, respectively, consisting of the following (in thousands):



|               |  |                |        |              |   |      
|-------------- |  | -------------- | ------ | ------------ | - | -----
|               |  | March 31, 2007 |        | June 30,2006
|Raw Materials  |  | $              | 410    |              | $ | 392  
|Finished Goods |  | $              | 14,576 |              | $ | 5,679
|               |  |                |        |              |   |      
|               |  | $              | 14,986 |              | $ | 6,071
|               |  |                |        |              |   |      

The acquisition of the assets of Vodavi on December 1, 2006 is the primary reason for the
substantial increase in inventory, adding $4.7 million in inventory as of March 31, 2007. The remainder of the increase is primarily due to an increase in the number of phones on hand.

(5) INTANGIBLE ASSETS

Intangible assets related to
the acquisitions of Vertical Networks, Comdial and Vodavi at March 31, 2007 and June 30, 2006 consist of the following (in thousands):



|                                                   |  |               |        |   |               |   |        |              |  |   
|-------------------------------------------------- |  | ------------- | ------ | - | ------------- | - | ------ | ------------ |  | --
|                                                   |  | March 31,2007 |        |   | June 30, 2006 |   |        | Life inYears
|Acquired technology-Vertical Networks              |  | $             | 800    |   |               | $ | 800    |              |  | 5 
|Acquired customers relationships-Vertical Networks |  |               | 3,500  |   |               |   | 3,500  |              |  | 5 
|Trade names/trademarks-Comdial                     |  |               | 200    |   |               |   | 200    |              |  | 1 
|Acquired customer relationships-Comdial            |  |               | 3,300  |   |               |   | 3,300  |              |  | 10
|Acquired technology- Comdial                       |  |               | 800    |   |               |   | 800    |              |  | 5 
|Trade names-Vodavi                                 |  |               | 690    |   |               |   |       |              |  | 4 
|Customer relationships-Vodavi                      |  |               | 10,440 |   |               |   |       |              |  | 9 
|Customer relationships, other-Vodavi               |  |               | 600    |   |               |   |       |              |  | 8 
|Existing technology-Vodavi                         |  |               | 220    |   |               |   |       |              |  | 4 
|                                                   |  |               |        |   |               |   |        |              |  |   
|                                                   |  |               | 20,550 |   |               |   | 8,600  |              |  |   
|Accumulated amortization                           |  |               | (3,582 | ) |               |   | (2,033 | )            |  |   
|                                                   |  |               |        |   |               |   |        |              |  |   
|                                                   |  | $             | 16,968 |   |               | $ | 6,567  |              |  |   
|                                                   |  |               |        |   |               |   |        |              |  |   

Amortization expense for the three and nine months ending March 31, 2007 was $703,000 and
$1,549,000 respectively, of which $84,000 and $258,000, respectively, was included in cost of sales. For the three and nine months ending March 31, 2006, amortization expense was $388,000 and $988,000 respectively, of which $80,000 and
$201,000, respectively, was included in cost of sales.



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(6) DEBT

Debt
Related to Comdial Acquisition

We financed a portion of the purchase price for the Comdial Assets (the 2005 Debt Financing)
by entering into a loan agreement with Silicon Valley Bank (SVB) on September 28, 2005 (the SVB Loan Agreement). The SVB Loan Agreement terms provided the Company with a revolving line of credit in an amount not to
exceed $7,000,000 (the Revolving Loan), as well as a $2,000,000 term loan (the Term Loan). The Revolving Loan initially matured on September 27, 2006. On September 27, 2006, the Company entered into a Third Loan
Modification Agreement with SVB under which the maturity date of the Revolving Loan was extended from September 27, 2006 to October 31, 2006. In addition, the credit limit was redefined as the lesser of (A) $7,000,000 less the amounts
outstanding under the term loan and the amounts outstanding for letter of credit or cash management services, or (B) 80% of eligible accounts receivable plus 20% of eligible inventory less the amounts outstanding under the term loan and the
amounts outstanding for letter of credit or cash management services. The interest rate on the Revolving Loan was changed to the Prime Rate plus 1.75% per annum and the interest rate on the Term Loan was changed to the Prime
Rate plus 2.25% per annum. Certain of the provisions of the financial covenants were modified to eliminate the minimum cash balances covenant and add a minimum equity raise covenant which specified that the Company must receive a minimum
of $5,000,000 in net proceeds from the issuance of equity securities and/or subordinated debt on or before November 1, 2006. In addition the minimum earnings before interest, taxes, depreciation and amortization covenant was modified.

The Term Loan was payable in monthly principal installments of $133,333 plus interest, due beginning July 31, 2006 through and until
the maturity date of September 26, 2007.

On September 28, 2005, the Company also executed a secured promissory note in the
aggregate principal amount of $2,500,000 (the Comdial Note). The Comdial Note was issued to the Comdial bankruptcy estate (the Comdial Estate) in connection with the acquisition of the Comdial Assets. The Comdial Note was
subject to interest at the rate of 8% per annum and initially matured on the first anniversary of the closing date. On September 28, 2006, the Company and the Comdial Estate entered into an agreement which extended the maturity date of the
Comdial Note from September 28, 2006 to November 1, 2006. The Comdial Note was made subject to the minimum equity raise and minimum earnings before interest, taxes, depreciation and amortization covenants contained in the SVB Revolving
Loan modification dated September 27, 2006. In addition, the Company was required to pay an extension fee of $150,000 plus all accrued interest on the note through September 28, 2006 up to a maximum of $400,000. Because the Company paid
off the Comdial Note in full prior to November 1, 2006, the extension fee was reduced to $75,000.

On October 18, 2006, the
Company issued a Senior Secured Promissory Note to NEIPF, L.P. (see Debt Related to Vodavi Acquisition below for additional detail). The Company used proceeds from this loan to extinguish all of the outstanding loans with SVB and the
Comdial Estate.

Debt Related to Vodavi Acquisition

On October 18, 2006, the Company entered into a Credit Agreement, a Security Agreement, a Pledge Agreement and an Intellectual Property Security Agreement by and among the Company, VCAC, Investment Manager and
Lender. Pursuant to the Credit Agreement, the Company agreed to (a) issue a senior secured promissory note payable to Lender (the Initial Bridge Note) in the amount of $10.0 million, (b) provided certain conditions were met,
issue a senior secured promissory note payable to Lender (the Subsequent Bridge Note) in the principal amount of $5.0 million; (c) issue a senior secured promissory note payable to Lender (the Term Note and, together
with the Initial Bridge Note, the Loans) in the principal amount of $15.0 million; and (d) upon the issuance of the Initial Bridge Note, issue to Lender (i) a warrant to purchase 4,500,000 shares of the Companys common
stock at an exercise price equal to $0.01 per share (the Lender Warrant) and (ii) an additional warrant for the purchase of 500,000 shares of the Companys common stock at an exercise price equal to $0.01 per share. The
Subsequent Bridge Note was not issued and the additional warrant for the purchase of 500,000 shares of the Companys common stock became null and void when the Company reached a specified commitment level in the sale of its Series E convertible
preferred stock (see Note 9).

The Loans are secured by substantially all of the assets of the Company including specifically all rights in
the outstanding shares of capital stock of VCAC held by the Company and certain intellectual property owned by the Company. Events of default under the Credit Agreement include failure by the Company to meet its obligations under the Credit
Agreement and any other outstanding indebtedness; breach of certain of its obligations and covenants under the Credit Agreement; breach of any representations and warranties made in any documents relating to the Loans; the Companys insolvency
and/or bankruptcy; the Companys incurrence of a final money judgment against its assets in excess of $250,000 per individual case or $1.0 million in the aggregate; the Companys receipt of an order requiring dissolution or split up; and
the Companys or any creditor of the Companys failure to comply with any subordination provisions in any document which benefit the Lender or Investment Manager. Should an Event of Default occur, remedies available to the Lender include
acceleration requiring immediate payment of all or any portion of the obligations under the Credit Agreement and, with prior written consent of the Investment Manager, the right to set off any of the Companys property held by the Lender
against the obligations.



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The Credit Agreement contains certain financial covenants under which the Company must (a) maintain
cash, cash equivalents or available borrowing capacity of at least $5.0 million for each fiscal quarter beginning with the quarter ending March 31, 2007; (b) beginning with the trailing twelve month period ended September 30, 2007 and
for each quarter thereafter, maintain a minimum EBITDA of $1.00; (c) beginning with the trailing twelve month period ended September 30, 2007, maintain minimum total consolidated revenues of $80.0 million and (d) for the six month
period ended March 31, 2007, maintain minimum total consolidated revenues of $30.0 million and minimum EBITDA of ($2.0) million.

The
Initial Bridge Note was issued on October 18, 2006 in the amount of $10.0 million and bears interest at the rate of 14% per annum. Interest is paid quarterly in arrears. The principal amount and any unpaid interest are payable in full on
July 1, 2007. The net proceeds from the Initial Bridge Note, after payment of costs of approximately $0.2 million, were utilized to retire all of the debt owed to SVB and the Comdial Estate with the remainder to supplement working capital. The
Lender Warrant is exercisable by the holder at any time until its expiration on October 18, 2013 either by paying the exercise price of $.01 per share or on a cashless exchange basis. This net exercise right is generally limited to times when
the Company is not in compliance with its obligations relating to the registration of the shares of common stock underlying the warrants for resale under the Companys registration rights agreement with respect to those shares. The number of
shares issuable upon exercise and the per share exercise price of the warrant is subject to adjustment in the case of any stock dividend, stock split, combination, capital reorganization, reclassification or merger or consolidation. Subject to
limited exceptions, the number of shares of common stock for which the warrant is exercisable is also subject to adjustment in the case of an issuance of shares of common stock or securities exercisable for or convertible into common stock, at a per
share price less than the exercise price of the warrant then in effect. In the event of such an issuance, the exercise price of the warrant will be reduced to equal the per share price of the newly issued securities. The conversion price, as defined
in the warrants, shall also be reduced to equal the purchase price of the new issuance of common stock (or securities convertible into common stock).

We allocated the proceeds between the debt and the warrant based upon their relative fair values as of the issuance date, resulting in $2.1 million being allocated to the warrants. We determined the fair value of the
warrants using the Black-Scholes option pricing model with the following assumptions: no dividend yield; weighted average risk free rate of 4.42%; volatility of 115% and a contractual life of 7 years. The proceeds attributable to the warrant were
recorded as a discount on the debt which will be accreted, with the deferred issuance costs and cash interest, over the term of the Initial Bridge Note using the effective interest method.

The Term Note was issued on December 1, 2006 in the amount of $15.0 million and bears interest at a rate per annum equal to the applicable federal
rate for the term of the Term Note. A portion of the interest accruing equal to .05% of the outstanding principal amount is payable quarterly in arrears. The Company is also obligated to pay the Lender a premium equal to the amount required to
provide the Lender with a rate of return of 13.5% per annum upon any payment or prepayment of any amount of the Term Note. This premium is subject to increase to 15.5% for any period in which an Event of Default occurs and continues. The
principal amount of the Term Note and any unpaid interest, including the payment premium, is payable in full on October 17, 2009. Cash interest, the premium and deferred issuance costs of $0.3 million will be accreted over the life of term note
using the effective interest method.

As of March 31, 2007, the Company was in compliance with the applicable financial covenants of
the Loans.

(7) INCOME TAXES

The
Company has not recognized any current income tax expense in any period presented due to the Companys net losses. However, in fiscal years beginning with 2005, the Company is recording a deferred tax provision and corresponding liability
arising from the timing differences associated with amortizing goodwill for income tax purposes over a 15 year life.

(8) CONVERTIBLE REDEEMABLE
PREFERRED STOCK

Series D Preferred Stock

On February 9, 2006, the Company completed the sale (the Series D Financing) of 5,000 shares of its Series D Convertible Preferred Stock, par value $1.00 per share (the Series D
Preferred Stock) and warrants to purchase an aggregate of 1,041,667 shares (the Series D Warrants) of the Companys common stock pursuant to a Securities Purchase Agreement (the 2006 Securities Purchase Agreement)
between the Company and certain investors (the Series D Investors). The aggregate proceeds to the Company from the Series D Financing was $5.0 million.

Obligation to Register Shares

Pursuant to the 2006 Securities Purchase Agreement, we agreed to
register the shares of common stock issuable upon conversion of the Series D Preferred Stock and upon exercise of the Series D Warrants (collectively, the Issued Shares) for resale by the Series D Investors under the Securities
Act. The Company also agreed to file with the SEC a registration statement with respect to the Issued Shares no later than March 27, 2006 (the Filing Date), and to use our best efforts to cause the registration statement to become
effective on or before the date that is the earlier of (1) in the event of no review by the SEC, within five days of



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being informed by the SEC that the SEC has decided not to review the registration statement, but in no event later than 30 days after the Filing Date,
(2) in the event of a review by the SEC, within five days of being informed by the SEC that the SEC has no further comments on such registration statement, but in no event later than 90 days after the Filing Date (the earlier of (1) and
(2), the Required Effective Date).

The Company is currently liable for liquidated damages to each Series D Investor
because the registration statement was not filed on or before March 27, 2006 (such an event, a Filing Default). As a result of the Filing Default, the Company must pay as liquidated damages to the Series D Investors, for each
30-day period of a default, an amount in cash equal to 1% of the aggregate purchase price paid by the Series D Investor pursuant to the 2006 Securities Purchase Agreement; provided that in no event will the aggregate amount of cash to be paid
as liquidated damages exceed 9% of the aggregate purchase price paid by such Series D Investor. Through March 31, 2007, the Company has accrued a total of $450,000 in liquidated damages and paid $135,000 in damages as a result of the
Filing Default.

Material Terms

The
material terms of the Companys Series D Preferred Stock are summarized below.

Dividends. From the date of issuance, the
Series D Preferred Stock accrues dividends at a rate of $80.00 per year and compounds annually. Dividends on the Series D Preferred Stock may be declared and paid from time to time as determined by the Companys board of directors.
The Company cannot declare, pay or set aside any dividends or distributions on any other shares of capital stock of the Company unless the holders of Series D Preferred Stock first receive or simultaneously receive a dividend or distribution on
each outstanding share of Series D Preferred Stock in such amounts as set forth in the Certificate of Powers, Designation, Preferences and Rights of the Series D Preferred Stock (the Certificate of Designations).

Anti-dilution Adjustments. In the event the Company issues additional shares of common stock (which includes certain options and convertible
securities issued by the Company), except in limited circumstances, for no consideration or for consideration per share that is less than the conversion price of the Series D Preferred Stock then in effect, the conversion price of the
Series D Preferred Stock will be reduced in accordance with the formula set forth in the Certificate of Designations.

Redemption. Beginning February 9, 2009, the Series D Preferred Stock may be redeemed at a price equal to the Original Issue Price, plus all declared and unpaid dividends, provided that the holders of a majority of the
issued and outstanding shares of Series D Preferred Stock consent to such redemption. Commencing 30 days after the consent, the Series D Preferred Stock must be redeemed in three equal annual installments. If the Company fails to redeem the
Series D Preferred Stock in accordance with the Certificate of Designations, then interest will accrue on any unpaid amount at a rate of 1% per each 30-day period that such amounts remain unpaid.

Series D Warrants

In addition to the shares of
Series D Preferred Stock, the Company issued warrants to purchase an aggregate of up to 1,041,667 shares of common stock at a per share exercise price of $0.01. The Series D Warrants have a term of exercise expiring on February 9, 2016.
The number of shares issuable upon exercise and the per share exercise price of the Series D Warrants is subject to adjustment in the case of any stock dividend, stock split, combination, capital reorganization, reclassification or merger or
consolidation. Subject to limited exceptions, the number of shares of common stock for which the warrant is exercisable is also subject to adjustment in the case of an issuance of shares of common stock or securities exercisable for or convertible
into common stock, at a per share price less than the per share conversion price of the Series D Preferred Stock then in effect. In the event of such an issuance, the number of shares of common stock for which the warrant is exercisable is
increased in accordance with the formula set forth in the warrant. The conversion price, as defined in the warrant, is also reduced to equal the purchase price of the new issuance of common stock (or securities convertible into common stock). The
Series D Warrants are exercisable at any time prior to their expiration date by delivering the warrant certificates to the Company, together with a completed election to purchase and the full payment of the exercise price or by means of a "net
exercise" clause under which the Company does not receive any cash, but rather, the number of shares issued upon exercise is net of the number of shares withheld by the Company in lieu of payment of the exercise price. This net exercise right is
generally limited to times when the Company is not in compliance with its obligations relating to the registration of the shares of common stock underlying the Series D Warrants for resale under the Company's registration rights agreement with
respect to those shares.

The Company allocated the proceeds between the stock and the warrants based upon their relative fair values as of
the closing date, resulting in $951 thousand being allocated to the warrants. We determined the fair value of the warrants using the Black-Scholes option pricing model with the following assumptions: no dividend yield; weighted average risk free
rate of 4.54%; volatility of 115% and a contractual life of 10 years. The Company recorded the portion of the proceeds attributable to the stock as mezzanine equity pursuant to EITF Topic D-98, Classification and Measurement of Redeemable
Securitiesafter determining the guidance in FAS 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equitydid not apply. The Company determined that the warrants meet the definition of a
derivative instrument as defined in SFAS 133, Accounting for Derivative



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Instruments and Hedging Activities, but do not require derivative treatment pursuant to the scope exception in paragraph 11(a) of SFAS 133. We
recorded the proceeds attributable to the warrants in permanent equity pursuant to guidance in EITF 00-19,Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Companys Own Stock, as the Company can
settle the warrants in unregistered shares and the liquidated damages are not believed to be uneconomic.

The Company evaluated
whether the embedded conversion feature in the stock required bifurcation and determined that the economic characteristics and risks of the embedded conversion feature in the stock were clearly and closely related to the stock and concluded that
bifurcation was not required under SFAS 133. We calculated the intrinsic value of the beneficial conversion feature embedded in the stock pursuant to the guidance in EITF 00-27, Application of Issue No. 98-5 to Certain Convertible
Instruments. The beneficial conversion of $659,000 was recognized as an additional discount on the stock. The total discount on the stock resulting from the allocation of proceeds to the warrants and recording of the beneficial conversion
feature will be accreted over the period through the earliest possible redemption date.

As a result of the issuance of the Lender Warrant
(see Note 6) and the Series E Preferred Stock (see below), the anti-dilution adjustments in the Series D Preferred Stock and the Series D Warrants were triggered. Accordingly, on December 1, 2006, the Company issued 539,787 additional Series D
Warrants to the Series D Investors which increased the portion of the proceeds allocable to the warrants to $1.3 million. In addition, the conversion price was adjusted to $0.79 which resulted in an increase in the value of the beneficial conversion
feature to $2.8 million which was recorded as an additional discount on the stock. The additional discounts recognized as a result of these adjustments will be accreted over the period through the earliest redemption date.

We will reevaluate the classification of the stock and warrants in each period to determine if reclassification is necessary. Our obligation to the
Series D Preferred Stockholders, should they choose to redeem the stock at or after the redemption date is $5.0 million plus accrued but unpaid dividends.

Series E Preferred Stock

On December 1, 2006, the Company completed the sale (the Series E
Financing) of 27,400 shares of its Series E Convertible Preferred Stock, par value $1.00 per share (the Series E Preferred Stock) and warrants to purchase an aggregate of 25,849,059 shares (the Series E
Warrants) of the Companys common stock pursuant to the Amended and Restated Securities Purchase Agreement between the Company and certain investors (the Series E Investors) (the Series E Securities Purchase
Agreement). The aggregate proceeds to the Company from the Series E Financing was $27.4 million.

Obligation to Register Shares

Pursuant to the Amended and Restated Securities Purchase Agreement, we agreed to register the shares of common stock issuable upon
conversion of the Series E Preferred Stock and upon exercise of the Series E Warrants (collectively, the Issued Shares) for resale by the Series E Investors under the Securities Act. The Company also agreed to file with the SEC a
registration statement with respect to the Issued Shares no later than 210 days after the effective time of the Merger, and to use our best efforts to cause the registration statement to become effective as promptly as reasonably practicable after
(1) being informed by the SEC that the SEC has decided not to review the registration statement or (2) being informed by the SEC that the SEC has no further comments on such Registration Statement.

Other Company Obligations

The Companys
negative covenants relate to obligations not to, without the prior consent of M/C Venture Partners, provided M/C Venture Partners holds 50% of the shares of Series E Preferred Stock purchased in the Series E Financing, (1) enter into
a transaction involving a change in control of the Company; (2) incur indebtedness in excess of $3.0 million, subject to specified exceptions; (3) create any security with an equity component unless that security is junior to the
common stock; (4) issue any equity securities; (5) transfer its intellectual property; (6) repurchase, redeem or pay dividends on any shares of capital stock (subject to limited exceptions); (7) grant stock options that are not
authorized by a vote of the Board of Directors or its Compensation Committee; (8) liquidate or dissolve; (9) change the size of the Companys Board of Directors; (10) amend the Companys certificate of incorporation or
bylaws; (11) change the nature of the Companys business; (12) alter the voting rights of shares of the Companys capital stock in a disparate manner; (13) take any action which would cause an adjustment to the exercise
price or number of shares to be delivered under the Section 8 of the Series E Warrants; or (14) amend the Credit Agreement or the warrant issued in connection with the Credit Agreement, or take any action that would cause any increase in
the number of shares for which such warrants would be exchanged.

Material Terms

The material terms of the Companys Series E Preferred Stock are summarized below.



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Voting. The holders of Series E Preferred Stock are entitled to vote on any matter presented at
any meeting of the stockholders of the Company. Each holder of Series E Preferred Stock is entitled to cast a number votes equal to the number of whole shares of common stock into which the shares of Series E Preferred Stock are convertible as of
the record date for determining stockholders entitled to vote on such matter. Currently, the issued and outstanding shares of Series E Preferred Stock would convert into an aggregate of 51,698,113 shares of common stock, which represents
approximately 31.8% of the total voting power of the Company on a fully diluted basis.

Dividends. From the date of issuance, the
Series E Preferred Stock accrues dividends at a rate of $100.00 per year and compounds annually. Dividends on the Series E Preferred Stock may be declared and paid from time to time as determined by the Companys board of directors. The Company
cannot declare, pay or set aside any dividends or distributions on any other shares of capital stock of the Company unless the holders of Series E Preferred Stock first receive or simultaneously receive a dividend or distribution on each outstanding
share of Series E Preferred Stock in such amounts as set forth in the Certificate of Powers, Designation, Preferences and Rights of the Series E Preferred Stock (the Certificate of Designations).

Liquidation. Upon liquidation, dissolution or winding up, the holders of Series E Preferred Stock are entitled, before any distributions are made
to the holders of the common stock, or any other class or series of capital stock of the Company ranking junior to the Series E Preferred Stock as to such distributions, to be paid an amount equal to $1,000 per share (the Original Issue
Price) and any unpaid dividends thereon, subject to adjustment. For purposes of this liquidation preference, unless waived in writing by any single holder of at least thirty percent (30%) of the outstanding Series E Preferred Stock and/or
Series D Preferred Stock (as adjusted) then outstanding, a consolidation or merger of the Company into or with another entity or the sale of all or substantially all of the Companys assets, in each case under circumstances in which the holders
of a majority in voting power of the outstanding capital stock of the Company, immediately prior to such transaction, owned less than a majority in voting power of the outstanding capital stock of the Company or its successor, would be treated as a
liquidation, dissolution or winding up of the Company.

Conversion. The holders of the Series E Preferred Stock have the right, at
any time and at their option, to convert each share of Series E Preferred Stock into a number of shares of the Companys common stock determined by dividing the Original Issue Price (as adjusted) by the then-applicable per share conversion
price of the Series E Preferred Stock. The conversion price is subject to adjustment in the case of any stock dividend, stock split, combination, capital reorganization, reclassification, merger or consolidation by the Company. With limited
exceptions, the conversion price is also subject to adjustment in the case of an issuance of shares of the Companys common stock, or securities exercisable for or convertible into the Companys common stock, at a per share price less than
the conversion price then in effect. In the event that this occurs, the conversion price would be reduced to equal the per share price of the newly issued securities. Initially, the conversion price of the Series E Preferred Stock is $0.53 per
share. Currently, the Series E Preferred Stock would convert into 51,698,113 shares of common stock.

Anti-dilution Adjustments. In
the event the Company issues additional shares of common stock (which includes certain options and convertible securities issued by the Company), except in limited circumstances, for no consideration or for consideration per share that is less than
the conversion price of the Series E Preferred Stock then in effect, the conversion price of the Series E Preferred Stock will be reduced to equal the per share price of the newly issued securities.

Redemption. Starting three years from the date the Series E Certificate of Designations was filed, the Series E Preferred Stock may be redeemed in
three equal annual installments commencing 30 days after any single holder of at least thirty percent (30%) of the issued and outstanding shares of Series E Preferred Stock consents to such redemption. The Series E Preferred Stock may be
redeemed at a price equal to the Original Issue Price, plus all declared but unpaid dividends. If the Company fails to redeem the Series E Preferred Stock in accordance with the Certificate of Designations, then interest will accrue on any unpaid
amount at a rate of 1% per each 30-day period that such amounts remain unpaid.

Special Redemption. Upon notice of certain
events triggering a mandatory conversion under the Series E Certificate of Designations, a holder of Series E Preferred Stock may instead elect to have the Company redeem its shares of Series E Preferred Stock (the Special Redemption).
Any such shares will be redeemed at a price equal to the Original Issue Price, plus all declared and unpaid dividends (the Special Redemption Price). If the Company fails to redeem the shares of Series E Preferred Stock pursuant to the
Special Redemption, the holders of such shares will sell such shares to any persons that the Company designates and will sell such shares at the Special Redemption Price.

Series E Warrants

In addition to the shares of Series E Preferred Stock, the Company issued warrants
to purchase an aggregate of up to 25,849,059 shares of common stock at a per share exercise price of $0.58. The Series E Warrants have a term of exercise expiring on December 1, 2016. The number of shares issuable upon exercise and the per
share exercise price of the Series E Warrants is subject to adjustment in the case of any stock dividend, stock split, combination, capital reorganization, reclassification or merger or consolidation. Subject to limited exceptions, the number of
shares of common stock for which the warrant is exercisable is also subject to adjustment in the case of an issuance of shares of common stock or securities exercisable for or convertible into common stock, at a per share price less than the per
share conversion price of the Series E Preferred Stock then in effect. In the event of such an issuance, the number of shares of common stock for which the warrant is exercisable is increased in accordance with the formula set forth in the



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warrant. The conversion price, as defined in the warrant, is also reduced to equal the purchase price of the new issuance of common stock (or securities
convertible into common stock). The Series E Warrants are exercisable at any time prior to their expiration date by delivering the warrant certificates to the Company, together with a completed election to purchase and the full payment of the
exercise price or by means of a "net exercise" clause under which the Company does not receive any cash, but rather, the number of shares issued upon exercise is net of the number of shares withheld by the Company in lieu of payment of the exercise
price. This net exercise right is generally limited to times when the Company is not in compliance with its obligations relating to the registration of the shares of common stock underlying the Series E Warrants for resale under the Company's
registration rights agreement with respect to those shares.

The Company allocated the proceeds between the stock and the warrants based
upon their relative fair values as of the closing date, resulting in $11.8 million being allocated to the warrants. We determined the fair value of the warrants using the Black-Scholes option pricing model with the following assumptions: no dividend
yield; weighted average risk free rate of 4.43%; volatility of 111% and a contractual life of 10 years. The Company determined that the warrants meet the definition of a derivative instrument as defined in SFAS 133, Accounting for Derivative
Instruments and Hedging Activities, but do not require derivative treatment pursuant to the scope exception in paragraph 11(a) of SFAS 133. We recorded the proceeds attributable to the warrants in permanent equity pursuant to guidance in EITF
00-19, Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Companys Own Stock.

The
Company evaluated whether the embedded conversion feature in the stock required bifurcation and determined that the economic characteristics and risks of the embedded conversion feature in the stock were clearly and closely related to the stock and
concluded that bifurcation was not required under SFAS 133. We calculated the intrinsic value of the beneficial conversion feature embedded in the stock pursuant to the guidance in EITF 00-27, Application of Issue No. 98-5 to Certain
Convertible Instruments. The beneficial conversion value, as calculated, exceeds the amount of the proceeds allocated to the stock, thus is capped at $15.6 million allocated to the Series E Preferred Stock, which is recognized as an additional
discount on the stock. The Company determined that the portion of the proceeds attributable to the stock should be recorded as mezzanine equity pursuant to EITF Topic D-98, Classification and Measurement of Redeemable Securitiesafter
determining the guidance in FAS 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equitydid not apply. However, since the total discount on the stock resulting from the allocation of proceeds to
the warrants and recording of the beneficial conversion feature equals the face value of the Series E Preferred Stock, no initial value has been recognized in mezzanine equity for the Series E preferred stock. The total discount on the stock
resulting from the allocation of proceeds to the warrants and recording of the beneficial conversion feature and the cash dividends will be accreted over the period through the earliest possible redemption date using the effective interest method.
Accretion of the discount and dividends for the fiscal years ended June 30, 2007, 2008, 2009 and 2010 will be approximately $0, $7,000, $2.1 million and $33.5 million, respectively.

We will reevaluate the classification of the stock and warrants in each period to determine if reclassification is necessary. Our obligation to the
Series E Preferred Stockholders, should they choose to redeem the stock at or after the redemption date is $27.4 million plus accrued but unpaid dividends.

A material relationship exists between certain of the Series E investors and the Company. Specifically, each of M/C Venture Partners V, L.P. and its affiliates, Special Situations Fund III, L.P. and its affiliates ,
Pathfinder Ventures IV, L.L.C. and its affiliates and William Y. Tauscher, the Companys Chief Executive Officer, President and Chairman of the Board, own shares of the Companys common stock. LG-Nortel Co., Ltd. is the primary supplier of
the products sold in the Vodavi business. Additionally, Peter Bailey, through West Laurelhurst LLC, and Scott Pickett are Series E Investors and executive officers of the Company. Mr. Bailey is a Senior Vice President of the Company and
Mr. Pickett is the Companys Chief Technology Officer.

(9) EQUITY

On September 28, 2004 and October 1, 2004, we sold a total of 24,159,468 shares of our common stock at a per share purchase price of $1.1386 to
several investors (the 2004 Investors), including M/C Venture Partners, under the terms of the 2004 Stock Purchase Agreement. In connection with, or prior to the financing, the holders of all shares of our Series B and Series C Preferred
Stock converted those shares into Common Stock.

On September 28, 2005 we sold a total of 11,329,785 shares of common stock at a per
share purchase price of $1.1386, under the terms of the 2005 Stock Purchase Agreement.

As a result of these and previous financings, we
entered into arrangements with certain parties to register shares of our common stock pursuant to the following agreements:



| |  |  | Registration Rights Agreement, dated August 8, 2001 (the 2001 Agreement) related to the Series B Preferred Stock financing;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------



| |  |  | Registration Rights Agreement, dated September 27, 2002 (the 2002 Agreement);
| | - |  | -------------------------------------------------------------------------------



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| |  |  | Registration Rights Agreement, dated June 27, 2003, (the 2003 Agreement, together with the 2001 Agreement and the 2002 Agreement, the Prior
Agreements) related to the Series C Preferred Stock financing;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | the 2004 Stock Purchase Agreement; and
| | - |  | --------------------------------------



| |  |  | the 2005 Stock Purchase Agreement.
| | - |  | ----------------------------------

The 2004 Investors and certain parties to the Prior Agreements (the Prior Investors) holding enough voting power to amend the 2004 Stock Purchase Agreement and the Prior Agreements, executed a consent, waiver, and release
agreement, dated September 28, 2005, pursuant to which the 2004 Investors and the Prior Investors consented to the execution of the 2005 Stock Purchase Agreement (the 2005 Stock Purchase Agreement) and executed agreements to amend
the 2004 Stock Purchase Agreement and the Prior Agreements (collectively, the Amendments). The Amendments effected, among other things, the following:

With respect to the 2004 Stock Purchase Agreement (i) tolled the liquidated damages accrued or accruing under the 2004 Stock Purchase Agreement through September 28, 2005 by reason of our failure to file and
have declared effective by the SEC a registration statement covering the resale of the shares of our common stock purchased pursuant to the 2004 Stock Purchase Agreement and (ii) changed the time frame in which we are obligated to register the
shares issued in the 2004 Agreements to match the time frame for registering shares under the 2005 Stock Purchase Agreement and (iii) agreed to issue new warrants to the 2004 investors in lieu of payment of the Liquidated Damages.

With respect to the Prior Agreements, amended the registration rights provisions of the Prior Agreements including, among other things,
(i) releasing us from any liability and waiving in full, the application of the Prior Agreements with respect to the payment of liquidated damages and permanently, irrevocably and unconditionally waived in full, any right to the payment of the
liquidated damages, whether accrued or accruing, under the Prior Agreements, and (ii) changing the time frame in which we are obligated to register the shares issued in the Prior Agreements to match the time frame for registering shares under
the 2005 Stock Purchase Agreement.

The Company is currently liable for liquidated damages to the 2005 Investors and the 2004 Investors
because the registration statement was not declared effective on or before March 12, 2006 (such an event, an Effectiveness Default). As a result of the Effectiveness Default, the Company must pay as liquidated damages to the 2005
Investors and the 2004 Investors, for each 30-day period of a default, an amount in cash equal to 1% of the aggregate purchase price paid by the Investors; provided that in no event will the aggregate amount of cash to be paid as liquidated damages
exceed 9% of the aggregate purchase price paid by each Investor. As of March 31, 2007, the Company has accrued $2.2 million in liquidated damages as a result of the Effectiveness Default.

(10) COMPUTATION OF NET LOSS PER SHARE

Net loss per
basic and diluted share are based upon the weighted average number of common shares outstanding. Common equivalent shares, consisting of outstanding stock options, convertible preferred shares and warrants to purchase common stock are included in
the diluted per share calculations where the effect of their inclusion would be dilutive. Common stock equivalents have been excluded for all periods presented as they are antidilutive. For the periods ended March 31, 2007 and 2006, total
common stock equivalents excluded are 109.1 million and 10.6 million, respectively.

(11) GUARANTEES

We are subject to lawsuits and other claims arising in the ordinary course of our operations. In the opinion of management, based on consultation with
legal counsel, the effect of such matters will not have a material adverse effect on our financial position or results of operations.

We
enter into standard indemnification agreements in our ordinary course of business. Pursuant to these agreements, we indemnify, hold harmless, and agree to reimburse the indemnified party for losses suffered or incurred by the indemnified party,
generally our business partners or customers, in connection with any patent or any copyright or other intellectual property infringement claim by any third party with respect to our products.

The term of these indemnification agreements is generally perpetual. The maximum potential amount of future payments we could be required to make under
these indemnification agreements is unlimited. We have never incurred costs to defend lawsuits or settle claims related to these indemnification agreements. Accordingly, we have no liabilities recorded for these agreements.

We warrant that our software products will perform in all material respects in accordance with our standard published specifications in effect at the
time of delivery of the licensed products to the customer for 90 days. We warrant that our maintenance services will be performed consistent with generally accepted industry standards through completion of the agreed upon services. Additionally, we
warrant that our hardware products will perform in all material respects in accordance with our standard published



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specifications in effect at the time of delivery of the products to the customer for the specified periods as per our warranty policies and agreement. We
provide for the estimated cost of hardware product warranties based on specific warranty claims and claim history. If necessary, we would provide for the estimated cost of the software and services warranties based on specific warranty claims and
claim history, however, we have never incurred any significant expenses under our product or service warranties.



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FORWARD-LOOKING STATEMENTS

This Quarterly Report on Form 10-Q, including, without limitation, the section entitled Managements Discussion and Analysis of Financial Condition and Results of Operations, contains forward-looking
statements. These statements relate to future events or to our future financial performance, and involve known and unknown risks, uncertainties and other factors that may cause our actual results, levels of activity, performance, or achievements to
be materially different from any future results, levels of activity, performance or achievements expressed or implied by these forward-looking statements. In some cases, you can identify forward-looking statements by the use of words such as
expect, intend, may, would, could, plan, seek, potential, continue, or the negative of these terms or other comparable terminology. You
should not place undue reliance on forward-looking statements since they involve known and unknown risks, uncertainties and other factors which are, in some cases, beyond our control and which could materially affect actual results, levels of
activity, performance or achievements. Factors that may cause actual results to differ materially from current expectations, which we describe in more detail elsewhere in this Quarterly Report on Form 10-Q under the heading Item 1-A Risk
Factors, include, but are not limited to:



| |  |  | failure to increase the sales of our products;
| | - |  | ----------------------------------------------



| |  |  | continued inability to achieve profitability;
| | - |  | ---------------------------------------------



| |  |  | the loss of any of our key customers;
| | - |  | -------------------------------------



| |  |  | failure to successfully integrate the operations of Vodavi into our business;
| | - |  | -----------------------------------------------------------------------------



| |  |  | the introduction of competitive products, including other software- or server-based phone systems;
| | - |  | --------------------------------------------------------------------------------------------------



| |  |  | slower than expected development of the software- or server-based phone system market or any event that causes software- or server-based phone systems to be less
attractive to customers;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | deteriorating financial performance;
| | - |  | ------------------------------------



| |  |  | failure to protect our intellectual property;
| | - |  | ---------------------------------------------



| |  |  | failure to achieve the anticipated benefits from our acquisitions of Vodavi, Comdial and Vertical Networks, including, without limitation, failing to obtain the
desired benefits for the Companys dealers and customers;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | failure to retain our rights to certain patents that we acquired through a license agreement resulting from the Vertical Networks Acquisition;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | the assumptions about the future performance of the Vodavi operations may prove to be incorrect;
| | - |  | ------------------------------------------------------------------------------------------------



| |  |  | the inability to achieve the desired synergies and economies of scale after the acquisition of Vodavi;
| | - |  | ------------------------------------------------------------------------------------------------------



| |  |  | the inability to become a significant player within the IP-PBX telephony market.
| | - |  | --------------------------------------------------------------------------------

If one or more of these or other risks or uncertainties materialize, or if our underlying assumptions prove to be incorrect, actual results may vary
significantly from what we projected. Any forward-looking statement you read in this Quarterly Report on Form 10-Q reflects our current views with respect to future events and is subject to these and other risks, uncertainties and assumptions
relating to our operations, results of operations, growth strategy and liquidity. We assume no obligation to publicly update or revise these forward-looking statements for any reason, or to update the reasons actual results could differ materially
from those anticipated in these forward-looking statements, even if new information becomes available in the future.



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Item 2MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

You should read the
following discussion together with the consolidated financial statements and related notes appearing elsewhere in this quarterly report on Form 10-Q. This item contains forward-looking statements within the meaning of Section 27A of the
Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934 that involve risks and uncertainties. Actual results may differ materially from those included in such forward-looking statements. Factors which could cause actual
results to differ materially include those set forth under "Risk Factors" as well as those otherwise discussed in this section and elsewhere in this quarterly report on Form 10-Q. See "Forward-Looking Statements".

Our discussion and analysis of our financial condition and results of operations are based upon our unaudited condensed consolidated financial
statements, which have been prepared in accordance with accounting principles generally accepted in the United States and the rules and regulations of the SEC. The preparation of these financial statements requires us to make estimates and judgments
that affect the reported amount of assets and liabilities at the date of the financial statements and revenues and expenses during the reporting period. Areas where significant judgments are made include, but are not limited to revenue recognition
and values attributed to the assets and liabilities acquired pertaining to the acquisition of Vodavi. The estimated values of current assets and liabilities and property and equipment were based upon their historical costs in the hands of the seller
on the date of acquisition due to their short-term nature. This amount may be adjusted subsequently when we complete our assessment of the property and equipment that will be utilized in the combined operations and those that will be disposed.

Actual results could differ materially from any one or all of these estimates discussed above. For a more detailed explanation of the
judgments made in these areas, please refer to our annual report on Form 10-K for the year ended June 30, 2006, as filed with the SEC on October 16, 2006.

Critical Accounting Policies

Revenue Recognition

The Company recognizes revenue for the sale of its InstantOffice and TeleVantage products pursuant to Statement of Position (SOP) 97-2, Software
Revenue Recognition, and SOP 98-9, Software Revenue Recognition With Respect to Certain Transactions. For revenue generated by the sale of Comdial and Vodavi products, where the Company has determined that the software is incidental, the
Company follows Staff Accounting Bulletin (SAB) 104, Revenue Recognition. Generally, the Company recognizes revenue when it is realized or realizable and earned. The Company considers revenue realized or realizable and earned when persuasive
evidence of an arrangement exists, the product has been shipped or the services have been provided to the customer, the sales price is fixed or determinable and collectability is reasonably assured. The Company reduces revenue for estimated customer
returns, rotations and sales rebates when such amounts are estimable. When not estimable, the Company defers revenue until the product is sold to the end customer or the customers rights expire. As part of its product sales price, the Company
provides telephone support, which is generally utilized by the customer shortly after the sale. The cost of the phone support is not significant but is accrued in the financial statement. In addition to the aforementioned general policy, the
following are the specific revenue recognition policies for each major category of revenue.

The Company defers revenue on shipments to
Toshiba until the product is resold by Toshiba to its customers. The deferral of revenue is due to the Companys inability to reasonably estimate potential future stock rotations resulting from future product releases and their effect on future
revenue as Toshiba purchases the TeleVantage software and license keys in bulk amounts and maintains an inventory for future sales to customers. For all other TeleVantage license sales, assuming that all other revenue recognition criteria have been
met, revenue is recognized at the time of delivery of the software to the customer.

Revenue from delivered elements of one-time charge
licensed software is recognized at the inception of the license term using the residual method, provided we have vendor-specific objective evidence (VSOE) of the fair value of each undelivered element. Revenue is deferred for the fair
value of the undelivered elements based upon the price of these elements when sold separately. Revenue is also deferred for the entire arrangement if VSOE does not exist for each undelivered contract element. Examples of undelivered elements in
which the timing of delivery is uncertain include contractual elements that give customers rights to any future upgrades at no additional charge or future maintenance that is provided within the overall price. The revenue that is deferred for any
contract element is recognized when all of the revenue recognition criteria have been met for that element. Revenue for annual software subscriptions is recognized ratably over the length of the software subscription. Certain contracts for the sale
of telephone systems acquired with Vertical Networks in September 2004 were determined to be bundled with software subscriptions with lengths of up to five years from the date of acquisition. The revenue and cost of sales of the systems under these
contracts have been deferred and will be amortized ratably over the length of the associated software subscription, as the Company does not have VSOE for these subscription agreements.



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Due to the lengthy period of time over which we amortize the revenue and cost of goods sold related to
these systems, the revenue and cost of goods sold we report in any one period excludes certain of the revenue and cost of goods sold relating to shipments in that period and includes revenue and costs of goods sold relating to shipments made in
prior periods. As a result, our reported revenue and costs of goods sold may not necessarily be indicative of our ability to generate customer orders in a particular period. The difference between reported revenue and costs of goods sold and
customer orders in any period could be either positive or negative, and cannot be reliably predicted from period to period. The following tables demonstrate this effect by showing the amount of revenue, cost of goods sold and gross profit from
systems shipped during the three months ended March 31, 2007 and 2006 that was deferred at each quarter end (in thousands).



|               |  |                  |       |                            |   |                      |  |   |      
|-------------- |  | ---------------- | ----- | -------------------------- | - | -------------------- |  | - | -----
|               |  | Deferred Revenue |       | Deferred Cost ofGoods Sold |   | Deferred GrossProfit
|March 31, 2007 |  | $                | 56    |                            | $ | 29                   |  | $ | 27   
|March 31, 2006 |  |                  | 2,522 |                            |   | 1,355                |  |   | 1,167

The following table details the amount of revenue, cost of goods sold and gross profit from
systems shipped during prior reporting periods that was recognized at each quarter end for the three month period ended March 31, 2007 and 2006 (in thousands).



|               |  |                                               |       |                                                         |   |                                                   |  |   |      
|-------------- |  | --------------------------------------------- | ----- | ------------------------------------------------------- | - | ------------------------------------------------- |  | - | -----
|               |  | Recognition ofRevenue Deferredin Prior Period |       | Recognition of Costof Goods SoldDeferred in PriorPeriod |   | Recognition ofGross ProfitDeferred in PriorPeriod
|March 31, 2007 |  | $                                             | 2,222 |                                                         | $ | 1,215                                             |  | $ | 1,007
|March 31, 2006 |  |                                               | 1,310 |                                                         |   | 735                                               |  |   | 575  

The following tables show the amount of revenue, cost of goods sold and gross profit from systems
shipped during the nine months ended March 31, 2007 and 2006 that was deferred at each quarter end (in thousands).



|               |  |                  |       |                            |   |                      |  |   |      
|-------------- |  | ---------------- | ----- | -------------------------- | - | -------------------- |  | - | -----
|               |  | Deferred Revenue |       | Deferred Cost ofGoods Sold |   | Deferred GrossProfit
|March 31, 2007 |  | $                | 2,406 |                            | $ | 1,106                |  | $ | 1,300
|March 31, 2006 |  |                  | 3,306 |                            |   | 1,702                |  |   | 1,604

The following table details the amount of revenue, cost of goods sold and gross profit from
systems shipped during prior reporting periods that was recognized for the nine month periods ended March 31, 2007 and 2006 (in thousands).



|               |  |                                               |       |                                                         |   |                                                   |  |   |      
|-------------- |  | --------------------------------------------- | ----- | ------------------------------------------------------- | - | ------------------------------------------------- |  | - | -----
|               |  | Recognition ofRevenue Deferredin Prior Period |       | Recognition of Costof Goods SoldDeferred in PriorPeriod |   | Recognition ofGross ProfitDeferred in PriorPeriod
|March 31, 2007 |  | $                                             | 6,388 |                                                         | $ | 3,500                                             |  | $ | 2,888
|March 31, 2006 |  |                                               | 3,803 |                                                         |   | 2,189                                             |  |   | 1,614



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As a result of the significant revenue and cost of goods sold deferral related to current period
shipments of systems, the revenue and cost of goods sold reflected in our Condensed Consolidated Financial Statements may not be indicative of our ability to generate sales of our product into the marketplace in the current period. Likewise,
recognition in the current or a future period of revenue and cost of goods sold related to shipments of systems that occurred in prior years may cause the impression that we are generating a higher volume of sales of our telephone systems into the
market in that period than is the case.

Revenue from time and material service contracts is recognized as the services are provided.
Revenue from fixed price, long-term service or development contracts is recognized over the contract term, using a proportional performance method, based on the percentage of services that are provided during the period compared with the total
estimated services to be provided over the entire contract. Losses on fixed price contracts are recognized during the period in which the loss first becomes apparent.

Warranty

In many cases, we provide a one-year limited warranty to our customers, including repair or
replacement of defective equipment. For certain product lines and customers, we offer longer warranty periods or extended warranties. Our contract manufacturing partners are responsible for the first year of the warranty repair work. We provide for
the estimated cost of product warranties at the time the revenue is recognized. We calculate our warranty liability based on historical product return rates and estimated average repair costs. While we engage in various product quality programs and
processes, our warranty obligation may be affected by product failure rates and the ability of our contract manufacturers to satisfy warranty claims. The outcome of these items could differ from our estimates and revisions to the warranty estimates
could be required.

Accounts Receivable

We provide allowances for doubtful accounts for estimated losses from the inability of our customers to satisfy their accounts as originally contemplated at the time of sale. We calculate these allowances based on the detailed review of
certain individual customer accounts, historical collection rates and our estimation of the overall economic conditions affecting our customer base. If the financial condition of our customers were to deteriorate, resulting in an impairment of their
ability to make payments, additional allowances may be required.

We also provide reserves for returns and sales incentives to reduce
revenue and accounts receivable for product returns and other credits we may grant to customers. Such reserves are recorded at the time of sale and are calculated based on the historical information (such as rates of product returns) and the
specific terms of sales programs, taking into account any other known information about likely customer behavior. If actual customer behavior differs from our expectations, additional reserves may be required. Also, if we determine that we can no
longer accurately estimate amounts for returns and sales incentives, we would not be able recognize revenue until the customers exercise their rights, or such rights lapse, whichever is later.

Inventory

We measure our inventories at lower of
cost or market. For those items that are manufactured by our contract manufacturers, cost is determined using standards that we believe approximate the first-in, first-out (FIFO) method. We also provide allowances for excess and obsolete
inventory equal to the difference between the cost of our inventory and the estimated market value based upon assumptions about product life cycles, product demand and market conditions. If actual product life cycles, product demand or market
conditions are less favorable than those projected by management, additional inventory allowances or write-downs may be required.

Long-lived Assets,
including Goodwill and Other Intangibles

Statement of Financial Accounting Standards (SFAS) No. 144, Accounting
for the Impairment or Disposal of Long-Lived Assets (SFAS No. 144) establishes a single accounting model for long-lived assets to be disposed of by sale. For long-lived assets that are held for use, when circumstances suggest
that there may be an impairment, we compare the forecasted undiscounted net cash flows to the carrying amount. If the long-lived asset is determined to be unable to recover the carrying amount, then it is written down to fair value. A considerable
amount of judgment is required in calculating this impairment charge, principally in determining financial forecasts. Unanticipated changes in market conditions could have a material impact on our projected cash flows. Differences in actual cash
flows as compared to the projected cash flows could require us to record an impairment.

SFAS No. 142, Goodwill and Other
Intangible Assets includes requirements to test goodwill and indefinite lived intangible assets for impairment rather than amortize them. Goodwill and other indefinite lived intangible assets must be tested for impairment on at least an annual
basis. Our goodwill resulting from our acquisitions of Vertical Networks, Comdial and Vodavi will be tested



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annually. Although the goodwill was deemed to not be impaired when it was tested in 2006, there can be no assurances that subsequent reviews will not result
in material impairment charges. A considerable amount of judgment is required in calculating this impairment analysis, principally in determining discount rates, financial forecasts and allocation methodology. Unanticipated changes in market
conditions could have a material impact on our projected cash flows. Differences in actual cash flows as compared to the projected discounted cash flows could require us to record an impairment loss.

Summary

The following is a summary of the areas that
management believes are important in understanding the results of the fiscal quarter and nine months ended March 31, 2007. This summary is not a substitute for the detail provided in the following pages or for the condensed consolidated
financial statements and notes that appear elsewhere in this document.

Revenues

We derive revenues primarily from sales of our hardware and software products. The timing and amount of our net revenues has been, and is expected to
continue to be, influenced by a number of factors, including the following:



| |  |  | Product design, including our hardware, software and our bundled hardware and services where applicable;
| | - |  | --------------------------------------------------------------------------------------------------------



| |  |  | The demand for our current products;
| | - |  | ------------------------------------



| |  |  | Requirements of generally accepted accounting principles for deferral of certain product sales when combined with long-term maintenance services;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Acquisitions made by us, such as the acquisitions of the assets of Vertical Networks, Comdial and Vodavi;
| | - |  | ---------------------------------------------------------------------------------------------------------



| |  |  | The length of our sales cycle; and
| | - |  | ----------------------------------



| |  |  | Budgeting cycles of our customers.
| | - |  | ----------------------------------

Cost of Sales

Cost of sales is generally comprised of materials, manufacturing, shipping and repair of our products. Prior to the acquisitions of
Vertical Networks, Comdial and Vodavi, cost of sales consisted primarily of materials for a limited amount of shrink wrap product including software CDs and manuals and also small amounts of amortization of purchased technology. As a result of the
acquisition of Vertical Networks, Comdial and Vodavi, cost of sales increased substantially due to the hardware costs associated with sales of the InstantOffice, Comdial and Vodavi product lines and due to additional amortization of technology-based
intangible assets associated with the acquisitions. Cost of sales also includes royalties paid to third parties.

Operating Expenses

Our operating expenses are comprised of:



| |  |  | Sales and marketing costs, which consist primarily of salaries and employee benefits for sales and marketing employees, travel, advertising, tradeshows and various
other marketing programs;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Product development costs, which consist primarily of salaries and employee benefits for engineering and technical personnel and third party consulting services;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | General and administrative expenses, which generally represent salaries and employee benefits for executive, administrative, operations, finance, human resource and
IT personnel, as well as professional fees, insurance costs, consulting fees and administrative expenses;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Stock-based, non-cash compensation expense;
| | - |  | -------------------------------------------



| |  |  | Amortization of intangible assets acquired from Vertical Networks, Comdial and Vodavi; and
| | - |  | ------------------------------------------------------------------------------------------



| |  |  | Depreciation.
| | - |  | -------------



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Results of Operations

Net Revenue

Net revenue was $22.7 million and $56.6 million for the three and nine months ended March 31, 2007,
respectively, representing an increase of 58% and 39%, from $14.4 million and $40.6 million for the same fiscal periods from prior year. The increase in net revenue is primarily attributable to the acquisition of Vodavi, which was completed on
December 1, 2006 and the acquisition of Comdial, which was completed on September 28, 2005.

We distribute our products both
domestically and internationally. International product revenue was $0.5 million, or 2% of total revenue, for the three months ended March 31, 2007 and $0.5 million, or 3% of total revenue, for the three months ended March 31,
2006. International product revenue for the nine months ended March 31, 2007 was $1.5 million, or 3% of total revenue, and $0.9 million, or 2% of total revenue, for the nine months ended March 31, 2006.

Gross Profit(in thousands, except percentages)



|                 |  |                    |        |   |                |   |                   |        |  |                |  |   |                |   |  |        |        |   |  |      
|---------------- |  | ------------------ | ------ | - | -------------- | - | ----------------- | ------ |  | -------------- |  | - | -------------- | - |  | ------ | ------ | - |  | -----
|                 |  | Three Months Ended |        |   |                |   | Nine Months Ended |        |  |               
|                 |  | March 31, 2007     |        |   | March 31, 2006 |   |                   | Change |  | March 31, 2007 |  |   | March 31, 2006 |   |  | Change
|Gross Profit     |  | $                  | 10,458 |   |                | $ | 7,809             |        |  | 2,649          |  | $ | 27,231         |   |  | $      | 21,915 |   |  | 5,316
|% of Net Revenue |  |                    | 46     | % |                |   | 54                | %      |  |                |  |   | 48             | % |  |        | 54     | % |  |      

Gross profit as a percentage of revenue declined in the quarter ended March 31, 2007 as compared with the
same quarter of 2006, primarily as a result of the sales and associated cost of sales of the Vodavi products which sales have a lower margin compared to other of our product lines. The decrease in gross profit as a percentage of net revenue for the
nine months ended March 31, 2007, compared to the corresponding period ended March 31, 2006, was due primarily to the addition of revenue and associated cost of sales from the acquisitions of Vodavi and Comdial, which sales have a lower
margin compared to other of our product lines.

Operating Expenses(in thousands, except percentages)



|                                                                 |  |                    |        |   |                |   |        |                   |  |    |                |  |   |                |   |  |        |        |   |  |    |   
|---------------------------------------------------------------- |  | ------------------ | ------ | - | -------------- | - | ------ | ----------------- |  | -- | -------------- |  | - | -------------- | - |  | ------ | ------ | - |  | -- | --
|                                                                 |  | Three Months Ended |        |   |                |   |        | Nine Months Ended |  |    |                | 
|                                                                 |  | March 31, 2007     |        |   | March 31, 2006 |   |        | Change            |  |    | March 31, 2007 |  |   | March 31, 2006 |   |  | Change |       
|Sales and Marketing                                              |  | $                  | 4,677  |   |                | $ | 4,193  |                   |  | 12 | %              |  | $ | 11,952         |   |  | $      | 12,845 |   |  | (7 | )%
|% of Net Revenue                                                 |  |                    | 21     | % |                |   | 29     | %                 |  |    |                |  |   | 21             | % |  |        | 32     | % |  |    |   
|Product Development                                              |  | $                  | 3,573  |   |                | $ | 2,889  |                   |  | 24 | %              |  | $ | 9,706          |   |  | $      | 8,812  |   |  | 10 | % 
|% of Net Revenue                                                 |  |                    | 16     | % |                |   | 20     | %                 |  |    |                |  |   | 17             | % |  |        | 22     | % |  |    |   
|General and Administrative                                       |  | $                  | 3,945  |   |                | $ | 4,105  |                   |  | (4 | )%             |  | $ | 11,972         |   |  | $      | 11,362 |   |  | 5  | % 
|% of Net Revenue                                                 |  |                    | 17     | % |                |   | 29     | %                 |  |    |                |  |   | 21             | % |  |        | 28     | % |  |    |   
|Total Operating Expenses (including Amortization of intangibles) |  | $                  | 12,814 |   |                | $ | 11,495 |                   |  | 11 | %              |  | $ | 34,920         |   |  | $      | 33,808 |   |  | 3  | % 
|% of Net Revenue                                                 |  |                    | 56     | % |                |   | 80     | %                 |  |    |                |  |   | 62             | % |  |        | 83     | % |  |    |   

Sales and Marketing

For the three months ended March 31, 2007, sales and marketing expenses increased by $0.5 million, while their costs as a percentage of revenue decreased from 29% to 21% compared with the corresponding period in
2006. The increase in sales and marketing expenses in aggregate dollars is primarily a result of the acquisition of Vodavi operations and to the expenses related to introducing Verticals new and existing products to our customers. For the nine
months ended March 31, 2007, sales and marketing expenses decreased by $0.9 million, and their costs as a percentage of revenue decreased from 32% to 21% compared with the corresponding period in 2006. The decrease in sales and marketing
expenses in aggregate dollars for the nine months ended March 31, 2007 compared to the corresponding period ended March 31, 2006 was due primarily to decreased payroll and related expenses as a result of cost reductions in fiscal 2006 from
consolidation efforts related to the Comdial acquisition offset by the increase in sales support as a result of the Vodavi acquisition. The Company employed 120 sales and marketing personnel throughout the quarter ended March 31, 2007.



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Product Development

For the three months ended March 31, 2007, product development expenses increased by $0.7 million, whereas such costs as a percentage of revenue decreased from 20% to 16% compared with the corresponding period in
2006. For the nine months ended March 31, 2007, product development expense increased by $0.9 million, whereas such costs decreased as a percentage of revenue from 22% to 17% compared with the corresponding period in 2006. The increase in
product development expenses in aggregate dollars for the three and nine months ended March 31, 2007 compared to the corresponding periods ended March 31, 2006 was due primarily to additional costs related to our next generation product
development efforts and to the acquisition of the Vodavi development personnel and expenses. The Company employed 91 product development personnel throughout the quarter ended March 31, 2007.

General and Administrative

For the three months
ended March 31, 2007, general and administrative expense decreased $0.2 million, and such costs as a percentage of revenue decreased from 29% to 17% as compared with the same period in 2006. This is primarily a result of elimination of
redundant overhead operations related to the acquisition of Comdial offset by the additional expenses related to the Vodavi acquisition. For the nine months ended March 31, 2007, general and administrative expense increased $0.6 million,
whereas such costs as a percentage of revenue decreased from 28% to 21% as compared with the same period in 2006. The increase in general and administrative expenses for the nine month period ended March 31, 2007 compared to the same period
ended March 31, 2006, was primarily driven by the additional expenses related to the Vodavi acquisition. The Company employed 67 general and administrative personnel throughout the quarter ended March 31, 2007.

General and Administrative expense also includes liquidated damages that we are accruing related to the 2004 Stock Purchase Agreement, the 2005 Stock
Purchase Agreement and the 2006 Securities Purchase Agreement. Total liquidated damages recorded for the three and nine months ended March 31, 2007 was $0 and $1.0 million, respectively. Total liquidated damages recorded for the three and nine
months ended March 31, 2006 was $0.2 million and $0.8 million, respectively.

Operating Loss

For the quarter ended March 31, 2007, our operating loss decreased $1.3 million, or 36%, to ($2.4) million on revenue of $22.7 million, from an
operating loss of ($3.7) million on revenue of $14.4 million for the quarter ended March 31, 2006. This was due to an increase in gross profit of $2.6 million offset by a $1.3 million increase in operating expense. For the nine months ended
March 31, 2007, our operating loss decreased $4.2 million, or 35%, to ($7.7) million on revenue of $56.6 million, from an operating loss of ($11.9) million on revenue of $40.6 million for the nine months ended March 31, 2006. The factors
affecting this decrease in operating loss were a $5.3 million increase in gross profit associate with higher revenue offset by a $1.1 million increase in operating expense, primarily a result of the margin and operating expenses added as a result of
the Vodavi acquisition.

Included in the operating loss are non-cash stock-based compensation expense of $1.3 million and $3.4 million in
the three and nine months ended March 31, 2007, respectively, compared with $0.9 million and $3.1 million in the three and nine months ended March 31, 2006, respectively, and depreciation and amortization expense of $1.1 million and $2.6
million in the three and nine months ended March 31, 2007, respectively, compared with $0.8 million and $2.1 million in the three and nine months ended March 31, 2006, respectively.

As mentioned above under the caption Revenue Recognition, we defer a significant portion of the revenue and cost of goods sold related to current
period shipments while recognizing revenue and cost of goods sold from shipments in prior periods. As a result, our reported revenue and cost of goods sold may not necessarily be indicative of our ability to generate sales of our products in a
particular period.

Interest Expense

Interest expense for the three and nine months ended March 31, 2007 was $1.7 million and $3.1 million, respectively, compared with $0.2 million and $0.5 million, respectively, for the three and nine months ended March 31, 2006.
The increase in interest expense relates to debt instruments incurred in order to finance the acquisitions of Comdial and Vodavi.

Income Tax Expense

While we incurred net losses in the three and nine month periods ended March 31, 2007 and 2006, we recorded a deferred tax
provision associated with the goodwill created and intangibles acquired with the Vertical Networks, Comdial and Vodavi acquisitions. The effective tax rate utilized for the provision was 40.0 %.



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Financial Condition, Liquidity And Capital Resources

Despite the overall decrease in our operating expenses as a percentage of revenue, we will be required to carefully manage our expenses to maximize our
liquidity and meet our debt service obligations. We are continuing to review our integration plans and expect to continue to reduce expenses as we reduce redundancies and streamline our operations.



|                                        |  |                |        |               |   |        |        |  |   |       
|--------------------------------------- |  | -------------- | ------ | ------------- | - | ------ | ------ |  | - | ------
|                                        |  | Positions at   |        |               |  
|                                        |  | March 31, 2007 |        | June 30, 2006 |   |        | Change
|Cash and cash equivalents               |  | $              | 14,546 |               | $ | 4,726  |        |  | $ | 9,820 
|Working capital (excl. restricted cash) |  | $              | 6,700  |               | $ | (6,823 | )      |  | $ | 13,523



|                                      |  |                                  |         |   |                                 |   |         |            |  |   |        |  
|------------------------------------- |  | -------------------------------- | ------- | - | ------------------------------- | - | ------- | ---------- |  | - | ------ | -
|                                      |  | Nine Months Ended March 31, 2007 |         |   | Nine Months EndedMarch 31, 2006 |   |         | Difference | 
|Cash used in operating activities     |  | $                                | (4,606  | ) |                                 | $ | (5,667  | )          |  | $ | 1,061  |  
|Cash used in investing activities     |  | $                                | (25,817 | ) |                                 | $ | (20,188 | )          |  | $ | (5,629 | )
|Cash provided by financing activities |  | $                                | 40,247  |   |                                 | $ | 24,798  |            |  | $ | 15,449 |  

Net cash flows used in operating activities were $4.6 million during the nine months ended
March 31, 2007. The cash used in operating activities was due primarily to a net loss of $11.2 million, offset by depreciation and amortization of $2.6 million, $3.4 million relating to non-cash stock-based compensation expense and
$1.5 million of non-cash interest expense related to the amortization of discounts on our debt and preferred stock.

Net cash flows used in
investing activities were $25.8 million during the nine months ended March 31, 2007. The cash used in investing activities primarily relates to the acquisition of Vodavi. Net cash flows provided by financing activities was $40.2 million during
the nine months ended March 31, 2007. The cash provided by financing activities reflects the debt and equity proceeds received in order to finance the acquisition of Vodavi.

Working capital, consisting of total current assets minus current liabilities, was $6.7 million at March 31, 2007. This compared to a working
capital deficit of $6.8 million at June 30, 2006, representing an increase of $13.5 million. The increase in working capital at March 31, 2007 is a result of the cash proceeds related to the financing for the acquisition of Vodavi.

We have incurred losses and negative or minimal positive cash flows from operations in every fiscal period since 1996 and have an
accumulated deficit, including non-cash equity charges, of $86.6 million as of March 31, 2007. For the three months ended March 31, 2007 we incurred a net loss of approximately $4.2 million. Our management expects that operating
losses will continue in the near future. As of June 30, 2006, our cash resources were not adequate to meet our short-term requirements through the end of the 2007 fiscal year. Therefore in October, 2006, we obtained binding, non-cancellable
commitments from certain of our investors and our chief executive officer to fund our operations, up to $5.0 million, through September, 2007. In addition we completed the debt and equity financings in conjunction with our acquisition of Vodavi (see
Notes 6 and 8 to the Condensed Consolidated Financial Statements). The Company is currently in negotiations to establish an asset based line of credit which, along with our current cash on hand, will be used to retire our short term debt and fund
our operations, as necessary. As a result, we anticipate that we will meet our forecasted cash requirements for the next twelve months. A change in circumstance, such as a reduction in the demand for our products, could necessitate that we seek
additional debt or equity capital or take actions to reduce our operating costs to levels that can be supported by our available cash. Such additional financings may not be available on terms acceptable to us, or at all, and may significantly affect
our stockholders, including for example, by substantially diluting their ownership interest.

Contractual Obligations



|                                    |  |                       |        |                 |   |           |  |           |        |                  |   |       |  |   |  
|----------------------------------- |  | --------------------- | ------ | --------------- | - | --------- |  | --------- | ------ | ---------------- | - | ----- |  | - | -
|(in thousands)                      |  | Payment due by Period
|Contractual Obligations             |  | Total                 |        | Less than1 year |   | 1-3 years |  | 3-5 years |        | More than5 years
|Debt Obligations (1)                |  | $                     | 25,022 |                 | $ | 10,018    |  | $         | 15,004 |                  | $ |      |  | $ | 
|Operating Lease Obligations (2)     |  |                       | 6,685  |                 |   | 1,872     |  |           | 3,064  |                  |   | 1,749 |  |   | 
|Open Purchase Order Commitments (3) |  |                       | 21,016 |                 |   | 21,016    |  |           |       |                  |   |      |  |   | 
|                                    |  |                       |        |                 |   |           |  |           |        |                  |   |       |  |   |  
|Total                               |  | $                     | 52,723 |                 | $ | 32,906    |  | $         | 18,068 |                  | $ | 1,749 |  | $ | 

---

(1) Debt obligations include a bridge
loan and term loan with Columbia Partners and capital equipment leases. See Note 6 to the Condensed Consolidated Financial Statements for additional information.

(2) We lease office, product packaging and storage space and equipment warehouses under noncancelable operating lease agreements expiring through 2011.

(3) We outsource substantially all of our manufacturing requirements. As of March 31, 2007, purchase obligations of $6.3 million are related to the
Vodavi acquisition.



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##### Table of Contents

Item 3.QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Market Risk.During the normal course of
business we are routinely subjected to a variety of market risks, examples of which include, but are not limited to, interest rate movements and collectability of accounts receivable. We currently assess these risks and have established policies and
practices to protect against the adverse effects of these and other potential exposures. Although we do not anticipate any material losses in these risk areas, no assurances can be made that material losses will not be incurred in these areas in the
future.

Interest Rate Risk.We may be exposed to interest rate risk on certain of our cash equivalents. The value of certain of our investments may
be adversely affected in a rising interest rate investment environment. Although we do not anticipate any material losses from such a movement in interest rates, no assurances can be made that material losses will not be incurred in the future.

Item 4.CONTROLS AND PROCEDURES

Disclosure Controls and Procedures are defined in Exchange Act Rules
13a-15(e) and 15d-15(e) as the controls and procedures of an issuer that are designed to ensure that information required to be disclosed by the issuer in the reports that it files or submits under the Exchange Act is recorded, processed,
summarized, and reported, within the time period specified by the SECs rules and forms. Disclosure Controls and Procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an
issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to the issuers management, including our principle executive and principal financial officers, to allow for timely decisions regarding
required disclosure.

We have endeavored to design our Disclosure Controls and Procedures and Internal Controls Over Financial Reporting to provide
reasonable assurances that their objectives will be met. However, management and our audit committee do not expect that our disclosure controls or internal controls over financial reporting will prevent all errors or all instances of fraud or a
material weakness. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control systems objectives will be met. All control systems are subject to inherent limitations, such
as resource constraints, the possibility of human error, lack of knowledge or awareness, and the possibility of intentional circumvention of these controls. Furthermore, the design of any control system is based, in part, upon assumptions about the
likelihood of future events, which assumptions may ultimately prove to be incorrect. As a result, we cannot assure you our control system will detect every error or instance of fraudulent conduct, including an error or instance of fraudulent conduct
that could have a material adverse impact on our operations or results.

Evaluation of Disclosure Controls and Procedures.

As of March 31, 2007, our management, with the participation of our Audit Committee, Chief Executive Officer and Chief Financial Officer, evaluated
the effectiveness of our Disclosure Controls and Procedures. Based upon this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that, as of March 31, 2007, the design and operation of these disclosure controls and
procedures were effective during the quarter ended March 31, 2007. We believe that we have adequate staffing in our finance group with the appropriate level of experience to effectively control the increased level of transaction activity,
address the complex accounting matters and manage the increased financial reporting complexities resulting from the acquisitions of Vertical Networks, Comdial and Vodavi and the associated integration activities.

We continue to evaluate our resources for addressing our financial reporting and making appropriate changes to provide sufficient resources and time to
prepare and file periodic reports within the time periods specified in the SECs rules and regulations and provide for reviews by our management, our audit committee and our board of directors. Our Chief Executive Officer and Chief Financial
Officer continue to review our personnel, resources and disclosure controls and procedures.

Changes in Internal Control Over Financial Reporting.

There were no changes in the Company's internal control over financial reporting during the quarter ended March 31, 2007, that
materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting.



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##### Table of Contents

PART IIOTHER INFORMATION

Item 1Legal Proceedings

From time to time we are involved in various claims and other legal
proceedings which arise in the normal course of our business. Such matters are subject to many uncertainties and outcomes that are not predictable. However, based on the information available to us and after discussions with legal counsel, we do not
believe any such proceedings will have a material adverse effect on our business, results of operations, financial position or liquidity. We cannot provide assurance, however that damages that result in a material adverse effect on our financial
position or results of operations will be not be imposed in these matters.

Item 1ARisk Factors

We caution you that the following important factors, among others, in the
future could cause our actual results to differ materially from those expressed in forward-looking statements made by, or on behalf of, us in filings with the SEC, press releases, communications with investors and oral statements. Any or all of our
forward-looking statements in this Form 10-Q, and in any other public statements we make may turn out to be wrong. They can be affected by inaccurate assumptions we might make or by known or unknown risks and uncertainties. Many factors mentioned in
the discussion below are important in determining future results. We undertake no obligation to publicly update any forward-looking statements, whether as a result of new information, future events or otherwise. You are advised, however, to consult
any further disclosures we make in our reports filed with the SEC.

We have a history of losses and expect to incur future losses.

We had operating losses for the quarter ended March 31, 2007 and in each of the last 12 fiscal years. We also had negative cash flow from operating
activities in the quarter ended March 31, 2007 and had negative cash flow in seven out of the last eleven fiscal years. If our revenues do not increase significantly, without a corresponding decrease in expenses, we may never achieve
profitability, on a sustained basis or at all, or generate positive cash flow in the future. In that case our business will fail. We expect to incur significant future operating losses and negative cash flows. Vertical Networks, Inc. also incurred
operating losses in each of their last three fiscal years prior to being acquired by us. Comdials revenues and operating results have experienced fluctuations in the past and may cause our revenues and operating results to vary in the future.
Comdials revenues and operating results have varied significantly in the past due to various factors, including changes in market acceptance of Comdials services, regulatory changes that may affect the marketability of Comdials
services, budgetary cycles of Comdials principal clients, the mix and timing of client projects, and one-time nonrecurring and unusual charges. As a result, the operations acquired from Vertical Networks and Comdial may not consistently
generate profits or positive cash flow, which would likely have a material negative impact on our business, our financial condition and our results of operations.

We will need additional working capital, the lack of which would likely have a significant negative impact on our current level of operations.

The Comdial acquisition consumed significant amounts of working capital and the Comdial Assets were acquired with limited working capital. As a result, we may require additional capital in the future to fund our
operations, finance investments in product development and corporate infrastructure, expand in our various geographic markets and respond to competitive pressures and opportunities for growth. Failure to obtain additional funding would prevent us
from making expenditures that are needed to allow us to grow or maintain our operations. We cannot assure you that additional financing will be available on favorable terms, or at all. If funds are not available when required for our working capital
needs or other transactions, our ability to carry out our business plan will be adversely affected, and we may be required to scale back our growth and operations to reflect the extent of available funding. If we are able to arrange for additional
credit facilities from lenders, the debt instruments are likely to include limitations on our ability to incur other indebtedness, to pay dividends, to create liens, to sell or purchase our capital stock, to sell assets or to make acquisitions or
enter into other transactions. Such restrictions may adversely affect our ability to finance our future operations or capital needs or to engage in other business activities, including, without limitation, acquisitions of additional businesses. We
are already subject to such restrictions under the stock purchase agreement executed on September 28, 2004 (the 2004 Stock Purchase Agreement), the stock purchase agreement executed on September 28, 2005 (the 2005 Stock
Purchase Agreement), securities purchase agreement executed on February 9, 2006 (the 2006 Securities Purchase Agreement), the Credit Agreement executed on October 18, 2006 and the Securities Purchase Agreement, executed
on October 18, 2006, as amended and restated. If we raise additional funds by issuing equity or convertible debt securities, the percentage ownership of our stockholders will be reduced. These securities would likely have rights, preferences or
privileges senior to those of our common stockholders. The inability to obtain substantial increases in our working capital resources will likely have a material negative impact on our business, our financial condition and our results of operations.



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We have not timely filed several of our periodic reports under the Exchange Act and may fail to timely file periodic
Exchange Act reports in the future.

We failed to timely file our Quarterly Reports on Form 10-Q for the quarters ended
September 30, 2004, December 31, 2004, and March 31, 2005, our Annual Report on Form 10-K for the year ended June 30, 2006, an amendment to our Current Report on Form 8-K originally filed September 29, 2004 to disclose
certain financial data in connection with our acquisition of Vertical Networks, and our Current Report on Form 8-K relating to the execution of an office lease dated July 6, 2005. We filed the Quarterly Report for the quarter ended
September 30, 2004 on January 25, 2005, filed the Quarterly Report for the quarter ended December 31, 2004 on April 1, 2005, filed the Quarterly Report for the quarter ended March 31, 2005 on June 3, 2005, filed the
Annual Report on Form 10-K for the year ended June 30, 2006 on October 16, 2006 and amended it on October 31, 2006 to include Part III information, filed our amendment to our Form 8-K on April 20, 2005, and our 8-K on
July 14, 2005. If we cannot timely file our Exchange Act reports in the future, we will remain ineligible to register our securities on Form S-3 until 12 months after the last late filed Exchange Act report, and ineligible to qualify for the
safe harbor provisions for resale of restricted securities under Rule 144 of the Exchange Act. Inability to register securities on Form S-3 or sell restricted securities under the safe harbor provisions of Rule 144 limits the liquidity of our
securities and restricts the market for our securities.

In addition, failure to remain current in our Exchange Act reporting requirements
in the future may in the future result in our common stock being de-listed from the OTC Bulletin Board and adversely affect our ability to list our common stock on a national exchange or the NASDAQ Stock Market in the future. If our common stock
were to be de-listed from the OTC Bulletin Board, the market for our common stock would become severely restricted and holders of our common stock may be unable to sell their shares. We have agreed in the 2004 and 2005 Stock Purchase Agreements and
the 2006 Securities Purchase Agreement to seek a listing of our common stock on a national exchange or the NASDAQ Stock Market. If we are unable to list our securities on a national exchange or the NASDAQ Stock Market because we have failed to
remain current in our Exchange Act reporting requirements, we may be subject to claims by M/C Venture Partners for indemnification, liability for breach of contract or other common law remedies.

If we do not resume trading on a national exchange or the NASDAQ Stock Market and if we are de-listed from the OTC Bulletin Board, trading in our common
stock may only be conducted based on trading information referenced on the Pink Sheets. Being quoted on the Pink Sheets could damage our general business reputation, could impair our ability to raise additional capital and
cause the market price for our shares to fall. Securities quoting on the Pink Sheets tend to be less liquid and subject to volatile stock prices.

Our stockholders could be adversely affected if M/C Venture Partners use their influence in a manner adverse to our stockholders interests.

As of March 31, 2007, M/C Venture Partners beneficially owned approximately 34.5% of our common stock. Based upon its substantial voting power and their director rights, M/C Venture Partners is in a position to
exert substantial influence over matters submitted to our stockholders for approval and our management and affairs, including the election and removal of directors and any merger, consolidation or sale of all or substantially all of our assets. In
addition, M/C Venture Partners currently maintains the contractual right to nominate two members to our seven member board of directors and has a shared right with our board of directors to nominate an additional two members. Accordingly, such
concentration of ownership and ability to appoint members to our board may have the effect of delaying, deterring or preventing a change in control of our company, impeding a merger, consolidation, takeover or other business combination or
discouraging a potential acquirer from making a tender offer or otherwise attempting to take control of our company, which in turn could have a negative effect on the market price of our stock. These actions could also be adverse to our other
stockholders interests.

Because we failed to cause the registration statement filed on December 6, 2005 to be declared effective in
accordance with the timetables set forth in 2005 Stock Purchase Agreement and the 2004 Stock Purchase Agreement, as amended, we are subject to liquidated damages or liability for breach of contract.

We are obligated to pay approximately $2.2 million in liquidated damages to the 2005 Investors and 2004 Investors. Pursuant to the 2005 Stock Purchase
Agreement and the 2004 Stock Purchase Agreement, as amended, we agreed to register the shares of our common stock issued to the 2005 Investors and the 2004 Investors for resale under the Securities Act of 1933. We agreed to file a registration
statement covering these shares no later than December 12, 2005. We filed this registration statement relating to these shares of common stock, among others, on December 6, 2005 (the Filing Date). We further agreed to use our
best efforts to cause the registration statement to become effective in certain events but no later than 90 days after the Filing Date (referred to as the Required Effective date). We are liable for liquidated damages to each investor as
a result of the Effectiveness Default.

We must pay as liquidated damages to the 2005 Investors, and the 2004 Investors for each 30-day
period of the effectiveness default, an amount in cash equal to 1% of the aggregate purchase price paid by the 2005 Investor or 2004 Investor as the case may be, pursuant to the 2005 Stock Purchase Agreement or the 2004 Stock Purchase Agreement,
provided that in no event will the aggregate amount of cash to be paid as liquidated damages exceed 9% of the aggregate purchase price paid by any respective 2005 Investor or 2004 Investor. Currently, we have not paid any liquidated damages to any
2005 Investor or any 2004 Investor.

Should we be required to make payment of these liquidated damages, it will likely have a material
adverse effect on our liquidity, our financial position and our results of operations, particularly if we became obligated to make payment in full of all liquidated damages potentially due and payable under these agreements.



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Because we failed to file a registration statement in accordance with the timetable set forth in the 2006 Securities
Purchase Agreement, we are subject to liquidated damages and possibly liability for breach of contract.

We are obligated to pay
$315,000 in liquidated damages to the Series D Investors. Pursuant to the 2006 Securities Purchase Agreement, we have agreed to register the shares of common stock issuable upon conversion of the Series D Convertible Preferred Stock (the Series D
Preferred Stock) and upon exercise of the warrants for resale by the 2006 investors under the Securities Act. We agreed to file with the SEC a registration statement with respect to the Series D Preferred Stock and warrants no later than
March 27, 2006 (the 2006 Filing Date), and to use our best efforts to cause the registration statement to become effective on or before the date that is the earlier of (1) in the event of no review by the SEC, within five days
of being informed by the SEC that the SEC has decided not to review the Registration Statement, but in no event later than 30 days after the 2006 Filing Date, (2) in the event of a review by the SEC, within five days of being informed by the
SEC that the SEC has no further comments on such registration statement, but in no event later than 90 days after the 2006 Filing Date (the earlier of (1) and (2), the 2006 Required Effective Date).

Because we failed to file the registration statement by the 2006 Filing Date, we are obligated to pay as liquidated damages to the Series D Investors,
for each 30-day period of a 2006 Registration Default, an amount in cash equal to 1% of the aggregate purchase price paid by the 2006 Investor pursuant to the 2006 Stock Purchase Agreement; provided that in no event will the aggregate amount of cash
to be paid as liquidated damages exceed 9% of the aggregate purchase price paid by such Series D Investor. We must pay the liquidated damages on the business day following the 2006 Filing Default, and each 30th day thereafter, until the registration
statement has been filed with the SEC. Currently, we have not paid any liquidated damages to any Series D Investor.

In addition to
liquidated damages pursuant to the 2004 and 2005 Stock Purchase Agreements, our obligations to pay these liquidated damages will likely have a material adverse effect on our liquidity, our financial position and our results of operations,
particularly if we become obligated to make payment in full of all liquidated damages potentially due and payable under these agreements.

Restrictive
covenants in the 2004 and 2005 Stock Purchase Agreement, the 2006 Securities Purchase Agreement and the Series E Securities Purchase Agreement may limit our ability to pursue our business strategies.

We have agreed under the terms of the 2004 and 2005 Stock Purchase Agreements and the 2006 Securities Purchase Agreement that we will not, without the
prior consent of M/C Venture Partners, (1) enter into a transaction involving a change in control of our company; (2) incur indebtedness in excess of $3.0 million, subject to specified exceptions; (3) create any security with an
equity component unless that security is junior to the common stock; (4) issue any equity securities; (5) transfer our intellectual property; (6) repurchase, redeem or pay dividends on any shares of capital stock (subject to limited
exceptions); (7) grant stock options that are not authorized by a vote of the board of directors or its compensation committee; (8) liquidate or dissolve; (9) change the size of our board of directors; (10) amend our Certificate
of Incorporation or bylaws; (11) change the nature of the Companys business; (12) alter the voting rights of shares of our capital stock in a disparate manner; or (13) take any action which would cause an adjustment to the
exercise price or number of shares to be delivered under Section 8 of the warrants issued to the 2006 Investors.

If we do not comply with these
covenants, we could be subject to claims for indemnification, liability for breach of contract and other common law remedies. Compliance with these covenants may limit our ability to pursue growth opportunities or address concerns with our
operations. Our ability to comply with these covenants and restrictions may be affected by changes in the economic or business conditions or events beyond our control.

Restrictive covenants in the Credit Agreement may limit our ability to pursue our business strategies.

Under the terms of the Credit Agreement, we are not permitted to take certain actions without the prior written consent of Investment Manager and Lender, including, without limitation, the following:



| |  |  | mortgage, assign, pledge, transfer or otherwise permit any lien, charge, security interest encumbrance or judgment to exist on any of the collateral pledged under
the Credit Agreement and related Security Agreement or our other assets, whether now owned or acquired later, except for certain permitted encumbrances;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | incur or create any indebtedness, except for certain permitted indebtedness;
| | - |  | ----------------------------------------------------------------------------



| |  |  | sell, lease, assign, transfer or otherwise dispose of (i) any collateral pledged under the Credit Agreement and Security Agreement, except for the sale of
inventory and equipment in the ordinary course of our business, or (ii) all or any substantial part of our assets that do not constitute collateral. We, however, may sell obsolete or surplus equipment if certain conditions specified in the
Credit Agreement are met;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | merge or consolidate with any other entity, except as permitted by the Credit Agreement, change our structure or organizational form, reincorporate or reorganize in
a new jurisdiction, or enter into or engage in any operation or activity materially different from that presently being conducted by our company;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | pay any dividend or distribution of any kind on, or purchase, acquire, redeem or retire, any of its equity interests;
| | - |  | ---------------------------------------------------------------------------------------------------------------------



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| |  |  | create any new subsidiary (other than to consummate certain acquisitions), make any advance or loan to, or any investment in any firm, entity, person or
corporation, or acquire all or substantially all of the assets of, or any capital stock or equity interests in any firm, entity or corporation, except our current investments in existing subsidiaries;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | enter into any transaction with any shareholder, officer, director, direct or indirect parent, direct or indirect subsidiary or other related person, except for
certain permitted transactions;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | make certain specified restricted payments described in the Credit Agreement;
| | - |  | -----------------------------------------------------------------------------



| |  |  | use proceeds of funds received under the Credit Agreement in any manner prohibited by the Credit Agreement;
| | - |  | -----------------------------------------------------------------------------------------------------------



| |  |  | cause any encumbrance or restriction on the ability of our subsidiaries to make certain payments to us;
| | - |  | -------------------------------------------------------------------------------------------------------



| |  |  | engage in any business other than certain specified businesses;
| | - |  | ---------------------------------------------------------------



| |  |  | change or amend the terms of any of our subordinated debt for certain specified purposes; or
| | - |  | --------------------------------------------------------------------------------------------



| |  |  | other customer restrictions.
| | - |  | ----------------------------

If we
do not comply with these covenants, we will be subject to claims for indemnification, liability for breach of contract and other common law remedies. Compliance with these covenants may limit our ability to pursue growth opportunities or address
concerns with our operations. Our ability to comply with these covenants and restrictions may be affected by changes in the economic or business conditions or events beyond our control.

Certain restrictions in the certificates of designations for the Series D Preferred Stock and the Series E Preferred Stock may limit our ability to carry out our business plan.

Under the terms of the certificates of designation for our Series D Preferred Stock and our Series E Preferred Stock, we are not permitted to take certain
actions without the prior written consent of holders of a majority of the outstanding Series D Preferred Stock and Series E Preferred Stock including, without limitation, the following:



| |  |  | amend, alter or repeal any right, preference or privilege of the Series D Preferred Stock or the Series E Preferred Stock, respectively, any provision of our
certificate of incorporation or bylaws, or any document executed in connection with the Series E Financing;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | create any additional class or series of shares of stock, or any convertible debt securities, unless it is subordinate to the common stock as to dividends and
distribution of assets on the liquidation, dissolution or winding up of our company;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | issue or agree to issue any equity security or any security that is convertible, exercisable or exchangeable for or into any equity security (including convertible
debt securities) except certain permitted issuances;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | change the number of shares of our capital stock reserved for grants or issuance to employees, directors, contractors or consultants under our equity incentive
plans;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | approve or engage in any transaction for the acquisition of any other person, entity or organization, the business or substantially all of the assets of any other
person, entity or organization, except the acquisition of any of our subsidiaries;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | liquidate, dissolve or wind-up our business and affairs, effect any deemed liquidation event or consent to do any of the foregoing;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------



| |  |  | purchase or redeem, or pay any dividend or make any distribution on, any shares of our capital stock or permit any subsidiary to do any of the foregoing except for
certain permitted dividends and redemptions; or
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | change the number of directors constituting the size of the Board of Directors.
| | - |  | -------------------------------------------------------------------------------

These restrictions may limit our ability to raise capital in the future or may limit our operations while they are in effect. If we take one of the above
actions and fail to obtain the required consent of the respective holders of our Series D Preferred Stock and Series E Preferred Stock, it may result in the prohibited transactions being voided and we may be liable for breach of contract and other
common law remedies. Additionally, we may damage our relationship with certain of our stockholders whose participation in future equity financings may be required for us to continue operations or consummate key transactions necessary for the success
of our business. If these relationships are irreparably damaged, we may be unable to consummate certain transactions that may be necessary for the operation of our business.

Failure to successfully integrate the acquired operations of Vodavi could have a material adverse effect on our combined operations.

Our decision to acquire the operations of Vodavi were based in part, on our belief in the growth opportunities and cost savings we hope to achieve from the integration of those operations into our operations and our
plans to expand our product offerings to our customers and future customers. Our success in realizing these and other anticipated benefits could be adversely affected by a number of factors, many of which are outside our control. These challenges
include the timely, efficient and successful execution of a number of post-acquisition events, including:



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| |  |  | integrating the operations and technologies of the three companies;
| | - |  | -------------------------------------------------------------------



| |  |  | retaining and assimilating the key personnel of each company;
| | - |  | -------------------------------------------------------------



| |  |  | retaining existing customers of these companies and attracting additional customers;
| | - |  | ------------------------------------------------------------------------------------



| |  |  | retaining strategic partners of each company and attracting new strategic partners; and
| | - |  | ---------------------------------------------------------------------------------------



| |  |  | creating uniform standards, controls, procedures, policies and information systems.
| | - |  | -----------------------------------------------------------------------------------

The execution of these post-acquisition events will involve considerable risks and may not be successful. These risks include:



| |  |  | the potential disruption of the combined companys ongoing business and distraction of its management;
| | - |  | ------------------------------------------------------------------------------------------------------



| |  |  | the potential strain on our financial and managerial controls and reporting systems and procedures;
| | - |  | ---------------------------------------------------------------------------------------------------



| |  |  | unanticipated expenses and potential delays related to integration of the operations, technology and other resources of the two companies and
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | the impairment of relationships with employees, suppliers and customers as a result of the integration of personnel and any reductions in force.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------

The combined company may not succeed in addressing these risks or any other problems encountered in connection with
these acquisitions. The inability to successfully integrate our operations, technology and personnel with those of Vodavi or any significant delay in achieving integration, could have a material adverse effect on the combined company after the
acquisition and, as a result, on the market price of our common stock.

We may experience difficulties marketing our products following the acquisitions
of Vertical Networks, Comdial and Vodavi.

With the acquisition of Vertical Networks, we now market a significant amount of products,
primarily InstantOffice and its family of products, to several large enterprise customers, including CVS and Staples. We have little experience marketing our products to, or establishing and maintaining customer relationships with, such large
enterprise customers. If we are unable to maintain what are essentially new customers, it would likely result in a decline in sales of InstantOffice, which would likely have a material adverse effect on our ability to generate revenues. If we are
unable to add additional large enterprise customers, we may have difficulty in our efforts to increase our revenues and achieve profitability.

The former customers of Comdial may not continue their current buying patterns following our acquisition of the Comdial Assets. Any significant delay or reduction in orders for the Comdial Products could harm the combined companys
business, financial condition and results of operations. Former customers of Comdial may defer purchasing decisions as they evaluate the likelihood of successful integration of our products with those of Comdial, and the combined companys
future product strategy, or consider purchasing products of our competitors. Former Comdial customers may also seek to modify or terminate existing agreements, or prospective customers may delay entering into new agreements or purchasing our
products. In addition, by increasing the breadth of our business, the acquisition may make it more difficult for the combined company to enter into relationships, including customer relationships, with strategic partners, some of whom may view the
combined company as a more direct competitor than either entity as an independent company.

Vodavis customers may not continue their
current buying patterns following our acquisition of the company. Any significant delay or reduction in orders for Vodavis products could harm the combined companys business, financial condition and results of operations. Former
customers of Vodavi may defer purchasing decisions as they evaluate the likelihood of successful integration of our products with those of Vodavi, and the combined companys future product strategy, or consider purchasing products of our
competitors. In addition, by increasing the breadth of our business, the acquisition may make it more difficult for the combined company to enter into relationships, including customer relationships, with strategic partners, some of whom may view
the combined company as a more direct competitor than either entity as an independent company.

Integrating our companies may divert managements
attention away from our operations.

Successful integration of our operations, products and personnel with those of Vodavi may place a
significant burden on our management and our internal resources. The diversion of management attention and any difficulties encountered in the transition and integration process could harm our business, financial condition and operating results.

If we fail to retain key employees, the benefits of the acquisitions could be diminished.

The successful acquisition of Vodavi will depend in part on the retention of key personnel. As a result of the acquisition, our employees and those of
Vodavi could experience uncertainty about their future roles within our continuing operations. This uncertainty may adversely affect our ability to attract and retain key management, sales, marketing and technical personnel. There can be no
assurance that we will be able to retain our key management, technical, sales and customer support personnel or those of Vodavi. If we fail to retain such key employees, we may not realize the anticipated benefits of the acquisition.



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We are relying on our next generation product to launch in mid-2007 and if we fail to achieve general release in that
time period our operations will be negatively impacted.

We are currently making a substantial investment in the unified engineering and
product management team that is working on our next-generation IP-PBX product family, which is expected to ship in 2007. If there are delays in release or insurmountable problems with this next generation product, our operations will be negatively
impacted as we require this new product to remain competitive in our market and to achieve profitability.

Our revenues are highly concentrated among a
small number of customers and the loss of one of these customers would harm our business and prospects, perhaps materially.

A
significant portion of our revenues are generated by a small number of customers. If we were to lose one or more of these customers, our revenues would decline and our business and prospects would be materially harmed. We expect that even if we are
successful in developing relationships with additional customers through the acquisition of the Vodavi, or through additional sales of our historic products, our revenues will continue to be concentrated. We cannot assure you that we will be able to
retain any of our current customers or that we will be able to obtain new customers.

We do not have long-term contracts with a majority of our
customers, which renders our sales channels particularly unstable.

We do not have any long-term agreements with our customers who
acquire our products. Accordingly, our customers are not contractually obligated to buy from us in the future. Our customers are not required to make minimum purchases from us or make purchases at any particular time and are free to purchase from
our competitors. Also, our customers can stop purchasing our products at any time without penalty. If our customers do not purchase our products in sufficient quantities or on a recurring basis, our business and prospects will suffer. Even if our
customers are willing to purchase our products, we cannot assure you that we will be able to sell our products at prices that are favorable to us.

We
rely on others to promote and sell our products, and their failure to do so may seriously harm our business.

We depend on distributors
and resellers and system integrators to market and sell our products. If these customers do not focus their marketing efforts on software- or server-based phone systems or focus on products competitive with our products our sales will be materially
adversely affected. Failure of distributors, system integrators, and resellers to focus on software- or server-based phone systems may send a negative signal to current and potential customers concerning the viability of our industry or our product
offerings. We depend upon the availability of distribution outlets to market our products. Loss of these outlets will harm our ability to broaden our brand acceptance and enhance our reputation in the market. In addition, our operating results would
be adversely affected if one of our major distributors, resellers or original equipment manufacturers failed to timely and fully pay us for the products they purchased from us for resale or integration, as the case may be.

If software- and server-based phone systems do not achieve widespread acceptance, we may not be able to continue our operations.

The market for software- and server-based business phone systems is relatively new and rapidly evolving. Businesses have invested substantial resources in
the existing telecommunications infrastructure, including traditional private telephone systems, and may be unwilling to replace these systems in the near term or at all. Businesses also may be reluctant to adopt computer telephony systems because
of their concern about the current limitations of data networks, including the Internet. For example, end-users sometimes experience delays in receiving calls and reduced voice quality during calls when routing calls over data networks. Moreover,
businesses that begin to route calls over the same networks that currently carry only their data also may experience these problems if the networks do not have sufficient capacity to carry all of these communications at the same time. We cannot
assure you that businesses will migrate toward computer telephony systems or that computer telephony systems will gain widespread acceptance.

Rapid
technological change creates a dependence on development of new products.

The market for telecommunications systems and products has
been characterized by rapid technological change and continuing demand for new products and features. Accordingly, the timely introduction of new products and product features, as well as new telecommunications applications are expected to continue
to be major factors in our future success. Market needs and expectations will require us to continue to identify, develop, and sell new products and features that keep pace with technological developments and competitive pressures. In addition,
technological difficulties occasionally inherent in new products and the time necessary to stabilize new product manufacturing costs may adversely affect operating costs. There can be no assurance that our products will achieve market acceptance, or
that we will be able to continue to develop new products, technologies, and applications as required by changing market needs in the future.



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Products in our Comdial and Vodavi inventories may become obsolete.

Comdial and Vodavi offer a variety of communications products which included technologies that are enhanced rapidly in todays business environment.
Both companies measured their product inventories on hand at the lower of cost or market and provided allowances for excess and obsolete inventory equal to the difference between the cost of inventory and the estimated market value based on
assumptions about product life cycles, product demand and market conditions. The technologies incorporated into our newer products are periodically modified in reaction to both customer requirements and to market conditions. This rapid technology
change potentially impacts the carrying value of our inventory on hand due to obsolescence.

Disruption in supplies of certain essential components will
impair our ability to manage our inventory with distributors and resellers.

If our contract manufacturers are unable to obtain supplies
necessary to the manufacture of our hardware, our ability to maintain inventory with our distributors and resellers will be harmed. Continued sales of our hardware-based products are dependent upon continued availability of the commercially
available components used to manufacture the custom hardware, as well as continued cooperation by the manufacturers involved in assembling the custom servers used by the product. Our contract manufacturers may not be able to secure enough components
at reasonable prices or of acceptable quality to build new products in a timely manner in the quantities or configurations needed. Accordingly, our revenues and gross margins could suffer until other sources can be developed. Our operating results
would also be adversely affected if, anticipating greater demand than actually develops, we commit to the purchase of more finished goods than we need. We cannot assure you that we will not encounter these problems in the future. Although in many
cases our contract manufacturers use standard parts and components for our products, certain components are presently available only from a single source or limited sources. Our contract manufacturers may not be able to diversify sources in a timely
manner, which could harm our ability to deliver products to customers and seriously impact present and future sales.

We do not manufacture
the hardware utilized by InstantOffice and hold in-house only limited amounts of inventory for purposes of replacements of systems or parts as required for field support. Should we experience a disruption in the supply of these finished goods, it
could have a material adverse effect on our ability to sell and service our InstantOffice product line. The fact that we do not own our manufacturing facilities could have an adverse impact on the supply of our products and on operating results.
Financial problems of contract manufacturers on whom we rely, or reservation of manufacturing capacity by other companies, inside or outside of our industry, could either limit supply or increase costs.

As part of its restructuring program, Comdial outsourced substantially all of its manufacturing requirements. Outsourced manufacturing is carried out in
three principal locations: Asia, Mexico and the United States. Outsourcing, particularly with international manufacturers, carries certain risks which include, but may not be limited to:



| |  |  | the outsourcing contractors ability to manufacture products that meet our technical specification and that have minimal defects;
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| |  |  | the outsourcing contractors ability to honor their product warranties;
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| |  |  | the financial solvency, labor concerns and general business condition of our outsourcing contractors;
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| |  |  | unexpected changes in regulatory requirements;
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| |  |  | inadequate protection of intellectual property in foreign countries;
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| |  |  | political and economic conditions in overseas locations;
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| |  |  | risks of fire, flood or acts of God affecting manufacturing facilities; and
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| |  |  | our ability to meet our financial obligations with our outsourcing contractors.
| | - |  | -------------------------------------------------------------------------------

In addition, our new outsourcing contractors acquire component parts from various suppliers. Similar risks are involved in such procurement efforts. Due
to our new dependency on outsourced manufacturing and the inherent difficulty in replacing outsourced manufacturing capacity in an efficient or expeditious manner, the occurrence of any condition preventing or hindering the manufacture or delivery
of manufactured goods by any one or more of our outsourcing contractors would have a material adverse affect on our business in the short term and may have a material adverse affect in the long term. In calendar 2002, Comdial experienced significant
problems associated with a principal outsource manufacturer. Faulty component parts used by the manufacturer in the production of a principal product caused a significant shortfall in product inventory, and led to Comdials inability to meet
product orders, negatively impacting sales and revenues. In addition, Comdial was adversely affected by a port strike that resulted in the temporary closure of certain ports on the West Coast of the United States.

During the third quarter of 2002, Comdial experienced difficulties in fulfilling certain product orders as a result of the production transition from
Virginia to the outsourcing partners, and a backlog that has been built up with one of the United States outsourcing partners. Also in 2002, Comdial was forced to terminate its relationship with a principal outsource manufacturer and transition that
work to other contractors. The terminated manufacturer was unable to meet substantially all of Comdials product delivery orders because of financial and operational problems. That inability caused further problems for Comdial in meeting
customer orders and resulted in a substantial backlog, potential lost business and other losses. Comdial filed an arbitration action against that manufacturer in 2002 in order to seek recovery of the losses caused by their failure in performance.
While these problems with these contract manufacturers have been addressed by Comdial, we cannot give assurances that they will not continue to have an impact on sales and revenues, or that similar or other significant problems will not occur in the
future.



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We rely upon LG-Nortel Co., Ltd. (LGN) as a strategic partner for our Vodavi business

Vodavi obtains a majority of its telephone systems, voice mail products and IP-based commercial grade telephones from LGN, which owns the rights to
produce this equipment. Under an agreement with Vodavi, LGN granted us the exclusive right to distribute and sell throughout North America and the Caribbean the products that LGN manufactures for us. The agreement expires in December 2009.
Vodavi conducts joint development activities with LGN for the design and development of hardware incorporated into some of their existing and planned telephone systems and commercial grade telephone product lines. Other products are completely
developed by LGN. In connection with the products jointly developed with LGN, Vodavi provides market analysis, product management, functional and performance standards, software development, quality control program development, sales and
distribution, and customer service and support, while LGN provides hardware research, design, and development, development of components such as integrated circuits and semiconductor chips, and manufacturing and production engineering. Generally,
LGN contributes the ongoing research and development costs for the product hardware in return for an arrangement under which LGN produces the finished goods developed under the alliance.

As a result of this arrangement, Vodavi has been able to obtain access to LGNs research and development expertise and resources while controlling
capital expenditures for much of their product development efforts. In addition, the arrangement with LGN enables us to minimize the risks inherent in making significant investments in research and development infrastructure or personnel. To the
extent that we develop new hardware in conjunction with LGN or another development partner, the development partner typically retains ownership rights to the new hardware and we retain the right to sell products incorporating that hardware
throughout North America and the Caribbean. Vodavi relies on LGN to supply most of our telephone systems and voice mail products and all of their commercial grade telephones. They also rely on LGNs engineering, hardware and circuit
development, and manufacturing capabilities. Vodavi purchased approximately $21.2 million, $22.2 million, and $21.1 million of product LGN, constituting approximately 84%, 88%, and 87% of their total purchases in calendar years 2005, 2004,
and 2003, respectively.

Additionally, we consider Nortel Networks Corporation, the controlling joint venture partner in LGN, to be a
direct competitor with our company in North America. Although, we have a long-term manufacturing and supply agreement with LGN that expires in December 2009, we cannot be assured that LGN will continue to support our business or operations.

Certain conflicts of interest may arise as a result of LGNs ownership interest in our company.

LGN currently owns approximately 24% of our Series E Preferred Stock. We obtain most of our telephone systems, IP-based products, and voice mail products
for the Vodavi business from LGN and obtain all of their commercial grade telephones and replacement parts for such telephones from LGICTH, an affiliate of LGN. As a result of LGNs ownership interest in us, an inherent conflict of interest
exists in establishing the volume and terms and conditions of our purchases from LGN and LGICTH. In order to mitigate such conflicts, all decisions with respect to such purchases are made by our officers and may be reviewed by directors who have no
relationship with LGN.

Our relationship with LGN may have the effect of making more difficult or delaying attempts by others to obtain
control of us, even when these attempts may be in the best interests of stockholders. Through LGNs stockholder interest and business interests in our company, LGN may have significant influence over our business.

Undetected flaws in our products may damage our reputation, cause loss of customers and increase customer support costs.

Telecommunications products as complex as our products may contain undetected errors or flaws. The presence of any such errors or flaws could result in
damage to our reputation, loss of customers, delay of market acceptance of our products or all of these consequences. Our customers or we may find errors in current or any new products after commencement of commercial shipments. In addition, if our
products are flawed or are difficult to use, customer support costs could rise. If we are unable to timely and effectively correct flaws in our products, we will lose customers and our ability to make future sales will be adversely affected. If we
are unable to produce reliable products, our reputation will suffer, perhaps irreparably, and our business could fail.

Malfunctions or errors in
third-party technology may limit our ability to sell our products and may damage the reputation of our products, perhaps materially.

Our TeleVantage, Instant Office, Comdial and Vodavi products operate on or are comprised of hardware manufactured by third parties. We are dependent on the reliability of this hardware and, to the extent the hardware has defects, it will
affect the performance of our products. If the hardware becomes unreliable, does not perform in a manner that is acceptable to our customers or becomes more expensive, sales of our products could decline. Because many of our products run on
Microsoft software products and use other Microsoft Corporation technologies, we must depend on the reliability and quality of such products and technologies. Errors or vulnerabilities in Microsoft products could impair sales of some of our
products. Our customers may associate unreliability of the hardware and flaws in Microsoft products with a lack of quality of some of our products, which may cause us to lose customers and hurt future sales. Our ability to remedy malfunctions or
errors will depend on the timeliness and availability of repair solutions from the manufacturers. Future success of our products and any new products will depend on the ability of our hardware and software manufacturers to produce reliable products
in the future.



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Many of our products incorporate technology licensed or acquired from third parties.

We sell products in markets that are characterized by rapid technological changes, evolving industry standards, frequent new product introductions, short
product life cycles and increasing levels of integration. Our ability to keep pace with this market depends on our ability to obtain technology from third parties on commercially reasonable terms to allow our products to remain in a competitive
posture. If licenses to such technology are not available on commercially reasonable terms and conditions, and we cannot otherwise integrate such technology, our products or our customers products could become unmarketable or obsolete, and we
could lose market share. In such instances, we could also incur substantial unanticipated costs or scheduling delays to develop substitute technology to deliver competitive products.

We are subject to risks associated with international operations.

We conduct business globally.
International sales accounted for approximately 2% of net sales for the quarter ended March 31, 2007 and 8% of net sales for the year ended June 30, 2006. We also acquire various raw materials and components from international suppliers.
We intend to expand our presence in international markets, and we cannot assure you that we will compete successfully in international markets or meet the service and support needs of foreign customers. Our future results could be harmed by a
variety of factors relating to international operations, including:



| |  |  | difficulties in enforcing agreements and collecting receivables through the legal systems of foreign countries;
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| |  |  | the longer payment cycles associated with many foreign customers;
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| |  |  | the possibility that foreign countries may impose additional withholding taxes or otherwise tax our foreign income, impose tariffs or adopt other restrictions on
foreign trade;
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| |  |  | fluctuations in exchange rates, which may affect product demand and adversely affect the profitability in U.S. dollars of products and services provided by us in
foreign markets where payment is made in local currency;
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| |  |  | our ability to obtain U.S. export licenses and other required export or import licenses or approvals;
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| |  |  | changes in the political, regulatory or economic conditions in a country or region; and
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| |  |  | difficulty protecting our intellectual property in foreign countries.
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Our market is highly competitive, and if we fail to compete successfully our products will not be successful.

We compete with other companies offering proprietary private branch exchanges, such as Nortel Networks Corporation, Siemens AG, and Avaya, Inc. As we focus on the development and marketing of computer telephony systems, we face intense
competition from providers of voice communications systems as well as from data networking companies such as Cisco Systems, Inc. and 3Com Corp. In addition, because the market for our products is subject to rapid technological change, as the market
evolves we may face competition in the future from companies that do not currently compete in the software- and server-based phone systems market, including companies that currently compete in other sectors of the technology, communications and
software industries. Competition from these potential market entrants may take many forms, including offering products and applications similar to those we offer as part of a larger, bundled offering.

Comdial and Vodavi competed with approximately 25 companies, many of which have significantly greater financial, marketing, and technical resources than
we do. In addition, we must compete to attract and retain dealers for our new Comdial an Vodavi Products. There can be no assurance that we will be able to compete successfully in the marketplace or that we will be able to maintain Comdials
prior dealer network.

Several of these existing competitors have, and many of our future competitors may have, greater financial,
personnel and capacity resources than us and as a result, these competitors may be in a stronger position to respond quickly to potential acquisitions and other market opportunities, new or emerging technologies and changes in customer requirements.
Competitors with greater financial resources also may be able to offer lower prices, additional products or services or other incentives that we cannot match or do not offer. We cannot predict with precision which competitors may enter our markets
in the future or what form such competition may take. In order to effectively compete with any new market entrant, we may need to make additional investments in our business or use more capital resources than our business currently requires.

The failure of our products to perform properly could result in a number of significant negative consequences to us, including a claim for substantial
damages, the diversion of managements attention and resources, and damage to our reputation. In addition, current and prospective customers may become discouraged from purchasing our products.

Because customers purchasing our products rely on them for the communication needs of their respective businesses, we may be exposed to potential claims
for damages, including special or consequential damages, as a result of an actual or perceived failure of our products. Our failure or inability to meet a customers expectations in the performance of our products, or failure to address any
failure of our products in a timely manner, regardless of our responsibility for failure, could (1) result in a claim for substantial damages against us; (2) divert managements attention and resources; (3) damage our business
reputation; and (4) discourage other customers from purchasing our products in the future.



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We maintain certain contractual limitations of liability and insurance against some of these risks;
however, there can be no assurance that such provisions would be enforced or effective or that such insurance would be sufficient to cover the cost of damages. Further, we cannot assure you that insurance will continue to be available at
commercially reasonable rates. If we are unable to rely on our contractual limitations of liability and/or maintain sufficient insurance, our business could be harmed.

Our market is subject to changing preferences and technological change, and our failure to keep up with these changes would harm our business and prospects, perhaps materially.

The introduction of products incorporating new technologies and the emergence of new industry standards could render our products obsolete and
unmarketable. If we are unable to stay current or ahead of changes in the technology or industry standards, our business and prospects will suffer, perhaps materially. We cannot assure you that we will be able to respond to rapid technological
change, changing customer needs, frequent product introductions and evolving industry standards within the markets for computer telephony solutions. We may be unable to develop and introduce new computer telephony products (including new releases
and enhancements) on a timely basis that keep pace with technological developments and emerging industry standards and address the increasingly sophisticated needs of our customers.

We have adopted anti-takeover defenses that could make it difficult for another company to acquire control of our company or limit the price investors might be willing to pay for our stock.

Certain provisions of our Certificate of Incorporation, as amended, could make a merger, tender offer or proxy contest involving us difficult, even if
such events would be beneficial to the interests of our stockholders. These provisions include a classified board of directors, restrictions on calling and holding stockholder meetings, and giving our board the ability to issue preferred stock and
determine the rights and designations of the preferred stock at any time without stockholder approval. The rights of the holders of our common stock will be subject to, and may be adversely affected by, the rights of the holders of any preferred
stock that may be issued in the future. The issuance of preferred stock, while providing flexibility in connection with possible acquisitions and other corporate purposes, could have the effect of making it more difficult for a third party to
acquire, or of discouraging a third party from acquiring, a majority of our outstanding voting stock. These factors and certain provisions of the Delaware General Corporation Law may have the effect of deterring hostile takeovers or otherwise
delaying or preventing changes in control or changes in our management, including transactions in which our stockholders might otherwise receive a premium over the fair market value of our common stock.

Our protection of intellectual property may not allow us to effectively prevent others from using our business model or our technology.

Our success is dependent upon our software code base, our programming methodologies and other intellectual property. We rely on copyright protection for
such works of authorship and trade secret protection for our technical know-how and other confidential information. We do not currently maintain patent protection for our business model or our technology and we currently do not plan significant
patent applications in the future. We generally enter into confidentiality agreements with our employees, vendors and consultants and with our clients and corporations with whom we have strategic relationships; however, the terms of these agreements
vary and may not provide us with adequate protection against non-disclosure. In addition, we attempt to maintain control over, access to, and distribution of our intellectual property and technical know-how; however, despite these efforts,
unauthorized parties may attempt to copy aspects of our service offering or the documentation used by us in delivering such services or to obtain and use other information that we regard as proprietary.

Monitoring infringement of intellectual property rights is difficult and we cannot be certain that the steps we have taken will prevent unauthorized use
of our intellectual property and technical know-how, particularly in foreign countries where the laws may not protect our proprietary rights as fully as in the United States. Accordingly, other parties, including competitors, may duplicate our
product offerings.

Furthermore, Comdial and Vodavi have, from time to time, been subject to proceedings alleging infringement of the
intellectual property rights of others. We may find ourselves defending infringement claims related to intellectual property assets that are included in the Comdial and Vodavi Assets. Such proceedings could require us to expend significant sums in
litigation, pay significant damages, develop non-infringing technology, or acquire licenses to the technology which is the subject of the asserted infringement, any of which could have a material adverse effect on our business. Moreover, Comdial and
Vodavi have relied in the past upon intellectual property rights to protect its proprietary rights in its products and software. There can be no assurance that these protections will be adequate to deter misappropriation of our new Comdial and
Vodavi technologies or independent third-party development of potentially infringing technologies.



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We may become involved in intellectual property or other disputes that could cause us to incur substantial costs,
divert the efforts of our management, and require us to pay substantial damages or require us to obtain licenses, which may not be available on commercially reasonable terms, if at all.

Third parties, including competitors, may already have patents on inventions, or may obtain patents on new inventions in the future, that could limit our
ability to market and sell the products we provide now or new products we may offer in the future. Such third parties may claim that our products infringe their patent rights and assert claims against us. In addition, we have agreed in some of our
contracts, and may in the future agree in other contracts, to indemnify third parties for any expenses or liabilities resulting from claimed infringements of the proprietary rights of third parties as it relates to the products we provide. We, or
third parties that we are obligated to indemnify, may receive notifications alleging infringements of intellectual property rights relating to our business or the products previously sold by us. Litigation with respect to patents or other
intellectual property matters, whether with or without merit, could be time-consuming to defend, result in substantial costs and diversion of management and other resources, cause delays or other problems in the marketing and sales of our products,
or require us to enter into royalty or licensing agreements, any or all of which could have a material adverse effect on our business, operating results and financial condition. If any infringement claim is successful against us, we may be required
to pay substantial damages or we may need to seek and obtain a license of the other partys intellectual property rights. We may be unable to obtain such a license on commercially reasonable terms, if at all. We may be required to redesign
those products that use the infringed technology. Moreover, we may be prohibited from selling, using, or providing any of our products that use the challenged intellectual property. Although we carry general liability insurance, our insurance may
not cover potential claims of this type or may not be adequate to cover us for all liability that may be imposed.

Our common stock has a limited
trading market, which could limit the liquidity of our common stock and our access to capital markets.

Our common stock is currently
quoted on both the over-the-counter electronic bulletin board, also referred to as the OTC Bulletin Board, and the National Quotation Service Bureau, also known as the Pink Sheets. There is only limited trading activity in our securities. We do not
know if a market for our common stock will be re-established or that, if re-established, a market will be sustained. This could limit the liquidity of our common stock and reduce our stock price. The limited liquidity and reduced price of our common
stock could have a material adverse effect on our ability to raise capital through alternative financing sources on terms acceptable to us or at all. The limited trading market may also result in other negative implications, including the potential
loss of confidence by suppliers, customers and employees, the loss of institutional investor interest and fewer business development opportunities.

Our
common stock is subject to additional regulation as a penny stock, which may reduce the liquidity of our common stock.

The
SEC has adopted regulations that generally define a penny stock to be any security that is priced under five dollars. These regulations may have the effect of reducing the level of trading activity in our common stock and investors in
our common stock may find it difficult to sell their shares. We cannot assure you that you will be able to resell our common stock and may lose your investment.

In addition, since the trading price of our common stock is less than $5.00 per share, trading in our common stock is also subject to the requirements of Rule 15g-9 of the Exchange Act. Under Rule 15g-9, brokers who
recommend our common stock to persons who are not established customers and accredited investors, as defined in the Exchange Act, must satisfy special sales practice requirements, including requirements that they:



| |  |  | make an individualized written suitability determination for the purchaser; and
| | - |  | -------------------------------------------------------------------------------



| |  |  | receive the purchasers written consent prior to the transaction.
| | - |  | -----------------------------------------------------------------

The Securities Enforcement Remedies and Penny Stock Reform Act of 1990 also requires additional disclosures in connection with any trades involving a
penny stock, including the delivery, prior to any penny stock transaction, of a disclosure schedule explaining the penny stock market and the risks associated with that market. Such requirements may severely limit the market liquidity of our common
stock and the ability of purchasers of our equity securities to sell their securities in the secondary market. For all of these reasons, an investment in our equity securities may not be attractive to our potential investors.

Revenues in any quarter may vary to the extent recognition of revenue is deferred when contracts are signed. As a result, revenues in any quarter may be difficult to
predict and are unreliable indicators of future performance trends.

We frequently enter into contracts where we recognize only a
portion of the total revenue under the contract in the quarter in which we enter into the contract. For example, we may recognize revenue on a ratable basis over the life of the contract or enter into contracts where the recognition of revenue is
conditioned upon delivery of future product or service elements. This is the case with our contracts with CVS, Aramark and Household Financial. The portion of revenues that are deferred may vary significantly in any given quarter, and revenues in
any given quarter are a function both of contracts signed in such quarter and contracts signed in prior quarters. We anticipate that product revenues in future quarters will generally be more dependent on revenues from new customer contracts entered
into in those quarters rather than from amortization or recognition of product revenues deferred in prior quarters.



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We sometimes experience long implementation cycles, which may increase our operating costs and delay recognition of
revenues.

Our products are sophisticated systems that are generally deployed with many users. Implementation of these systems by
enterprises is complex, time consuming and expensive. Long implementation cycles may delay the recognition of revenue as some of our customers engage us to perform system implementation services, which can defer revenue recognition for the related
product revenue. In addition, when we experience long implementation cycles, we may incur costs at a higher level than anticipated, which may reduce the anticipated profitability of a given implementation.

Our costs could substantially increase if we receive a significant number of warranty claims.

We generally warrant each of our products against defects in materials and workmanship for a period of 12 months from the date of shipment. If we
experience an increase in product returns or warranty claims, we could incur unanticipated additional expenditures for parts and service. In addition, our reputation and goodwill could be damaged, perhaps irreparably. While we have established
reserves for liability associated with product warranties, unforeseen warranty exposure in excess of those reserves could adversely affect our operating results.



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##### Table of Contents

Item 6EXHIBITS



|            |  |                                                                                                                                                  
|----------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |  | Description                                                                                                                                      
|            | 
|31.1        |  | Certification of Chief Executive Officer pursuant to Rule 13a-14(a)/Rule 15d-14(a) of the Securities Exchange Act of 1934, as
amended            
|31.2        |  | Certification of Chief Financial Officer pursuant to Rule 13a-14(a)/Rule 15d-14(a) of the Securities Exchange Act of 1934, as
amended            
|32.1        |  | Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
|32.2        |  | Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002



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##### Table of Contents

SIGNATURES

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.



|                    |  |                                                                                   
|------------------- |  | ----------------------------------------------------------------------------------
|                    |  | VERTICAL COMMUNICATIONS, INC.                                                     
|                    | 
|Dated: May 15, 2007 |  | /s/ William Y. Tauscher                                                           
|                    |  | William Y. Tauscher                                                               
|                    |  | Chief Executive Officer andChairman of the Board                                  
|                    | 
|Dated: May 15, 2007 |  | /s/ Kenneth M. Clinebell                                                          
|                    |  | Kenneth M. Clinebell                                                              
|                    |  | Chief Financial Officer (Principal Financial Officer andChief Accounting Officer )



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