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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 December 31, 2005

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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ARTISOFT, INC.

(Exact Name of Registrant as Specified in Its Charter)



|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|Delaware                                                       |  | 86-0446453                          
|(State or other jurisdiction of incorporation or organization) |  | (I.R.S. Employer Identification No.)

One Memorial Drive, Cambridge, Massachusetts 02142

(Address of Principal Executive Offices) (Zip Code)

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

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 February 14, 2006
|Common Stock, $0.01 par value per share |  | 45,808,862                                



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##### Table of Contents

ARTISOFT, INC.

QUARTERLY REPORT ON FORM 10-Q

INDEX



|                                                                                               |  |   
|---------------------------------------------------------------------------------------------- |  | --
|                                                                                               | 
|PART I  FINANCIAL INFORMATION                                                                 |  | 3 
|                                                                                               | 
|Item 1  FINANCIAL STATEMENTS                                                                  |  | 3 
|                                                                                               | 
|Item 2  MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |  | 19
|                                                                                               | 
|Item 3  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                            |  | 26
|                                                                                               | 
|Item 4  CONTROLS AND PROCEDURES                                                               |  | 26
|                                                                                               | 
|PART II  Item 6  EXHIBITS OTHER INFORMATION                                                  |  | 28
|                                                                                               | 
|Item 1  LEGAL PROCEEDINGS                                                                     |  | 28
|                                                                                               | 
|Item 1A  RISK FACTORS                                                                         |  | 28
|                                                                                               | 
|Item 2  UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS                           |  | 38
|                                                                                               | 
|Item 3  DEFAULT UPON SENIOR SECURITIES                                                        |  | 39
|                                                                                               | 
|Item 6  EXHIBITS                                                                              |  | 40



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##### Table of Contents

PART IFINANCIAL INFORMATION

Item 1.FINANCIAL STATEMENTS

ARTISOFT, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except share and per share amounts)



|                                                                                                                                                                    |  |                  |         |   |               |   |         |  
|------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ---------------- | ------- | - | ------------- | - | ------- | -
|                                                                                                                                                                    |  | December 31,2005 |         |   | June 30, 2005 |  
|                                                                                                                                                                    |  | (Unaudited)      |         |   |               |  
|ASSETS                                                                                                                                                              |  |                  |         |   |              
|Current assets:                                                                                                                                                     |  |                  |         |   |               |   |         |  
|Cash and cash equivalents                                                                                                                                           |  | $                | 2,196   |   |               | $ | 4,880   |  
|Trade receivables, net of allowances of $770 and $423, respectively                                                                                                 |  |                  | 11,606  |   |               |   | 5,887   |  
|Inventories, net                                                                                                                                                    |  |                  | 5,457   |   |               |   | 1,686   |  
|Prepaid expenses                                                                                                                                                    |  |                  | 2,244   |   |               |   | 737     |  
|Deferred costs                                                                                                                                                      |  |                  | 3,144   |   |               |   | 2,738   |  
|Restricted cash                                                                                                                                                     |  |                  | 1,130   |   |               |   | 1,145   |  
|                                                                                                                                                                    |  |                  |         |   |               |   |         |  
|Total current assets                                                                                                                                                |  |                  | 25,777  |   |               |   | 17,073  |  
|                                                                                                                                                                    |  |                  |         |   |               |   |         |  
|Property and equipment                                                                                                                                              |  |                  | 4,602   |   |               |   | 6,114   |  
|Less accumulated depreciation and amortization                                                                                                                      |  |                  | (1,938  | ) |               |   | (4,663  | )
|                                                                                                                                                                    |  |                  |         |   |               |   |         |  
|Net property and equipment                                                                                                                                          |  |                  | 2,664   |   |               |   | 1,451   |  
|                                                                                                                                                                    |  |                  |         |   |               |   |         |  
|Goodwill                                                                                                                                                            |  |                  | 23,836  |   |               |   | 13,020  |  
|Intangible assets, net of accumulated amortization                                                                                                                  |  |                  | 7,342   |   |               |   | 3,648   |  
|Deferred costs  long term                                                                                                                                          |  |                  | 5,922   |   |               |   | 7,243   |  
|Other assets                                                                                                                                                        |  |                  | 142     |   |               |   | 263     |  
|                                                                                                                                                                    |  |                  |         |   |               |   |         |  
|Total assets                                                                                                                                                        |  | $                | 65,683  |   |               | $ | 42,698  |  
|                                                                                                                                                                    |  |                  |         |   |               |   |         |  
|LIABILITIES AND SHAREHOLDERS EQUITY                                                                                                                                |  |                  |         |   |               |   |         |  
|Current liabilities:                                                                                                                                                |  |                  |         |   |               |   |         |  
|Accounts payable                                                                                                                                                    |  | $                | 3,323   |   |               | $ | 4,134   |  
|Accrued liabilities                                                                                                                                                 |  |                  | 8,652   |   |               |   | 3,473   |  
|Deferred revenue                                                                                                                                                    |  |                  | 9,191   |   |               |   | 7,697   |  
|Customer deposits                                                                                                                                                   |  |                  | 176     |   |               |   | 176     |  
|Current portion of long term debt                                                                                                                                   |  |                  | 11,474  |   |               |   |        |  
|                                                                                                                                                                    |  |                  |         |   |               |   |         |  
|Total current liabilities                                                                                                                                           |  |                  | 32,816  |   |               |   | 15,480  |  
|                                                                                                                                                                    |  |                  |         |   |               |   |         |  
|Deferred Revenue-long term                                                                                                                                          |  |                  | 11,708  |   |               |   | 12,727  |  
|Deferred tax liability                                                                                                                                              |  |                  | 500     |   |               |   | 257     |  
|Capital lease obligations                                                                                                                                           |  |                  | 27      |   |               |   |        |  
|                                                                                                                                                                    |  |                  |         |   |               |   |         |  
|Total liabilities                                                                                                                                                   |  |                  | 45,051  |   |               |   | 28,464  |  
|                                                                                                                                                                    |  |                  |         |   |               |   |         |  
|Shareholders equity:                                                                                                                                               |  |                  |         |   |               |   |         |  
|Preferred stock, $1.00 par value, authorized 11,433,600 shares.                                                                                                     |  |                  |        |   |               |   |        |  
|Series A preferred stock, $1.00 par value, authorized 50,000 Series A shares; no Series A shares issued at December 31, 2005 or June 30,
2005.                      |  |                  |         |   |               |   |         |  
|Series B preferred stock, $1.00 par value, authorized 2,800,000 Series B shares; no Series B shares issued or outstanding at December 31,
2005 or June 30, 2005.    |  |                  |        |   |               |   |        |  
|Series C preferred stock, authorized 2,627,002 shares; no shares issued or outstanding at December 31, 2005 or June 30,
2005.                                       |  |                  |        |   |               |   |        |  
|Series D preferred stock, authorized 5,000 shares; no shares issued or outstanding at December, 2005 or June 30, 2005                                               |  |                  |        |   |               |   |        |  
|Common stock, $.01 par value per share. Authorized 50,000,000 shares; issued and outstanding 45,777,309 shares at December 31, 2005 and
36,612,765 at June 30, 2005 |  |                  | 458     |   |               |   | 366     |  
|Accumulated other comprehensive income                                                                                                                              |  |                  | (23     | ) |               |   | 4       |  
|Additional paid-in capital                                                                                                                                          |  |                  | 88,893  |   |               |   | 151,842 |  
|Accumulated deficit                                                                                                                                                 |  |                  | (68,128 | ) |               |   | (59,411 | )
|Deferred compensation                                                                                                                                               |  |                  |        |   |               |   | (8,243  | )
|Deferred Toshiba equity cost                                                                                                                                        |  |                  | (568    | ) |               |   | (644    | )
|Less treasury stock, at cost, 0 shares and 2,216,783 shares of common stock, respectively                                                                           |  |                  |        |   |               |   | (69,680 | )
|                                                                                                                                                                    |  |                  |         |   |               |   |         |  
|Net shareholders equity                                                                                                                                            |  |                  | 20,632  |   |               |   | 14,234  |  
|                                                                                                                                                                    |  |                  |         |   |               |   |         |  
|                                                                                                                                                                    |  | $                | 65,683  |   |               | $ | 42,698  |  
|                                                                                                                                                                    |  |                  |         |   |               |   |         |  

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



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ARTISOFT, INC. AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands,
except per share amounts)



|                                                                       |  |                                 |        |   |                               |   |        |      |  |        |      |  |        |  
|---------------------------------------------------------------------- |  | ------------------------------- | ------ | - | ----------------------------- | - | ------ | ---- |  | ------ | ---- |  | ------ | -
|                                                                       |  | Three Months Ended December 31, |        |   | Six Months Ended December 31, |  
|                                                                       |  | 2005                            |        |   | 2004                          |   |        | 2005 |  |        | 2004 | 
|Net revenue                                                            |  | $                               | 16,306 |   |                               | $ | 4,668  |      |  | 26,193 |      |  | 7,602  |  
|Cost of sales                                                          |  |                                 | 8,441  |   |                               |   | 934    |      |  | 12,087 |      |  | 1,299  |  
|                                                                       |  |                                 |        |   |                               |   |        |      |  |        |      |  |        |  
|Gross profit                                                           |  |                                 | 7,865  |   |                               |   | 3,734  |      |  | 14,106 |      |  | 6,303  |  
|Operating expenses:                                                    |  |                                 |        |   |                               |   |        |      |  |        |      |  |        |  
|Sales and marketing                                                    |  |                                 | 4,713  |   |                               |   | 3,359  |      |  | 8,652  |      |  | 5,157  |  
|Product development                                                    |  |                                 | 2,928  |   |                               |   | 2,338  |      |  | 5,923  |      |  | 3,211  |  
|General and administrative                                             |  |                                 | 4,834  |   |                               |   | 1,558  |      |  | 7,257  |      |  | 2,860  |  
|Amortization of intangible assets                                      |  |                                 | 302    |   |                               |   | 222    |      |  | 481    |      |  | 222    |  
|                                                                       |  |                                 |        |   |                               |   |        |      |  |        |      |  |        |  
|Total operating expenses                                               |  |                                 | 12,777 |   |                               |   | 7,477  |      |  | 22,313 |      |  | 11,450 |  
|                                                                       |  |                                 |        |  
|Loss from operations                                                   |  |                                 | (4,912 | ) |                               |   | (3,743 | )    |  | (8,207 | )    |  | (5,147 | )
|Other income, net                                                      |  |                                 | (284   | ) |                               |   | 23     |      |  | (267   | )    |  | 26     |  
|                                                                       |  |                                 |        |   |                               |   |        |      |  |        |      |  |        |  
|                                                                       |  |                                 |        |  
|Loss before provision for income tax                                   |  |                                 | (5,196 | ) |                               |   | (3,720 | )    |  | (8,474 | )    |  | (5,121 | )
|Provision for income taxes                                             |  |                                 | (159   | ) |                               |   | (84    | )    |  | (243   | )    |  | (89    | )
|                                                                       |  |                                 |        |   |                               |   |        |      |  |        |      |  |        |  
|                                                                       |  |                                 |        |  
|Net loss                                                               |  |                                 | (5,355 | ) |                               |   | (3,804 | )    |  | (8,717 | )    |  | (5,210 | )
|                                                                       |  |                                 |        |  
|Series C preferred deemed dividend                                     |  |                                 |       |   |                               |   |       |      |  |       |      |  | (1,368 | )
|Series B preferred deemed dividend                                     |  |                                 |       |   |                               |   |       |      |  |       |      |  | (100   | )
|Net loss applicable to common shareholders                             |  | $                               | (5,355 | ) |                               | $ | (3,804 | )    |  | (8,717 | )    |  | (6,678 | )
|Net loss applicable to common shareholders per sharebasic and diluted |  | $                               | (0.12  | ) |                               | $ | (0.11  | )    |  | (0.22  | )    |  | (.35   | )
|Weighted average common shares outstandingbasic and diluted           |  |                                 | 45,799 |   |                               |   | 33,981 |      |  | 40,260 |      |  | 19,344 |  

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



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ARTISOFT, INC. AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)



|                                                                                                                                                                                    |  |                               |         |   |      |   |         |  
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ----------------------------- | ------- | - | ---- | - | ------- | -
|                                                                                                                                                                                    |  | Six Months Ended December 31, |        
|                                                                                                                                                                                    |  | 2005                          |         |   | 2004 |  
|Cash flows from operating activities:                                                                                                                                               |  |                               |         |   |      |   |         |  
|Net loss                                                                                                                                                                            |  | $                             | (8,717  | ) |      | $ | (5,210  | )
|Adjustments to reconcile net loss to net cash used by operating activities:                                                                                                         |  |                               |         |   |      |   |         |  
|Depreciation and amortization                                                                                                                                                       |  |                               | 1,274   |   |      |   | 480     |  
|Amortization of deferred Toshiba equity costs                                                                                                                                       |  |                               | 76      |   |      |   | 166     |  
|Non-cash compensation                                                                                                                                                               |  |                               | 2,196   |   |      |   | 634     |  
|Deferred tax liability                                                                                                                                                              |  |                               | 243     |   |      |   | 89      |  
|Non-cash changes in accounts receivable allowances                                                                                                                                  |  |                               | 615     |   |      |   | 71      |  
|Changes in assets and liabilities:                                                                                                                                                  |  |                               |         |   |      |   |         |  
|Trade accounts receivables                                                                                                                                                          |  |                               | (3,176  | ) |      |   | (3,170  | )
|Other receivables                                                                                                                                                                   |  |                               |        |   |      |   | 4       |  
|Inventories                                                                                                                                                                         |  |                               | 769     |   |      |   | (348    | )
|Prepaid expenses                                                                                                                                                                    |  |                               | 843     |   |      |   | 283     |  
|Deferred costs                                                                                                                                                                      |  |                               | 915     |   |      |   | (3,335  | )
|Other assets                                                                                                                                                                        |  |                               | (20     | ) |      |   | (44     | )
|Accounts payable                                                                                                                                                                    |  |                               | (2,025  | ) |      |   | (4      | )
|Accrued liabilities                                                                                                                                                                 |  |                               | 2,164   |   |      |   | (358    | )
|Deferred revenue                                                                                                                                                                    |  |                               | 475     |   |      |   | 4,990   |  
|Customer deposits                                                                                                                                                                   |  |                               |        |   |      |   | (3      | )
|                                                                                                                                                                                    |  |                               |         |   |      |   |         |  
|Net cash used in operating activities                                                                                                                                               |  |                               | (4,368  | ) |      |   | (5,755  | )
|                                                                                                                                                                                    |  |                               |         |   |      |   |         |  
|Cash flows from investing activities:                                                                                                                                               |  |                               |         |   |      |   |         |  
|Cash used for acquisitions net of cash acquired                                                                                                                                     |  |                               | (19,249 | ) |      |   | (13,227 | )
|Purchases of property and equipment                                                                                                                                                 |  |                               | (556    | ) |      |   | (726    | )
|Increase in other restricted cash                                                                                                                                                   |  |                               | (251    | ) |      |   |        |  
|Restricted cash payable to Vertical Networks shareholders                                                                                                                           |  |                               |        |   |      |   | (1,000  | )
|                                                                                                                                                                                    |  |                               |         |   |      |   |         |  
|Net cash used in investing activities                                                                                                                                               |  |                               | (20,056 | ) |      |   | (14,953 | )
|                                                                                                                                                                                    |  |                               |         |   |      |   |         |  
|Cash flows from financing activities:                                                                                                                                               |  |                               |         |   |      |   |         |  
|Payments of capital lease obligations                                                                                                                                               |  |                               | (5      | ) |      |   |        |  
|Proceeds from bank term loan                                                                                                                                                        |  |                               | 2,000   |   |      |   |        |  
|Net proceeds from bank revolver facility                                                                                                                                            |  |                               | 6,903   |   |      |   |        |  
|Proceeds from issuance of common stock 26                                                                                                                                           |  |                               | 12,869  |   |      |   | 26,241  |  
|                                                                                                                                                                                    |  |                               |         |   |      |   |         |  
|Net cash provided by financing activities                                                                                                                                           |  |                               | 21,767  |   |      |   | 26,241  |  
|                                                                                                                                                                                    |  |                               |         |   |      |   |         |  
|Effect of foreign currency exchange rates                                                                                                                                           |  |                               | (27     | ) |      |   |        |  
|                                                                                                                                                                                    |  |                               |         |   |      |   |         |  
|Net (decrease) increase in cash and cash equivalents                                                                                                                                |  |                               | (2,684  | ) |      |   | 5,533   |  
|Cash and cash equivalents at beginning of period                                                                                                                                    |  |                               | 4,880   |   |      |   | 2,747   |  
|Cash and cash equivalents at end of period                                                                                                                                          |  | $                             | 2,196   |   |      | $ | 8,280   |  
|SUPPLEMENTAL CASH FLOW INFORMATION:                                                                                                                                                 |  |                               |         |   |      |   |         |  
|Non cash dividend to series C preferred shareholders                                                                                                                                |  |                               |        |   |      |   | 1,368   |  
|Non cash dividend to series B preferred shareholders                                                                                                                                |  |                               |        |   |      |   | 100     |  
|Restricted cash released to Vertical Networks shareholders                                                                                                                          |  |                               | 416     |   |      |   |        |  
|Cash paid for taxes                                                                                                                                                                 |  |                               |        |   |      |   |        |  
|Cash paid for interest                                                                                                                                                              |  |                               | 174     |   |      |   |        |  
|                                                                                                                                                                                   
|On September 28, 2004 the Company acquired the assets of Vertical Networks and on September 28, 2005 the Company acquired the assets of Comdial Corporation as follows (see
Note 4) | 
|                                                                                                                                                                                    |  |                              
|Accounts receivable                                                                                                                                                                 |  | $                             | 3,158   |   |      | $ | 3,792   |  
|Inventory                                                                                                                                                                           |  |                               | 4,540   |   |      |   | 1,308   |  
|Other current assets                                                                                                                                                                |  |                               | 2,248   |   |      |   | 315     |  
|Property and equipment                                                                                                                                                              |  |                               | 1,285   |   |      |   | 395     |  
|Other assets                                                                                                                                                                        |  |                               | 150     |   |      |   | 89      |  
|Intangible assets                                                                                                                                                                   |  |                               | 4,300   |   |      |   | 4,300   |  
|Goodwill                                                                                                                                                                            |  |                               | 9,190   |   |      |   | 13,020  |  
|Cash used in acquisitions, net of cash acquired                                                                                                                                     |  |                               | (19,249 | ) |      |   | (13,227 | )
|                                                                                                                                                                                    |  |                               |         |   |      |   |         |  
|                                                                                                                                                                                    |  |                               | 5,622   |   |      |   | 9,992   |  
|Note payable to Comdial Corporation                                                                                                                                                 |  |                               | (2,500  | ) |      |   |        |  
|Accrued direct acquisition costs                                                                                                                                                    |  |                               |        |   |      |   |        |  
|                                                                                                                                                                                    |  |                              
|Liabilities assumed                                                                                                                                                                 |  |                               | 3,122   |   |      |   | 9,992   |  

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



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##### Table of Contents

ARTISOFT, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(1) BASIS OF PRESENTATION

Artisoft, Inc., currently doing business as Vertical Communications, 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 unaudited condensed consolidated financial statements include the accounts of the Company and our wholly owned
subsidiaries. All significant 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, 2005 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, 2005. 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, 2005 on file with the SEC. The results of
operations for the three and six months ended December 31, 2005 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 recent acquisition of the assets of Comdial Corporation 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 1.

Acquisition of Vertical Networks Inc.

On September 28, 2004, we completed the acquisition of substantially all of the assets, other than patents and patent rights, of Vertical Networks Inc. (Vertical Networks), pursuant to the terms of an asset purchase
agreement entered into on September 23, 2004. 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 operational
results of this acquisition have been included in all periods since September 28, 2004, the date that the acquisition was consummated.

Acquisition
of the Assets of Comdial Corporation

On September 28, 2005, pursuant to approval of the United State Bankruptcy Court for the District of Delaware
(the Bankruptcy Court), we, through our subsidiary Vertical Communications Acquisitions Corporation (Acquisition Sub) acquired certain assets and assumed certain liabilities of Comdial Corporation (Comdial and the
Comdial Acquisition).

Comdial was a manufacturer and distributor of telephone systems targeted to small to midsize businesses, branch or
regional offices of large organizations, national retailers, government agencies, and education campuses. The purchase price consisted of $18.6 million in cash plus a $2.5 million 8% secured subordinated promissory note which matures on
September 27, 2006 (the Comdial Note). The Comdial Note is secured by all of our assets, and is junior in interest to any security interest granted with respect to any of our current or future indebtedness owed to Silicon Valley
Bank (SVB), including, without limitation, amounts owing under the debt financing, up to a maximum of $9 million plus principal amounts in connection with any existing cash secured credit extensions (including letters of credit and cash
management services) in an amount not to exceed $0.5 million. The operational results of this acquisition have been included in all periods since September 28, 2005, the date that the Comdial Acquisition was consummated.



6



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##### Table of Contents

(2) RESTATEMENT

In
September 2004, Artisoft granted stock options to its executives and employees, including new employees hired that month as a result of the acquisition of Vertical Networks. These options were granted with a strike price 15%, or 17 cents below the
price of shares sold as part of the 2004 Equity Financing which was completed at the same time at a per share price of $1.1386 per share. Initially, no stock based compensation or deferred compensation expense was recorded for these grants, and the
discount to the presumed basis of $1.1386 per share price was determined to create a non-material stock-based compensation expense under APB 25.

The
Company subsequently determined that under APB 25, in computing the intrinsic value of the stock underlying the stock options granted in September 2004, the Company should have used the undiscounted market value on the day of the grant. This value
was determined to be $2.85 per share. This intrinsic value yields a discount of $1.88 per share for the options that were granted in September 2004. This substantial discount yields an initial deferred compensation of $10.1 million, and a
stock-based compensation expense of $634 thousand per quarter based on the four year vesting schedule of the stock options in question.

The Company has
restated the financial statements for the quarters ended September 30, 2004, December 31, 2004 and March 31, 2005 to reflect the correct deferred compensation balance at the end of each quarter, as well as the stock-based
compensation expense that should have been recorded in each quarter.

The principal adjustments to restate the financial statements for the quarter ended
December 31, 2004 are as follows:

Balance Sheet

The Balance Sheet impact of the changes discussed above include a reduction of Additional Paid in Capital of $10.1 million, and increase in the Accumulated Deficit of $634 thousand and the creation of a Deferred Compensation in Shareholders
Equity of $9.5 million, all as of December 31, 2004. The unamortized deferred compensation as of June 30, 2005 was reversed upon the Companys adoption of SFAS No. 123R on July 1, 2005 (see Note 3).

Statement of Operations

The Statement of Operations impact of the
changes discussed above include an increase in Operating Expenses of $634 thousand, and a resulting increase in the Operating Loss, Net Loss and Loss Applicable to Common Shareholders of $634 thousand, for both the three and six month periods ended
December 31, 2004.

(3) 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. The modified prospective transition method requires that compensation cost be recognized in the financial statements for all
awards granted after the date of adoption as well as for existing awards for which the requisite service has not been rendered as of the date of adoption. As a part of this adoption method, prior periods are not restated. Prior to the adoption of
SFAS No. 123R, we used the intrinsic-value based method to account for stock options and made charges against earnings with respect to options granted.

Prior to July 1, 2005, the Company applied Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employeesin accounting for its stock incentive plan and accordingly, compensation cost
was recognized for its stock options in the financial statements when the exercise price was below the fair market value. During the three and six months ended December 31, 2004, $634 thousand of stock-based compensation cost was recorded under
the intrinsic value based method. Had the Company determined compensation cost in all periods based on the fair value at the grant date for its stock options under SFAS No. 123R, the Companys net loss and net loss per common equivalent
share for the three and six months ended December 31, 2005, and 2004 would have been increased to the pro forma amounts indicated below (in thousands, except per share prices):



|                                                                                   |  |                                 |        |   |                              |   |        |      |  |   |        |   |  |   |        |  
|---------------------------------------------------------------------------------- |  | ------------------------------- | ------ | - | ---------------------------- | - | ------ | ---- |  | - | ------ | - |  | - | ------ | -
|                                                                                   |  | Three Months Ended December 31, |        |   | Six Months EndedDecember 31, |  
|                                                                                   |  | 2005                            |        |   | 2004                         |   |        | 2005 |  |   | 2004   |  
|Reported net loss applicable to common shareholders                                |  | $                               | (5,355 | ) |                              | $ | (3,804 | )    |  | $ | (8,717 | ) |  | $ | (6,678 | )
|Stock based compensation expense included in reported net loss                     |  | $                               | 1,028  |   |                              | $ | 634    |      |  | $ | 2,196  |   |  | $ | 634    |  
|Stock based compensation expense determined under fair value method for all awards |  | $                               | (1,028 | ) |                              | $ | (1,238 | )    |  | $ | (2,196 | ) |  | $ | (1,649 | )
|Pro forma net loss applicable to common shareholders                               |  | $                               | (5,355 | ) |                              | $ | (4,408 | )    |  | $ | (8,717 | ) |  | $ | (7,693 | )
|Reported loss per share applicable to common shareholders                          |  | $                               | (.12   | ) |                              | $ | (.11   | )    |  | $ | (0.22  | ) |  | $ | (.35   | )
|Pro forma loss per share applicable to common shareholders                         |  | $                               | (.12   | ) |                              | $ | (.13   | )    |  | $ | (0.22  | ) |  | $ | (.40   | )



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The adoption of SFAS No. 123R reduced income from operations and net income for the three and six months ended
December 31, 2005 by $1.0 million ($0.02 per basic and diluted share) and $2.2 million ($0.05) per basic and diluted share), respectively. The adoption of this Statement had no effect on the Statement of Cash Flows for the six months ended
December 31, 2005.

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



|                           |  |                                 |       |                               |   |      |  |             |       |  |   |    
|-------------------------- |  | ------------------------------- | ----- | ----------------------------- | - | ---- |  | ----------- | ----- |  | - | ---
|                           |  | Three Months Ended December 31, |       | Six Months Ended December 31,
|                           |  | 2005                            |       | 2004                          |   | 2005 |  | 2004       
|                           |  |                                 |       | As Restated                   |   |      |  | As Restated
|Sales and marketing        |  | $                               | 237   |                               | $ | 205  |  | $           | 506   |  | $ | 205
|Product development        |  | $                               | 339   |                               | $ | 281  |  | $           | 724   |  | $ | 281
|General and administrative |  | $                               | 452   |                               | $ | 148  |  | $           | 966   |  | $ | 148
|                           |  |                                 |       |                               |   |      |  |             |       |  |   |    
|Total                      |  | $                               | 1,028 |                               | $ | 634  |  | $           | 2,196 |  | $ | 634

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 2.08333% 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:



|                        |  |             |   |  |             |  
|----------------------- |  | ----------- | - |  | ----------- | -
|                        |  | Fiscal 2006 |   |  | Fiscal 2005 |  
|Expected dividend yield |  | 0           | % |  | 0           | %
|Volatility factor       |  | 115         | % |  | 115         | %
|Risk free interest rate |  | 4.1         | % |  | 3.45        | %
|Expected life           |  | 6 Years     |   |  | 6 Years     |  

For the three months ended December 31, 2005 stock options issued, exercised and forfeited were 0,29,605 and
402,467, respectively. For the six months ended December 31, 2005, stock options issued, exercised and forfeited were 0,61,180 and 533,488 respectively.

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, 2005, 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.

(4) ACQUISITIONS AND RELATED FINANCINGS

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. 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 $5.5 million. The earnout obligation is equal to the first $5.5 million of
non-refundable software license revenues collected by us from CVS Pharmacy, Inc. (CVS) in connection with a specific contract which provided CVS with software to be used in connection with, among other things, a rapid prescription refill
project that CVS is implementing. We have paid $0.7 of the earn-out provision and accrued an additional $1.2 million of the earn-out provision to date, all of which is included in the purchase price table below. The balance of the potential
earn-out, $3.6 million has been excluded. As of December 31, 2005, we made a $0.6 million claim against the escrow and released the balance to Vertical Networks. The $0.6 million held in escrow is presented on the Consolidated Balance Sheet as
Restricted Cash and the $0.4 million that was released is included in the table below. The remaining contingent payments will be recorded as a component of the purchase price if and when the related contingencies are resolved.

The acquisition was financed with a portion of the proceeds from a common stock financing completed pursuant to a stock purchase agreement executed on September 28,
2004 (the 2004 Stock Purchase Agreement) in two tranches on September 28, 2004 and October 1, 2004 (the



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##### Table of Contents

2004 Equity Financing). We sold a total of 24,159,468 shares of our common stock at a per share purchase price of $1.1386 per share to several
investors, including M/C Venture Partners V, L.P. and its affiliates (collectively M/C Venture Partners), for net proceeds of $25.8 million, net of issuance costs of $1.7 million, of which $1.3 million was cash-based and $0.4 million was
in the form of a warrant. The warrant was to purchase 168,542 shares of common stock, has an exercise price of $2.85 per share, and expires 5 years from the date of issuance. The warrant was payment in lieu of cash for investment banking services
performed during the 2004 Equity Financing. We recorded the fair value of the warrant, $0.4 million, as a reduction of the proceeds from the 2004 Equity Financing. 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 3.45%; volatility of 115% and a contractual life of 5 years.

In connection with, or prior to the 2004 Equity Financing, the holders of all shares of our preferred stock converted those shares into common stock. Following the issuance and sale of common stock in the 2004 Equity Financing and the
conversions of our preferred stock to common stock, as at December 31, 2005, M/C Venture Partners is the largest beneficial holder of our common stock, currently with a 48.5% beneficial ownership interest.

We agreed to register, under the Securities Act of 1933, as amended (the Securities Act), the shares issued and sold in the 2004 Equity Financing, for resale
by the investors in this financing (the 2004 Investors). We agreed to file with the SEC the registration statement with respect to this registration by November 12, 2004 and to use our best efforts to cause the registration
statement to become effective on or before December 31, 2004. Since the registration statement was not declared effective by the SEC prior to March 31, 2005, we were required to pay each 2004 Investor monthly liquidated damages in an
amount equal to 1% per month of the aggregate purchase price paid by each investor under the purchase agreement (not to exceed 9% of such purchase price, in the aggregate). Commencing in April 2005, the fee resulting from each month of delay in
achieving effective registration of the shares was $275,000 per month, and accordingly, we have recorded an expense and corresponding accrual of $1,375,000 through August 2005.

In lieu of a payment of the accrued liquidated damages under the 2004 Equity Financing, we issued warrants for the purchase of our common stock on September 28, 2005 to the 2004 Investors (the New
Warrants). Each New Warrant has a term of exercise expiring on September 28, 2010. The number of shares issuable upon exercise is subject to adjustment in the case of any stock dividend, stock split, combination, capital reorganization,
reclassification or merger or consolidation. The New Warrants are exercisable at any time prior to the expiration date by delivering the warrant certificate to us, together with a completed election to exercise and payment of the exercise price,
which is equal to $0.01 per share of common stock. The New Warrants contain a net exercise feature under which we do not receive any cash, but rather, the number of shares issued upon exercise is net of the number of shares withheld by
us pursuant to a formula, with the result that if all holders of New Warrants elect to use the net exercise feature, we would issue an aggregate of 1,202,728 shares of common stock. Upon the filing of the certificate of amendment to effect an
amendment to our Certificate of Incorporation to increase the authorized number of our common stock to 250,000,000 shares, allowing us to issue shares to fulfill the exercise of the New Warrants (the Capitalization Amendment), the New
Warrants will be automatically exercised in a cashless exercise. If the Capitalization Amendment is not completed by April 15, 2006 the holders of the New Warrants will be entitled to a cash settlement in the amount of $1,375,000 in lieu of
warrants. In accordance with Emerging Issues Task Force Issue 00-19 Accounting for Derivative Financial Instruments Indexed to and Potentially Settled in a Companys Own Stock we have recorded the New Warrants as an accrued liability in
the amount of $1,375,000 at December 31, 2005.

We also made other customary agreements regarding this registration, including matters relating to
indemnification; maintenance of the registration statement; payment of expenses; and compliance with state blue sky laws.

We also agreed to
several negative covenants under the 2004 Stock Purchase Agreement. Our negative covenants relate to obligations not to, without the prior consent of M/C Venture Partners, enter into a transaction involving a change in control of our company; incur
indebtedness in excess of $3.0 million; create any security with an equity component unless that security is junior to the common stock or, subject to specified exceptions, issue any equity securities; transfer our intellectual property; repurchase,
redeem or pay dividends on any shares of capital stock (subject to limited exceptions); grant stock options that are not authorized by a vote of the board of directors or our compensation committee; liquidate or dissolve; change the size of our
board of directors; amend our certificate of incorporation or bylaws; change the nature of our business; or alter the voting rights of shares of our capital stock in a disparate manner. We believe that we are in compliance with all covenants other
than the registration covenant described above.

The following table represents the allocation of the purchase price for our acquisition of Vertical
Networks over the fair value of the assets acquired and liabilities assumed at the date of acquisition. The fair value of the identified intangible assets and the deferred revenue below were obtained using third party valuations.



|                          |  |                             |      |  
|------------------------- |  | --------------------------- | ---- | -
|                          |  | Values at December 31, 2005 |     
|                          |  | (millions)                  |     
|Cash                      |  | $                           | 0.3  |  
|Accounts receivable net   |  |                             | 3.8  |  
|Inventory, net            |  |                             | 1.3  |  
|Other current assets      |  |                             | 0.3  |  
|Property and equipment    |  |                             | 0.4  |  
|Other Assets              |  |                             | 0.1  |  
|Intangible assets         |  |                             | 4.3  |  
|Goodwill                  |  |                             | 14.6 |  
|Accounts payable          |  |                             | (4.8 | )
|Accrued expenses          |  |                             | (2.3 | )
|Other current liabilities |  |                             | (0.3 | )
|Deferred revenue          |  |                             | (2.6 | )
|                          | 
|Total Purchase Price      |  | $                           | 15.1 |  



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The values of current assets and liabilities were based upon their historical costs in the hands of the seller, Vertical
Networks, on the date of acquisition due to their short-term nature. 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 closely approximated fair value. The estimated value of deferred revenue was based upon the guidance in EITF 01-03, Accounting in a Business Combination for Deferred Revenue of an Acquiree,and was calculated as the estimated cost
for us to fulfill the contractual obligations acquired under various customer contracts plus a fair value profit margin. Of the sellers recorded deferred revenue of $6.6 million, we determined that only $2.6 million met the standard set by
EITF 01-03 as representing assumed legal obligations; the balance of the deferred revenue, representing mostly customer payments with no remaining obligations, was not recorded by us. The excess purchase price was allocated to goodwill based upon
the following factors: the value acquired in the form of additional scale and economies of scale resulting from the size of the combined entity, and the value of the assembled workforce, especially the engineering and sales talent personnel who have
continued as part of the acquired operation. The benefits of added scale and the economics resulting therefrom was a primary reason for the acquisition, along with the talents of the acquired personnel and the ability to leverage existing, owned
technology over the acquired products.

The following pro forma unaudited condensed financial information gives effect to our acquisition of Vertical
Networks as if it had occurred on July 1, of each period presented. The following information is based on historical results of our operations for the three months ended December 31, 2005 and 2004 and of Vertical Networks for the same
historical period. The pro forma financial information is presented for illustrative purposes only and is not necessarily indicative of the results of operations of the consolidated company that would have actually occurred had the acquisition of
Vertical Networks been effected as of July 1, 2004.



|                                                        |  |                                    |   |  |                   |   |  |                       |   |  |                       |  
|------------------------------------------------------- |  | ---------------------------------- | - |  | ----------------- | - |  | --------------------- | - |  | --------------------- | -
|                                                        |  | Six Months Ended December 31, 2004 |  
|                                                        |  | Artisoft                           |   |  | Vertical Networks |   |  | Pro Forma Adjustments |   |  | Pro Forma as Adjusted |  
|Net product revenue                                     |  | 7,602                              |   |  | 3,923             |   |  | (447                  | ) |  | 11,078                |  
|Net (loss)/income                                       |  | (5,210                             | ) |  | (1,181            | ) |  | (602                  | ) |  | (6,359                | )
|                                                        |  |                                    |   | 
|Net (loss)/income applicable to common shareholders     |  | (6,678                             | ) |  | (1,181            | ) |  | (602                  | ) |  | (7,827                | )
|Net loss applicable to common stock  Basic and Diluted |  | (0.34                              | ) |  | (0.25             | ) |  |                       |   |  | (0.40                 | )

The following adjustments have been reflected in the above pro forma condensed financial information to adjust
Vertical Networks historical reported revenues from the sale of telephone systems to the amount that would have been reported under our revenue recognition policy:

(a) In 2002 and 2003, Vertical Networks entered into multiple element arrangements consisting of an extended warranty arrangement, software license agreements with rights for updates and upgrades on a when and if
available basis and an agreement to specify pricing of uncommitted future telephone systems. Under Vertical Networks policy, the extended warranty and software license arrangements were recognized over the term of the arrangements. The
telephone system pricing agreement was assessed for significant and incremental discounts and future telephone systems were recognized upon shipment if all other revenue recognition criteria of SAB 104 had been met.

Under our revenue recognition policy, the software license agreement for the telephone systems core software that provides when and if available updates and
upgrades (extended software support arrangement) and the telephone system sales are considered multiple element arrangements. The extended software support agreement would apply to all previous and future system sales. As Vertical
Networks had not historically sold extended software support separately to other customers or on a renewal basis, sufficient vendor-specific objective evidence of fair value does not exist to allocate the arrangement fee to the systems and the
extended software support arrangement. Accordingly, the fee for previous and future system sales considered to be part of a multiple element arrangement, or combined unit of accounting, with the extended software support arrangement is recognized
ratably over the term of the extended software support arrangement along with the extended support fee and related costs of these sales. The pro forma adjustment reduces revenues and net income (loss) to the amount that would have been recognized
under our policy in order to provide a better indication of what the results of operations would have been had the transaction



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occurred at the beginning of the period presented. For historical reporting purposes the deferred revenue and related deferred costs which are approximately
$16.9 million and $9.6 million, for the year ended June 30, 2005 will be amortized over a period of up to sixteen quarters or four years.

(b) Prior
to the our acquisition of Vertical Networks, Vertical Networks had deferred revenue relating to certain software licenses, extended software support arrangements and an extended hardware warranty arrangement over the terms of the support
arrangements. We evaluated its legal obligation that would have been assumed under these contracts if the acquisition had occurred on July 1, 2003 and estimated the fair value of this assumed liability. In arriving at the pro forma adjusted
numbers above, the recorded value of the deferred revenue on July 1, 2003 was reduced by $5.4 million to reflect the fair value of the deferred revenue and the related amortization to revenue was similarly reduced by $0.2 million per quarter.

The value of intangible assets we acquired as part of the acquisition of Vertical Networks was based upon the fair value of those assets on the
acquisition date. Three amortizable intangible assets were identified: existing technology, existing customer contracts, and other anticipated revenue from existing customers. The total amortizable intangible assets value was determined to be $4.3
million, and each of the three elements of the intangible assets were determined to have a 5 year life. Accordingly, these intangible assets will be amortized over a 5 year period. The pro-forma adjustment reflects this amortization over the periods
presented.

(c) An income tax expense has been recorded against earnings to reflect the tax benefit received from amortizing goodwill for income tax
purposes over a 15 year life. All periods presented include this tax charge.

Comdial Corporation

On September 28, 2005, we completed the acquisition of substantially all of the assets of Comdial (the Comdial Assets) from Comdial, pursuant to the
terms of an asset purchase agreement entered into on September 1, 2005.

The Comdial Assets include 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 which matures on the first anniversary of the closing date, (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 includes $6.0 million in open
purchase order obligations.

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



|                          |  |                                             |      |  
|------------------------- |  | ------------------------------------------- | ---- | -
|                          |  | Fair Values at December 31, 2005 (millions) |     
|Cash                      |  | $                                           | 0.2  |  
|Accounts Receivable, net  |  | $                                           | 3.2  |  
|Inventory, net            |  | $                                           | 4.5  |  
|Other Current Assets      |  | $                                           | 2.2  |  
|Property and Equipment    |  | $                                           | 1.3  |  
|Intangible assets         |  | $                                           | 4.3  |  
|Goodwill                  |  | $                                           | 9.2  |  
|Accounts Payable          |  | $                                           | (0.2 | )
|Accrued Expenses          |  | $                                           | (1.0 | )
|Other Current Liabilities |  | $                                           | (1.9 | )
|                          |  |                                             |      |  
|Net assets acquired       |  | $                                           | 21.8 |  
|                          |  |                                             |      |  



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The values of current assets and liabilities were based upon their historical costs on the date of acquisition due to
their short-term nature. Property and equipment was also valued 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 excess purchase price was recorded to goodwill based upon the following factors: the value acquired in the form of additional scale and economies of
scale resulting from the size of the combined entity, the value of the assembled workforce, especially the sales, engineering and operations personnel who have continued as part of the acquired business and the ability to leverage existing, owned
technology over the acquired products.

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 |  | $              | 200   |            | 1 
|Customer relationships |  | $              | 3,300 |            | 10
|Existing technology    |  |                | 800   |            | 5 
|                       |  |                |       |            |   
|                       |  | $              | 4,300 |            |   
|                       |  |                |       |            |   

The amounts assigned to identifiable intangible assets acquired was based on their respective fair values
determined as of the acquisition date. The valuation is preliminary and is subject to change. The excess of the purchase price over the tangible and identifiable intangible assets was recorded as goodwill and amounted to approximately $9.2 million.
In accordance with current accounting standards, the goodwill is not being amortized and will be tested for impairment annually in the fourth quarter of our fiscal year, as required by SFAS No. 142 or more often if impairment indicators arise.

The following pro forma unaudited condensed financial information gives effect to our acquisition of Comdial as if it had occurred on July 1, of each
period presented. The following information is based on historical results of our operations for the three and six months ended December 31, 2005 and 2004 and of Comdial for the same historical period. The pro forma financial information is
presented for illustrative purposes only and is not necessarily indicative of the results of operations of the consolidated company that would have actually occurred had the acquisition of Comdial been effected as of July 1 for each period
presented. The unaudited pro forma combined financial data and related notes thereto should be read in conjunction with our Managements Discussion and Analysis of Financial Condition and Results of Operations as previously filed on our Form
10-K for the year ended June 30, 2005 and the historical consolidated financial statements of Comdial as filed in our Form 8-K/A filed November 14, 2005.



|                                                        |  |                                               |          |  |                                      |         |  |        |                      |  |      |                               |  |        |  
|------------------------------------------------------- |  | --------------------------------------------- | -------- |  | ------------------------------------ | ------- |  | ------ | -------------------- |  | ---- | ----------------------------- |  | ------ | -
|                                                        |  | Three Months Ended December 31, 2005
Combined |          |  | Three Months Ended December 31, 2004 |        
|                                                        |  |                                               | Artisoft |  |                                      | Comdial |  |        | Pro Forma Adjustment |  |      | CombinedPro Forma as Adjusted | 
|Net product revenue                                     |  | 16,306                                        |          |  | 4,668                                |         |  | 9,293  |                      |  |      |                               |  | 13,961 |  
|Net (loss)/income                                       |  | (5,355                                        | )        |  | (3,804                               | )       |  | (2,496 | )                    |  | (409 | )                             |  | (6,709 | )
|Net (loss)/income applicable to common shareholders     |  | (5,355                                        | )        |  | (3,804                               | )       |  | (2,496 | )                    |  | (409 | )                             |  | (6,709 | )
|Net loss applicable to common stock  Basic and Diluted |  | (0.12                                         | )        |  | (0.11                                | )       |  |        |                      |  |      |                               |  | (0.20  | )



|                                                    |  |                                    |   |  |                                    |   |  |                       |   |  |                       |   |  |          |   |  |         |   |  |                      |   |  |                       |  
|--------------------------------------------------- |  | ---------------------------------- | - |  | ---------------------------------- | - |  | --------------------- | - |  | --------------------- | - |  | -------- | - |  | ------- | - |  | -------------------- | - |  | --------------------- | -
|                                                    |  | Six Months Ended December 31, 2005 |   |  | Six Months Ended December 31, 2004 |  
|                                                    |  | Artisoft                           |   |  | Comdial                            |   |  | Pro Forma Adjustments |   |  | Pro Forma as Adjusted |   |  | Artisoft |   |  | Comdial |   |  | Pro Forma Adjustment |   |  | Pro Forma as Adjusted |  
|Net product revenue                                 |  | 26,193                             |   |  | 8,969                              |   |  |                       |   |  | 35,162                |   |  | 7,602    |   |  | 21,206  |   |  |                      |   |  | 28,808                |  
|Net (loss)/income                                   |  | (8,717                             | ) |  | (2,806                             | ) |  | (409                  | ) |  | (11,932               | ) |  | (5,210   | ) |  | (3,128  | ) |  | (818                 | ) |  | (9,156                | )
|(Loss)/income applicable to common shareholders     |  | (8,717                             | ) |  | (2,806                             | ) |  | (409                  | ) |  | (11,932               | ) |  | (6,678   | ) |  | (3,128  | ) |  | (818                 | ) |  | (10,624               | )
|Loss applicable to common stock  Basic and Diluted |  | (0.22                              | ) |  |                                    |   |  |                       |   |  | (0.30                 | ) |  | (0.35    | ) |  |         |   |  |                      |   |  | (0.55                 | )



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The pro forma adjustments include the amortization expense for the acquired identifiable intangible assets, of
approximately $0.1 million per quarter, and the interest expense for the amounts borrowed to finance the acquisition of approximately $0.2 million. An income tax expense has been recorded on the goodwill valuation of $9.2 million over a 15 year lie.
All periods presented include this tax charge.

(5) LIQUIDITY

We have incurred losses and negative cash flows from operations in every fiscal period since 1996 and have an accumulated deficit, including non-cash equity charges, of $68 million as of December 31, 2005.
For the three months ended December 31, 2005 we incurred a net loss of approximately $5.4 million and negative cash flows from operations of approximately $4.4 million. Our management expects that operating losses and negative cash flows will
continue in the near future. As a result of the projected negative cash flow trends and in order to finance operating activities, management determined that we required an additional capital infusion to support our negative cash flow from
operations. Accordingly, on February 9, 2006, we completed the sale of 5,000 shares of preferred stock resulting in aggregate proceeds to the company of $5.0 million. Please see Note 13 Subsequent Events for a complete description
of this financing. We anticipate that, with the proceeds of this equity offering and available cash of $2.2 million at December 31, 2005, we will meet our anticipated cash requirements for the next twelve months. We will also utilize
available borrowing under a revolving line of credit with SVB. Please see Note 10 Debt for details on this line of credit. Management hopes to increase our revenue and improve our cash flows in the foreseeable future. However, there
can be no assurance that the available cash and increased revenues, if we are able to achieve them, will be sufficient to meet our cash requirements. If we are unable to satisfy such cash requirements from these sources, our ability to continue as a
going concern and to achieve our intended business objectives could be adversely affected. In such case, we could be required to adopt one or more alternatives, such as reducing or delaying marketing and promotional activities, reducing or delaying
capital expenditures, developing restructuring plans to reduce discretionary costs deemed nonessential, and raising additional cash through the sale of our capital stock or increasing our debt. There can be no assurance that any such additional
financing will be available when needed or on acceptable terms to allow us to successfully achieve our operating plan or fund future investment in our product lines.

(6) PREFERRED STOCK

Series A Preferred Stock.Prior to September 28, 2004, we had authorized 11,433,600
shares of preferred stock par value $1.00 per share, of which 5,427,002 shares had been issued as of June 30, 2004. On December 6, 1994, our board of directors authorized the designation and reservation of 50,000 shares of preferred stock
as Series A Participating Preferred Stock subject to a Rights Agreement dated December 23, 1994. The reserved shares were to be automatically adjusted to reserve such number of shares as may be required in accordance with the
provisions of the Series A Participating Preferred Stock and the Rights Agreement. The Rights Agreement was to expire in December 2004. In connection with the issuance of the Series B convertible preferred stock in 2001, our board of directors
terminated the Rights Agreement effective December 31, 2001.

2001 Financing Series B Preferred Stock.In August and November 2001, we issued
and sold an aggregate of 2,800,000 shares of our Series B convertible preferred stock (the Series B Preferred Stock) to investors in a private placement at a per share price equal to $2.50. The investors also received warrants to purchase
up to 466,666 shares of our common stock at an initial per share exercise price equal to $1.50 (the 2001 Warrants). Gross proceeds from the financing were $7.0 million.

Each share of Series B preferred stock was initially convertible into one-sixth of a share of common stock, subject to adjustment. Under certain circumstances, we had the right to effect the automatic conversion of
the Series B Preferred Stock to common stock in the event the closing per share bid price of the common stock exceeds $30.00 for 30 consecutive trading days. Prior to the 2004 Equity Financing, all shares of Series B Preferred Stock were
converted to common stock.

The holders of the Series B Preferred Stock, as a class, were also initially entitled to elect two of our directors. In August
2002, the holders of our series B Preferred Stock exercised this right, in part, to elect Robert J. Majteles one of our directors.

The 2001
Warrants will expire on September 30, 2006. The expiration date, the per share exercise price and the number of shares issueable upon exercise of the 2001 Warrants were initially subject to adjustment in certain events. Following the 2004
Equity Financing, the per share exercise price of the 2001 Warrants is $1.1386, and the per share exercise price and the number of shares issueable upon exercise of the 2001 Warrants are no longer subject to adjustment. The 2001 Warrants have a call
provision that provides that if the closing per share bid price of the common stock exceeds $45.00 for 30 consecutive trading days and certain other conditions are met, we have the right to require the 2001 Warrant holders to exercise their warrants
for Common Stock.

The closing of the issuance and sale of shares of common stock in our September 2002 financing, a private placement of restricted common
stock, resulted in anti-dilution adjustments to the Series B Preferred Stock and the 2001 Warrants. As a result of these anti-dilution adjustments, each share of Series B Preferred Stock was convertible into approximately 2.38 shares of common
stock. Prior to the issuance and sale of shares of common stock under this agreement each share of Series B Preferred Stock was convertible into one share of common stock. In addition, the per share exercise price of each 2001 Warrant was reduced
from $3.75 to $1.05. These adjustments resulted in a significant increase in potential common shares outstanding. Prior to the 2004 Equity Financing, the remaining outstanding Series B Preferred Stock was converted into common stock at a rate
of approximately 1.22 shares of common stock for each share of Series B Preferred Stock.

2003 Financing, Series C Preferred Stock. In
September 2003, we issued and sold an aggregate of 2,627,002 shares of Series C convertible preferred stock (the Series C Preferred Stock) to investors in a private placement at a per share price equal to $1.50. The investors also



13



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received warrants to purchase up to 2,627,002 shares of our common stock at a per share exercise price equal to $1.88 (the 2003 Warrants). Gross
proceeds from the financing were $3.9 million.

The shares of Series C Preferred Stock were initially convertible into a like number of shares of Common
Stock, subject to adjustment. Each share of Series C Preferred Stock generally received .8152 of a vote, subject to adjustment, when voting on matters presented for the approval of our stockholders. The holders of the Series C Preferred Stock, as a
class, were also entitled to elect one of our directors. In September 2003, the holders of our Series C Preferred Stock exercised this right to elect Steven C. Zahnow as a director.

The holders of Series C Preferred Stock were entitled, before any distributions were made to the holders of Common Stock, to an amount equal to $1.50 per share, subject to adjustment. For purposes of this liquidation
preference, the Series C Preferred Stock ranked on parity with the Series B Preferred Stock, which carried a similar liquidation preference in the amount of $2.50 per share.

The holders of the Series C Preferred Stock were entitled to receive dividends only when and if declared by our board of directors. Any such dividends were to be paid to the holders of the Series C Preferred Stock and
Series B Preferred Stock prior to any distribution to holders of common stock, on a per share basis equal to the number of shares of Common Stock into which each share of preferred stock is then convertible.

The 2003 Warrants will expire on June 27, 2010. The expiration date, the per share exercise price and the number of shares issuable upon exercise of the 2003
Warrants were initially subject to adjustment in certain events. Following the September 2004 Equity Financing, the per share exercise price of the 2003 Warrants is $1.1386, and the per share exercise price and the number of shares issuable upon
exercise of the 2003 Warrants are no longer subject to adjustment. Prior to the 2004 Equity Financing, the remaining outstanding Series C Preferred Stock was converted into Common Stock at a rate of one share of Common Stock for each share of Series
C Preferred Stock.

As a result of the sale of Common Stock in the 2004 Equity Financing, the exercise price of all of the 2001 and 2003 Warrants was
reduced to $1.1386 per share pursuant to the terms of those warrants. Immediately prior to the sale of Common Stock under the 2004 Stock Purchase Agreement, the exercise price of the 2001 Warrants was $1.50 per share, and the exercise price of the
2003 Warrants was $1.88 per share. The reduction of the exercise price of these warrants resulted in the recording of a non-cash deemed dividend equal to approximately $1.5 million in the first quarter of fiscal 2005. Additionally, under a consent,
amendment and waiver agreement, (the 2004 Consent), all warrants issued in the 2001 and 2003 financings were amended to delete the price protection provisions of those warrants. Therefore, as so amended, the per share exercise price of
those warrants will no longer be subject to adjustment in the event of future sales of our securities, except for customary adjustments for stock splits, dividends, recapitalizations and other similar transactions.

(7) 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, 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 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 per share purchase price of $1.1386, under the terms of the 2005 Stock Purchase Agreement. Following the issuance and sale of common stock in the financing and the conversions of ours preferred stock to common stock, M/C Venture
Partners continues as the largest beneficial holder of our common stock, with a 48.7% beneficial ownership interest.

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);
|- |  | -------------------------------------------------------------------------------



| |  | 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; and
|- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | the 2004 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). We agreed, among other things, to propose the Capitalization Amendment. 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
|- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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| | covering the resale of the shares of our common stock purchased pursuant to the 2004 Stock Purchase Agreement (the Liquidated Damages);
(ii) amended provisions relating to rights of first refusal, issuances of equity securities and restrictions on indebtedness with respect to the entry into the agreements with SVB, solely for purposes of effecting the transactions contemplated
by the 2005 Stock Purchase Agreement; (iii) changing 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
(iv) in lieu of the cash payment of the Liquidated Damages, we agreed to issue the New Warrants to the 2004 Investors.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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

Further, if (1) the Capitalization Amendment is not effective as of April 15, 2006, and (2) M/C Venture Partners and Special
Situations Fund and its affiliates (collectively SSF) have voted their shares of Common Stock in favor of the Capitalization Amendment, which they are obligated to do under the terms and conditions of voting agreements each of M/C
Venture Partners and SSF entered into with us (the Voting Agreements), then the Liquidated Damages will be paid in cash by wire transfer of immediately available funds to each of the parties and upon payment thereof, and the New Warrants
issued in satisfaction of the Liquidated Damages will expire unexercised. If the Capitalization Amendment is not completed by April 15, 2006 the holders of the New Warrants will be entitled to a cash settlement in the amounts of $1,375,000 in
lieu of warrants.

(8) 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.



|                                                                                  |  |                                 |  |                               |  |        |  |      
|--------------------------------------------------------------------------------- |  | ------------------------------- |  | ----------------------------- |  | ------ |  | -----
|                                                                                  |  | Three Months Ended December 31, |  | Six Months Ended December 31,
|                                                                                  |  | 2005                            |  | 2004                          |  | 2005   |  | 2004 
|Antidilutive potential common shares excluded from net loss per share (thousands) |  | 9,319                           |  | 3,721                         |  | 10,184 |  | 6,597

(9) 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 specifications in effect at the time of delivery of the
products to the customer for one year, with the exception of shipments to one customer which was offered warranties that expire sixteen months after the date of shipment, and there are extended warranty agreements with other customers that allows
those customers to submit warranty claims after the initial one-year period. We have no liabilities recorded for these agreements since any warranty claims will be expensed as they occur to match the associated deferred revenue amortization. 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.

(10) DEBT

The Company financed a portion of the purchase price for the Comdial Assets (the 2005 Debt Financing) by entering into a loan agreement with SVB on
September 28, 2005 (the SVB Loan Agreement). The SVB Loan Agreement terms provide the Company with a revolving line



15



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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 matures and the principal balance thereof is payable in full, on September 27, 2006. The Term Loan is 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. Borrowing availability under the Revolving Loan is based on the amount of the Companys accounts receivable.

For both the Term Loan and the Revolving Loan, interest shall accrue at a rate per annum equal to the Prime Rate in effect from time to time, plus 1.50% per annum. However during the period beginning on September 28,
2005 and continuing until September 30, 2006, interest under the Term Loan shall accrue a rate per annum equal to the Prime Rate in effect from time to time plus 2.00% per annum. Thereafter, interest shall accrue on the Term
Loan at a rate equal to the Prime Rate in effect from time to time, plus (a) 2.00% per annum if the Companys previous quarters Fixed Charge Coverage Ratio (FCCR) is less than or equal to 2.00 to 1.00, or
(b) 1.50% per annum if the Companys previous quarters FCCR is greater than or equal to 2.00 to 1.00, each as determined by SVB in accordance with generally accepted accounting principles. Pricing adjustments shall be effective
no later than three business days after SVBs receipt of satisfactory financial reporting and shall remain effective until receipt by SVB of financial statements for such next successive quarter. Interest in all circumstances shall be
calculated on the basis of a 360-day year for the actual number of days elapsed. Prime Rate means the greater of (i) 6.50%, or (ii) the rate announced from time to time by SVB as its prime rate; it is a base rate
upon which other rates charged by SVB are based, and it is not necessarily the best rate available at SVB. The interest rate applicable to the outstanding obligations shall change on each date there is a change in the Prime Rate. Regardless of the
amount of obligations that may be outstanding from time to time under the SVB Loan Agreement, the Company is obligated to make minimum monthly interest payments to SVB equal to $15,000 during the term of this Agreement.

The Companys obligations under the SVB Loan Agreement are secured by all of the assets of the Company, including the Comdial Assets. These include accounts
receivable, inventory, equipment, intellectual property, all claims, credit balances, proceeds (including proceeds of any insurance policies, proceeds of proceeds and claims against third parties), and all products, books and records related to such
assets.

On September 28, 2005 (the Closing Date) we also executed a secured promissory note in the aggregate principal amount of
$2,500,000 (the Comdial Note). The Comdial Note bears interest at the rate of 8% per annum and matures on the first anniversary of the Closing Date. The Comdial Note is secured by all our assets, and is junior in interest to any
security interest granted with respect to any current or future indebtedness of the Company owed to SVB, including, without limitation, amounts owing under the 2005 Debt Financing, up to $9,000,000 plus principal amounts in connection with any
existing cash secured credit extensions (including letters of credit and cash management services) in an amount not to exceed $500,000.

The SVB Loan
Agreement contains certain financial covenants related to net worth and minimum cash balances. During the first quarter of 2006, the Company was not able to comply with the net worth covenant in the existing agreement. As a result of this default,
the Bank may cease making loans and could accelerate and declare all amounts due. Consequently as of September 30, 2005, all of the SVB debt was classified as short term in our Condensed Consolidated Balance Sheet. Subsequently, the Company
obtained a loan modification agreement from the Bank which adjusted the net worth covenant which the Company was in compliance with. During the second quarter of 2006, the Company was not able to comply with the net worth covenant but has obtained a
waiver from the Bank. The Bank agreed to forbear from exercising its rights and remedies as a result of the default at December 31, 2005. Although the Company obtained a waiver from SVB with regard to the covenant default at December 31, 2005,
the debt remains classified as short term in our Condensed Consolidated Balance Sheet as there can be no assurance that the Company will be in compliance with the covenants in subsequent quarters.

(11) INVENTORIES

Inventories at December 31, 2005 and
June 30, 2005, net of obsolescence reserves of $2.8 million and $0.8, respectively, consist of the following (in thousands):



|               |  |                   |       |               |   |      
|-------------- |  | ----------------- | ----- | ------------- | - | -----
|               |  | December 31, 2005 |       | June 30, 2005
|Raw Materials  |  | $                 | 300   |               | $ | 156  
|Finished Goods |  | $                 | 5,157 |               | $ | 1,530
|               |  |                   |       |               |   |      
|               |  | $                 | 5,457 |               | $ | 1,686
|               |  |                   |       |               |   |      

The acquisition of the assets of Comdial Corporation on September 28, 2005 is the primary reason for the
substantial increase in inventory, having added $3.9 million in inventory as of December 31, 2005.



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(12) INTANGIBLE ASSETS

Intangible assets related to the acquisitions of Vertical Networks and Comdial at December 31, 2005 and June 30, 2005 consist of the following (in thousands):



|                                                   |  |             |   |  |              |   |  |              
|-------------------------------------------------- |  | ----------- | - |  | ------------ | - |  | -------------
|                                                   |  | Dec 31,2005 |   |  | June 30,2005 |   |  | Life in Years
|Acquired technology-Vertical Networks              |  | 800         |   |  | 800          |   |  | 5            
|Acquired customers relationships-Vertical Networks |  | 3,500       |   |  | 3,500        |   |  | 5            
|Trade names/trademarks-Comdial                     |  | 200         |   |  |             |   |  | 1            
|Acquired customer relationships-Comdial            |  | 3,300       |   |  |             |   |  | 10           
|Acquired technology-Comdial                        |  | 800         |   |  |             |   |  | 5            
|                                                   |  |             |   |  |              |   |  |              
|                                                   |  | 8,600       |   |  | 4,300        |   |  |              
|Accumulated amortization                           |  | (1,258      | ) |  | (652         | ) |  |              
|                                                   |  |             |   |  |              |   |  |              
|                                                   |  | 7,342       |   |  | 3,648        |   |  |              
|                                                   |  |             |   |  |              |   |  |              

Amortization expense for the three and six months ending December 31, 2005 was $382 and $601 respectively, of
which $80 and $120, respectively, was included in cost of sales. For the three and six months ending December 31, 2004, amortization expense was $262 of which $40 was included in cost of sales.

(13) 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 2005 and 2006, the Company recorded 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.

(14) SUBSEQUENT EVENTS

On February 9, 2006, the Company completed the sale (the Series D Financing) of 5,000 shares of its newly designated 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 Warrants) of the Companys Common Stock pursuant to a Securities Purchase
Agreement between the Company and certain investors (the Series D Investors) (the 2006 Securities Purchase Agreement). The aggregate proceeds to the Company from the Series D Financing was $5.0 million.

Under the 2006 Securities Purchase Agreement, we have an obligation to register the shares of Common Stock issuable upon conversion of the Series D Preferred Stock
and upon exercise of the 2006 Warrants and have agreed to file a registration statement no later than March 27, 2006. We have also agreed to hold the annual meeting of the stockholders for the fiscal year ended June 30, 2005 as soon as
possible after February 9, 2006 for, among other purposes, considering the approval of an amendment and restatement of the Companys Certificate of Incorporation (the Amended and Restated Charter).

The Company is in the process of allocating the proceeds between the Series D Preferred Stock and the warrants, and assessing whether the resulting allocation results in
a beneficial conversion feature. Also, in certain circumstances, the Series D Preferred Stock is redeemable. Accordingly, the Company is also in the process of assessing the classification of the Series D Preferred Stock and warrants as either
equity or liabilities.

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 Risk Factors,
include, but are not limited to:



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



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



| |  | failure to successfully integrate the Comdial Assets into our business;
|- |  | -----------------------------------------------------------------------



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



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| |  | 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;
|- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | continued failure to timely file our reports under the Exchange Act;
|- |  | --------------------------------------------------------------------



| |  | continued failure to have adequate disclosure controls in place;
|- |  | ----------------------------------------------------------------



| |  | continued lapses of internal controls;
|- |  | --------------------------------------



| |  | the finding by our independent registered public accounting firm that we have a material weakness in our internal controls over financial reporting;
|- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------



| |  | possible delisting from the OTC Bulletin Board for failure to remain current in our Exchange Act reporting obligations;
|- |  | -----------------------------------------------------------------------------------------------------------------------



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



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



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



| |  | failure to achieve the anticipated benefits from our acquisitions of 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 Comdial Assets may prove to be incorrect;
|- |  | ---------------------------------------------------------------------------------------------



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



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



| |  | the risk that the Company may be unable to meet its future obligations resulting from the acquisition of the Comdial Assets including but not limited to its obligations to meet its
financial covenants under the SVB Loan Agreement or meet its deadlines to register the shares of its Common Stock issued in the 2005 Equity Financing; and
|- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | the loss of any of its key dealers or customers or Comdials key dealers or customers.
|- |  | --------------------------------------------------------------------------------------

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 commencing on page 29, 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 Comdial Acquisition. 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, 2005, as filed with the SEC on October 13, 2005.

Critical Accounting Policies

Revenue Recognition

The Company recognizes revenue for the sale of its Instant Office 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 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 acquired with
Vertical Networks, Inc. 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 sold 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.

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 mode, 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 most cases, we provide a one-year limited warranty to our customers, including repair or replacement of defective equipment. We do provide additional years of extended warranty to one of our large enterprise
customers. 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 including material, labor and overhead. 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 and Comdial will be
tested during fiscal year 2006. Although the Vertical Networks goodwill was deemed to not be impaired when it was tested in 2005, 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.

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. The modified prospective transition method requires that compensation cost be recognized in the financial statements for all awards
granted after the date of adoption as well as for existing awards for which the requisite service has not been rendered as of the date of adoption. As a part of this adoption method, prior periods are not restated. Prior to the adoption of SFAS No.
123R, we used the intrinsic-value based method to account for stock options and made charges against earnings with respect to options granted.

Prior to
July 1, 2005, the Company applied Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employeesin accounting for its stock incentive plan and accordingly, compensation cost was recognized for its
stock options in the financial statements when the exercise price was below the fair market value. During the three and six months ended December 31, 2004, $634 thousand of stock-based compensation cost was recorded under the intrinsic value based
method

The adoption of SFAS No. 123R reduced income from operations and net income for the three and six months ended December 31, 2005 by $1.0 million
($0.02 per basic and diluted share) and $2.2 million ($0.05) per basic and diluted share), respectively. The adoption of this Statement had no effect on the Statement of Cash Flows for the six months ended December 31, 2005.

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

|                           |  |                                 |       |                               |   |      |  |             |       |  |   |    
|-------------------------- |  | ------------------------------- | ----- | ----------------------------- | - | ---- |  | ----------- | ----- |  | - | ---
|                           |  | Three Months Ended December 31, |       | Six Months Ended December 31,
|                           |  | 2005                            |       | 2004                          |   | 2005 |  | 2004       
|                           |  |                                 |       | As Restated                   |   |      |  | As Restated
|Sales and marketing        |  | $                               | 237   |                               | $ | 205  |  | $           | 506   |  | $ | 205
|Product development        |  | $                               | 339   |                               | $ | 281  |  | $           | 724   |  | $ | 281
|General and administrative |  | $                               | 452   |                               | $ | 148  |  | $           | 966   |  | $ | 148
|                           |  |                                 |       |                               |   |      |  |             |       |  |   |    
|Total                      |  | $                               | 1,028 |                               | $ | 634  |  | $           | 2,196 |  | $ | 634

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
2.08333% 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:

|                        |  |             |   |  |             |  
|----------------------- |  | ----------- | - |  | ----------- | -
|                        |  | Fiscal 2006 |   |  | Fiscal 2005 |  
|Expected dividend yield |  | %           |   |  | 0           | %
|Volatility factor       |  | 115         | % |  | 115         | %
|Risk free interest rate |  | 4.1         | % |  | 3.45        | %
|Expected life           |  | 6 Years     |   |  | 6 Years     |  

For the three months ended December 31, 2005 stock options issued, exercised and forfeited were 0,29,605 and
402,467, respectively. For the six months ended December 31, 2005, stock options issued, exercised and forfeited were 0,61,180 and 533,488 respectively.

Summary

The following is a summary of the areas that management believes are important in understanding the results of the fiscal quarter
and six months ended December 31, 2005. This summary is not a substitute for the detail provided in the following pages or for the 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;
|- |  | ------------------------------------



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



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



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

For the three and six months ended
December 31, 2005, Artisoft had total net revenue of approximately $16.3 million and $26.2 million, respectively, compared to total net revenue for the same periods in fiscal year 2005 of approximately $4.7 million and $7.6 million,
respectively. The increases in net revenue are primarily attributable to the acquisition of the assets of Comdial, which was completed on September 28, 2005. Our results include a full quarter of net revenue and expenses related to the Comdial
Assets for the three months ending December 31, 2005. We expect net revenues to increase in the fiscal year ending June 30, 2006, largely, as a result of the acquisition of the Comdial Assets.

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 and Comdial, 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 and Comdial, cost of sales increased substantially due to the hardware costs associated with sales of the Instant Office and Comdial 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.



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Gross margins for the quarter and six months ended December 31, 2005 decreased to 48.2% and 53.8%, respectively,
compared to 80.0% and 82.9% in the same periods in the prior fiscal year. This decrease was primarily the result of the cost of hardware included in the net revenue. The cost of goods for InstantOffice and Comdial products includes several elements
of telecommunication hardware.

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 and marketing programs;
|- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------



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



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



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



| | Amortization of intangible assets acquired from Vertical Networks and Comdial.
|- | ------------------------------------------------------------------------------

Operating expenses for the quarter ended December 31, 2005 increased approximately 71% compared to the same period in the prior fiscal year.

Sales and marketing expenses for the quarter ended December 31, 2005 increased by 40.0%, compared to the same period in the prior fiscal year, due to costs associated with the increase in personnel in the sales and marketing
organization resulting from the acquisition of Vertical Networks and Comdials sales and marketing activities.

Expenses in product development
for the quarter ended December 31, 2005 increased by 25% during the quarter ended December 31, 2005 compared to the same period in the prior fiscal year. This increase results from increased development costs resulting from the acquisition
of Vertical Networks and Comdials product development activities.

General and administrative expenses increased approximately 210% compared to
the same period in the prior fiscal year. This increase reflects an increase in expenses due to additional costs resulting from the acquisition of Vertical Networks and Comdials activities, offset by cost reductions from consolidation
efforts in these areas.

The Company expects operating expenses to begin to decline in the latter part of fiscal year 2006 as redundant operations are
eliminated and overhead cost elements are reduced.

The Comdial Acquisition

The Acquisition. On September 28, 2005, pursuant to Bankruptcy Court approval, we acquired certain assets and assumed certain liabilities of Comdial. Comdial was a manufacturer and distributor of telephone
systems targeted to small to midsize businesses, branch or regional offices of large organizations, national retailers, government agencies, and education campuses. The purchase price consisted of $18.5 million in cash plus the Comdial Note. This
price included the assumption of the debtor in possession financing and an existing note from secured creditors, along with the settlement of certain obligations under Comdials key employee retention plan. We also assumed liabilities totaling
$3.1 million including certain payables and accrued liabilities. The Comdial Note is secured by all of our assets, and is junior in interest to any security interest granted with respect to any of our current or future indebtedness owed to SVB,
including, without limitation, amounts owing under the a debt financing, up to $9 million plus principal amounts in connection with any existing cash secured credit extensions (including letters of credit and cash management services) in an amount
not to exceed $0.5 million. The operational results of this acquisition have been included in all periods since September 28, 2005, the date that the acquisition was consummated.

The Comdial Note and Security Agreement.In connection with the closing of the Comdial acquisition, we executed the Comdial Note on the September 28, 2005, the same date that the 2005 Equity Financing was
consummated. The Comdial Note is in the original principal amount of $2,500,000 and bears interest at the rate of 8% per annum maturing on the first anniversary of the Closing Date. The Comdial Note is secured by all our assets and the assets
of our wholly owned subsidiary Vertical Communications Acquisition Corporation, and is junior in interest to the security interest granted with respect to any of our current or future indebtedness or Vertical Communications Acquisition Corporation
owed to SVB, including, without limitation, amounts owing under the 2005 Debt Financing, up to $9,000,000 plus principal amounts in connection with any existing cash secured credit extensions (including letters of credit and cash management
services) in an amount not to exceed $500,000.

In connection with the Comdial Note, on the Closing Date, the Comdial bankruptcy estate entered into a
security agreement (the Security Agreement) with us and Vertical Communications Acquisition Corporation wherein we and Vertical Communications Acquisition Corporation granted a security interest to the estate in all of our assets and
those of Vertical Communications Acquisition Corporation, including the Comdial Assets. In connection with the Security Agreement, the Comdial bankruptcy estate also entered into a Subordination



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Agreement with SVB, pursuant to which the estate agreed to subordinate our obligations and those of Vertical Communications Acquisition Corporation under the
Comdial Note, and its security interest under the Security Agreement, to the current and future obligations of us and Vertical Communications Acquisition Corporation to SVB, including, without limitation, amounts owing under the 2005 Debt Financing,
up to $9,000,000 plus principal amounts in connection with any existing cash secured credit extensions (including letters of credit and cash management services) in an amount not to exceed $500,000.

The 2005 Equity Financing.Under the 2005 Stock Purchase Agreement, we received a total of $12.9 million from the 2005 Investors in exchange for the issuance of
11,329,785 shares of common stock (the Issued Shares). The per share purchase price for the Issued Shares was $1.1386. Certain of our directors are designees of the 2005 investors who participated in the 2005 Equity Financing. Therefore,
our board of directors formed a special committee of directors (the Special Committee) to negotiate and finalize the terms of the 2005 Equity Financing. Among other things, the Special Committee (1) negotiated the terms of the
agreements related to the 2005 Equity Financing, (2) engaged a financial consultant to provide an estimate of the indicated fair value of our companys post acquisition equity, (3) approved the sale of shares of common stock to the
2005 Investors and (4) authorized and directed our officers to place the Capitalization Amendment on our proxy statement for our 2005 annual meeting (the Annual Meeting).

Our Obligation to Register Shares.Pursuant to the 2005 Stock Purchase Agreement, we agreed to register the Issued Shares for resale by the 2005 Investors under
the Securities Act. We agreed to file with the Commission a registration statement (the Registration Statement) with respect to the Issued Shares which we filed on December 12, 2005, 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 Commission, within five days of being informed by the Commission that the Commission 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 Commission, within five days of being informed by the Commission that the Commission 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). We will be liable for liquidated damages to each 2005 Investor under the following
circumstances:



| |  |  | if the Registration Statement is not declared effective by the Commission on or prior to the Required Effective Date (the Effectiveness Deadline) (such an event, an
Effectiveness Default); or
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | if the Registration Statement (after its effectiveness date) ceases to be effective and available to the 2005 Investors for any continuous period that exceeds 30 days or for one or
more periods that exceed in the aggregate 60 days in any 12-month period (such an event, a Suspension Default and together with an Effectiveness Default, a Registration Default).
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

In the event of a Registration Default, we will pay as liquidated damages to the 2005 Investors, for each 30-day period of a Registration Default, an amount in cash
equal to 1% of the aggregate purchase price paid by the 2005 Investor pursuant to the 2005 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 2005 Investor. We will pay the liquidated damages as follows:



| |  |  | in connection with an Effectiveness Default, on the business day following the Effectiveness Deadline, and each 30thday thereafter until the Registration Statement is declared effective by the Commission; or
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | in connection with a Suspension Default, on either (a) the 31stconsecutive day of any Suspension or (b) the 61stday (in the aggregate) of any
Suspensions in any 12-month period, and each 30th day thereafter until the Suspension is terminated in accordance with the 2005 Stock Purchase Agreement.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

All periods described above will be tolled during delays directly caused by the action or inaction of any 2005 Investor, and we will have no liability to any 2005 Investor in respect of any such delay. The liquidated
damages payable under the 2005 Stock Purchase Agreement will apply on a pro rata basis for any portion of a 30-day period of a Registration Default.

Our Obligation to Hold a Meeting.We agreed to hold the Annual Meeting on or before April 15, 2006, for, among other purposes, considering the approval of an amendment to our certificate of incorporation to effect, among other
things, the elimination of all authorized shares of our Series B Preferred Stock and our Series C Preferred Stock (the Preferred Stock Amendment), and the Capitalization Amendment.

The Voting Agreements.In connection with the 2005 Stock Purchase Agreement, the Company and each of the 2005 Investors entered into separate Voting Agreements,
pursuant to which each of the 2005 Investors agreed to vote all of their shares of common stock in favor of the Capitalization Amendment.

Affirmative
Covenants Under the 2005 Stock Purchase Agreement.We made certain affirmative and negative covenants under the 2005 Stock Purchase Agreement. Our affirmative covenants include obligations related to (1) providing the 2005 Investors with a
right of first refusal on our future issuances of securities; (2) seeking a listing of our common stock on the NASDAQ National Market, NASDAQ SmallCap Marketplace or the American Stock Exchange at such time that we are so eligible;
(3) using the proceeds from the 2005 Equity Financing for our acquisition of the Comdial Assets; (4) maintaining specified insurance coverage; (5) indemnifying and reimbursing the expenses of directors; (6) removing the legends
on the certificates representing the Issued Shares; (7) providing information required by Rule 144 under the Securities Act; (8) amending our certificate of incorporation to the extent necessary to reflect the transactions contemplated by
the 2005 Stock Purchase Agreement; (9) fixing the board of directors at seven and nominating directors in accordance with the terms of the 2005 Stock



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Purchase Agreement; (10) holding an annual meeting of our stockholders on or before April 15, 2006; and (11) altering the vesting schedules
for employee stock option grants.

Negative Covenants Under the 2005 Stock Purchase Agreement.Our negative covenants relate to obligations not to,
without the prior consent of M/C Venture Partners, (1) enter into a transaction involving a change in control; (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 our 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, other than to effect the Capitalization Amendment and the Preferred Stock Amendment; (11) change the nature of our 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 New Warrants.

Our Board of Directors.As of November 11, 2005, our board of directors consisted of (1) our chief executive officer serving as a Class II director (currently William Y. Tauscher); (2) one member serving as a
Class II director designated by the written consent of the majority-in-interest of the shares of common stock held by the investors (including the affiliated assignees of such investors, the Series B Investors) that are parties to the
Series B Purchase Agreement, dated as of August 8, 2001, that were acquired upon the conversion of the shares of Series B Preferred Stock held by them, pursuant to the terms of the 2004 Consent dated September 25, 2004 (the 2004
Consent), acting as a single class (currently Robert J. Majteles); (3) one member serving as a Class II director designated by the written consent of the majority-in-interest of the shares of common stock held by the investors (including
the affiliated assignees of such investors, the Series C Investors), that are parties to the Series C Purchase Agreement, dated as of June 27, 2003, as amended, that were acquired upon the conversion of the shares of Series C
Preferred Stock held by them, pursuant to the terms of the 2004 Consent, acting as a single class (currently R. Randy Stolworthy); (4) two members serving as Class III directors designated in writing by M/C Venture Partners (currently
John P. Ward and Matthew J. Rubins); and (5) two non-executive members serving as Class I directors designated by the mutual agreement of M/C Venture Partners and our board of directors (reflected by approval of the board of directors
(or its nominating or corporate governance committee) of a written designation by M/C Venture Partners), provided that each such non-executive member has relevant industry (each, an Industry Director) (currently Michael P. Downey
and Francis E. Girard).

After March 28, 2006, the members of our board of directors shall consist of (and we agree to nominate for election)
(1) our the chief executive officer who will serve as a Class II director, (2) one member who will serve as a Class II director designated by the written consent of (a) SSF, so long as SSF and its affiliates continue to beneficially
own at least 50% of the shares of common stock acquired by SSF and its affiliates upon the conversion of the shares of Series B preferred stock held by them, pursuant to the terms of the 2004 Consent or (b) in the event that SSF is not entitled
to appoint a director pursuant to clause (a), the majority-in-interest of the shares of common stock held by the Series B and Series C Investors that were acquired by them upon the conversion, pursuant to the terms of the 2004 consent, of the shares
of Series B Preferred Stock and Series C Preferred Stock held by them, acting as a single class, (3) two members who will serve as Class III directors designated in writing by M/C Venture Partners and (4) three industry directors who will
serve as Class I directors designated by the mutual agreement of M/C Venture Partners and our board of directors.

Amendments of the 2004 Stock Purchase
Agreement and Prior Agreements.

The 2004 Investors and prior investors holding enough voting power to amend the 2004 Stock Purchase Agreement and the
Prior Agreements, executed the 2004 Consent, pursuant to which the 2004 Investors and the Prior Investors consented to the execution of the 2005 Stock Purchase Agreement and executed agreements to amend the 2004 Stock Purchase Agreement and the
Prior Agreements (collectively, the Amendments). We agreed, among other things, to propose the Capitalization Amendment. The Amendments effected, among other things, the following



| |  | With respect to the 2004 Stock Purchase Agreement (i) tolled the Liquidated Damages; (ii) amended provisions relating to rights of first refusal, issuances of equity
securities and restrictions on indebtedness with respect to the entry into the agreements with SVB, solely for purposes of effecting the transactions contemplated by the 2005 Stock Purchase Agreement; (iii) changing 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 (iv) in lieu of the cash payment of the Liquidated Damages, we agreed to issue the
New Warrants to the 2004 Investors.
|- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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

Further, if (1) the Capitalization Amendment is not effective as of April 15, 2006, and (2) the 2005 Investors affiliated
with M/C Venture Partners and SSF have voted their shares of common stock in favor of the Capitalization Amendment, which they are obligated to do under the terms and conditions of the Voting Agreement, then the Liquidated Damages will be paid in
cash by wire transfer of immediately available funds to each of the parties and upon payment thereof, and the New Warrants issued in satisfaction of the Liquidated Damages will expire



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unexercised. If the Capitalization Amendment is not completed by April 15, 2006 the holders of the New Warrants will be entitled to a cash settlement in
the amounts of $1,375,000 in lieu of warrants.

The 2005 Debt Financing.We entered into the SVB Loan Agreement with SVB on September 28, 2005.
The SVB Loan Agreement terms provide us with a Revolving Loan in an amount not to exceed $7,000,000, as well as a $2,000,000 Term Loan. We will make monthly payments of all outstanding and accrued interest on the Revolving Loan beginning on
October 31, 2005. The Revolving Loan matures and the principal balance thereof is payable in full, on September 27, 2006. The Term Loan is payable in monthly principle installments of $133,333.33 plus interest, due beginning July 31,
2006 through and until the maturity date of September 26, 2007. Borrowing availability under the Revolving Loan is based on the amount of the accounts receivable held by us and our acquisition subsidiary. Our obligations under the SVB Loan
Agreement are secured by all of our assets and the assets of Vertical Communications Acquisition Corporation, including the Comdial Assets. These include accounts receivable, inventory, equipment, intellectual property, all claims, credit balances,
proceeds (including proceeds of any insurance policies, proceeds of proceeds and claims against third parties), and all products, books and records related to such assets.

For both the Term Loan and the Revolving Loan, interest shall accrue at a rate per annum equal to the Prime Rate in effect from time to time, plus 1.50% per annum. However during the period beginning
on September 28, 2005 and continuing until September 30, 2006, interest under the Term Loan interest shall accrue a rate per annum equal to the Prime Rate in effect from time to time plus 2.00% per annum. Thereafter,
interest shall accrue on the Term Loan at a rate equal to the Prime Rate in effect from time to time, plus (a) 2.00% per annum if our previous quarters Fixed Charge Coverage Ratio (FCCR) is less than or equal
to 2.00 to 1.00, or (b) 1.50% per annum if our previous quarters FCCR is greater than or equal to 2.00 to 1.00, each as determined by SVB in accordance with generally accepted accounting principles. Pricing adjustments shall be effective
no later than three business days after SVBs receipt of satisfactory financial reporting and shall remain effective until receipt by SVB of financial statements for such next successive quarter. Interest in all circumstances shall be
calculated on the basis of a 360-day year for the actual number of days elapsed. Prime Rate means the greater of (i) 6.50%, or (ii) the rate announced from time to time by SVB as its prime rate; it is a base rate
upon which other rates charged by SVB are based, and it is not necessarily the best rate available at SVB. The interest rate applicable to the outstanding obligations shall change on each date there is a change in the Prime Rate. Regardless of the
amount of obligations that may be outstanding from time to time under the SVB Loan Agreement, we are obligated to make minimum monthly interest payments to SVB equal to $15,000 during the term of this Agreement. As of December 31, 2005, we have
borrowed $2.0 million under the Term Loan and $6.9 under the Revolving Loan.

Results of Operations

Net Revenue

Net revenue was $16.3 million and $26.2 million for
the three and six months ended December 31, 2005, respectively, representing an increase of 349% and 345%, from $4.7 million and $7.6 million for the same fiscal periods from prior year.

We distribute our products both domestically and internationally. International product revenue was $.7 million, or 4% of total revenue, for the three months ended
December 31, 2005 and $.4 million, or 13% of total revenue, for the three months ended December 31, 2004. International product revenue for the six months ended December 31, 2005 was $.9 million, or 3% of total revenue, for the
six months ended December 31, 2005 and $.7 million, or 9% of total revenue, for the six months ended December 31, 2004.

Gross Profit(in thousands, except percentages)



|                 |  |                    |   |                  |                   |   |  |        |  |                   |   |  |                   |   |  |       
|---------------- |  | ------------------ | - | ---------------- | ----------------- | - |  | ------ |  | ----------------- | - |  | ----------------- | - |  | ------
|                 |  | Three Months Ended |   | Six Months Ended |                   |   | 
|                 |  | December 31, 2005  |   |                  | December 31, 2004 |   |  | Change |  | December 31, 2005 |   |  | December 31, 2004 |   |  | Change
|Gross Profit     |  | 7,865              |   |                  | 3,734             |   |  | 4,131  |  | 14,106            |   |  | 6,303             |   |  | 7,803 
|% of Net Revenue |  | 48                 | % |                  | 80                | % |  |        |  | 54                | % |  | 83                | % |  |       

The decrease in gross profit as a percentage of net revenue for the three and six months ended December 31,
2005, compared to the corresponding periods ended December 31, 2004, was due primarily to the addition of revenue and associated cost of sales from the acquisition of the assets of Comdial, which sales have a lower margin compared to other of
our product lines.

Operating Expenses(in thousands, except percentages)



|                                                                 |  |                    |   |  |                   |   |  |                  |   |  |                   |   |  |                   |   |  |        |  
|---------------------------------------------------------------- |  | ------------------ | - |  | ----------------- | - |  | ---------------- | - |  | ----------------- | - |  | ----------------- | - |  | ------ | -
|                                                                 |  | Three Months Ended |   |  |                   |   |  | Six Months Ended |   |  |                   |  
|                                                                 |  | December 31, 2005  |   |  | December 31, 2004 |   |  | Change           |   |  | December 31, 2005 |   |  | December 31, 2004 |   |  | Change |  
|Sales and Marketing                                              |  | 4,713              |   |  | 3,359             |   |  | 40               | % |  | 8,652             |   |  | 5,157             |   |  | 68     | %
|% of Net Revenue                                                 |  | 29                 | % |  | 72                | % |  |                  |   |  | 33                | % |  | 68                | % |  |        |  
|                                                                 |  |                    |   |  |                   |  
|Product Development                                              |  | 2,928              |   |  | 2,338             |   |  | 25               | % |  | 5,923             |   |  | 3,211             |   |  | 84     | %
|% of Net Revenue                                                 |  | 18                 | % |  | 50                | % |  |                  |   |  | 23                | % |  | 42                | % |  |        |  
|                                                                 |  |                    |   |  |                   |  
|General and Administrative                                       |  | 4,834              |   |  | 1,558             |   |  | 210              | % |  | 7,257             |   |  | 2,860             |   |  | 154    | %
|% of Net Revenue                                                 |  | 30                 | % |  | 33                | % |  |                  |   |  | 28                | % |  | 38                | % |  |        |  
|                                                                 |  |                    |   |  |                   |  
|Total Operating Expenses (including Amortization of intangibles) |  | 12,777             |   |  | 7,477             |   |  | 71               | % |  | 22,313            |   |  | 11,450            |   |  | 95     | %
|% of Net Revenue                                                 |  | 78                 | % |  | 160               | % |  |                  |   |  | 85                | % |  | 151               | % |  |        |  



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Sales and Marketing

The increase in sales and marketing expense for the three and six months ended December 31, 2005, compared to the corresponding periods ended December 31, 2004, was due primarily to the acquisition of the
operations of Comdial. For the three months ended December 31, 2005, sales and marketing expenses increased by $1.4 million, whereas their costs as a percentage of revenue decreased from 72% to 29%. This is primarily a result of the increase in
revenue due to the acquisition of the Comdial assets. For the six months ended December 31, 2005, sales and marketing expenses increased by $3.5 million, whereas their costs as a percentage of revenue decreased from 68% to 33%. The increase in
sales and marketing expenses in aggregate dollars for the three and six months ended December 31, 2005 compared to the corresponding periods ended December 31, 2004 was due primarily to an increase in payroll and related expenses for the
additional Comdial sales organization. The acquisition of the assets of Comdial occurred on September 28, 2005 thus for the three months ended December 31, 2005 there is a full quarter of such expenses. The Company employed 121 sales and
marketing personnel throughout the quarter ended December 31, 2005. The Company employed 66 sales and marketing personnel throughout the quarter ended December 31, 2004.

Product Development

The increase in product
development expenses for the three and six months ended December 31, 2005, compared to the corresponding periods ended December 31, 2004, was due primarily to the acquisition of the operations of Comdial. For the three months ended
December 31, 2005, product development expense increased by $0.6 million, whereas their costs as a percentage of revenue decreased from 50% to 18%. This is primarily a result of the increase in revenue due to the acquisition of the Comdial
assets. For the six months ended December 31, 2005, product development expense increased by $2.7 million, whereas their costs decreased as a percentage of revenue from 42% to 23%. The increase in product development expenses for the three and
six months ended December 31, 2005 compared to the same periods ended December 31, 2004, was driven by increased payroll expenses and employee related costs. The Company employed 84 product development personnel throughout the quarter
ended December, 2005. The Company employed 64 product development personnel throughout the quarter ended December 31, 2004.

General and Administrative

The increase in General and Administrative expenses for the three and six months ended December 31, 2005,
compared to the corresponding periods ended December 31, 2004, was due primarily to the acquisition of the operations of Comdial. For the three months ended December 31, 2005, general and administrative expense increased $3.3 million,
whereas their costs as a percentage of revenue decreased from 33% to 30% as compared with the same period ended December 31, 2004. This is primarily a result of the increase in revenue attributable to sales of the Comdial products. For the six
months ended December 2005, general and administrative expense increased $4.4 million, whereas their costs as a percentage of revenue decreased from 38% to 28% as compared with the same period ended December 31, 2004. The increase in general
and administrative expenses for the three and six month periods ended December 31, 2005 compared to the same periods ended December 31, 2004, was driven by increased payroll expenses and employee related costs. The Company employed 37
general and administrative personnel throughout the quarter ended December, 2005. The Company employed 20 general and administrative personnel throughout the quarter ended December 31, 2004.

Financial Condition, Liquidity And Capital Resources(in thousands)



|                                        |  |                   |   |  |               |  |        |  
|--------------------------------------- |  | ----------------- | - |  | ------------- |  | ------ | -
|                                        |  | Positions at      |   |  |              
|                                        |  | December 31, 2005 |   |  | June 30, 2005 |  | Change |  
|Cash and cash equivalents               |  | 2,196             |   |  | 4,880         |  | (2,684 | )
|Working capital (excl. restricted cash) |  | (8,169            | ) |  | 448           |  | (8,617 | )



|                                      |  |                                    |   |  |                                    |   |  |            |  
|------------------------------------- |  | ---------------------------------- | - |  | ---------------------------------- | - |  | ---------- | -
|                                      |  | Six Months Ended December 31, 2005 |   |  | Six Months Ended December 31, 2004 |   |  | Difference |  
|Cash used in operating activities     |  | (4,368                             | ) |  | (5,755                             | ) |  | (1,387     | )
|Cash used in investing activities     |  | (20,056                            | ) |  | (14,953                            | ) |  | 5,103      |  
|Cash provided by financing activities |  | 21,767                             |   |  | 26,241                             |   |  | (4,474     | )



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We used cash of $4.4 million to fund operating activities during the six months ended December 31, 2005. The
cash used in operating activities was due primarily to a net loss of $5.4 million, offset by depreciation and amortization of $1.3 million, and amortization of deferred Toshiba equity costs of $0.1 million, and $2.2 million relating
to a non-cash reserve charge. At December 31, 2005, compared to at June 30, 2005, trade receivables, net of allowances, increased by $5.7 million, inventory, net of reserves, increased by $3.8 million and prepaid expenses increased by
$1.5 million. Accounts payable decreased by $0.8 million and accrued liabilities increased by $5.2 million.

Working capital, consisting of total current
assets minus current liabilities, was ($8.2) million at December 31, 2005. This compared to working capital of $.4 million at June 30, 2005, representing a decrease of $8.6 million. The decrease in working capital at
December 31, 2005 is primarily a result of the short term debt used to finance the acquisition of the assets of Comdial and operations during the three months ended December 31, 2005.

We have incurred losses and negative cash flows from operations in every fiscal period since 1996 and have an accumulated deficit, including non-cash equity charges, of
$68 million as of December 31, 2005. For the three months ended December 31, 2005 we incurred a net loss of approximately $5.4 million, which includes negative cash flows from operations of approximately $4.4 million. Our
management expects that operating losses and negative cash flows will continue in the near future. As a result of the projected negative cash flow trends and in order to finance operating activities, management determined that we required an
additional capital infusion to support our negative cash flow from operations. Accordingly, on February 9, 2006, we completed the Series D Financing resulting in aggregate proceeds to the company of $5.0 million. We anticipate that, with the
proceeds of this equity offering and available cash of $2.2 million at December 31, 2005, we will meet our anticipated cash requirements for the next twelve months. We will also utilize available borrowing under our Revolving Loan with
SVB. Management hopes to increase our revenue and improve our cash flows in the foreseeable future. However, there can be no assurance that the available cash and increased revenues, if we are able to achieve them, will be sufficient to meet our
cash requirements. If we are unable to satisfy such cash requirements from these sources, our ability to continue as a going concern and to achieve our intended business objectives could be adversely affected. In such case, we could be required to
adopt one or more alternatives, such as reducing or delaying marketing and promotional activities, reducing or delaying capital expenditures, developing restructuring plans to reduce discretionary costs deemed nonessential, and raising additional
cash through the sale of our capital stock or increasing our debt. There can be no assurance that any such additional financing will be available when needed or on acceptable terms to allow us to successfully achieve our operating plan or fund
future investment in our product lines

Contractual Obligations



|                                    |  |                       |  |                  |  |           |  |           |  |                  
|----------------------------------- |  | --------------------- |  | ---------------- |  | --------- |  | --------- |  | -----------------
|                                    |  | Payment due by Period
|Contractual Obligations             |  | Total                 |  | Less than 1 year |  | 1-3 years |  | 3-5 years |  | More than 5 years
|Debt Obligations (1)                |  | 11,501                |  | 10,274           |  | 1,227     |  |          |  |                 
|Operating Lease Obligations (2)     |  | 4,639                 |  | 1,544            |  | 1,758     |  | 1,337     |  |                 
|Open Purchase Order Commitments (3) |  | 9,166                 |  | 9,166            |  |           |  |           |  |                  
|                                    |  |                       |  |                  |  |           |  |           |  |                  
|Total                               |  | 25,306                |  | 20,984           |  | 2,985     |  | 1,337     |  |                 

(1) Debt obligations include a revolving credit facility and term loan with SVB and a note payable to Comdial. See
Note 8 above for additional detail regarding these obligations.

(2) The Company leases office, product packaging, storage space and equipment warehouses
under noncancelable operating lease agreements expiring through 2010.

(3) We outsource substantially all of our manufacturing requirements. As of
December 31, 2005, we have outstanding purchase obligations of approximately $9.2 million with our contract manufacturers that could not be canceled without significant penalties. In addition, many of our contract manufacturers acquire
fabricated parts from various suppliers.

.



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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

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 all timely decisions regarding 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
December 31, 2005, our management, with the participation of our Audit Committee, Chief Executive Officer and Interim Chief Financial Officer, evaluated the effectiveness of our Disclosure Controls and Procedures. Based upon this evaluation,
our Chief Executive Officer and Interim Chief Financial Officer concluded that, as of December 31, 2005, the design and operation of these disclosure controls and procedures were not effective during the quarter ended December 31, 2005.

This determination was made because of our Chief Executive Officers and Interim Chief Financial Officers belief that our companys
resources were insufficient to address our financial reporting requirements in a timely fashion during the quarter ended December 31, 2005. 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, 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, and the filing of our Annual Reports on Form 10-K. Our management, including our Chief Executive Officer and Interim Chief Financial Officer, believes that,
during the quarter ended December 31, 2005, our company lacked the resources to address the financial reporting related to significant and complex business transactions.

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. We are taking steps that are intended to lead to changes that will ensure that our disclosure controls are effective at a reasonable assurance level. Specifically, beginning in the quarter ended September 30,
2005 we took a number of corrective actions to address the material weaknesses discussed above, including:



| |  |  | Engaged a full-time contract senior finance professional to supplement our accounting and financial reporting resources;
| | - |  | ------------------------------------------------------------------------------------------------------------------------



| |  |  | Commenced search for a new senior corporate controller, subsequently hired a new corporate controller with extensive software industry experience in November 2005;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Migrated the accounting systems of our operations in California and Massachusetts onto a common general ledger system;
| | - |  | ----------------------------------------------------------------------------------------------------------------------



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In addition, in the quarter ended December 31, 2005, the Company utilized additional senior personnel from the former
Comdial finance department to assist with the review and analysis of transactions and complex accounting matters. These steps are aimed at ensuring that our disclosure controls are effective for gathering, analyzing and disclosing in a timely manner
the information we are required to disclose in our reports filed under the Securities Exchange Act of 1934.

Assessment of Internal Controls Over
Financial Reporting.

Our former independent registered public accounting firm, KPMG, advised management and the audit committee that, in connection
with their review of our financial statements for the three month period ended December 31, 2004, KPMG noted certain matters involving internal control and its operation that it considered to be material weaknesses that constituted reportable
conditions under standards established by the American Institute of Certified Public Accountants. Reportable conditions are matters coming to an independent registered public accounting firms attention that, in their judgment, relate to
significant deficiencies in the design or operation of internal control and could adversely affect the organizations ability to record, process, summarize, and report financial data consistent with the assertions of management in the financial
statements. Further, a material weakness is a reportable condition in which the design or operation of one or more internal control components does not reduce to a relatively low level the risk that errors or fraud in amounts that would be material
in relation to the financial statements being audited may occur and not be detected within a timely period by employees in the normal course of performing their assigned functions. KPMG advised management and the audit committee that it considered
the following to constitute a material weakness in internal control and operations: we did not 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 acquisition of Vertical Networks and the associated integration activities.

Our current independent registered public accounting firm, Vitale Caturano and Company LTD. (VCC) advised our management and our audit committee that, in
connection with their audit of our financial statements for the year ended June 30, 2005, VCC noted certain matters involving internal control and its operation that it considered to be material weaknesses that constituted reportable conditions
under the standards of the Public Accounting Oversight Board (PCAOB). VCC advised our management and our audit committee that it considered the following to constitute a material weakness in internal control and operations: we did not have adequate
staffing in our accounting and finance group with the appropriate level of experience to effectively accomplish timely and accurate closings, control the increased level of transaction activity, address the complex accounting matters and manage the
increased financial reporting complexities resulting from recent acquisitions.

We are evaluating 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 are, in connection with the evaluation, reviewing our personnel, resources and disclosure controls and procedures. The evaluation is intended to lead to changes that will
ensure that our disclosure controls are effective at a reasonable assurance level. Specifically, the evaluation is aimed at ensuring that our disclosure controls are effective for gathering, analyzing and disclosing in a timely manner the
information we are required to disclose in our reports filed under the Securities Exchange Act of 1934.

Changes in Internal Control Over Financial
Reporting.

There have been no changes in our internal control over financial reporting that occurred during our most recent quarter that have
materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. However, as noted above, we are taking certain actions designed to enhance our internal control over financial reporting and our
disclosure controls and procedures. We have hired additional senior finance personnel as noted above and are also utilizing the personnel from the former Comdial finance department to assist with the review and analysis of our transactions
processing, reporting and disclosure controls and procedures.



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##### Table of Contents

PART IIOTHER INFORMATION

Item 1Legal

On September 27, 2005 we delivered a claim to Consolidated IP Holdings, Inc. (CIPH), the
former Vertical Networks, Inc. making claims against the escrow established as a part of the acquisition of the asset of Vertical Networks on September 28, 2004. We have asserted claims that $0.6 million of the $1 million escrow should be retained
as a result of a failure by CIPH to meet certain terms and conditions under the Asset Purchase Agreement entered into September 23, 2004. We have subsequently received a Response to Claim notice from CIPH, wherein they dispute our claims.

As part of our agreement to acquire the assets of Vertical Networks, we entered into a separate agreement with Vertical Networks on September 28, 2004
(the License Agreement). The License Agreement, among other things, granted us the license to use certain patents held by Vertical Networks (the Licensed Patents). On or about November 4, 2005, we received a notice from CIPH
claiming that we have materially breached certain terms under the License Agreement, and on or about December 8, 2005, we received notice that CIPH was purporting to terminate the License Agreement. We do not believe that we have breached the
License Agreement, or that any license has been terminated. Should this dispute result in the termination of the License Agreement and our inability to use the Licensed Patents, it would limit our ability to produce and sell our InstantOffice
products, which would have a material adverse effect on our financial condition and results of operations.

On or about November 10, 2005, CIPH filed suit
in the United States District Court for the District of Massachusetts (Civil Action No. 05 CV 12250 RWZ ), and filed an amended complaint on or about December 9, 2005. The Company filed its answer and counterclaim on or about January 10, 2006, and
Consolidated filed its answer to the counterclaim on or about February 1, 2006. The amended suit and counterclaim includes the two above-referenced disputes, as well a dispute over whether the Company owes payments pursuant to an earn-out pursuant
to the asset purchase agreement. An initial status conference was held with the Court on January 18, and another status conference is scheduled for May 4, 2006.

Item 1ARISK FACTORS

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.

RISKS RELATED TO OUR HISTORIC BUSINESS OPERATIONS

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

We had operating losses for the year ended
December 31, 2005 and in each of the last 14 fiscal quarters. We also had negative cash flow from operating activities in the year ended June 30, 2005 and in six out of the last ten 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 our last three fiscal years, and had negative cash flow from operating activity many of which were acquired when we acquired most of the
assets of Vertical Networks. 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 may 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 had negative working capital at December 31, 2005, and 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 could 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 could 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. 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



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##### Table of Contents

senior to those of our Common Stockholders. In addition, we may seek to obtain a working capital or other traditional loan facility from a bank or other
lending source. 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.

Our disclosure controls and procedures are not effective.

Our Chief
Executive Officer and Chief Financial Officer have determined that as of December 31, 2005, our disclosure controls and procedures were not effective to ensure that information we are required to disclose in our Exchange Act reports is
recorded, processed, summarized and reported within the time specified by the SECs rules and forms. This determination was made, in part, because 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, 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. Our management also believes that we currently lack sufficient resources to address the financial reporting related to significant and
complex business transactions.

Our former and current independent registered public accounting firms have indicated that we have certain material
weaknesses with our internal controls and as a result, our internal controls over financial reporting may not be effective.

Our former independent
registered public accounting firm, KPMG LLP (KPMG), advised our management and our audit committee that, in connection with its review of our financial statements for the three month period ended December 31, 2004, KPMG noted
certain matters involving internal control and its operation that it considered to be a material weakness that constituted reportable conditions under standards established by the American Institute of Certified Public Accountants. Reportable
conditions are matters coming to an independent registered public accounting firms attention that, in its judgment, relate to significant deficiencies in the design or operation of internal control and could adversely affect the
organizations ability to record, process, summarize, and report financial data consistent with the assertions of management in the financial statements. KPMG advised our management and our audit committee that it considered the following to
constitute reportable conditions related to internal control and their operations: we did not 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 acquisition of Vertical Networks and the associated integration activities.

Our current independent registered public accounting firm, Vitale Caturano and Company Ltd. (VCC) advised our management and our audit committee that, in
connection with their audit of our financial statements for the year ended June 30, 2005, VCC noted certain matters involving internal control and its operation that it considered to be material weaknesses that constituted material weaknesses
under the standards of the Public Accounting Oversight Board (PCAOB). VCC advised our management and our audit committee that it considered the following to constitute a material weakness in internal control and operations: we did not have adequate
staffing in our accounting and finance group with the appropriate level of experience to effectively accomplish timely and accurate closings, control the increased level of transaction activity, address the complex accounting matters and manage the
increased financial reporting complexities resulting from recent acquisitions.

We are also in the preliminary stages of preparing for our report on
internal controls over financial reporting, which must be filed with the annual report for our fiscal year ending June 30, 2008. The effectiveness of our controls and procedures may be limited by a variety of risks, including, without
limitation, faulty human judgment and simple errors, omissions, or mistakes; the collusion of two or more people or inappropriate management override of procedures; and imprecision in estimating and judging cost-benefit relationships in designing
controls. At this point in the process, it is not possible to ascertain whether this report will disclose any significant deficiencies or material weaknesses in our internal controls over financial reporting or even whether we will be able to
conclude, after such analysis, that our internal controls are effective; however, our recent failure to timely file certain Exchange Act reports, as well as the matters discussed above, resulted in our auditor determining that we have a material
weakness in our internal controls system. Upon a determination that we have such a material weakness, we will be required to report that our internal controls over financial accounting are not effective. If we fail to have effective internal
controls and procedures for financial reporting in place, we could be unable to provide timely and reliable financial information.

We have not timely
filed several of our periodic reports under the Securities Exchange Act of 1934 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, 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 our amendment to our Form 8-K on April 20, 2005, and our 8-K on July 14, 2005. As a result, we will be ineligible to register our securities on Form S-3 until 12 months after July 14, 2005, 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 was
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 your shares. We have agreed in the stock



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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 and could impair our ability to raise
additional capital. 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 October 1,
2005, M/C Venture Partners beneficially owned approximately 48.5% of our Common Stock. Based upon its substantial stock ownership 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.

If we fail to meet our obligations under the Comdial Note, our payment obligations may be accelerated.

Under the terms of the Comdial Note, if certain events occur, including, without limitation, our failure to pay any installment of principal or interest due under the
Comdial Note, then the Comdial bankruptcy estate may, among other things, elect to accelerate our obligations under the Comdial Note and declare the outstanding principal balance and accrued but unpaid interest immediately due and payable. It could
also elect to increase the interest rate of the Comdial Note from 8% to 10% per year. Should we be unable to make immediate repayment of the Comdial Note at the time of an acceleration demand, the Comdial bankruptcy estate could elect to pursue
its rights under the Security Agreement, which secured our obligations under the Comdial Note by granting a security interest on all of our assets and the assets of Acquisition Sub, subject to a subordination agreement with SVB. In the event that
the Comdial bankruptcy estate declares the Comdial Note immediately due and payable or seeks to foreclose on any of our assets under the Security Agreement, it would likely have a material adverse affect on our financial position and our results of
operations.

If we fail to meet certain covenants under our 2005 Debt Financing, our payment obligations may be accelerated.

We are obligated to make certain payments of principal and interest for both the Term Loan and The Revolving Loan under the SVB Loan Agreement. In addition, we are
obligated to take certain actions and refrain from taking certain actions during the term of the SVB Loan Agreement, including, without limitation, meeting certain financial covenants, some of which are not completely within our ability to control.
Should we fail to meet our payment obligations, fail to comply with any affirmative or negative covenant, or should any other situation arise which constitutes an Event of Default under the SVB Loan Agreement, SVB could elect, among
other things, to accelerate our indebtedness under the Term Loan and the Revolving Loan, or to take possession of, sell, lease, or otherwise dispose of any of our assets, including the Comdial Assets, which were pledged as collateral under the SVB
Loan Agreement. In the event that SVB declares the Term Loan and/or Revolving Loan immediately due and payable or seeks to foreclose on any of our assets, it would likely have a material adverse affect on our financial position and our results of
operations.

If we fail to cause the registration statement filed on December 6, 2006 to be declared effective in accordance to the timetable set
forth in the September 28, 2005 Stock Purchase Agreement, we will be subject to liquidated damages or liability for breach of contract.

Pursuant
to the stock purchase agreement we entered into on September 28, 2005 (the 2005 Stock Purchase Agreement), we agreed to register the shares of our common stock issued to the investors (referred to as the 2005 Investors)
for resale under the Securities Act of 1933. We have agreed to file a registration statement covering these shares no later than December 12, 2005. We have filed this registration statement relating to these shares of common stock, among
others, on December 6, 2005 (the Filing Date). We have 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 will be liable for liquidated damages to each 2005 investor (a) if the registration statement is not declared effective by the Commission on or prior to the required Effective Date or (b) if
this registration statement (after its effectiveness date) ceases to be effective and available to the 2005 Investors for any continuous period that exceeds 30 days or for one or more periods that exceed in the aggregate 60 days in any 12-month
period. Our obligations to register shares under the stock purchase agreement entered into on September 28, 2004 (referred to as the 2004 Stock Purchase Agreement) and certain prior registration rights agreements, as amended, is
identical to the schedule for registration under the 2005 Stock Purchase Agreement.

In the event of a registration default, we shall pay as liquidated
damages to the 2005 Investors, and the investors who were parties to the 2004 Stock Purchase Agreement (the 2004 Investors 0 for each 30-day period of a registration default, an amount in cash equal to 1% of the



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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.

Should we become obligated 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 potential due and payable under these agreements.

If we fail to effect our Capitalization Amendment on or before April 15, 2006, we will be obligated to make a $1.375 million cash payment to the 2004 Investors.

Under the terms of Amendment Number 1 to the 2004 Agreement, we issued the New Warrants to the 2004 Investors and agreed to present the Capitalization Amendment for consideration at a meeting of our stockholders to be
held on or before April 15, 2006 in lieu of making a cash payment in the amount of $1.375 million for liquidated damages under the 2004 Agreement accrued through August 31, 2005 (the Accrued Liquidated Damages). In the event
the Capitalization Amendment is not effective on or before April 15, 2006 and M/C Venture Partners and SSF have voted their shares in favor of the Capitalization Amendment, which they are obligated to do under the terms of the Voting Agreement,
then we will be required to make a cash payment of the Accrued Liquidated Damages to the 2004 Investors, at which time the New Warrants issued in satisfaction of the Accrued Liquidated Damages which will expire unexercised. Should we become
obligated to make immediate payment of these amounts to the 2004 Investors, it would reduce our available working capital and likely have a material adverse affect on our liquidity, our financial condition and our results of operations.

Restrictive covenants in the Stock Purchase Agreement and the 2004 Agreement may limit our ability to pursue our business strategies.

We have agreed under the terms of the Stock 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, other than to effect the Capitalization
Amendment and the Preferred Stock Amendment, (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 the Section 8 of the New Warrants.

We have agreed under the 2004 Agreement
that we will not, without the prior consent of M/C Venture Partners, (1) enter into a transaction involving a change in control; (2) incur indebtedness in excess of $3.0 million; (3) create any security with an equity component unless
that security is junior to the Common Stock or, subject to specified exceptions, issue any equity securities; (4) transfer our intellectual property; (5) repurchase, redeem or pay dividends on any shares of capital stock (subject to
limited exceptions); (6) grant stock options that are not authorized by a vote of our board of directors or our compensation committee; (7) liquidate or dissolve; (8) change the size of our board of directors; (9) amend our
certificate of incorporation or bylaws; (10) change the nature of our business; or (11) alter the voting rights of shares of our capital stock in a disparate manner.

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 SVB Loan Agreement may limit our ability to pursue our business strategies.

Under the terms of the SVB Loan Agreement, we are not permitted to take certain actions, without the prior written consent of SVB, including, without limitation, the
following: (1) merge or consolidate with another corporation or entity except that we may merge with Acquisition Sub; (2) acquire any assets, except in the ordinary course of business; (3) enter into any other transaction outside the
ordinary course of business; (4) sell or transfer any collateral pledged to SVB under the SVB Loan Agreement, except for the sale of finished inventory in the ordinary course of our business, and except for the sale of obsolete or unneeded
equipment in the ordinary course of business and transfers between us and Acquisition Sub; (5) store any inventory or other collateral with any warehouseman or other third party; (6) sell any inventory on a sale-or-return, guaranteed sale,
consignment, or other contingent basis; (7) except for advances in the ordinary course of business not exceeding $100,000 in the aggregate outstanding at any time, make any loans of any money or other assets; (8) incur any debts outside
the ordinary course of business other than debts outstanding as of the date of the SVB Loan Agreement; (9) guarantee or otherwise become liable with respect to the obligations of another party or entity; (10) pay or declare any dividends
on our Common Stock (except for dividends payable solely in our capital stock) or dividends paid by Acquisition Sub to us; (11) redeem, retire, purchase or otherwise acquire, directly or indirectly, any of our stock; (12) make any change
in our capital structure which would have a material adverse effect on us or on the prospect of repayment of the our obligations under the SVB Loan Agreement; (13) engage, directly or indirectly, in any business other than the business we
currently engage in; or (14) dissolve or elect to dissolve.



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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.

Failure to successfully integrate the acquired operations of Vertical
Networks and Comdial could have a material adverse effect on our combined operations.

Our decisions to acquire the operations of both Vertical Networks
and Comdial 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:



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



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



| |  | retaining existing customers of both 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 Vertical Networks and Comdial, 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 and
Comdial.

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

Successful integration of our operations, products and personnel with those of Comdial 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 the Comdial Assets will depend in part on the retention of key personnel. As a result of the acquisition, our employees and those of Comdial 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
Comdial. If we fail to retain such key employees, we may not realize the anticipated benefits of the acquisition.

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 is 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 Comdial Assets, 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. Scansource, Inc., through its division Paracon, accounted for 19% of net revenue for the year ended June 30, while CVS accounted for 92% of deferred revenue as
of June 30, 2005.

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.

Products in our new Comdial inventory may become obsolete.

Comdial offered a variety of communications products which included technologies that are enhanced rapidly in todays business environment. Comdial measured its product inventories on hand at the lower of costs or market. Comdial also
provided allowances for excess and obsolete



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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 new Comdial 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 new Comdial 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.

As a result of the acquisitions of Vertical Networks, we now design and distribute the hardware on which
many of our products, particularly our InstantOffice products operate including phones and custom server hardware. If we 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 incorporated into the product, as
well as continued cooperation by the manufacturers involved in assembling the custom servers used by the product. We 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 components than we need. We cannot assure you that we will not encounter these problems in the future. Although in many cases we use standard parts and components for our products, certain components are presently
available only from a single source or limited sources. We 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 components, 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;
|- |  | ---------------------------------------------------------------------------------------------------------------------------------



| |  | the outsourcing contractors ability to honor their product warranties;
|- |  | -----------------------------------------------------------------------



| |  | the financial solvency, labor concerns and general business condition of our outsourcing contractors;
|- |  | -----------------------------------------------------------------------------------------------------



| |  | unexpected changes in regulatory requirements;
|- |  | ----------------------------------------------



| |  | inadequate protection of intellectual property in foreign countries;
|- |  | --------------------------------------------------------------------



| |  | political and economic conditions in overseas locations;
|- |  | --------------------------------------------------------



| |  | risks of fire, flood or acts of God affecting manufacturing facilities; and
|- |  | ---------------------------------------------------------------------------



| |  | 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 lead 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



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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.

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 and Comdial products operate on 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.

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 in a dispute
regarding patent licenses we obtained when we acquired the assets of Vertical Networks.

As part of our agreement to acquire the assets of
Vertical Networks, we entered into a separate agreement with Vertical Networks on September 28, 2004 (the License Agreement). The License Agreement, among other things, granted us the license to use certain patents held by Vertical
Networks (the Licensed Patents). On November 4, 2005, we received a notice from CIPH claiming that we have materially breached certain terms under the License Agreement. Should this dispute result in the termination of the License
Agreement and our inability to use the Licensed Patents, it would limit our ability to produce and sell our InstantOffice products, or may necessitate licensing or developing alternate technology, any of which would have a material adverse effect on
our financial condition and results of operations.

We are subject to risks associated with international operations.

We conduct business globally. International sales accounted for approximately 8% of net sales for the year ended June 30, 2005, and 15% the year ended June 30,
2004. 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;
|- |  | ---------------------------------------------------------------------------------------------------------------



| |  | the longer payment cycles associated with many foreign customers;
|- |  | -----------------------------------------------------------------



| |  | 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;
|- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | 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;
|- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | our ability to obtain U.S. export licenses and other required export or import licenses or approvals;
|- |  | -----------------------------------------------------------------------------------------------------



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

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 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 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.

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.



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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 has, 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 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 has 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 technologies or independent third-party development of
potentially infringing technologies.

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.
|- |  | -----------------------------------------------------------------



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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.

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. Further, we have
entered into a long-term service agreement with a certain customer pursuant to which we have agreed to provide all necessary maintenance and services for a fixed fee. 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.

We depend on distributors and resellers to market and sell our
products.

If distributors and resellers in the software industry do not focus their marketing efforts on software- or server-based phone systems or on
products competitive with TeleVantage or InstantOffice, our sales will be materially adversely affected. Failure of distributors and resellers to focus on software- or server-based phone systems may send a negative signal to current and potential
customers concerning the viability our industry or product offering. 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.

Item 2UNREGISTERED SALES OF EQUITY SECURITIES

On February 9, 2006, the Company completed the sale (the
Series D Financing) of 5,000 shares of its newly designated 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 Warrants) of the Companys Common Stock pursuant to a Securities Purchase Agreement between the Company and certain investors (the Series D Investors) (the 2006 Securities Purchase
Agreement). The aggregate proceeds to the Company from the Series D Financing was $5.0 million.

Under the 2006 Securities Purchase Agreement,
we have an obligation to register the shares of Common Stock issuable upon conversion of the Series D Preferred Stock and upon exercise of the 2006 Warrants and have agreed to file a registration statement no later than March 27, 2006. We have
also agreed to hold the annual meeting of the stockholders for the fiscal year ended June 30, 2005 as soon as possible after February 9, 2006 for, among other purposes, considering the approval of an amendment and restatement of the
Companys Certificate of Incorporation (the Amended and Restated Charter).



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The Company made certain affirmative and negative covenants under the 2006 Securities Purchase Agreement. The
Companys affirmative covenants include obligations related to (1) providing the Series D Investors with a right of first refusal on future issuances of securities by the Company; (2) amending the Companys Certificate of
Incorporation to the extent necessary to reflect the transactions contemplated by the 2006 Securities Purchase Agreement; (3) holding the Annual Meeting to approve the Amended and Restated Charter; (4) reserving shares of Common Stock for
issuance upon conversion of the Series D Preferred Stock and exercise of the 2006 Warrants and any additional warrants; (5) the issuance of additional warrants in connection with a future financing transaction; and (6) removing the
legends on the Common Stock issued.

The Companys negative covenants relate to obligations not to, without the prior consent of M/C Venture Partners
as long as 2,500 shares of Series D Preferred Stock are outstanding, (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; or (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 Warrants.

The Company has made representations and warranties to the Series D Investors in the 2006 Securities Purchase Agreement regarding matters that are customarily included in financings of this nature. These matters
include (1) capitalization; (2) Commission filings and compliance with the Securities Exchange Act of 1934, as amended (the Exchange Act), and the OTC Bulletin Board; (3) financial statements; (4) solvency and
obligations to related parties; (5) intellectual property; (6) absence of material adverse changes, (7) due authorization and valid issuance of the purchased shares; (8) private offering; (9) taxes; (10) contracts;
(11) no manipulation of stock; (12) controls and procedures; (13) accountants; (14) legal proceedings; (15) investment company status; (16) permits; (17) foreign corrupt practices; and (18) no violations and
non-contravention and organization. The representations and warranties will survive for one year after the closing. The Company has agreed to indemnify the Series D Investors and specified related parties against damages with respect to
breaches of the representations, warranties and covenants of the Company in the 2006 Securities Purchase Agreement.

The foregoing description of the
Series D Financing and related agreements does not purport to be a complete summary of the transaction. You are urged to read the complete documents, copies of which were filed as exhibits to the Form 8-K filed by Artisoft on February 15, 2006,
for a complete description of the terms and conditions of such documents.

Item 3DEFAULT UPON SENIOR SECURITIES

The Company financed a portion of the purchase price for the Comdial Assets
(the 2005 Debt Financing) by entering into a loan agreement with SVB on September 28, 2005 (the SVB Loan Agreement). The SVB Loan Agreement terms provide 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 matures and the principal balance thereof is payable in full, on September 27, 2006. The Term Loan is 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. Borrowing availability under the Revolving Loan is based on the amount of the
Companys accounts receivable.

For both the Term Loan and the Revolving Loan, interest shall accrue at a rate per annum equal to the Prime
Rate in effect from time to time, plus 1.50% per annum. However during the period beginning on September 28, 2005 and continuing until September 30, 2006, interest under the Term Loan shall accrue a rate per annum equal to the
Prime Rate in effect from time to time plus 2.00% per annum. Thereafter, interest shall accrue on the Term Loan at a rate equal to the Prime Rate in effect from time to time, plus (a) 2.00% per annum if the
Companys previous quarters Fixed Charge Coverage Ratio (FCCR) is less than or equal to 2.00 to 1.00, or (b) 1.50% per annum if the Companys previous quarters FCCR is greater than or equal to 2.00 to
1.00, each as determined by SVB in accordance with generally accepted accounting principles. Pricing adjustments shall be effective no later than three business days after SVBs receipt of satisfactory financial reporting and shall remain
effective until receipt by SVB of financial statements for such next successive quarter. Interest in all circumstances shall be calculated on the basis of a 360-day year for the actual number of days elapsed. Prime Rate means the greater
of (i) 6.50%, or (ii) the rate announced from time to time by SVB as its prime rate; it is a base rate upon which other rates charged by SVB are based, and it is not necessarily the best rate available at SVB. The interest rate
applicable to the outstanding obligations shall change on each date there is a change in the Prime Rate. Regardless of the amount of obligations that may be outstanding from time to time under the SVB Loan Agreement, the Company is obligated to make
minimum monthly interest payments to SVB equal to $15,000 during the term of this Agreement.

The SVB Loan Agreement contains certain financial covenants
related to net worth and minimum cash balances. During the first quarter of 2006, the Company was not able to comply with the net worth covenant in the existing agreement. As a result of this default, the Bank may cease making loans and could
accelerate and declare all amounts due. Consequently as of September 30, 2005, all of the SVB debt was classified as short term in our Condensed Consolidated Balance Sheet. Subsequently, the Company obtained a loan modification agreement from
the Bank which adjusted the net worth covenant which the Company was in compliance with. During the second quarter of 2006, the Company was not able to comply with the net worth covenant but has obtained a waiver from the Bank. The Bank agreed to
forbear from exercising its rights and remedies as a result of the default at December 31, 2005. Although the Company obtained a waiver from SVB with regard to the covenant default at December 31, 2005, the debt remains classified as short term
in our Condensed Consolidated Balance Sheet as there can be no assurance that the Company will be in compliance with the covenants in subsequent quarters.



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Item 6EXHIBITS

The Exhibits filed as part of this quarterly report on Form 10-Q for the
quarter ended December 31, 2005 are listed on the Exhibit Index immediately preceding such Exhibits, which Exhibit Index is incorporated herein by reference. Documents listed on such Exhibit Index, except for documents identified by footnotes,
are being filed as exhibits herewith. Documents identified by footnotes are not being filed herewith and, pursuant to Rule 12b-32 under the Securities Exchange Act of 1934, reference is made to such documents as previously filed as exhibits
filed with the Securities and Exchange Commission. Our file number under the Securities Exchange Act of 1934 is 000-19462.



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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.



|      |  |                   |  |    |  |                                                 |  |                     
|----- |  | ----------------- |  | -- |  | ----------------------------------------------- |  | --------------------
|      |  | ARTISOFT, INC.    |  |   
|      |  |                   |  |   
|Date: |  | February 21, 2006 |  | By |  | /s/ WILLIAM Y. TAUSCHER                         |  | William Y. Tauscher 
|      |  |                   |  |    |  | Chief Executive Officer and                     |  |                     
|      |  |                   |  |    |  | Chairman of the Board                           |  |                     
|      |  |                   |  |   
|Date: |  | February 21, 2006 |  | By |  | /s/ KENNETH M. CLINEBELL                        |  | Kenneth M. Clinebell
|      |  |                   |  |    |  | Interim Chief Financial Officer (Principal      |  |                     
|      |  |                   |  |    |  | Financial Officer and Chief Accounting Officer) |  |                     

EXHIBIT INDEX



|           |  |                                                                                                                                                  
|---------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------
|ExhibitNo. |  | 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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