**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,D.C. 20549**

**FORM 10-K**

**ANNUAL REPORT PURSUANT TO SECTION 13 OR15(d)OF THE SECURITIES EXCHANGE ACT OF 1934**

**Forthe year ended December 31, 2005**

**CommissionFile Number 0-25882**

**EZENIA! INC.**

(Exact name of registrantas specified in its charter)

| **DELAWARE**

**(State or other jurisdiction of  incorporation or organization)** | **04-3114212**  (I.R.S. employer  identification number) |
|-----------------------------------------------------------------------------------|----------------------------------------------------------|

 

**14 Celina Ave, Suite 17-18,Nashua, New Hampshire 03063**

(Address of principalexecutive offices, including zip code)

**(781) 505-2100**

(Registrant’s telephone number, including area code)

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**Securities RegisteredPursuant to Section 12(b) of the Act:**

None

**Securities RegisteredPursuant to Section 12(g) of the Act:**

Common Stock $.01 par value

Indicate by check mark ifthe Registrant is a well-known seasoned issuer, as defined in Rule 405 ofthe Securities Act.   Yes  o   No  x

Indicate by check mark ifthe Registrant is not required to file reports pursuant to Section 13 or15(d) of the Act.   Yes  o   No  x

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

Indicate by check mark ifdisclosure of delinquent filers pursuant to Item 405 of Regulation S-K is notcontained herein, and will not be contained, to the best of Registrant’sknowledge, in definitive proxy or information statements incorporated byreference in Part III of this Form 10-K or any amendment tothis Form 10-K.   Yes  o   No  x

Indicate by check markwhether the Registrant is a large accelerated filer, an accelerated filer or anon-accelerated filer. See definition of “accelerate filer” and “largeaccelerated filer” in Rule 12b-2 of the Exchange Act). LargeAccelerated Filer   Yes  o   No  x   Accelerated Filer   Yes  o   No  x   Non-AcceleratedFiler   Yes  x   No  o

Indicate by checkmarkwhether the Registrant is a shell company (as defined in Rule 12b-2of the Exchange Act).   Yes  o   No  x

The aggregate market valueof the voting and non-voting common stock held by non-affiliates of theRegistrant was $28,146,459 (computed by reference to the price at which theRegistrant’s common stock was last sold on the OTC Bulletin Board on June 30,2005).

The number of shares outstanding of the Registrant’scommon stock as of March 24, 2006 was 14,623,422.

**DOCUMENTS INCORPORATED BYREFERENCE**

Portionsof the definitive Proxy Statement to be delivered to Shareholders in connectionwith the Annual Meeting of Shareholders to be held May 24, 2006 areincorporated by reference into Part III hereof. With the exception of theportion of such Proxy Statement that is expressly incorporated herein, suchProxy Statement shall not be deemed filed as part of this Annual Report on Form 10-K.

 

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**Ezenia!Inc.2005 Form 10-K Annual ReportTable of Contents**

|            | ** ** | ** **                                                                                                         | ** ** | **Page**   | ** ** |
|------------|------------|--------------------------------------------------------------------------------------------------------------------|------------|------------|------------|
| ** ** |       | **PART I**                                                                                                    | ** ** |       | ** ** | ** ** |   |
| Item 1.    |       | Business                                                                                                           |       |       | 3          | ** ** |   |
| Item  1A.  |       | Risk  Factors                                                                                                      |       |       | 10         | ** ** |   |
| Item  2.   |       | Description  of Property                                                                                           |       |       | 13         | ** ** |   |
|       |       | **PART II**                                                                                                   |       |       |       | ** ** |   |
| Item 5.    |       | Market for Registrant’s Common Equity, Related  Stockholder Matters and Issuer Purchases of Equity Securities |       |       | 13         | ** ** |   |
| Item  6.   |       | Selected  Financial Data                                                                                           |       |       | 14         | ** ** |   |
| Item 7.    |       | Management’s Discussion and Analysis of Financial  Condition and Results of Operations                        |       |       | 15         | ** ** |   |
| Item 7A.   |       | Quantitative and Qualitative Disclosures about Market  Risk                                                        |       |       | 23         | ** ** |   |
| Item 8.    |       | Financial Statements and Supplementary Data                                                                        |       |       | 24         | ** ** |   |
| Item 9A.   |       | Controls and Procedures                                                                                            |       |       | 43         | ** ** |   |
|       |       | **PART III**                                                                                                  |       |       |       | ** ** |   |
| Item 10.   |       | Directors and Executive Officers of the Registrant                                                                 |       |       | 43         | ** ** |   |
| Item 11.   |       | Executive Compensation                                                                                        |       |       | 43         | ** ** |   |
| Item 12.   |       | Security Ownership of Certain Beneficial Owners and  Management and Related Stockholder Matters               |       |       | 44         | ** ** |   |
| Item 13.   |       | Certain Relationships and Related Transactions                                                                     |       |       | 44         | ** ** |   |
| Item 14.   |       | Principal Accountant Fees and Services                                                                             |       |       | 44         | ** ** |   |
|       | ** ** | **PART IV**                                                                                                   |       |       |       | ** ** |   |
| Item 15.   |       | Exhibits and Financial Statements Schedules                                                                        |       |       | 45         | ** ** |   |
| Signatures |       |                                                                                                               | 47         | ** ** |       |

 

The Company’s trademarks include Ezenia!, the Ezenia!Logo, InfoWorkSpace, LaunchPad, and Encounter.  All other trademarks referred to in thisdocument are the property of their respective companies.

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**PART I**

**ITEM 1.**                BUSINESS

Founded in 1991, Ezenia! Inc. (“Ezenia” or the “Company”)a Delaware corporation, develops and markets products that enable organizationsto provide high-quality group communication and collaboration capabilities tocommercial, governmental, consumer and institutional users. Ezenia’s productsallow individuals and groups, regardless of proximity constraints, to interactand share information in a natural, spontaneous way—voice-to-voice,face-to-face, mouse-to-mouse, keyboard-to-keyboard flexibly, securely and inreal-time. Using our products, individuals can interact through a naturalmeeting experience, allowing groups to work together effectively anddisseminate vital information quickly in a secure environment.

Ezenia offers one of the most comprehensivecommercially available lines of collaborative products. Ezenia’s InfoWorkSpace(IWS) software product, combined with its legacy videoconferencing products,enables voice communication, instant messaging, white boarding, virtual workspaces,and video conferences across a wide range of networks including local areanetworks (LAN), intranets, the Internet, and circuit-based networks. Furthermore,because Ezenia products include both software-only solutions and configurablehardware solutions, they can be deployed with relative ease at small sites orin locations with a large number of users.

Ezenia historically hassold the legacy videoconferencing products worldwide through leading resellers,integrators and marketers of video collaboration, and networking solutions, andwill continue to do so as long as demand exists. Most recently, for the IWSproduct and services, Ezenia sells to customers in the Federal government,mostly in the Department of Defense (DoD) and the intelligence community,either directly, or in many instances, in partnership with the premier defensecontractors and/or integrators. It is in Ezenia’s interest to leverage thesepartnerships with well-established contractors and/or integrators to furtherexpand the deployment and provide the support of IWS in large-scaleopportunities.

**CompanyBackground and Evolution—True Collaboration versus Videoconferencing**

In 1991, Ezenia, known at the time as VideoServer,designed, developed, manufactured, and sold Multipoint Control Systems or Units(MCS or MCU) for both the circuit-oriented, Integrated Services Digital Network(ISDN)-based and packet-switched, Internet Protocol (IP)-basedvideoconferencing applications. Ezenia’s MCS was unique at the time with itsPC-based, flexible hardware design approach and system configurations,leveraging commercial off-the-shelf base operating systems. At that time,traditional videoconferencing vendors concentrated mostly on the development ofmore and more sophisticated, standard-based endpoints to be used inpoint-to-point videoconferencing. Ezenia focused its business, not on theendpoints, but on systems deployed in the infrastructure backroom, to enablethree or more sites or parties involved in videoconferencing to properly communicateamong themselves, by switching video sources based on audio processing ofcurrent and immediately preceding speakers. Ezenia’s technical advantages werederived by masking and compensating for incompatibilities between endpointsfrom different manufacturers, algorithmic transcoding, compensation fordifferent bandwidth requirements, and simultaneous multi-windowed videoarrangements on the monitor known as “Hollywood Squares”, just to name a few.

For the circuit-switched market segment, Ezenia offeredthe Series 2000 MCS which can scale up to forty eight (48) ports or siteswith a variety of network capabilities including but not limited to V.35, T1 andE1 interfaces, Asynchronous Transfer Mode (ATM) and Frame Relay. Multiple Series 2000MCS can be cascaded together to allow for large-scale videoconferences. To thisday, the Series 2000 MCS is still considered the cornerstone of rock solidreliability in the industry and in many customer installations. Ezenia stillproduces, ships, and provides support for the Series 2000 MCS.

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For the packet-switched market segment, Ezenia offereda low-end, software-only solution NetServer 1000 which provides acost-effective solution for departmental applications. For comparabledeployments to its ISDN counterparts, Ezenia offered the NetServer 3000 MCS,which can also scale up to forty eight (48) ports or sites. Similarly, multipleNetServer 3000 MCS can be cascaded together to support large-scale videoconferences. Ezenia also offered the NetGate which, with its associatedgatekeeper software, controls, monitors, polices, and facilitatescommunications traffic between the ISDN and IP environments. Ezenia stillproduces, ships, and provides support for the NetServer and NetGate MCS.

In the late 90’s, Ezenia fully realized thelimitations and narrow applications of its videoconferencing products which,among many deficiencies, are monolithic, require highly specialized support andservices, stand apart from the normal office environment that most informationworkers are accustomed to, and do not provide a solution to the need to trulycollaborate and disseminate information in real time. Contrary to how mostvideoconferencing vendors would like to indoctrinate potential customers, video—inparticular talking heads as in the case of most video conferences—was and is,now more than ever, far from being the “piece de resistance” of true,meaningful real-time collaboration. Furthermore, its monolithic approach,whereby you either get a successful videoconference session or get nothing,relegates all other more critical collaboration activities second to videotalking heads. Most importantly, the lack of presence awareness detection andthe inability to leverage the web for ease of access prevent flexible,on-demand, free-flowing collaboration sessions whereby participants can come,go, or be invited at will.

In March 2001,Ezenia completed the first phase of its transformation with the acquisition ofthe IWS business from General Dynamics. As an application solution and technologybuilt on top of Placeware’s (see Third Party Technology note below) webconferencing technology, IWS:

·       Allowsusers to be aware of the online presence of colleagues, enables true multimediacollaboration sessions starting with the simplest instant messaging(keyboard-to-keyboard) and expanding to the most complex all-encompassing(mouse-to-mouse) sharing and dissemination of mission critical informationsimultaneously with in-session, super-imposed audio conferencing and/or videostreaming;

·       Leveragescommercially off-the-shelf base operating systems such as the Windows andSolaris platforms; and

·       Fitsinto the virtual office environment that most information workers are familiarwith.

The use and growth ofreal-time collaborative technologies within commercial or governmentalenterprises, while still early in its adoption curve, are beginning toaccelerate. The investment in information and collaborative technologies helpscustomers flatten their organizations, improve enterprise wide communication, shortenthe decision-making process, and facilitate real-time reactions to criticalissues. Rather than just providing access to inert data stored on a server, thegoal today is to find ways to enable information workers to collaborate andshare their expertise to derive knowledge from databases in real time and in asecure environment. Collaborative technologies are about creating informationalvalue through better, faster and more efficient human interaction andcooperation, not just more data. Businesses and governmental organizationstoday need solutions that make it easier for people to work together, shareinformation and expertise, coordinate activities across departments, networks,agencies, building complexes, facilities spread all over the country, and fielddeployments around the world.

**Products**

Ezenia’s expertise is indeveloping products that deliver highly secure and flexible support forinformational collaboration, in-session audio conferencing, and video streamingcapabilities across a wide range of platforms. The Company’s products have beendesigned with a scaleable, modular architecture to give customers theflexibility to add capacity, processing power, and conferencing features as thecustomer 

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networkand application requirements grow. Using a common set of hardware and softwarebuilding blocks, customers can choose from a wide range of productconfigurations that differ in capacity, price, network connectivity andfeatures, all of which share the same operating software user interface. Productsmay be configured for use in customer premises environments or may beconfigured with specialized packaging for use in a telephone carrier’s centraloffice setting. The Company believes a key differentiator for its products isthe built-in robust security features, allowing them to be installed in some ofthe highest clearance and security sites in the market.

***InfoWorkSpace***

IWS is a comprehensive suite of collaborationapplications designed to allow any organization to more efficientlycommunicate, particularly when attempting to work as, and within, a group. Froman overall perspective, IWS, when used effectively can reduce or even eliminatedependency on travel, traditional video conferencing, traditional audioconferencing and the phone, and even e-mail and file servers. Essentially, IWSis like a corporate campus or enterprise whose resources can be accessed by aninformation worker through his or her own desktop or laptop PC. Users canbrowse through the virtual campus, facility, or building to locate the room tobe used for a meeting, or just pick the needed contact(s) and initiate themeeting with the click of the mouse.

Our customers, including the U.S. intelligencecommunity, the U.S. Joint Forces Command, and various branches of the U.S.Armed Forces including the Marines, Navy, Air Force and Army, have leveragedthe flexibility of IWS to aid in a myriad of missions. From daily missionbriefs to medivac procedures in Afghanistan to operational support in Fallujah,IWS has increasingly become a vital part of the U.S. defense network. Thestability, scalability and security of IWS allows our customers to depend onour software to complete mission-critical assignments and save lives in some ofthe world’s most dangerous areas.

At a basic level, IWS is a cross-platform solution ina box, supporting both UNIX and Windows base operating systems. A standardsoftware suite comes complete with our server software package, database,application server, and user directory along with a number of ancillary add-ons.This suite provides a self-sufficient workgroup environment for a user base ofup to several hundred users. However, with a few simple system configurations,IWS servers can be federated in such a way that multiple servers can trust oneanother in order to support collaboration across an enterprise with thousandsof participants.

IWS security infrastructure is built upon the bestpractices that have been in use in operating systems for decades. Much like aUNIX administrator can limit access to a directory or even a file to a limitedset of users, IWS administrators can lock rooms down to restrict users fromseeing sensitive data that is outside their area of responsibility. Permission-basedaccess allows administrators to finely tune a user’s access profile to the filelevel. Data can be encrypted using standard SSL protocols and access can becontrolled with PKI and X.509 certificates. All data within the application canbe audited and searched for specific words or patterns of words. IWS provides ahigh level of security capabilities as well as a safety net to capture anybreaches that may arise from human errors.

The stability, scalability, flexibility and securitycapabilities of IWS are critically important for our customers, but the true powerof IWS is in its collaboration applications. Users can participate in aninteractive conference with absolutely no set up procedures. This is asignificant leap forward from where the industry was just a few years ago,using videoconferences as the only interactive medium. With IWS, no longer is aheavy piece of hardware required at each terminal point of collaboration. Nolonger is it necessary to schedule a conference with a bridge operator, and nolonger is a whole new network infrastructure required to support an interactiveconferencing capability. Information workers, once logged in to IWS, caninitiate a conference by going to a virtual room and inviting the participantsas needed. Rooms are either pre-defined or created on demand as needs dictate. Onceinside a room, either by 

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joining or being invitedinto a session, participants can have an audio conference straight from thesoftware. No set up is required. No additional cost is incurred. Participantseven can be in multiple rooms at the same time, offering a more productivevirtual environment than in the physical world. Participants can share and workon documents from the file cabinet associated with a room. Users can have aninteractive white board session and save the results. Users also can managetheir calendar and participate in message boards and save that information tothe server where they can access it any time from any place.

A high-levelsummary of IWS features and functions is listed below:

·       Textchat, in a one-to-one arrangement, in a conference environment, or in multiplecombinations of one-on-one and/or conference environments;

·       Audiochat, in a one-to-one arrangement, in a conference environment, or in multiplecombinations of one-on-one and/or conference environments;

·       Interactivewhiteboard which all users can see and modify in real time;

·       Applicationsharing allowing the screen view of any application on any desktop or laptop PCof any information worker to be broadcasted to all other participants;

·       Securedfile cabinet, from which permission-based access allows for documents to bestored, retrieved, and monitored at any time from any place;

·       Multi-Levelsecurity allows users of one security level to have real-time collaborationsessions with users at another security level;

·       SSLand PKI encryption, which, when configured, renders traffic secure across thewire;

·       Fullsystem auditing, which allows all data and actions to be audited andsearchable;

·       Instantmessaging, a lightweight application that provides all interactivecapabilities; and

·       Virtual meeting area, amore robust application that provides both real-time collaborative capabilitiesas well as static functions like file cabinet, message board, and calendaring.

***Encounter MCSFamily***

The Encounterproduct line includes:

·       Encounter3000 NetServer: real-time collaboration server designed to support largeenterprise and service provider customers;

·       Encounter3000 NetGate: gateway solution that allows traditional videoconferencingsystems to participate in IP-based collaboration sessions; and

·       Encounter 1000 NetServer:real-time collaboration server geared towards smaller, departmental workgroupsor more distributed organizations.

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***Series 2000MCS***

The Series 2000MCS product line, designed for switched digital circuit networks, includes anumber of platform configurations which can be expanded through customerselection of optional processing modules and software applications. Thefollowing table lists the configurations offered by the Company:

| **MODEL**      | ** ** | ** **     | ** ** | **CAPACITY**                                                             | ** ** | **TARGET MARKET/APPLICATION** |
|----------------|------------|----------------|------------|--------------------------------------------------------------------------|------------|-------------------------------|
| 2007           |       | 8  users  |       | Mid-range CPE for  distributed network environments                      |
| 2020           |       | 48  users      |       | Large CPE/central office  network with extensive multimedia applications |
| CO   |       | 48 users       |       | High availability central office server                                  |

 

**Market and Channels**

Ezenia markets its IWS products and related servicesto customers within the US federal government, primarily to the US DoD and tothe US intelligence community worldwide. Ezenia also provides these productsand services to the defense and intelligence organizations of foreign allies ofthe United States government.

IWS products and services are licensed on an annualsubscription and renewal basis, during which software updates and basictechnical support are included as part of base offerings. Enhanced serviceofferings are also offered in a subscription model. Training, installation, andcustomization are sold on an incidental basis.

The worldwide government marketplace is bestunderstood as a matrix of customers, sales vehicles (contracts), and sales channels.Ezenia employs a sales model which is an analog to this government marketmatrix. IWS products and related services are available to specific segments ofthe government, using various vehicles, including Ezenia’s own GSA Schedule,and multiple channels both directly, with the Company’s own sales force, andindirectly. For indirect channels, Ezenia partners with General Dynamics, SAIC,and Northrop Grumman among others.

In fiscal year 2005, approximately 43% of our sales ofIWS products and related services were through our indirect channels. Ezenia’stop three end-user customers for IWS products and related services in 2005 wereUS Joint Forces Command, Defense Intelligence Agency, and the US Army.

Meanwhile, our legacy MCS sales are primarily to internationalcustomers and end users.  In 2005, Ezeniadelivered these products through distributors, dealers, vertical marketresellers, and systems integrators, as well as directly to end-users. Revenuefrom international markets accounted for approximately 3%, 2%, and 14% of ourrevenue for the years ended December 31, 2005, 2004, and 2003,respectively.

Ezenia conducts its salesand marketing activities from its principal offices in Nashua, New Hampshire,as well as from two other sales locations in the United States.

**Research and Product Development**

Ezenia believes that its future success depends on itsability to continue to enhance and expand its existing enterprise collaborationproducts and to develop new products that maintain its technology leadership.Ezenia has invested and will continue to invest in the development of productsand core technologies while also leveraging the integration of “best-of-breed”software components through strategic partnerships. Extensive productdevelopment input is obtained via direct feedback from end users and suggestedimprovements from strategic partners and resellers. We carefully monitor themigration of industry standards and remain committed to developing productsutilizing such standards. This includes the development of interoperablecollaboration products to meet either industry needs and/or DoD-driven 

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interoperability criteria,while maintaining a keen focus on the security aspects of enterprisecollaboration, including solutions in the web conferencing arena.

As of December 31,2005, Ezenia’s research and development staff consisted primarily of softwareengineers augmented with US-based and US-citizen software contractors. Many ofour software engineers carry top-secret levels of security clearance. The Company’snet research and development expenditures were approximately $1.2 million, $1.1million, and $1.9 million in 2005, 2004 and 2003, respectively, representingapproximately 9%, 10%, and 23% of revenue, respectively. All softwaredevelopment costs have been expensed as incurred because costs eligible forcapitalization have not been material to date.

**Customer Support and Service**

Ezenia provides technical support and services to itsresellers and direct customers. A high level of continuing service and supportis critical to our objective of developing long-lasting relationships withcustomers and partners. Ezenia’s partners and resellers offer a broad range ofsupport including installation, maintenance and on-site and headquarters-leveltechnical support of products to their end-user customers. Ezenia provides acomprehensive service program including problem management, training,diagnostic tools, software updates and upgrades, as well as spare partsprograms to facilitate and supplement the efforts of our partners andresellers.

Ezenia offers a technical support hotline to itsresellers and customers, which is staffed by our network engineers whogenerally provide either immediate or same-day responses to most questions. Asour products have built-in remote diagnostic capabilities, most problems can bediagnosed without incurring travel or on-site visits. When necessary, however,support engineers are dispatched to the customer’s facility for criticalsituations. All of our support engineers carry various levels of securityclearance.

With respect to the Series 2000 and EncounterMCS, Ezenia warranties related software and hardware products for 90 days. Wealso offer post-warranty support programs ranging from services on atime-and-material basis to full-service contracts on a 24-hour, 7-day-a-weekbasis as well as training courses.

**Manufacturing—Series 2000and Encounter Systems**

Ezenia’s manufacturingoperations consist primarily of materials management, quality control, testengineering, production, shipping and logistics related to its legacyvideoconferencing hardware products. Ezenia employs an outsourced manufacturingmodel in which it designs the significant hardware subassemblies for itsproducts and uses independent third-party contract assembly companies toperform printed circuit board assembly and other production activities withinternal efforts generally limited to final product configuration, assembly andtesting. This manufacturing model offers the capability to quickly fulfillorders with limited lead times thus providing enhanced customer satisfactionand improved inventory management. Because****ofthe generally short cycle between order and shipment and because the majorityof our sales in each quarter result from orders booked in that quarter, Ezeniadoes not have a material backlog.

**Third Party Technology**

Ezenia licenses technologyfrom third parties, including software which is integrated with internallydeveloped software, and used in our products to perform key functions. Therecan be no assurance that functionally similar technology will continue to beavailable on commercially reasonable terms in the future, or at all. Inparticular, in February 2005 we entered into a new agreement withMicrosoft Corporation, with an effective date of January 1, 2005, toextend an existing software distribution license agreement throughDecember 2007. The software distribution license agreement allows us tointegrate Microsoft’s Live Communication software into our IWS product line.

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**Competition**

The market for multimedia collaboration is an emergingsegment with a variety of either new vendors entering the competitive landscapeor old vendors from existing industries, such as legacy videoconferencing,attempting to claim a new turf. Furthermore, multimedia collaboration can alsobe grouped into two main groups: real-time synchronous solutions versusasynchronous products a la antiquated Lotus Notes. While most vendorsadopt the client-server architecture, a very few insist on the merit ofpeer-to-peer. Still yet, large vendors offer both types of products. Fromanother perspective, vendors could be classified into two classes of providers.The first group provides customer-premise solutions, while the secondimplements a hosted environment.

Even though Ezenia business primarily focuses on thereal-time synchronous, client-server, customer-premise market segment withinthe government, depending upon the possible perspectives, various vendors couldbe considered as likely competitors. From the legacy videoconferencingindustry, Polycom, RADvision and Tandberg are legitimate contenders.Established industry giants such as AOL, Cisco, EMC, Google, IBM, Microsoft,Oracle and, more recently, Adobe with its acquisition of Macromedia, amongothers, offer a wide variety of solutions ranging from simple instant messagingto complete offerings. In addition, a multitude of smaller and well-respectedcompanies such as WebEx, Raindance, Saba, Jabber, Interwise, etc... constitutesa new breed of emerging contenders in this intensely contested market segment.

Many of these companies, as well as other current andpotential competitors, have substantially greater financial, technical, andsales and marketing resources than Ezenia. If we are unable to retain ourexisting customers in the US government, or are unable to convince a sufficientnumber of new companies or customers with an interest in collaborativetechnologies to adopt our IWS collaborative software product over alternativetechnologies marketed by our competitors, our financial results will suffer,through price reductions and loss of market share.

With respect to our legacyvideoconferencing hardware products, we consider our primary videoconferencingcompetitors to be Polycom, RADvision and Tandberg Telecom.

The principal competitivefactors in the market for multimedia collaboration are, and should continue tobe, breadth of capabilities, security, stability, reliability, price,performance, network management capabilities, customer support andinteroperability. We plan to compete by offering the best-of-breed enterprisesolutions encompassing all of these factors. However, we cannot be certain thatpotential customers will be attracted to our products, especially if ourcompetitors invest substantially more money into their products and technology.

**Proprietary Rights**

Ezenia relies on acombination of contractual rights, trade secrets and copyright laws toestablish and protect its intellectual property rights. We believe that,because of the rapid pace of technological change in the data communicationsand telecommunications industries, intellectual property protection for itsproducts is only one factor in our success, complementing the knowledge,abilities and experience of our employees, the frequency of our productenhancements, our relationships with our partners, our relationships with ourcustomers and their satisfaction with the performance of IWS, the effectivenessof our marketing activities, and the responsiveness and quality of ourservices.

In August 2002,Ezenia entered into an agreement with Tandberg Telecom AS to sell all patentsand pending applications related to its videoconferencing products, which wascompleted in October 2002. In exchangefor an up-front license fee of $1.25 million, a loan for an additional $1.25million which was forgiven at the closing, and an additional $2.4 million alsoreceived at the closing, Ezenia granted Tandberg a fully paid, non-exclusive,non-transferable license under the patents and pending applications relating toour videoconferencing technology (the video patent portfolio). Additionally, weretained a fully 

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paid, non-exclusive, non-transferable license for ouruse in connection with its videoconferencing and enterprise collaborationproducts.

In June 2000, Ezeniasettled its patent infringement suit against Accord Networks Ltd. (Accord) inthe United States District Court for the District of Massachusetts. Thesettlement agreement provided, among other things, that Ezenia receive $6.5million, which the Company received net of foreign tax withholding of $975thousand, pending a resolution of certain tax matters related to the settlementwith the tax authorities in Israel. In April 2004, Ezenia reached asettlement agreement with the Israeli Tax Commission (ITC), resulting in thereceipt by the Company of cash proceeds related to the disputed amount, net ofinterest earned and associated fees, of approximately $706 thousand.

**Employees**

At December 31, 2005,Ezenia employed 46 people, including 20 in research and development, 10 incustomer support, 8 in sales and marketing, and 8 in finance andadministration. None of our employees are represented by a labor organization.

Ezenia’s success depends,to a significant degree, upon the continuing contributions of its keymanagement, sales, marketing and research and development personnel, many ofwhom would be difficult to replace, including Khoa Nguyen, the Company’s ChiefExecutive Officer, President and Chief Financial Officer. We do not carrykey-man life insurance on any of our employees, including Mr. Nguyen. Wedo not have employment contracts with our key personnel other than Mr. Nguyen.We believe that our future success will depend in large part upon our abilityto attract additional key employees and retain our key employees.

**Availability ofFilings**

Youmay access, free of charge, through our website at www.ezenia.com, our AnnualReport on Form 10-K, Quarterly Reports on Form 10-Q,Current Reports on Form 8-K and any amendments to such reports, allfiled pursuant to Section 13(a) and 15(d) of the SecuritiesExchange Act of 1934, as amended. The information contained on our web site isnot incorporated by reference into this document and should not be considered apart of this report. Our web site address is included in this document as aninactive textual reference only.

**ITEM 1A.**        RISKFACTORS

***Liquidity and history of losses.***   Asfurther described under Liquidity and Capital Resources, management believes,although there can be no assurances, due to the growth and  acceptance of our IWS product, the expectedgrowth of Internet-based collaboration products in general, and our successivequarters of profitability and continued vigilance on cost control, that ourcash and available resources will enable us to continue as a viable entity.****There can be no assurances that we canachieve our goal of showing consistent quarterly revenue and profit growth,which are both largely dependent on whether we can meet our future new orderbookings targets.

***Dependence on major customers.****  *While we are focusing efforts on broadening ourcustomer base, sales to a relatively small number of customers within the USgovernment, specifically within the DoD and the intelligence community, haveaccounted for a significant portion of revenue. This concentration of customersmay cause revenues and operating results to fluctuate from quarter-to-quarterbased on major customers’ requirements, and the timing of their orders andshipments. Our agreements with customers generally do not include minimum purchasecommitments or exclusivity arrangements. Our operating results could bematerially and adversely affected if any present or future major customer wereto choose to reduce its level of orders, were to change to another vendor forpurchases of a similar product, were to realize a reduction in approved fundingfor collaborative technologies, or were to delay paying or fail to pay amountsdue to us.

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***Third Party Technology.***   Ezenia utilizes certain technology whichit licenses from third parties, including software which is integrated withinternally developed software, and used in the Company’s products to performkey functions. There can be no assurance that functionally similar technologywill continue to be available on commercially reasonable terms in the future,or at all. In particular, in February 2005 Ezenia entered into a new agreementwith Microsoft Corporation to extend an existing software distribution licenseagreement. The software distribution license agreement allows Ezenia to integrateMicrosoft’s Live Communication software with our proprietary software, tocreate IWS.

***Reduced demand for traditional videoconferencingproducts.****  *Thedemand for traditional videoconferencing technology has experienced a rapiddecline. Ezenia’s videoconferencing product and related services revenuedeclined to approximately $495 thousand in 2005, from approximately $633thousand in 2004 and approximately $2.3 million in 2003. We expect that salesof this legacy hardware technology will continue to decline in 2006.

***Evolving markets.*****  **Sales of real-time collaborationproducts account for a significant and increasing portion of Ezenia’s revenue.Our success depends, to a significant extent, on the acceptance and the rate ofadoption of Internet-based collaboration products, in general, and the IWSproduct, in particular. There can be no assurance that any of the markets forour products will develop to the extent, in the manner, or at the rateanticipated by us. In addition, future prices that we are able to obtain forour products may decrease as a result of new product introductions by others,price competition, technological change or other factors.

***Rapid technological change.****  *The market for our products is characterized byrapidly changing technology, evolving industry standards, emerging networkarchitectures and frequent new product introductions. The adoption rate of newtechnologies and products may adversely impact near-term growth of theconferencing market as users evaluate the alternatives. We have invested, andfor 2006 plans to continue to invest, in product development and productsincorporating certain of these new technologies. Many other companies are alsodeveloping products incorporating these new technologies that are competitivewith our current and future offerings. Ezenia’s success will depend, in part,upon our ability through continued investments to maintain technologicalleadership, to enhance and expand our existing product offerings, and to selectand develop in a timely manner new products that achieve market acceptance.

***Competition.****  *The market for multimedia collaboration products ishighly competitive. Ezenia expects competition to increase significantly in thefuture, as the market for similar products is expected to significantly expand.A number of companies have introduced or announced their intention to introduceproducts that could be competitive with Ezenia’s products, and the rapidlyevolving nature of the markets in which Ezenia competes may attract other newentrants, as they perceive opportunities. Some of the Ezenia’s current andpotential competitors have longer operating histories and greater financial,technical, sales, and marketing resources. If we are unable to retain ourexisting customers in the US government, or were unable to convince asufficient number of new companies or customers with an interest incollaborative technologies to adopt the IWS collaborative software product overalternative technologies marketed by our competitors, our financial resultswould suffer.

The principal competitivefactors in the market for multimedia collaboration are, and should continue tobe, breadth of capabilities, demonstrated interoperability, price, performance,network management capabilities, reliability, scalability, customer support andsecurity. Ezenia plans to compete by offering collaboration and enterpriseproducts with a broad range of capabilities and high performance. However, wecannot be certain that potential customers will be attracted to our products,especially if competitors were to invest substantially more money into theirproducts and technology.

***Acceptance of IWS in the commercial market.******  ***In 2001, Ezeniapurchased the operating assets and intellectual property of the IWS businessunit of General Dynamics Electronic Systems. We entered into the purchaseagreement with the expectation that the transaction would result in certainbenefits including, 

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among other things,benefits relating to expanded and complementary product offerings, enhancedrevenues, increased market opportunity, new technology, the addition ofengineering personnel, and the expectation that we would be successful inexpanding the market for IWS products, both within certain organizations of theUS government, including the DoD and the intelligence community, but alsocommercially. There can be no assurance of success in the commercial market forIWS or other products that we may introduce, in 2006 or beyond.

***Protection of proprietary technology.****  *Ezenia’s success depends, to a large extent, on itsability to protect its proprietary technology. Ezenia relies primarily on acombination of contractual rights, trade secrets and copyrights to protect itsintellectual property rights, including the fully-paid, non-exclusive,non-transferable license granted by Tandberg to Ezenia for use in connectionwith its videoconferencing and enterprise collaboration products.

***Retention of key employees.******  ***Ezenia’s successdepends, to a significant degree, upon the continuing contributions of its keymanagement, sales, marketing, and research and development personnel, many ofwhom would be difficult to replace, including Khoa Nguyen, Ezenia’s ChiefExecutive Officer, President and Chief Financial Officer. Ezenia does not carry a key-man lifeinsurance on any of its employees, including Mr. Nguyen. Ezeniadoes not have employment contracts with its key personnel other than Mr. Nguyen.Ezenia believes that its future success will depend in large part upon itsability to attract and retain such key employees.

***Stock price volatility.******  ***The market price of Ezenia’scommon stock, like that of other technology companies, is highly volatile andis subject to wide fluctuations in response to quarterly variations inoperating results, announcements of technological innovations or new productsby Ezenia or its competitors, changes in financial estimates by securitiesanalysts or other events or factors. Ezenia’s stock price may also be affectedby broader market trends unrelated to Ezenia’s performance.

***Market for Company’s common equity.***   Theshares of the Ezenia’s common stock were delisted from The Nasdaq NationalMarket in August 2003 and are now traded on the OTC Bulletin Board. As aresult, an investor may find it more difficult to dispose of the securities dueto low trading volume or obtain accurate quotations as to the market value ofthe securities. In addition, Ezenia is subject to Rule 15c2-11promulgated by the SEC. If Ezenia fails to meet criteria set forth in such Rule (forexample, by failing to file periodic reports as required by the Exchange Act),various practice requirements are imposed on broker-dealers who sell securitiesgoverned by the Rule to persons other than established customers andaccredited investors. For these types of transactions, the broker-dealer mustmake a special suitability determination for the purchaser and have receivedthe purchaser’s written consent to the transactions prior to sale.Consequently, the Rule may have a material adverse effect on the abilityof broker-dealers to sell Ezenia’s securities, which may materially affect theability of shareholders to sell the securities in the secondary market. Thedelisting could make trading Ezenia’s shares more difficult for investors,potentially leading to further declines in the share price. It would also makeit more difficult for Ezenia to raise additional capital. Due to the delisting,Ezenia would also incur additional costs under state blue-sky laws if Ezeniawere to sell equity.

***Board of director recruitment.*****  **Currently we have six directors onour Board, five of whom meet the standards for independence as specified by theSEC and the national stock exchanges. Historically, we have strived to have anaudit committee comprised of at least three independent directors, as requiredby the national stock exchanges. Currently we have three directors serving onour audit committee, all of whom meet the standards for independence asspecified by the SEC. One of our directors, Gerald P. Carmen, has the necessaryfinancial expertise to serve as chairman of our audit committee. We arecontinuing in our attempts to identify additional qualified individuals toserve as independent directors of Ezenia. However, the market for highlyqualified individuals available and willing to serve as directors to companiessimilar to ours is intense, and there can be no assurance that we will be ableto identify, recruit and ultimately secure the services of such individuals ina timely manner or at all.

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**ITEM2.**                DESCRIPTION OFPROPERTY

Ezenia’s corporate officeand principal research, development and manufacturing facility is located inNashua, New Hampshire, in an approximately 6,000 square foot facility. InMarch 2005, we entered into an agreement to move our corporate office fromBurlington, Massachusetts at the conclusion of its lease in June 2005. Wedecided to make the move as part of an effort to reduce expenses and excesscapacity. Ezenia also has a sales and service office located in Sterling, Virginiaand a research, development and service office located in Colorado Springs,Colorado. As of December 31, 2003, Ezenia had closed all foreign offices,and therefore, no longer has any leases outside of the United States.

**PART II**

**ITEM5.**                MARKET FOR REGISTRANT’SCOMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITYSECURITIES

Since2003, Ezenia’s common stock has been quoted on the OTC Bulletin Board, underthe symbol “EZEN.OB”. The following table sets forth, for the periods indicated,the high and low bid or sale prices per share of our common stock as reportedon the OTC Bulletin Board.

| ** **                    | ** ** | **Quarter ended** | ** ** |
|-------------------------------|------------|------------------------|------------|
| ** **                    | ** ** | **March 31**      | ** ** | **June 30** | ** ** | **September 30** | ** ** | **December 31** | ** ** |
| 2005                          | ** ** |                   | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| Common stock  price—high |       |                   | $          | 2.34 | ** ** |   |   | $ | 2.95 | ** ** |   |   | $ | 2.87 | ** ** |   |   | $ | 2.91 | ** ** |   |
| Common stock  price—low  |       |                   | $          | .72 | ** ** |   |   | $ | 1.70 | ** ** |   |   | $ | 1.98 | ** ** |   |   | $ | 2.27 | ** ** |   |
| 2004                          | ** ** |                   | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| Common stock  price—high |       |                   | $          | .47 | ** ** |   |   | $ | .80 | ** ** |   |   | $ | 1.26 | ** ** |   |   | $ | 1.48 | ** ** |   |
| Common stock price—low   |       |                   | $          | .22 | ** ** |   |   | $ | .28 | ** ** |   |   | $ | .51 | ** ** |   |   | $ | .87 | ** ** |   |

 

As of March 24, 2006, Ezenia had approximately121 shareholders of record. This does not reflect persons or entities that holdtheir stock in nominee or “street” name through various brokerage firms. Ezeniahas not paid dividends on its common stock. Ezenia anticipates it will reinvestfuture earnings, if any, and therefore, does not intend to pay dividends in theforeseeable future.

See Part III, Item 12for information regarding securities authorized for issuance under Ezenia’sequity compensation plans.

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**ITEM6.**                SELECTED FINANCIALDATA

| ** **                                                                           | ** ** | **Year ended December 31**                             | ** ** |
|--------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|
| ** **                                                                           | ** ** | **2005 (1)**                                                     | ** ** | **2004 (2)** | ** ** | **2003 (3)** | ** ** | **2002 (4)** | ** ** | **2001 (5)** | ** ** |
| ** **                                                                           | ** ** | **(In thousands, except per share amounts)** | ** ** |
| **OPERATING  DATA**                                                                  |       |                                                                  |       |   |   |   |   |   |   |   |   |
| Revenue                                                                              |       | $                                                                     | 13,175     |   | $ | 10,391 |   | $ | 8,217 |   | $ | 11,373 |   | $ | 15,107 |   |
| Operating  income (loss)                                                             |       | 3,511                                                                 |       | 1,807 |   | (1,117 | ) | (15,094 | ) | (33,621 | ) |
| Income  (loss) before cumulative effect of change in accounting principle            |       | 3,712                                                                 |       | 1,757 |   | (1,095 | ) | (10,799 | ) | (33,490 | ) |
| Cumulative  effect of change in accounting principle                                 |       | —                                                                |       | — |   | — |   | (10,667 | ) | — |   |
| Net  income (loss)                                                                   |       | 3,803                                                                 |       | 3,184 |   | (828 | ) | (18,565 | ) | (31,340 | ) |
| Income  (loss) per share before cumulative effect of change in accounting principle: |       |                                                                  |       |   |   |   |   |   |   |   |   |
| Basic                                                                                |       | .26                                                                   |       | .23 |   | (.06 | ) | (.58 | ) | (2.29 | ) |
| Diluted                                                                              |       | .25                                                                   |       | .22 |   | (.06 | ) | (.58 | ) | (2.29 | ) |
| Net  income (loss) per share:                                                        |       |                                                                  |       |   |   |   |   |   |   |   |   |
| Basic                                                                                |       | .26                                                                   |       | .23 |   | (.06 | ) | (1.36 | ) | (2.29 | ) |
| Diluted                                                                              |       | .25                                                                   |       | .22 |   | (.06 | ) | (1.36 | ) | (2.29 | ) |
| **BALANCE SHEET DATA**                                                               |       |                                                                  |       |   |   |   |   |   |   |   |   |
| Cash  and cash equivalents                                                           |       | $                                                                     | 9,405      |   | $ | 5,520 |   | $ | 2,316 |   | $ | 2,403 |   | $ | 5,531 |   |
| Total  current assets                                                                |       | 16,864                                                                |       | 11,921 |   | 7,082 |   | 5,564 |   | 28,358 |   |
| Common  stock subject to put                                                         |       | —                                                                |       | — |   | — |   | 2,875 |   | 2,875 |   |
| Stockholders’  equity (deficit)                                                 |       | 7,932                                                                 |       | 3,838 |   | 552 |   | (1,504 | ) | 16,450 |   |

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(1)          2005amounts include a tax benefit of $91 thousand, related to a reduction in thevaluation allowance associated with deferred tax assets.

(2)          2004amounts include a tax benefit of $1.4 million, or $0.10 per share, related to anet benefit of approximately $819 thousand as a result of the ITC settlement,and approximately $608 thousand relating to a tax refund for tax years 1996,1997, and 1998.

(3)          2003amounts include a tax benefit of $267 thousand, or $0.02 per share, related toa change in the estimate for potential liabilities related to federal and stateincome taxes paid in prior years.

(4)          2002amounts include a write-down of inventory of $3.7 million, or $0.27 per share,an impairment of goodwill of $10.7 million, or $0.78 per share relating to thechange in accounting principle, an impairment of fixed assets of $2.3 million,or $0.17 per share, a tax benefit of $2.7 million, or $0.19 per share, relatedprimarily to a tax refund, and a gain on sale of patents of $4.9 million, or$.36 per share.

(5)          2001amounts include a charge to operations of $2.0 million, or $0.15 per share,related to the restructuring of certain of the Company’s operations, awrite-down of goodwill and other long-term assets totaling $7.1 million, or$0.52 per share, and a tax benefit of $2.2 million, or $0.16 per share,relating to the reversal of reserves recorded in prior years.

Effective January 1,2002, Ezenia adopted the provisions of Statement of Financial AccountingStandards (SFAS) No. 142, “Goodwill and Other Intangible Assets.”  This statement affects Ezenia’s treatment ofgoodwill and other intangible assets. Had SFAS No. 142 been adopted for theyear ended December 31, 2001, the net loss and loss per share would havebeen $28.3 million and $2.07 per share, respectively. No other years presentedabove would have been affected.

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**ITEM 7.**                MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

**Management’sDiscussion and Analysis of Financial Condition and Results of Operations**

**SAFEHARBOR FOR FORWARD LOOKING STATEMENTS**

*Management’s Discussion and Analysis of FinancialCondition and Results of Operations (“MD&A”) should be read in conjunctionwith the Consolidated Financial Statements and Notes included in Item 8 of thisAnnual Report. MD&A contains forward-looking statements includingstatements concerning drivers of revenue growth; our plans to improveperformance and execution; changes in accounting principles and changes inactual or assumed tax liabilities; product demand and growth opportunities;industry trend  and conditions, our useof direct and indirect sales channels; expense monitoring and management; ouranticipated capital requirements and working capital needs; and our anticipatedreinvestment of future earnings. These forward-looking statements are neitherpromises nor guarantees, but involve risks and uncertainties that may causeactual results to differ materially from those in the forward-lookingstatements. Factors that may cause such differences include, but are notlimited to, our ability to maintain or accurately forecast revenue growth or toanticipate and accurately forecast a decline in revenue from any of ourproducts or services; our ability to compete in an intensely competitivemarket; our ability to develop and introduce new products or enhancements onschedule and that respond to customer requirements and rapid technologicalchange; new product introductions and enhancements by competitors; our abilityto select and implement appropriate business models, plans and strategies andto execute on them; our ability to identify, hire, train, motivate, and retainhighly qualified management/other key personnel and our ability to manage changes and transitions in management/otherkey personnel; the impact of global economic and political conditions on ourbusiness; unauthorized use or misappropriation of our intellectual property; aswell as the risk factors discussed herein and in other periodic reports filedwith the SEC. Readers should not place undue reliance on any suchforward-looking statements, which speak only as of the date they are made. Wedisclaim any obligation to publicly update or revise any such statement toreflect any change in our expectations or in events, conditions, orcircumstances on which any such statements may be based, or that may affect thelikelihood that actual results will differ from those contained in theforward-looking statements.*

**Overview**

The growth and acceptance of the IWS product linecontinued for the quarter and the year ending December 31, 2005 as werecorded our ninth consecutive quarter of profitability. For the year, revenuesincreased approximately 27%, operating income was up approximately 94%, andearnings per share were $0.26, up $0.03 per share. Revenue relating to ourInfoWorkSpace product increased approximately 30% in 2005 over 2004. IWS-relatedrevenue accounted for approximately 96% of total revenues. We continued to seea decline in revenue related to our legacy videoconferencing product line asexpected in 2005, with total revenue of approximately $495 thousand, down fromapproximately $633 thousand in 2004. In addition, we continued to control costsas operating expenses as a percentage of revenue dropped to approximately 39%for the year ending December 31, 2005, as compared to approximately 48%for the year ended December 31, 2004.

Our current business focus is to continue to enhanceour various collaborative product and service offerings, develop and deploy newproducts and services, and to expand our sales, service, engineering, andmarketing organizations. This focus is subject to change as the drivinginfluence in our future direction will be based on the needs of our customerbase. The market for multi-media collaboration products is highly competitiveand we expect both, competition and the overall market competitive products tosignificantly increase in the future. In addition, some of our current andpotential competitors have longer operating histories and greater financial,technical, sales, and marketing resources. If we are unable to retain ourexisting customers in the US government, or we are unable to convince asufficient number of new companies or customers with an interest incollaborative technologies to adopt the IWS collaborative 

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software product overalternative technologies marketed by our competitors, our financial resultswould suffer. We believe that the key differentiating factors in the marketwill continue to be breadth of capabilities, demonstrated interoperability,price, performance, network management capabilities, reliability, scalability,customer support and security.

Ezenia plans to continueto enhance existing products and offerings based on our customer requirements,as well as to work on developing new products and services which will expandthe opportunities available to us in the overall collaboration market. In March 2006,the Company released its newest version of InfoWorkSpace, version 3.0, alongwith announcing a number of new service offerings. InfoWorkSpace 3.0 adds andor enhances features which specifically address the key factors above:  interoperability, scalability, multi-levelsecurity, enhancements to the user experience, network management, andreliability. In addition, we currently offer the following services for ourproducts:  IWS User Training, IWSAdministrator Training, IWS Installation Training, Installation service, andDaily Consulting service. Extended maintenance service plans are also available.Beginning in April 2006, Ezenia will begin offering On-Line training forthe IWS Administrator and IWS User courses. This training should save customerstravel time, lost productivity, and unnecessary collateral expenses. Inaddition to expanding our training course offerings, we will provide anunprecedented level of support to our customer base with our “Exercise andDeployment Services”, which are targeted to our government customers and allowmilitary or other units or teams preparing for deployment or exercise maneuversto eliminate the need to tear down, transport, and bring up their own systems,prior to and following these activities.

**Critical Accounting Policies**

The discussion and analysis of our financial conditionand results of operations are based upon our consolidated financial statements,which have been prepared in accordance with accounting principles generally acceptedin the United States of America. The preparation of these financial statementsrequires us to make estimates and judgments that affect the reported amounts ofassets, liabilities, revenues and expenses and related disclosure of contingentassets and liabilities. On an on-going basis, we evaluate our estimates,including those related to revenue recognition, bad debts, inventories, incometaxes and warranty obligations. We base our estimates on historical experienceand on various other assumptions that we believe to be reasonable under thecircumstances, the results of which form the basis for making judgments aboutthe carrying value of assets and liabilities that are not readily apparent fromother sources. Actual results may differ from these estimates under differentassumptions or conditions. We believe the following critical accountingpolicies and the related judgments and estimates affect the preparation of ourconsolidated financial statements.

**Revenue Recognition**

Product revenue consists of sales of IWS softwarelicenses and maintenance agreements, IWS product related training,installation, and consulting, and video products. Revenue from sales of IWSsoftware license and maintenance agreements is recognized ratably over thelicense agreement  periods, which aregenerally one year, pursuant to the guidance provided by Statement of Position97-2, “Software Revenue Recognition” (SOP 97-2), issued by theAmerican Institute of Certified Public Accountants (AICPA). Revenue from IWStraining, installation, and consulting services are recognized as the servicesare performed provided there is vendor specific objective evidence (VSOE) offair value which is the price charged when the services are sold separately. Revenuefrom video product sales is recognized upon shipment to the customer and thefulfillment of all contractual terms and conditions, pursuant to the guidanceprovided by Staff Accounting Bulletin No. 104, “Revenue Recognition inFinancial Statements” (SAB 104), issued by the Securities and ExchangeCommission.

Product development revenue relates to contractsinvolving customization of the IWS product according to customerspecifications. Revenue associated with contracts for product developmentrevenue 

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with milestone-baseddeliverables requiring a customers’ acceptance is recognized upon the customer’sacceptance in accordance with terms of the contract, in conformity with theguidance provided by SOP 81-1, “Accounting For Performance ofConstruction Type and Certain Production Type Contracts” Issued by the AmericanInstitute of Certified Public Accountants. The cost recognition associated withthese deliverables or milestones is deferred until the terms of acceptance aresatisfied and revenue is recognized.

Service revenue represents sales of service contractsrelated to the maintenance of video products. Maintenance revenue is deferredand recognized ratably over the term of the applicable agreement.

Products and softwarelicenses are sold without any contractual right of return by the customer. Deferredrevenue represents amounts received from customers under subscription softwarelicenses, maintenance agreements, or for product sales in advance of revenuerecognition. Judgment is required in evaluating the creditworthiness of ourcustomers. In all instances, revenue is not recognized until we havedetermined, at the outset of the arrangement that collectibility is reasonablyassured. Amounts billed to customers related to shipping and handling chargesare recorded upon shipment and the related costs are included in cost of goodssold.

**Allowance for Doubtful Accounts**

Our policy is to maintain allowances for estimatedlosses resulting from the inability of our customers to make required payments.Credit limits are established through a process of reviewing the financialhistory and stability of each customer. Where appropriate, we obtain creditrating reports and financial statements of the customer when determining ormodifying their credit limits. We regularly evaluate the collectibility of ourtrade receivable balances based on a combination of factors. When a customer’saccount balance becomes past due, we initiate dialogue with the customer todetermine the cause. If it is determined that the customer will be unable tomeet its financial obligation to us, such as in the case of a bankruptcyfiling, deterioration in the customer’s operating results or financialposition, or other material events impacting the customer’s business, we recorda specific allowance to reduce the related receivable to the amount we expectto recover given all information presently available.

At December 31, 2005,our accounts receivable balance of approximately $4.5 million is reported netof allowances of approximately $339 thousand. We believe our reported allowancesare adequate. If the financial conditions of our customers were to deteriorate,however, resulting in their inability to make payments, we may need to recordadditional allowances, which would result in additional expenses being recordedfor the period in which such determination was made.

**Inventory Reserves**

Historically, as a designer, developer andmanufacturer of videoconferencing hardware solutions, we were exposed to anumber of economic and industry factors that could result in portions of ourinventory becoming either obsolete or in excess of anticipated usage. Ourpolicy is to establish inventory reserves when conditions exist that suggestthat our inventory may be in excess of anticipated demand or is obsolete basedupon our assumptions about future demand for our products and marketconditions. When recorded, our reserves are intended to reduce the carryingvalue of our inventory to its net realizable value.

Ezenia provided for an excess and obsolescence reservefor 100% of its inventory due to the continued decline in demand relating tothe legacy videoconferencing product line. During the three years in the periodended December 31, 2005 Ezenia was able to realize sales of its legacyvideoconferencing hardware products. The cost of these product sales was offsetby adjustments to reduce the related inventory reserves. At December 31,2005 and 2004, our net inventory reserves are approximately $4.5 million.

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**Income Taxes**

The calculation of tax assets and liabilities involvessignificant judgment in estimating the impact of uncertainties in theapplication of complex tax laws. Deferred tax assets and liabilities aredetermined at the end of each year based on the future tax consequences thatcan be attributed to net operating loss and credit carryovers as well as thedifferences between the financial statement carrying amounts of existing assetsand liabilities and their respective tax bases. The deferred tax assets arereduced by a valuation allowance if it is more likely than not that the taxbenefits will not be realized. The realization of deferred tax assets isdependant upon the generation of future taxable income. In determining thevaluation allowance, Ezenia considers past performance, expected future taxableincome, and qualitative factors which Ezenia considers to be appropriate to beconsidered in estimating future taxable income. Ezenia’s forecast of expectedfuture taxable income is for future periods that can be reasonably estimated. Changesin results that differ materially from our current expectations may cause us tochange our judgment on future taxable income. These changes, if any, mayrequire us to adjust our existing tax valuation allowance higher or lower thanthe amount we have previously recorded.

In the fourth quarter of2005, as a result of our assessment of future taxable income, we releasedapproximately $138 thousand of valuation allowance against deferred tax assetsresulting in a net tax benefit of approximately $91 thousand. Please see PartII, Note 6, regarding disclosure with respect to a restatement of 2004 and 2003components of deferred tax items.

**Product Warranties**

Our products are sold with warranty provisions thatrequire us to remedy deficiencies in quality or performance of our productsover a period of 90 days, at no cost to our customers. Our policy is toestablish warranty reserves at the time of sale when our estimate of the coststhat will be incurred to fulfill those warranty requirements becomes material.As of December 31, 2005, we believed that our future cost of materials,labor and overhead for the servicing of our products sold through that date werenot material and no reserve was warranted. If actual product failures ormaterial or service delivery costs differ from our estimates, our warrantyliability would need to be revised accordingly.

**Resultsof operations—years ended December 31, 2005, 2004 and 2003**

**Revenue**

Revenue increased to approximately $13.2 million in2005 from approximately $10.4 million in 2004. The increase in revenue wasprincipally related to a 30% increase in sales related to our IWS product line.The increase in sales of IWS can be attributed to an increasing rate of productacceptance within the developing collaborative software market as well asgreater spending within our customer base. Product revenue related to IWSincreased approximately $3.2 million or 39%, while product development revenuedeclined approximately $276 thousand. Product development revenue is revenuerelated to product customization work performed for customers seekingenhancements to our current product.  Thedecline in product development revenue was primarily driven by themilestone-based deliverable schedule of the underlying contracts. Our legacyvideoconferencing products and related service revenues continued to decline toapproximately $495 thousand (4% of total revenues) in 2005 from approximately $633thousand (6% of total revenues) in 2004. We expect to see a continued declinein videoconferencing-related products and services revenue.

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Revenue increased toapproximately $10.4 million in 2004 from approximately $8.2 million in 2003.The increase in revenue was principally related to a 64% increase in salesrelated to our IWS product line. Significant gains were made in the productdevelopment area as revenue grew from approximately $73 thousand in 2003to approximately $1.5 million in 2004. Revenue from videoconferencing productsand related services declined to approximately $633 thousand (6% of totalrevenues) in 2004 from approximately $2.3 million (28% of total revenues) in2003.

**Gross profit**

**Cost of revenues includes materialcosts, costs of third-party software licenses, assembly labor and overhead,customer support costs, and engineering and development costs associated withproduct development revenue. Gross profit as a percentage of revenues increasedin 2005, to 66.0%, from 65.5% in 2004 and 54.6% in 2003. The increase in grossprofit is primarily attributed to reduced IWS licensing costs offset by adecline in margin related to product development work recognized from 73.3% in2004 to 55.6% in 2005. Gross margin related to product development revenue was51.0% in 2003. Gross profit in 2003 was significantly impacted by our legacyvideoconferencing hardware sales of $1.9 million during the year, which had nonet reported cost basis due to the write down of inventory in the previous year.Adjusting for this impact, reported gross profit would have been 41.5% in 2003.**

**Research and development**

Research and developmentexpenses include payroll, employee benefits, other headcount related costs, andmiscellaneous costs associated with product development. Research anddevelopment expenses increased to approximately $1.2 million in the year ended December 31,2005, from approximately $1.1 million in 2004, but decreased fromapproximately $1.9 million in 2003. The increase in spending in 2005 ascompared with 2004 is primarily due to an increase in personnel related costsoffset by a decrease in consultant costs as we made a concerted effort toreplace outsourced engineering personnel with permanent employees. The decreasein spending in 2004 as compared with 2003 was primarily due to cost savinginitiatives undertaken by Ezenia in 2003 to better align its cost structurewith its revenues.

**Sales and marketing**

Sales and marketingexpenses include payroll, employee benefits, and other headcount related costsassociated with sales and marketing personnel and advertising, tradeshows,seminars, and other marketing-related programs. Sales and marketing expensesincreased to approximately $1.5 million in the year ended December 31,2005, from approximately $1.4 million in 2004, and from approximately $1.1million in 2003. The increase is primarily related to higher personnel relatedcosts and trade show costs, offset by lower commission and consultant costs. Theincreased spending in 2004 as compared with 2003 was primarily related tohigher salary, commission and travel costs associated with an increase in IWSpersonnel, as well as higher consulting and advertising costs.

**General and administrative**

General and administrativecosts include payroll, employee benefits, and other headcount-related costsassociated with the finance, human resources, management information systems,and other administrative headcount, and legal and investor relations costs, andother administrative fees. General and administrative expenses decreased toapproximately $1.8 million in the year ended December 31, 2005, fromapproximately $1.9 million in 2004.  Thedecreased spending in 2005 as compared with 2004 was primarily due to decreasesseen in legal, professional fees, and insurance costs partially offset byincreases in compensation related costs, consultant costs related to SarbanesOxley compliance work, and bad debt recoveries. General and administrativeexpenses increased approximately $68 thousand from the year ended December 31,2004 as compared with the year ended December 31, 2003. The increase was 

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primarilydue to an increase in legal and compensation related costs partially offset bydecreases in consultant costs and bad debt recoveries.

**Occupancyand other facilities-related expenses**

Occupancy and otherfacilities-related expenses increased to approximately $621 thousand in theyear ended December 31, 2005, from approximately $579 thousand in 2004,and decreased from approximately $675 thousand in 2003. These costs includerent expense and other operating costs associated with our former headquartersfacility in Burlington, Massachusetts, our current headquarters in Nashua, NewHampshire, and two other sales and development offices in the United States, inColorado and in Virginia. In February 2005, we moved its sales office inAlexandria, VA to Sterling, VA and in June 2005, the Company moved itsheadquarters facility to Nashua, New Hampshire from Burlington, Massachusetts.Both moves were to more cost efficient space. In December 2003, we alsomoved our Colorado development office to more cost efficient space. Theincreased spending in 2005 is primarily attributed to one time charges of $170thousand for a lease termination fee associated with our decision not to renewthe lease on our headquarters facility in Burlington, Massachusetts, and $12thousand related to the loss on the sublease of our Alexandria, VA office forthe remaining 14 months, offset by reduced rental costs. The decreased spendingin 2004 as compared to 2003 was primarily related to the Colorado office movein December 2003, and to additional cost savings initiatives we initiallyundertook during 2003 to better align its cost structure with its revenues.

**Interest income, net**

Interest income, net,consists of interest on cash, cash equivalents and marketable securities. Interestincome increased to approximately $191 thousand in 2005 from approximately $122thousand in 2004 and approximately $6 thousand in 2003. The increase in 2005was primarily related to an increase in the amount of cash available forinvestment during the year as compared to 2004. The increase in 2004 ascompared to 2003 was due primarily to approximately $66 thousand of interestreceived in connection with our settlement reached in April 2004 with theITC, approximately $30 thousand of interest received as a result of an incometax refund of approximately $608 thousand received in December 2004, andan increase in the amount of cash available for investment during the year.

**Settlement fees and other income**

The settlement feesreported for the year ended December 31, 2004 are one-time legal andprofessional fees related to our settlement reached in April 2004 with theITC concerning tax matters associated with its patent infringement suit againstAccord, which was settled in June 2000. Other income consists primarily ofsales of previously written off assets and other miscellaneous non-operatingincome.

**Income tax benefit**

The amount reported ascurrent income tax benefit in 2005 is comprised of current income tax expenseof approximately $47 thousand, in both estimated federal alternative minimumtax expense and state income tax expense. In addition, the amount includes adeferred tax benefit of approximately $138 thousand associated with therelease of a portion of our valuation allowance based on our conclusion that aportion of the deferred tax asset would be realized. The income tax benefitreported in the year ended December 31, 2004 of approximately $1.4 millionrelated to our settlement with the ITC resulting in the receipt in April 2004of $975 thousand, net of approximately $156 thousand of withholding tax on thegross settlement amount. The income tax benefit in 2004 also included anapproximately $608 thousand refund of prior year taxes relating to the carryback of the net operating losses incurred in 2001 to prior years. The incometax benefit reported in the year ended December 31, 2003 of approximately$267 

20

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thousandrelated to a change in the estimate for potential liabilities related tofederal and state income taxes paid in prior years.

**Liquidity and Capital Resources**

At December 31, 2005, wehad cash and cash equivalents of approximately $9.4 million. Wegenerated  profits from operations ofapproximately $3.5 million for the year ended December 31, 2005, and a netprofit for the year of approximately $3.8 million, as compared with anoperating profit in the year ended December 31, 2004 of $1.8 million, anda net profit of approximately $3.2 million in 2004.

We generated cash from operations of $3.8 million infiscal 2005 compared to $3.2 million in 2004 and cash used in operations of $96thousand in 2003. Increases in cash provided by operating activities in 2005were primarily the result of increases in net income and increases in accountspayable, accrued expenses, and deferred revenue offset by increased uses ofworking capital attributable to an increase in accounts receivable. Increasesin cash provided by operating activities in 2004 were primarily the result ofincreases in net income and increases in deferred revenue offset by increaseduses for working capital attributable to increases in accounts receivable andprepaid software licenses. In 2003, cash used by operating activities wasprimarily the result of an increase in deferred revenue offset by a net lossand uses for working capital attributable to increases in accounts receivableand prepaid software licenses.

The Company invested approximately $206 thousand inproperty and equipment in fiscal 2005 compared to $93 thousand in fiscal 2004and no outlay of cash relative to 2003 investing activities. The Company hasgenerated cash from financing activities of $291 thousand, $102 thousand, and$9 thousand in 2005, 2004, and 2003 respectively, primarily from proceeds ofsales of the Company’s common stock pursuant to the Company’s various stockplans.

Our contractual obligations relate primarily to itsfacilities leases and a contractual purchase commitment. We lease our primaryfacility in Nashua, New Hampshire, under an operating lease, which expires in June 2010.We also have three other leases for office space in the United States, locatedin Colorado Springs, Colorado, Sterling, Virginia, and Alexandria, Virginia forsales, development and technical support operations. We have entered into a sublease agreement for our Alexandria, Virginia office. These leases expire atvarious dates through November 2011. Future minimum lease obligations at December 31,2005 under all of these non-cancelable operating leases, including the effectsof the Alexandria, Virginia sublease, are approximately $153 thousand in 2006,$178 thousand in 2007, $179 thousand in 2008, $180 thousand in 2009, $126thousand in 2010, and $98 thousand in 2011.

In February 2005 we entered into a new agreementwith Microsoft to extend an existing software distribution license agreement. Underthe agreement, we are required to purchase a minimum of approximately $2.8million of product during the fiscal year 2006.

We include standard intellectual propertyindemnification provisions in our licensing agreements in the ordinary courseof business. Pursuant to our product license agreements, we will indemnify,hold harmless, and agree to reimburse the indemnified party for losses sufferedor incurred by the indemnified party, generally business partners or customers,in connection with certain patent, copyright or other intellectual propertyinfringement claims by third parties with respect to our products. Otheragreements with our customers provide indemnification for claims relating toproperty damage or personal injury resulting from the performance of servicesby Ezenia or its subcontractors. Historically, our costs to defend lawsuits orsettle claims relating to such indemnity agreements have been insignificant.Accordingly, the estimated fair value of these indemnification provisions isimmaterial.

In August 2002, Ezeniaentered into an agreement with Tandberg Telecom AS to sell all patents andpending applications related to its videoconferencing products, which wascompleted in October 2002. In exchange for an up-front license fee of$1.25 million, a loan for an additional $1.25 million which was 

21

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forgivenat the closing, and an additional $2.4 million also received at the closing,Ezenia granted Tandberg a fully paid, non-exclusive, non-transferable licenseunder the patents and pending applications relating to Ezenia’svideoconferencing technology (the video patent portfolio). Additionally, Ezeniaretained a fully paid, non-exclusive, non-transferable license for Ezenia’s usein connection with its videoconferencing and enterprise collaboration products.

In May 2003, after failingto comply with certain continued listing standards for the NASDAQ SmallCapMarket, including maintaining a minimum bid price of at least $1.00 per share,or the requirement for Ezenia to have a minimum $2.5 million in stockholdersequity, Ezenia received a delisting notification from NASDAQ. After exercisingits right for an appeal of this determination to a NASDAQ ListingQualifications Panel, the Panel determined to delist Ezenia’s securities fromThe NASDAQ Stock Market in August 2003. Since then, Ezenia’s common stockhas been quoted on the OTC Bulletin Board. The market value and liquidity ofEzenia’s common stock, as well as Ezenia’s ability to raise additional capital,has been and may continue to be materially adversely affected by this delistingdecision.

Operating costs were in linewith our expectations for the year ended December 31, 2005. If orderbookings are less than expected in 2006, we may take steps to reduce spendingon such discretionary items as capital expenditures and marketing, however, weare committed to making the necessary investments in building and expanding ourinfrastructure.

Ezenia’s success in achievingits goal of showing consistent quarterly top line and bottom line growth islargely dependent on whether it can continue to grow its future order bookingsand related revenue targets. Order bookings, which are purchase orders placedby customers, are properly not recorded as revenue or recognized as revenueuntil all requirements of that order are satisfied, although the cash flow receivedfrom these orders may more closely follow the receipt date of the order. Accordingly,largely as a result of its successive quarters of profitability, managementbelieves that its existing cash resources will be sufficient to fund itsanticipated working capital and capital expenditure needs for at least the nexttwelve months. We anticipate that we will continue to generate positive cashflow from operations for 2006 and that existing cash reserves will therefore besufficient to meet our working and capital requirement needs during thisperiod.

Thefollowing table summarizes our outstanding contractual obligations:

| ** **                     | ** ** | **2006**                | ** ** | **2007-2009** | ** ** | **2010-2011** | ** ** | **Total** | ** ** |
|--------------------------------|------------|-------------------------|------------|---------------|------------|---------------|------------|-----------|------------|
| ** **                     | ** ** | **(in thousands)** | ** ** |
| Operating leases               |       | $                       | 153        |          |       | $             | 536        |      |       |   | $ | 225 |   |   | $ | 914 |   |
| Purchase  commitments          |       | 2,750                   |       |          | —     |          |       |      | —     |   |   | 2,750 |   |
| Total contractual  obligations |       | $                       | 2,903      |          |       | $             | 536        |      |       |   | $ | 225 |   |   | $ | 3,664 |   |

 

**Recent Accounting pronouncements**

In December 2004, the Financial AccountingStandards Board issued SFAS No. 123R, *“*Share-Based Payment*”*(SFAS 123R). This Statement is a revision of SFAS 123 andsupersedes APB 25 and its related implementation guidance. SFAS 123Restablishes standards for transactions in which an entity exchanges its equityinstruments for goods or services. This standard requires a public entity to measurethe cost of employee services received in exchange for an award of equityinstruments based on the grant date fair value of the award. This eliminatesthe exception to account for such awards using the intrinsic method previouslyallowable under APB Opinion No.25. In March 2005, the Securities andExchange Commission (SEC) released Staff Accounting Bulletin (SAB) 107,Share-Based Payment, which expresses views of the SEC Staff about theapplication of SFAS No. 123R. SFAS No.123R was to be effective for interimor annual reporting periods beginning on or after June 15, 2005, but in April 2005the SEC issued a rule that SFAS No. 123R will be effective only forannual reporting periods beginning on or after June 15, 2005.

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Ezenia adopted SFAS 123Ron January 1, 2006 under the modified-prospective transition method andthe adoption will materially increases stock compensation expense and decreasesnet income. Accordingly, in fiscal 2006, total stock-based compensation expensefrom stock options using the fair value provisions of SFAS 123R, is estimatedto be approximately $800 thousand. In order to develop the fiscal 2006stock-based compensation expense estimate, we utilized assumptions on itemssuch as projected option grants and expected life and volatility, which weresimilar to the amounts in fiscal 2005. In addition, SFAS 123R requires that theexcess tax benefits related to stock compensation be reported as a cash inflowfrom financing activities rather than as a reduction of taxes paid in cash fromoperations.

**ITEM 7A.**        QUANTITATIVEAND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

To date, Ezenia has notutilized derivative financial instruments or derivative commodity instruments.Ezenia invests cash in highly liquid investments, consisting of highly ratedU.S. and state government securities, commercial paper and short-term moneymarket funds. These investments are subject to minimal credit and market riskand Ezenia has no debt other than its contractual lease obligations. A 10%change in interest rates would not have a material impact on Ezenia’s financialposition, operating results or cash flows. We have closed our foreign offices,and sales to foreign customers from the United States are in U.S. dollars. Therefore,Ezenia has no significant foreign currency risk.

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**ITEM8.**                FINANCIALSTATEMENTS AND SUPPLEMENTARY DATA

**INDEX**

|                                                                                                                      | ** ** | **Page** | ** ** |
|----------------------------------------------------------------------------------------------------------------------|------------|----------|------------|
| Report of Independent Registered Public Accounting Firm                                                              |       |     | 25         |   |   |
| Consolidated  Balance Sheets as of December 31, 2005 and 2004                                                   |       |     | 26         |   |   |
| Consolidated Statements of Operations for the years  ended December 31, 2005, 2004 and 2003.                    |       |     | 27         |   |   |
| Consolidated Statements of Stockholders’ Equity for  the years ended December 31, 2005, 2004 and 2003 |       |     | 28         |   |   |
| Consolidated Statements of Cash Flows for the years  ended December 31, 2005, 2004 and 2003                     |       |     | 29         |   |   |
| Notes to the Consolidated Financial Statements                                                                       |       |     | 30         |   |   |

 

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**Report of Independent Registered Public AccountingFirm**

The Board of Directors and StockholdersEzenia! Inc.

We have audited the accompanying consolidated balancesheets of Ezenia! Inc. and subsidiaries as of December 31, 2005 and 2004and the related consolidated statements of operations, stockholders’ equity,and cash flows for the three year period ended December 31, 2005. Ouraudits also included the financial statement schedules listed in the Index atItem 15(a). These financial statements and schedule are the responsibility ofthe Company’s management. Our responsibility is to express an opinion on thesefinancial statements and schedule based on our audits.

We conducted our audits in accordance with the auditingstandards of the Public Company Accounting Oversight Board (United States).Those standards require that we plan and perform the audit to obtain reasonableassurance about whether the financial statements are free of materialmisstatement. The Company is not required to have, nor were we engaged toperform, an audit of its internal controls over financial reporting. Our auditsincluded consideration of internal control over financial reporting as a basisfor designing audit procedures that are appropriate in the circumstances, butnot for the purpose of expressing an opinion on the effectiveness of theCompany’s internal control over financial reporting. Accordingly, we express nosuch opinion. An audit also includes examining, on a test basis, evidence supportingthe amounts and disclosures in the financial statements, assessing theaccounting principles used and significant estimates made by management, aswell as evaluating the overall financial statement presentation. We believe thatour audits provide a reasonable basis for our opinion.

In our opinion, such consolidated financial statementsreferred to above present fairly, in all material respects, the consolidatedfinancial position of Ezenia! Inc. and subsidiaries at December 31, 2005and 2004 and the consolidated results of their operations and their cash flowsfor each of the three years in the period ended December 31, 2005, inconformity with accounting principles generally accepted in the United Statesof America. Also, in our opinion, the related financial statement schedule,when considered in relation to the basic financial statements taken as a whole,presents fairly in all material respects the information set forth therein.

See Note 6 for adiscussion regarding restatement of previously filed disclosures regarding thecomponents of the Company’s deferred tax assets. The restatement has no effecton the consolidated financial position, results of operations or cash flows ofthe Company.

|  | /s/ BROWN &  BROWN LLP |
|--|---------------------------------|

 

Boston, Massachusetts

March 28, 2006

25

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**ConsolidatedBalance Sheets**

| ** **                                                                                                                                                               | ** ** | **December 31,**                                                       | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------|------------|
| ** **                                                                                                                                                               | ** ** | **2005**                                                                    | ** ** | **2004** | ** ** |
| ** **                                                                                                                                                               | ** ** | **(In thousands,  except for share related data)** | ** ** |
| **Assets**                                                                                                                                                               |       |                                                                        |       |   |   |
| Current assets                                                                                                                                                           |       |                                                                        |       |   |   |
| Cash and cash equivalents                                                                                                                                                |       | $                                                                           | 9,405      |   | $ | 5,520 |   |
| Accounts receivable, less allowances of $339 and  $371 in 2005 and 2004, respectively                                                                                    |       | 4,533                                                                       |       | 3,465 |   |
| Prepaid software licenses                                                                                                                                                |       | 2,477                                                                       |       | 2,630 |   |
| Prepaid expenses and other current assets                                                                                                                                |       | 311                                                                         |       | 306 |   |
| Deferred tax assets                                                                                                                                                      |       | 138                                                                         |       | — |   |
| Total current  assets                                                                                                                                                    |       | 16,864                                                                      |       | 11,921 |   |
| Equipment and improvements, net                                                                                                                                          |       | 247                                                                         |       | 85 |   |
| Total assets                                                                                                                                                             |       | $                                                                           | 17,111     |   | $ | 12,006 |   |
| **Liabilities  and stockholders’ equity**                                                                                                                           |       |                                                                        |       |   |   |
| Current liabilities                                                                                                                                                      |       |                                                                        |       |   |   |
| Accounts payable                                                                                                                                                         | ** ** | $                                                                           | 1,593      |   | $ | 734 |   |
| Accrued expenses                                                                                                                                                         |       | 415                                                                         |       | 571 |   |
| Employee compensation and benefits                                                                                                                                       |       | 46                                                                          |       | 200 |   |
| Deferred revenue                                                                                                                                                         |       | 7,125                                                                       |       | 6,663 |   |
| Total current  liabilities                                                                                                                                               |       | 9,179                                                                       |       | 8,168 |   |
| Commitments and  contingencies (Note 8)                                                                                                                                  |       |                                                                        |       |   |   |
| Stockholders’  equity:                                                                                                                                              |       |                                                                        |       |   |   |
| Preferred stock,  $.01 par value; 2,000,000 shares authorized; none issued and outstanding                                                                               |       |                                                                        |       |   |   |
| Common stock, $.01 par value; 40,000,000 shares  authorized; 15,248,386 issued and 14,587,949 outstanding in 2005; 14,846,598  issued and 14,186,161 outstanding in 2004 |       | 152                                                                         |       | 148 |   |
| Capital in excess of par value                                                                                                                                           |       | 63,930                                                                      |       | 63,643 |   |
| Accumulated deficit                                                                                                                                                      |       | (53,289                                                                     | )          | (57,092 | ) |
| Treasury stock; 660,437 shares at cost                                                                                                                                   |       | (2,861                                                                      | )          | (2,861 | ) |
|                                                                                                                                                                     |       | 7,932                                                                       |       | 3,838 |   |
| **Total liabilities and  stockholders’ equity**                                                                                                                     |       | $                                                                           | 17,111     |   | $ | 12,006 |   |

 

See accompanying notes.

26

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**ConsolidatedStatements of Operations**

| ** **                                        | ** ** | **Year ended December 31,**                                           | ** ** |
|---------------------------------------------------|------------|--------------------------------------------------------------------------------------|------------|
| ** **                                        | ** ** | **2005**                                                                             | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                        | ** ** | **(In thousands,  except for per share related data)** | ** ** |
| **Revenues**                                      |       |                                                                                 |       |   |   |   |   |
| Product revenue                                   | ** ** | **$**                                                                                | **11,726** |   | $ | 8,565 |   | $ | 7,663 |   |
| Product development revenue                       | ** ** | **1,178**                                                                            |       | 1,455 |   | 78 |   |
| Service revenue                                   | ** ** | **271**                                                                              |       | 371 |   | 476 |   |
|                                              |       | **13,175**                                                                           |       | 10,391 |   | 8,217 |   |
| **Costs of  revenues**                            |       |                                                                                 |       |   |   |   |   |
| Cost of product revenue                           | ** ** | **3,898**                                                                            |       | 3,107 |   | 3,355 |   |
| Cost of product development  revenue              | ** ** | **523**                                                                              |       | 388 |   | 39 |   |
| Cost of service revenue                           | ** ** | **59**                                                                               |       | 86 |   | 334 |   |
|                                              |       | **4,480**                                                                            |       | 3,581 |   | 3,728 |   |
| **Gross profit**                                  | ** ** | **8,695**                                                                            |       | 6,810 |   | 4,489 |   |
| **Operating expenses**                            |       |                                                                                 |       |   |   |   |   |
| Research and development                          | ** ** | **1,158**                                                                            |       | 1,087 |   | 1,921 |   |
| Sales and marketing                               | ** ** | **1,535**                                                                            |       | 1,370 |   | 1,119 |   |
| General and administrative                        | ** ** | **1,826**                                                                            |       | 1,959 |   | 1,891 |   |
| Depreciation                                      | ** ** | **44**                                                                               |       | 8 |   | — |   |
| Occupancy and other facilities  related expenses  | ** ** | **621**                                                                              |       | 579 |   | 675 |   |
| Total operating expenses                          | ** ** | **5,184**                                                                            |       | 5,003 |   | 5,606 |   |
| **Income (loss) from operations**                 | ** ** | **3,511**                                                                            |       | 1,807 |   | (1,117 | ) |
| Other income (expense)                            |       |                                                                                 |       |   |   |   |   |
| Interest income, net                              | ** ** | **191**                                                                              |       | 122 |   | 6 |   |
| Settlement fees                                   | ** ** | —                                                                               |       | (179 | ) | — |   |
| Other                                             | ** ** | **10**                                                                               |       | 7 |   | 16 |   |
|                                              |       | **201**                                                                              |       | (50 | ) | 22 |   |
| Income (loss) before income taxes                 | ** ** | **3,712**                                                                            |       | 1,757 |   | (1,095 | ) |
| Income tax benefit                                | ** ** | **(91**                                                                              | **)**      | (1,427 | ) | (267 | ) |
| **Net income (loss)**                             | ** ** | **$**                                                                                | **3,803**  |   | $ | 3,184 |   | $ | (828 | ) |
| **Basic and  diluted earnings (loss) per share:** |       |                                                                                 |       |   |   |   |   |
| Basic                                             | ** ** | **$**                                                                                | **.26**    |   | $ | .23 |   | $ | (.06 | ) |
| Diluted                                           | ** ** | **$**                                                                                | **.25**    |   | $ | .22 |   | $ | (.06 | ) |

 

See accompanying notes.

27

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**ConsolidatedStatements of Stockholders’ Equity (Deficit) and Comprehensive Income (Loss)**

| ** **                                 | ** ** | ** **                                                                      | ** ** | ** **                 | ** ** | **Capital**        | ** ** | ** **   | ** ** | ** **             | ** ** | **Total**                 | ** ** | **Comprehensive** | ** ** |
|--------------------------------------------|------------|---------------------------------------------------------------------------------|------------|----------------------------|------------|--------------------|------------|--------------|------------|------------------------|------------|---------------------------|------------|-------------------|------------|
| ** **                                 | ** ** | **Common Stock**                                                           | ** ** | **in Excess of** | ** ** | **Accumulated**    | ** ** | **Treasury** | ** ** | **Stockholders’** | ** ** | **Income**                | ** ** |
| ** **                                 | ** ** | **Shares**                                                                      | ** ** | **Par Value**         | ** ** | **Par Value** | ** ** | **Deficit**  | ** ** | **Stock**              | ** ** | **Equity (Deficit)** | ** ** | **(Loss)**        | ** ** |
| ** **                                 | ** ** | **(In thousands, except for share related data)** | ** ** |
| **BALANCES AS OF DECEMBER 31, 2002**       |       | 13,633,630                                                                      |       |                       | 139        |               |       |         | 60,666     |                   |       |                      | (59,448    | )                 |       | (2,861 | ) |   | (1,504 | ) |   |   |   |   |   |
| Stock issued under employee  benefit plans |       | 66,750                                                                          |       |                       | 5          |               |       |         | 4          |                   |       |                      |       |              |       |   |   |   | 9 |   |   |   |   |   |   |
| Cancellation of put                        |       |                                                                            |       |                       |       |               |       |         | 2,875      |                   |       |                      |       |              |       |   |   |   | 2,875 |   |   |   |   |   |   |
| **Net loss**                               |       |                                                                            |       |                       |       |               |       |         |       |                   |       |                      | (828       | )                 |       |   |   |   | (828 | ) |   |   | (828 | ) |   |
| Comprehensive loss                         |       |                                                                            |       |                       |       |               |       |         |       |                   |       |                      |       |              |       |   |   |   |   |   |   |   | $ | (828 | ) |   |
| **BALANCES AS OF DECEMBER 31,  2003**      |       | 13,700,380                                                                      |       |                       | 144        |               |       |         | 63,545     |                   |       |                      | (60,276    | )                 |       | (2,861 | ) |   | 552 |   |   |   |   |   |   |
| Stock issued under employee  benefit plans |       | 485,781                                                                         |       |                       | 4          |               |       |         | 98         |                   |       |                      |       |              |       |   |   |   | 102 |   |   |   |   |   |   |
| **Net income**                             |       |                                                                            |       |                       |       |               |       |         |       |                   |       |                      | 3,184      |              |       |   |   |   | 3,184 |   |   |   | 3,184 |   |   |
| Comprehensive income                       |       |                                                                            |       |                       |       |               |       |         |       |                   |       |                      |       |              |       |   |   |   |   |   |   |   | $ | 3,184 |   |   |
| **BALANCES AS OF DECEMBER 31,  2004**      |       | 14,186,161                                                                      |       |                       | 148        |               |       |         | 63,643     |                   |       |                      | (57,092    | )                 |       | (2,861 | ) |   | 3,838 |   |   |   |   |   |   |
| Stock issued under employee  benefit plans |       | 401,788                                                                         |       |                       | 4          |               |       |         | 287        |                   |       |                      |       |              |       |   |   |   | 291 |   |   |   |   |   |   |
| **Net income**                             |       |                                                                            |       |                       |       |               |       |         |       |                   |       |                      | 3,803      |              |       |   |   |   | 3,803 |   |   |   | 3,803 |   |   |
| Comprehensive income                       |       |                                                                            |       |                       |       |               |       |         |       |                   |       |                      |       |              |       |   |   |   |   |   |   |   | $ | 3,803 |   |   |
| **BALANCES AS OF DECEMBER 31, 2005**       | ** ** | 14,587,949                                                                      |       |                       | $          | 152                |       |         |       | $                      | 63,930     |                      |       |              | $          | (53,289 | ) |   | $ | (2,861 | ) |   | $ | 7,932 |   |   |   |   |   |   |
|                                            |            |                                                                                 |            |                            |            |                    |            |              |            |                        |            |                           |            |                   |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

See accompanying notes.

28

 

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**ConsolidatedStatements of Cash Flows**

| ** **                                                                                          | ** ** | **Year ended December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                                          | ** ** | **2005**                                   | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                                                                          | ** ** | **(In thousands)**                    | ** ** |
| **Operating activities**                                                                            |       |                                       |       |   |   |   |   |
| Net income (loss)                                                                                   | ** ** | **$**                                      | **3,803**  |   | $ | 3,184 |   | $ | (828 | ) |
| Adjustments to reconcile  net income (loss) to net cash provided by (used in) operating activities: |       |                                       |       |   |   |   |   |
| Depreciation                                                                                        | ** ** | **44**                                     |       | 8 |   | — |   |
| Bad debt (recoveries)                                                                               | ** ** | **(50**                                    | )          | (110 | ) | (50 | ) |
| Deferred taxes                                                                                      | ** ** | **(138**                                   | )          | — |   | — |   |
| Changes in  operating assets and liabilities:                                                       |       |                                       |       |   |   |   |   |
| Accounts receivable                                                                                 | ** ** | **(1,018**                                 | )          | (610 | ) | (915 | ) |
| Inventories                                                                                         | ** ** | —                                     |       | — |   | 112 |   |
| Prepaid software licenses                                                                           | ** ** | **153**                                    |       | (906 | ) | (716 | ) |
| Prepaid expenses and other current assets                                                           | ** ** | **(5**                                     | )          | (9 | ) | (36 | ) |
| Accounts payable, accrued expenses, and employee and  compensation benefits                         | ** ** | **549**                                    |       | 9 |   | 231 |   |
| Income taxes                                                                                        | ** ** | —                                     |       | — |   | (285 | ) |
| Deferred revenue                                                                                    | ** ** | **462**                                    |       | 1,629 |   | 2,391 |   |
| Net cash provided  by (used in) operating activities                                                | ** ** | **3,800**                                  |       | 3,195 |   | (96 | ) |
| **Investing activities**                                                                            |       |                                       |       |   |   |   |   |
| Purchases of  equipment and improvements                                                            | ** ** | **(206**                                   | )          | (93 | ) | — |   |
| Net cash used for  investing activities                                                             | ** ** | **(206**                                   | )          | (93 | ) | — |   |
| **Financing activities**                                                                            |       |                                       |       |   |   |   |   |
| Proceeds from  issuance of stock under employee benefit plans                                       | ** ** | **291**                                    |       | 102 |   | 9 |   |
| Net cash provided  by financing activities                                                          | ** ** | **291**                                    |       | 102 |   | 9 |   |
| Change in cash  and cash equivalents                                                                | ** ** | **3,885**                                  |       | 3,204 |   | (87 | ) |
| Cash and cash  equivalents at beginning of year                                                     | ** ** | **5,520**                                  |       | 2,316 |   | 2,403 |   |
| Cash and cash  equivalents at end of year                                                           | ** ** | **$**                                      | **9,405**  |   | $ | 5,520 |   | $ | 2,316 |   |
| Supplementary disclosure  of cash flow information:                                                 |       |                                       |       |   |   |   |   |
| Interest paid                                                                                       | ** ** | **$**                                      | **2**      |   | $ | 1 |   | $ | — |   |
| Income taxes (refunded) paid                                                                        | ** ** | **$**                                      | **—** |   | $ | (1,271 | ) | $ | — |   |
| Cancellation of  put                                                                                | ** ** | **$**                                      | **—** |   | $ | — |   | $ | 2,875 |   |

 

See accompanying notes.

29

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**Notes to the Consolidated Financial Statements**

**1.   Natureof Business and Basis of Presentation**

Ezenia! Inc. (“Ezenia” or the “Company”) operates inone business segment, which is the design, development, manufacturing,marketing and sale of conferencing and real-time collaboration solutions forcorporate and governmental networks and eBusiness.  Founded in 1991, Ezenia! develops and marketsproducts that enable organizations to provide high-quality group communicationand collaboration capabilities to commercial, governmental, consumer andinstitutional users. Ezenia’s products allow individuals and groups, regardlessof proximity constraints, to interact and share information in a natural,spontaneous way—voice-to-voice, face-to-face, mouse-to-mouse,keyboard-to-keyboard, flexibly, securely and in real-time.  Using our products, individuals can interactthrough a natural meeting experience, allowing groups to work togethereffectively and disseminate vital information quickly in a secure environment.

The consolidated financial statements include the accountsof Ezenia and its wholly owned subsidiaries. All significant inter-companytransactions and balances have been eliminated. All assets and liabilities ofEzenia’s foreign subsidiaries are translated at the rate of exchange at the endof the year, while sales and expense are translated at the average rate ineffect during the year. The net effect of these translation adjustments hasbeen immaterial.

Certain amounts in 2003have been reclassified to permit comparison with 2005 and 2004 classifications.

**2.   Management’sPlans**

Ezenia’ssuccess in achieving its goal of showing consistent quarterly top line andbottom line growth is largely dependent on whether it can continue to grow itsfuture order bookings, and related revenue targets. Prior to 2004, Ezenia incurred substantialrecurring operating losses and negative cash flow from operations and incurredan accumulated deficit of approximately $60.3 million at December 31, 2003.During 2005 and 2004, Ezenia achieved income from operations of $3.5 million and$1.8 million, net income of $3.8 million and $3.2 million, and generated cashfrom operations of $3.8 million and $3.2 million respectively, and has$9.4 million of cash and cash equivalents as of December 31, 2005. Accordingly, largely as a result of itssuccessive quarters of profitability, management believes, although there canbe no assurances, that its existing cash resources will be sufficient to fundits anticipated working capital and capital expenditure needs for at least thenext twelve months. We anticipate that we will continue to generate positivecash flow from operations for 2006 and that existing cash reserves willtherefore be sufficient to meet our working and capital requirement needsduring this period.

**3.   Summary ofSignificant Accounting Policies**

**Use of Estimates**

The preparation of thefinancial statements in conformity with accounting principles generallyaccepted in the United States of America requires management to make estimatesand assumptions that affect the reported amounts of assets and liabilities, anddisclosure of contingent assets and liabilities, if any, at the date of thefinancial statements and the reported amounts of revenues and expenses duringthe reporting period. Actual results could differ from these estimates.

30

----

**Notes to the Consolidated Financial Statements (Continued)**

**3.**   Summary of Significant Accounting Policies (Continued)

**Revenue recognition**

Product revenue consists of sales of InfoWorkSpace (“IWS”)software licenses and maintenance agreements, IWS product related training,installation, and consulting, and video products. Revenue from sales of IWSsoftware licenses and maintenance agreements is recognized ratably over thesubscription software license contract periods, which are generally one year,pursuant to the guidance provided by Statement of Position (“SOP”) 97-2, “*Software Revenue Recognition*” (SOP 97-2), issued bythe American Institute of Certified Public Accountants (AICPA). Revenue fromIWS training, installation, and consulting services are recognized as theservices are performed provided there is vendor specific objective evidence(VSOE) of fair value which is the price charged when the services are soldseparately. Revenue from video product sales is recognized upon shipment to thecustomer and the fulfillment of all contractual terms and conditions, pursuantto the guidance provided by Staff Accounting Bulletin No. 104, “*Revenue Recognition in Financial Statements*” (SAB 104),issued by the Securities and Exchange Commission.

Product development revenue relates to contractsinvolving customization of the IWS product according to customerspecifications. Revenue associated with contracts for product developmentrevenue with milestone-based deliverables requiring a customers’ acceptance isrecognized upon the customer’s acceptance in accordance with terms of thecontract, in conformity with the guidance provided by SOP 81-1, “*Accounting For Performance of Construction Type and Certain ProductionType Contracts*” issued by the AICPA. The associated cost recognitionwith these deliverables or milestones is deferred until the terms of acceptanceare satisfied and revenue is recognized.

Service revenue represents sales of service contractsrelated to the maintenance of video products. Maintenance revenue is deferredand recognized ratably over the term of the applicable agreement.

Products and software licenses are sold without anycontractual right of return by the customer. Deferred revenue representsamounts received from customers under subscription software licenses,maintenance agreements, or for product sales in advance of revenue recognition.Judgments are required in evaluating the creditworthiness of our customers. Inall instances, revenue is not recognized until we have determined, at theoutset of the arrangement that collectibility is reasonably assured. Amountsbilled to customers related to shipping and handling charges are recorded asrevenue upon shipment and the related costs are included in cost of goods sold.

**Product Warranties**

Our products are sold with warranty provisions thatrequire us to remedy deficiencies in quality or performance of our productsover a period of 90 days, at no cost to our customers. Our policy is toestablish warranty reserves at the time of sale when our estimates of the coststhat will be incurred to fulfill those warranty requirements become material.At December 31, 2005, we believe that our future cost of materials, laborand overhead for the servicing of our products sold through that date are notmaterial and no reserve is warranted. If actual product failures or material orservice delivery costs differ from our estimates, our warranty liability wouldneed to be revised accordingly.

**Third PartyTechnology**

Ezenia’s IWS product incorporates third partytechnology in the form of software licenses, which we purchase from othersoftware vendors. Software licenses purchased from vendors are reported asprepaid licenses and amortized to cost of revenue over the subscription period,which is generally one year.

31

----

**Notes to the Consolidated Financial Statements (Continued)**

**3.**   Summary of Significant Accounting Policies (Continued)

**Advertising**

Advertisingcosts are included in sales and marketing expense. Ezenia uses its website asits main form of advertising along with participating in various industryrelated trade shows and currently does not incur material advertising costs.Advertising costs are expensed as incurred. Advertising expense approximated$49 thousand in fiscal 2005 and $39 thousand in fiscal 2004. Ezenia did notincur advertising expense for fiscal 2003.

**Cash equivalents**

Ezenia considers allliquid investments with a maturity of 90 days or less at the date of purchaseto be cash equivalents. Cash equivalents and marketable securities consist ofhighly rated U.S. and state government securities, commercial paper andshort-term money market funds.

**Financialinstruments and concentrations of credit risk**

Ezenia’s financial instruments consist primarily ofcash and cash equivalents, trade receivables, accounts payable and accruedexpenses. The carrying value of these financial instruments approximates fairvalue due to their short term to maturity. Financial instruments, whichpotentially subject Ezenia to concentrations of credit risk, are cashequivalents and accounts receivable.

Major financial institutions maintain all the Company’scash equivalents. Concentration of credit risk with respect to accountsreceivable is limited to certain customers to whom Ezenia makes substantialsales. To reduce risk, we routinely assess the financial strength of our customers.Ezenia maintains an allowance for doubtful accounts based on accounts past dueaccording to contractual terms and historical collection experience. Actuallosses when incurred are charged to the allowance. Write-offs related toaccounts receivable have been within management’s expectations.

Revenue from one customeraccounted for approximately 20% of total revenues in 2005, 33% of totalrevenues in 2004, and 38% of total revenues in 2003. Accounts receivable fromthis customer amounted to approximately $1.8 million, $1.8 million and $1.9million at December 31, 2005, 2004 and 2003, respectively. Revenue frominternational markets was approximately $362 thousand, $391 thousand and $1.1million in 2005, 2004 and 2003, respectively.

**Equipment andimprovements**

Equipmentand improvements are stated at cost and depreciated using the straight-linemethod over the following estimated useful lives:

| Computer software and  equipment |   | 3 years                                        |
|----------------------------------|--------|------------------------------------------------|
| Office equipment                 |   | 5 years                                        |
| Furniture and fixtures           |   | 5 years                                        |
| Leasehold improvements           |   | Shorter of lease term or estimated useful life |

 

Repairs and maintenancecosts are expensed as incurred.

32

----

**Notes to the Consolidated Financial Statements (Continued)**

**3.**   Summary of Significant Accounting Policies (Continued)

**Research anddevelopment costs**

Research and developmentcosts are charged to expense as incurred. Internally developed software costsare expensed as incurred until it is determined that the technology needed toachieve performance requirements exists. To date, internally developed softwarehas been available for release concurrent with the establishment oftechnological feasibility and, accordingly, costs eligible for capitalizationhave been insignificant and expensed as incurred.

**Income taxes**

Deferred tax assets and liabilities are determined atthe end of each year based on the future tax consequences that can beattributed to net operating loss and credit carryovers as well as thedifferences between the financial statement carrying amounts of existing assetsand liabilities and their respective tax bases. The deferred tax assets arereduced by a valuation allowance if it is more likely than not that the taxbenefits will not be realized. The realization of deferred tax assets isdependant upon the generation of future taxable income. In determining thevaluation allowance, we consider past performance, expected future taxableincome, and qualitative factors which we consider to be appropriate to beconsidered in estimating future taxable income. The Company’s forecast ofexpected future taxable income is for future periods that can be reasonablyestimated. Results that differ materially from our current expectations may causeus to change our judgment on future taxable income. These changes, if any, mayrequire us to adjust our existing tax valuation allowance higher or lower thanthe amount we have recorded.

In the fourth quarter of 2005, as a result of ourassessment of future taxable income, we released approximately $138 thousand ofvaluation allowance against deferred tax assets resulting in a net tax benefitof approximately $91 thousand. The calculation of tax liabilities involvessignificant judgment in estimating the impact of uncertainties in theapplication of complex tax laws.

**Net income (loss)per share**

The Company reports net income (loss) per share inaccordance with the Statement of Financial Accounting Standards (“SFAS”) No. 128,“*Earnings per Share*.” Diluted earningsper share include the effect of dilutive stock options.

Sharesused in computing basic and diluted net income (loss) per share are as follows:

| ** **                                               | ** ** | **2005**   | ** ** | **2004**   | ** ** | **2003**   | ** ** |
|----------------------------------------------------------|------------|------------|------------|------------|------------|------------|------------|
| Basic                                                    |       | 14,483,399 |       | 14,070,034 |       | 13,580,118 |       |
| Effect of assumed exercise ofstock options               |       | 644,240    |       | 467,560    |       | —     |       |
| Diluted                                                  |       | 15,127,639 |       | 14,537,594 |       | 13,580,118 |       |
| Outstanding  options excluded as impact is anti-dilutive |       | 760,752    |       | 783,752    |       | 1,860,702  |       |

 

**Accounting forstock-based compensation**

Ezenia has elected to account for its stock-basedcompensation plans pursuant to Accounting Principles Board Opinion No. 25,“*Accounting for Stock Issued to Employees,*”(APB 25) and related interpretations rather than the alternative fair valueaccounting provided under SFAS No. 123, “*Accountingfor Stock-Based Compensation* (“SFAS No. 123”).” Ezenia hasrecognized no compensation expense related to its stock option plans and itsstock purchase plan.

33

----

**Notes to the Consolidated Financial Statements (Continued)**

**3.**   Summary of Significant Accounting Policies (Continued)

Pro-forma information regarding net income (loss) andincome (loss) per share, as if we had used the fair value method pursuant to SFASNo. 123 to account for stock options issued under our various stock optionplans, and shares purchased under the 1995 Employee Stock Purchase Plan, asamended,  is presented below. The fairvalue of stock activity under these plans was estimated at the date of grantusing a Black-Scholes option pricing model with the following assumptions as ofthe date of grant: risk-free interest rates equal to the then available ratefor zero-coupon U.S. government issues with a remaining term equal to theexpected life of the options; no dividend yields; an average volatility factorof the expected market price of Ezenia’s common stock over the expected life ofthe option of 1.50 in 2005, 1.24 in 2004 and 1.82 in 2003; and aweighted-average expected life of the option of 6.8 years in 2005, 6.4 years in 2004 and 7.4 years in 2003.

Forpurposes of pro-forma disclosures, the estimated weighted average grant datefair value of options granted during the year of $1.44, $0.53 and $0.19 in2005, 2004 and 2003, respectively, is amortized to expense over the relatedvesting period. Pro-forma information is as follows:

| ** **                                                                                 | ** ** | **2005**                                                                      | ** ** | **2004** | ** ** | **2003** | ** ** |
|--------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------|------------|----------|------------|----------|------------|
| ** **                                                                                 | ** ** | **(In thousands  except for per share information)** | ** ** |
| Net income (loss)  as reported                                                             |       | $                                                                             | 3,803      |     | $          | 3,184    |       | $ | (828 | ) |
| Deduct: total  stock-based employee compensation determined under fair value based methods |       | (273                                                                          | )          | (155     | )          | (805     | )          |
| Pro-forma net  income (loss)                                                               |       | $                                                                             | 3,530      |     | $          | 3,029    |       | $ | (1,633 | ) |
| Net income (loss)  per share as reported                                                   |       |                                                                          |       |     |       |     |       |
| Basic                                                                                      |       | .26                                                                           |       | .23      |       | (.06     | )          |
| Diluted                                                                                    |       | .25                                                                           |       | .22      |       | (.06     | )          |
| Pro-forma net  income (loss) per share                                                     |       |                                                                          |       |     |       |     |       |
| Basic                                                                                      |       | .24                                                                           |       | .21      |       | (.12     | )          |
| Diluted                                                                                    |       | .23                                                                           |       | .21      |       | (.12     | )          |

 

**Recent Accountingpronouncements**

In December 2004, theFinancial Accounting Standards Board issued SFAS No. 123R, *“Share**-**Based Payment”*(SFAS123R). This Statement is a revision of SFAS 123 and supersedes APB 25 and its relatedimplementation guidance. SFAS 123R establishes standards for transactions inwhich an entity exchanges its equity instruments for goods or services. Thisstandard requires a public entity to measure the cost of employee servicesreceived in exchange for an award of equity instruments based on the grant datefair value of the award. This eliminates the exception to account for suchawards using the intrinsic method previously allowable under APB Opinion No. 25.In March 2005, the Securities and Exchange Commission (SEC) released StaffAccounting Bulletin (SAB) 107, Share-Based Payment, which expresses views ofthe SEC Staff about the application of SFAS No. 123R. SFAS No. 123R was tobe effective for interim or annual reporting periods beginning on or after June 15,2005, but in April 2005 the SEC issued a rule that SFAS No. 123Rwill be effective only for annual reporting periods beginning on or after June 15,2005.

The Company is required toadopt SFAS 123R on January 1, 2006 and under the modified-prospectivetransition method, the adoption is expected to materially increase stockcompensation expense and decrease earnings. Accordingly, in fiscal 2006, totalstock-based compensation expense from stock options using the fair value provisionsof SFAS 123R, is estimated to be approximately $800 

34

----

**Notes to the Consolidated Financial Statements (Continued)**

**3.**   Summary of Significant Accounting Policies (Continued)

thousand.In order to develop the fiscal 2006 stock-based compensation expense estimate,we utilized assumptions on items such as projected option grants and expectedlife and volatility, which were similar to the amounts in fiscal 2005. Inaddition, SFAS 123R requires that the excess tax benefits related to stockcompensation be reported as a cash inflow from financing activities rather thanas a reduction of taxes paid in cash from operations.

**4.   Inventories**

Inventories consist primarily of finished goodsrelating to legacy video conferencing hardware equipment Historically, as adesigner, developer and manufacturer of videoconferencing hardware solutions,Ezenia was exposed to a number of economic and industry factors that couldresult in portions of our inventory becoming either obsolete or in excess ofanticipated usage. Our policy is to establish inventory reserves whenconditions exist that suggest that our inventory may be in excess of anticipateddemand or is obsolete based upon our assumptions about future demand for ourproducts and market conditions. When recorded, our reserves are intended toreduce the carrying value of our inventory to its net realizable value.

Ezenia has previously provided for excess andobsolescence reserve for 100% of its inventory due to the continued decline indemand relating to the legacy videoconferencing product line. During each of thethree years in the period ended December 31, 2005 Ezenia was able torealize sales of its legacy videoconferencing hardware products. The cost ofthese product sales was offset by adjustments to reduce the related inventoryreserves. At December 31, 2005 and 2004, our net inventory reserves areapproximately $4.5 million.

**5.   Equipment andImprovements**

Propertyand equipment are recorded at cost less accumulated depreciation andamortization. Depreciation is calculated using the straight-line method overthe useful lives of the respective assets. Leasehold improvements are amortizedover the shorter of the estimated useful lives of the improvements or theremaining lease term. Ezenia made no purchases of equipment or improvements inthe year ended December 31, 2003. For the years ended December 31,2005 and December 31, 2004, we had the following activity net ofdepreciation:

| ** **                                 | ** ** | **2005**                | ** ** | **2004** | ** ** |
|--------------------------------------------|------------|-------------------------|------------|----------|------------|
| ** **                                 | ** ** | **(in thousands)** | ** ** |
| Computer  equipment and purchased software |       | $                       | 172        |     |       | $ | 65 |   |   |
| Office equipment                           |       | 38                      |       |     | 26         |   |   |
| Furniture and  fixtures                    |       | 25                      |       |     | 2          |   |   |
| Leasehold  improvements                    |       | 64                      |       |     | —     |   |   |
| Total equipment and  improvements          |       | $                       | 299        |     |       | $ | 93 |   |   |
| Less: accumulated depreciation             |       | (52                     | )          |     | (8         | ) |   |
| Total equipment and  improvements, net     |       | $                       | 247        |     |       | $ | 85 |   |   |

 

35

----

**Notes to the Consolidated Financial Statements (Continued)**

**5.   Equipment andImprovements (Continued)**

Depreciation expense forthe years ended December 31, 2005 and 2004 was $44 thousand and $8thousand, respectively.

**6.   Income taxes**

Theprovision (benefit) for income taxes is as follows:

| ** **               | ** ** | **Year ended December 31** | ** ** |
|--------------------------|------------|-------------------------------------------|------------|
| ** **               | ** ** | **2005**                                  | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **               | ** ** | **(In thousands)**                   | ** ** |
| Current:                 |       |                                      |       |   |   |   |   |
| Federal                  |       | $                                         | 45         |   | $ | (608 | ) | $ | (267 | ) |
| State                    |       | 2                                         |       | — |   | — |   |
| Foreign                  |       | —                                    |       | (819 | ) | — |   |
| Total current            |       | $                                         | 47         |   | $ | (1,427 | ) | $ | (267 | ) |
| Deferred:                |       |                                      |       |   |   |   |   |
| Federal                  |       | $                                         | (107       | ) | $ | — |   | $ | — |   |
| State                    |       | (31                                       | )          | — |   | — |   |
| Foreign                  |       | —                                    |       | — |   | — |   |
| Total deferred           |       | $                                         | (138       | ) | $ | — |   | $ | — |   |
| Total income tax benefit |       | $                                         | (91        | ) | $ | (1,427 | ) | $ | (267 | ) |

 

The amount reported as current income tax benefit in2005 is comprised of current income tax expense of approximately $47 thousandin estimated federal alternative minimum tax expense and state income taxexpense and, a deferred tax benefit of approximately $138 thousand associatedwith the release of a portion of the Company’s valuation allowance. The amountreported as income tax benefit in 2004 is the result of an $819 thousand netsettlement reached with the ITC and a $608 thousand refund received inconnection with the 2002 carry back of net operating losses incurred in 2001.The amount reported as income tax benefit in 2003 is the result of the reversalof tax reserves recorded in prior years.

Areconciliation of the expected income tax (benefit) computed using the federalstatutory income tax rate to the Company’s effective income tax rate at December 31for the years ended 2005, 2004, and 2003 is as follows:

| ** **                                        | ** ** | **Year ended December 31** | ** ** |
|---------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                        | ** ** | **2005**                                  | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                        | ** ** | **(In thousands)**                   | ** ** |
| Federal income  tax at federal statutory tax rate |       | $                                         | 1,262      |   | $ | 597 |   | $ | (373 | ) |
| State taxes, net  of federal benefit              |       | 266                                       |       | 105 |   | — |   |
| Research and  development and other tax credits   |       | 45                                        |       | 708 |   | — |   |
| Change in  valuation allowance                    |       | (773                                      | )          | 1,259 |   | 1,038 |   |
| Prior year  refunds and reversal of reserves      |       | —                                    |       | (1,427 | ) | (267 | ) |
| Utilization of  net operating loss                |       | (688                                      | )          | — |   | — |   |
| Permanent  differences and other                  |       | (203                                      | )          | (151 | ) | (665 | ) |
| Total income tax expense  (benefit)               |       | $                                         | (91        | ) | $ | (1,427 | ) | $ | (267 | ) |

 

36

----

**Notes to the Consolidated Financial Statements (Continued)**

**6.**   Income taxes (Continued)

The American Jobs Creation Act of 2004 (the “Act”) wassigned into law on October 22, 2004. The Act contains numerous amendmentsand additions to the U.S. corporate income tax rules. None of these changes,either individually or in the aggregate, is expected to have a significanteffect on Ezenia’s income tax liability. The Company is continuing to evaluatethe Act and does not expect to complete this evaluation until after Congressand the Treasury Department provide guidance clarifying certain provisions.

TheCompany’s deferred tax assets consist of the following:

| ** **                        | ** ** | **2005**   | ** ** | **2004**   | ** ** |
|-----------------------------------|------------|------------|------------|------------|------------|
| **(In thousands)**           | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net operating  loss carryforwards |       | $          | 21,239     |       | $          | 21,927 |   |
| Purchased intangibles             |       | 5,389      |       | 6,013      |       |
| Tax credit carryforwards          |       | 3,077      |       | 3,342      |       |
| Reserves, accruals and allowances |       | 2,422      |       | 2,156      |       |
| Total gross  deferred tax asset   |       | 32,115     |       | 33,287     |       |
| Valuation allowance               |       | (31,977    | )          | (33,438    | )          |
| Net deferred tax  asset           |       | $          | 138        |       | $          | — |   |

 

At December 31, 2005, Ezenia had domestic federalnet operating loss carryforwards of approximately $53.1 million available toreduce future taxable income, which expire at various dates beginning in 2020through 2025. Ezenia also has federal research and development tax creditcarryforwards of approximately $2.4 million available to reduce future taxliabilities. Ezenia has state net operating loss carryforwards of approximately$53.2 million as of December 31, 2005 available to reduce state futuretaxable income, which expire at various dates beginning in 2005 through 2010.Ezenia also has state research and development tax credit carryforwards ofapproximately $918 thousand as of December 31, 2005.

Under the provisions of the Internal Revenue Code,certain substantial changes in the Company’s ownership may result in alimitation on the amount of net operating loss carryforwards and research anddevelopment credit carryforwards which may be utilized annually to offsetfuture taxable income and taxes payable.

As required by SFAS No. 109,management of the Company has evaluated the positive and negative evidencebearing upon the realizability of its deferred tax assets, which are comprisedprincipally of NOL carryforwards, research and experimentation creditcarryforwards, capitalized start up expenditures, purchased intangibles, andresearch and development expenditures amortizable over sixty months. Managementhas determined at this time that it is more likely than not that the Companywill recognize a portion of the benefits of its federal and state deferred taxassets. Accordingly, in 2005 a provision for current income tax ofapproximately $47 thousand relating primarily to federal alternative minimumtaxes was recorded, which was offset by the release of a valuation allowance ofapproximately $138 thousand in the fourth quarter. As a result, a valuationallowance of approximately $31.9 million has been established at December 31,2005, resulting in a net deferred tax asset of approximately $138 thousand. Theamount of the deferred tax asset considered realizable could be reduced orincreased in the near term if estimates of future taxable income during thecarryforward period change.

37

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**Notes to the Consolidated Financial Statements (Continued)**

**6.**   Income taxes (Continued)

*Restatement of 2004and 2003 deferred tax items:*

In connection with the Company’s review of income taxreturns previously filed in relation to our disclosures relative to certaintemporary differences we have restated certain of the deferred tax assetamounts and corresponding valuation allowance from our previously filed Form10-K’s for the years ended December 31, 2004 and 2003, respectively.  While the adjustments individually arematerial to our tax disclosures there was no impact to our balance sheet,statement of operations, stockholders equity or cash flows.  Accordingly, the following represents therestated amounts as compared to amounts previously disclosed in our prior Form10-K.

The Company’s deferred taxassets are comprised of the following:

| ** **                                                         | ** ** | ** **             | ** ** | ** **             | ** ** | **2004**                | ** ** | **2003**                | ** ** |
|--------------------------------------------------------------------|------------|------------------------|------------|------------------------|------------|-------------------------|------------|-------------------------|------------|
| ** **                                                         | ** ** | **2004**               | ** ** | **2003**               | ** ** | **(as originally** | ** ** | **(as originally** | ** ** |
| ** **                                                         | ** ** | **(as restated)** | ** ** | **(as restated)** | ** ** | **reported)**           | ** ** | **reported)**           | ** ** |
| Net operating  loss carryforwards                                  |       |                   | $          | 21,927                 |       |                    |       | $                       | 21,363     |   |   |   | $ | 21,400 |   |   |   | $ | 18,512 |   |   |
| Purchased  intangibles                                             |       |                   | 6,013      |                   |       |                    | 6,162      |                    |       |   | 6,013 |   |   |   | 5,903 |   |   |
| Research and  development and other credits                        |       |                   | 3,342      |                   |       |                    | 3,718      |                    |       |   | 3,718 |   |   |   | 5,166 |   |   |
| Accruals and  allowances not currently deductible for tax purposes |       |                   | 2,156      |                   |       |                    | 3,138      |                    |       |   | 2,156 |   |   |   | 1,425 |   |   |
| Depreciation and  other                                            |       |                   | —     |                   |       |                    | 316        |                    |       |   | — |   |   |   | 316 |   |   |
|                                                               |       |                   | 33,438     |                   |       |                    | 34,697     |                    |       |   | 33,287 |   |   |   | 31,322 |   |   |
| Valuation  allowance                                               |       |                   | (33,438    | )                      |       |                    | (34,697    | )                       |       |   | (33,287 | ) |   |   | (31,322 | ) |   |
| Total deferred tax  assets                                         |       |                   | $          | —                 |       |                    |       | $                       | —     |   |   |   | $ | — |   |   |   | $ | — |   |   |

 

The restatements in 2003 were primarily related to a$2,851 thousand understatement of state net operating loss carryforwards, anunderstatement of cumulative temporary differences related to purchasedintangibles of $259 thousand and of various reserves, accruals and allowancesof $1,713 thousand offset by an overstatement of tax credit carryforwards of$1,448 thousand.  The 2004 restatementsrelate primarily to a $527 thousand understatement of federal net operatinglosses offset by a $376 thousand overstatement of tax credit carryforwards.

As a result of theserestatements to the aforementioned deferred tax items a restated reconciliationof the expected income tax (benefit) computed using the federal statutoryincome tax rate to the Company’s effective income tax rate for the years 2004and 2003 is as follows:

| ** **                                        | ** ** | ** **             | ** ** | ** **             | ** ** | **2004**                | ** ** | **2003**                | ** ** |
|---------------------------------------------------|------------|------------------------|------------|------------------------|------------|-------------------------|------------|-------------------------|------------|
| ** **                                        | ** ** | **2004**               | ** ** | **2003**               | ** ** | **(as originally** | ** ** | **(as originally** | ** ** |
| ** **                                        | ** ** | **(as restated)** | ** ** | **(as restated)** | ** ** | **reported)**           | ** ** | **reported)**           | ** ** |
| Federal income  tax at federal statutory tax rate |       |                   | $          | 597                    |       |                    |       | $                       | (373       | ) |   |   | $ | 597 |   |   |   | $ | (373 | ) |   |
| State income  taxes, net of federal benefit       |       |                   | 105        |                   |       |                    | —     |                    |       |   | 105 |   |   |   | — |   |   |
| Research and  development and other tax credits   |       |                   | 708        |                   |       |                    | —     |                    |       |   | 708 |   |   |   | — |   |   |
| Change in  valuation allowance                    |       |                   | (1,259     | )                      |       |                    | 1,038      |                    |       |   | 1,965 |   |   |   | 1,038 |   |   |
| Prior year  refunds and reversal of reserves      |       |                   | (1,427     | )                      |       |                    | (267       | )                       |       |   | (1,427 | ) |   |   | (267 | ) |   |
| Adjustment of  prior year                         |       |                   | —     |                   |       |                    | —     |                    |       |   | (4,127 | ) |   |   | — |   |   |
| Other                                             |       |                   | (151       | )                      |       |                    | (665       | )                       |       |   | 752 |   |   |   | (665 | ) |   |
|                                              |       |                   | $          | (1,427                 | )          |                    |       | $                       | (267       | ) |   |   | $ | (1,427 | ) |   |   | $ | (267 | ) |   |

 

38

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**Notes to the Consolidated Financial Statements (Continued)**

**7.**   OtherIncome

Ezenia had previouslysettled a patent infringement suit against Accord in the United States DistrictCourt for the District of Massachusetts. The settlement agreement, provided,among other things, that Ezenia receive $6.5 million in return for a covenantnot to sue with respect to the patents that were the subject of the litigation.Ezenia received the payment in 2000, net of foreign tax withholding of $975 housand,pending a resolution of certain tax matters related to the settlement with thetax authorities in Israel. In April 2004, Ezenia reached a settlementagreement with the Israel Tax Commission (ITC), resulting in the receipt byEzenia of cash proceeds related to the disputed amount, net of interest earned,tax withholding, and settlement fees of approximately $179 thousand.

**8.   Commitmentsand Contingencies**

Ezenia’s contractualobligations relate primarily to its facilities leases and a contractualpurchase commitment. In 2005, Ezenia moved its headquarters facility fromBurlington, Massachusetts to Nashua, New Hampshire and incurred a $170 thousandlease termination fee. The primary facility in Nashua, New Hampshire is leased underan operating lease, which expires in June 2010. We also have three otherleases for office space in the United States, located in Colorado Springs,Colorado, Sterling, Virginia, and Alexandria, Virginia for sales, developmentand technical support operations. On February 28, 2005 we entered into anew five year operating lease to move our Alexandria, Virginia sales andservice office to a new facility in Sterling, Virginia. At the same time, weentered into a sublease agreement to lease our Alexandria, Virginia facilityfor the remaining 14 months of our lease term. As a result of the move, we willlower our overall facility costs in Virginia. These leases expire at variousdates through November 2011. Rent expense was approximately $199 thousand,$278 thousand, and $361 thousand in 2005, 2004 and 2003, respectively.

Thefollowing table summarizes our outstanding contractual obligations:

| ** **                     | ** ** | **2006**                | ** ** | **2007-2009** | ** ** | **2010-2011** | ** ** | **Total** | ** ** |
|--------------------------------|------------|-------------------------|------------|---------------|------------|---------------|------------|-----------|------------|
| ** **                     | ** ** | **(in thousands)** | ** ** |
| Operating leases               |       | $                       | 153        |          |       | $             | 536        |      |       |   | $ | 225 |   |   | $ | 914 |   |
| Purchase  commitments          |       | 2,750                   |       |          | —     |          |       |      | —     |   |   | 2,750 |   |
| Total contractual  obligations |       | $                       | 2,903      |          |       | $             | 536        |      |       |   | $ | 225 |   |   | $ | 3,664 |   |

 

Purchase commitmentsrepresent obligations under agreements, which are not unilaterally cancelableby us, are legally enforceable and specify fixed or minimum amounts of goods orservices at fixed or minimum prices. If order bookings are less than expectedin 2006, it is possible that we will be unable to meet our minimum purchasecommitment resulting in a possible material adjustment later in the year.

Ezenia is subject to avariety of claims and suits that arise from time to time in the ordinary courseof its business. Currentlywe are not a defendant in any claims or suits.  As of December 31, 2004, Ezeniahad reserved approximately $160 thousand for potential liabilities that weexpected to incur as a result of lawsuits filed during the fourth quarter of2004. During the quarter ended June 30, 2005, we resolved these suits forapproximately $15 thousand and therefore reversed the excess accrual ofapproximately $145 thousand, which is included as a credit in general andadministrative expense as a change in estimate.

39

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**Notes to the Consolidated Financial Statements (Continued)**

**9.**   StockholdersEquity

The Company has authorized 2,000,000 shares ofundesignated Preferred Stock. Each series of Preferred Stock shall have suchrights, preferences, privileges and restrictions, including voting rights,dividend rights, conversion rights, redemption privileges and liquidationpreferences as determined by the Board of Directors.

In connection with theCompany’s prior acquisition of the IWS business unit we issued400,000 shares of our common stock of which 290,000 of those shares weresubject to a put right by the seller of the IWS business unit. Such commonstock subject to the put right was reported as temporary equity. In July 2003,in connection with an amendment to a software development agreement, the selleragreed to estimate its put right and, accordingly, the $2.9 million valueassociated with the 290,000 shares of common stock that was no longer subjectto the put option, was credited to stockholders equity.

**10.**   BenefitPlans

**Stock option plans**

The Company’s Amended and Restated 1991 StockIncentive Plan (the “1991 Plan”) provided for the sale or award of commonstock, or the grant of incentive stock options or nonqualified stock optionsfor the purchase of common stock, for up to 6,090,541 shares to officers,employees and consultants. The 1991 Plan terminated on March 31, 2001, andno further options have been granted under the 1991 Plan subsequent to thatdate. At December 31, 2005, there were 655,252 shares of common stockreserved to be issued upon exercise of outstanding options granted under the1991 Plan.

The 2001 Stock Incentive Plan was approved and adoptedby the Board of Directors on April 11, 2001 (the “2001 Stock IncentivePlan”). The 2001 Stock Incentive Plan provided for the sale or award of commonstock, or the grant of non-qualified stock options for the purchase of commonstock, for up to 5,000,000 shares to officers, directors, employees andconsultants of the Company. Vesting of options granted under the 2001 StockIncentive Plan accelerates upon change of control or acquisition as defined inthe 2001 Stock Incentive Plan. The 2001 Stock Incentive Plan terminated on December 31,2004 and no further options have been granted under the 2001 Stock IncentivePlan subsequent to this date.  At December 31,2005, there were 239,437 shares of common stock reserved to be issued uponexercise of outstanding options granted under the 2001 Stock Incentive Plan.

The 2004 Stock IncentivePlan was approved and adopted by the Board of Directors on December 31,2004 (the “2004 Stock Incentive Plan”). The 2004 Stock Incentive Plan providesfor the sale or award of common stock or the grant of non-qualified stockoptions for the purchase of common stock, for up to 7,500,000 shares toofficers, directors, employees and consultants of the Company. The Board ofDirectors administers the 2004 Stock Incentive Plan, and the terms of grantsand awards made pursuant to the 2004 Stock Incentive Plan. Vesting of optionsgranted under the 2004 Stock Incentive Plan accelerates upon change of controlor acquisition as defined in the 2004 Stock Incentive Plan. The 2004 StockIncentive Plan will terminate on December 31, 2014. At December 31,2005, there were 916,950 shares of common stock reserved to be issued uponexercise of outstanding options granted under the 2004 Stock Incentive Plan.

**1994Non-employee director stock option plan**

In April 1995, the Board ofDirectors and shareholders approved the Director Plan, which was amended by theBoard of Directors on June 5, 2002 (the “Director Plan”). The DirectorPlan provided that the Board of Directors, at its discretion, was permitted togrant options to non-employee directors, 

40

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**Notes to the Consolidated Financial Statements (Continued)**

**10.**   Benefit Plans (Continued)

subjectto terms and conditions as determined by the Board of Directors. TheDirector Plan terminated on November 9, 2004, and no further options havebeen granted under the Director Plan subsequent to that date. At December 31,2005, there were 34,000 shares of common stock reserved to be issued uponexercise of outstanding options granted under the Director Plan.

Asummary of option activity under the 2004 Stock Incentive Plan, 2001 StockIncentive Plan, the 1991 Plan and the Director Plan is as follows:

| ** **                             | ** ** | **Shares** | ** ** | **Weighted Average  Exercise Price** | ** ** |
|----------------------------------------|------------|------------|------------|-------------------------------------------|------------|
| Outstanding at  December 31, 2002 |       | 2,084,327  |       |                                      | $          | 4.66 |   |   |
| Granted                                |       | 770,250    |       |                                      | 0.19       |   |   |
| Terminated                             |       | (981,125   | )          |                                      | 3.76       |   |   |
| Exercised                              |       | (66,750    | )          |                                      | 0.15       |   |   |
| Outstanding at December 31, 2003  |       | 1,806,702  |       |                                      | $          | 3.29 |   |   |
| Granted                                |       | 337,750    |       |                                      | 0.53       |   |   |
| Terminated                             |       | (220,450   | )          |                                      | 1.07       |   |   |
| Exercised                              |       | (485,781   | )          |                                      | 0.22       |   |   |
| Outstanding at December 31, 2004  |       | 1,438,221  |       |                                      | $          | 4.02 |   |   |
| Granted                                |       | 1,045,200  |       |                                      | 1.44       |   |   |
| Terminated                             |       | (271,388   | )          |                                      | 1.10       |   |   |
| Exercised                              |       | (366,394   | )          |                                      | 0 .71      |   |   |
| Outstanding at  December 31, 2005 |       | 1,845,639  |       |                                      | $          | 3.65 |   |   |

 

Relatedinformation for options outstanding and exercisable as of December 31,2005 under these option plans is as follows:

| ** **  | **Range of exercise prices** | ** ** | ** ** | **Outstanding  Options** | ** ** | **Weighted  Average  Remaining  Contractual Life** | ** ** | **Weighted  Average  Exercise Price** | ** ** | **Exercisable  Options** | ** ** | **Weighted  Average  Exercise Price** | ** ** |
|-------------|---------------------------------------------|------------|------------|--------------------------|------------|---------------------------------------------------------|------------|--------------------------------------------|------------|--------------------------|------------|--------------------------------------------|------------|
| $0.11-$0.97 |                                        |       | 871,437    |                     |       |                                                    | 8.49       |                                       |       |                     | $          | 0.79                                       |       |   |   | 123,534 |   |   |   | $ | 0.33 |   |   |
| 1.02-1.92   |                                        |       | 91,950     |                     |       |                                                    | 8.91       |                                       |       |                     | 1.61       |                                       |       |   | 16,750 |   |   |   | 1.48 |   |   |
| 2.10-2.74   |                                        |       | 234,500    |                     |       |                                                    | 9.66       |                                       |       |                     | 2.41       |                                       |       |   | 7,000 |   |   |   | 2.74 |   |   |
| 3.63-4.50   |                                        |       | 12,252     |                     |       |                                                    | 4.48       |                                       |       |                     | 4.36       |                                       |       |   | 12,252 |   |   |   | 4.36 |   |   |
| 7.81-9.13   |                                        |       | 635,500    |                     |       |                                                    | 3.39       |                                       |       |                     | 8.33       |                                       |       |   | 635,500 |   |   |   | 8.33 |   |   |
|        |                                        |       | 1,845,639  |                     |       |                                                    | 6.88       |                                       |       |                     | 3.65       |                                       |       |   | 795,036 |   |   |   | 6.83 |   |   |

 

**Employee stock purchase plan**

The Company’s 1995Employee Stock Purchase Plan (the “1995 Employee Stock Purchase Plan”) asamended on May 30, 2001 and further amended on January 24, 2005,provides eligible employees the right to purchase common stock at a price pershare equal to 85% of the lower of the fair market value of the common stock atthe beginning or end of each offering period. Participation in the offering islimited to 10% of an employee’s compensation (not to exceed amounts allowedunder Section 423 of the Internal Revenue Code), may be terminated at anytime by the employee and automatically ends on termination of employment withthe Company. A total of 900,000 shares of common stock have been reserved for 

41

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**Notes to the Consolidated Financial Statements (Continued)**

**10.**   Benefit Plans (Continued)

issuanceunder the 1995 Employee Stock Purchase Plan. Pursuant to the terms of the 1995Employee Stock Purchase Plan, no options under the 1995 Employee Stock PurchasePlan can be issued after January 31, 2005 and, as such, the 1995 EmployeeStock Purchase Plan is now terminated. In fiscal year 2005, 35,394 shares ofcommon stock were issued at the grant date fair value of $0.85 per share underthe 1995 Employee Stock Purchase Plan. No shares were issued under the 1995Employee Stock Purchase Plan during fiscal year 2004, 2003, and 2002.

**Savings plan**

The Company sponsors asavings plan for its employees, which has been qualified under Section 401(k) ofthe Internal Revenue Code. Eligible employees are permitted to contribute to the401(k) plan through payroll deductions within statutory and plan limits. Contributionsfrom the Company are made at the discretion of the Board of Directors andapproximated $22,000, $18,000, and $30,000 in 2005, 2004, and 2003, respectively.

**11.**   Quarterlyfinancial information (unaudited)

| ** **              | ** ** | **Quarter ended** | ** ** |
|-------------------------|------------|------------------------|------------|
| ** **              | ** ** | **March 31**      | ** ** | **June 30** | ** ** | **September 30** | ** ** | **December 31** | ** ** |
| 2005                    |       |                   |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Revenue                 |       |                   | $          | 3,142 |   |   | $ | 3,273 |   |   | $ | 3,281 |   |   |   | $ | 3,479 |   |   |
| Gross profit            |       |                   | 2,045      |   |   | 2,143 |   |   | 2,199 |   |   |   | 2,308 |   |   |
| Income from  operations |       |                   | 668        |   |   | 885 |   |   | 986 |   |   |   | 972 |   |   |
| Net income              |       |                   | $          | 705 |   |   | $ | 929 |   |   | $ | 1,042 |   |   |   | $ | 1,127 |   |   |
| Net income per share:   |       |                   |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Basic                   |       |                   | $          | .05 |   |   | $ | .06 |   |   | $ | .07 |   |   |   | $ | .08 |   |   |
| Diluted                 |       |                   | $          | .05 |   |   | $ | .06 |   |   | $ | .07 |   |   |   | $ | .07 |   |   |
| 2004                    |       |                   |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Revenue                 |       |                   | $          | 2,625 |   |   | $ | 2,486 |   |   | $ | 2,498 |   |   |   | $ | 2,782 |   |   |
| Gross profit            |       |                   | 1,578      |   |   | 1,606 |   |   | 1,622 |   |   |   | 2,004 |   |   |
| Income from  operations |       |                   | 406        |   |   | 387 |   |   | 422 |   |   |   | 592 |   |   |
| Net income              |       |                   | $          | 409 |   |   | $ | 1,103 |   |   | $ | 427 |   |   |   | $ | 1,244 |   |   |
| Net income per share:   |       |                   |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Basic                   |       |                   | $          | .03 |   |   | $ | .08 |   |   | $ | .03 |   |   |   | $ | .09 |   |   |
| Diluted                 |       |                   | $          | .03 |   |   | $ | .08 |   |   | $ | .03 |   |   |   | $ | .08 |   |   |

 

**12.   Subsequentevents**

On February 7, 2006, Ezenia entered into anagreement amending its operating lease for its sales and service facilitylocated in Colorado Springs, Colorado. Under the agreement, an additional 2,010square feet of space was added to the premises and the term of the lease wasextended an additional five years.

On February 17, 2006,Ezenia received a favorable ruling on its Motion for Summary Judgment on twoclaims brought against Datacraft Mexico, S.A. (“Datacraft”) for breach ofcontract. The claims stem from a balance due of approximately $276 thousand forthe delivery of goods to Datacraft in 2002 and 2003. The Company expects, as aresult of this ruling, to have these claims settled in 2006.

42

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**ITEM9A.**        CONTROLS AND PROCEDURES

As required by Rule 13a-15 under theSecurities Exchange Act of 1934, as of December 31, 2005, the Company’smanagement, under the supervision and with the participation of the personcurrently acting as both the chief executive officer and the chief financialofficer, carried out an evaluation of the effectiveness of the Company’sdisclosure controls and procedures. Based on this evaluation, the Company’schief executive officer and chief financial officer concluded that theCompany’s disclosure controls and procedures were effective at the reasonableassurance level to ensure that the information required to be disclosed on thereports filed or submitted by the Company under the Securities Exchange Act of1934 was recorded, processed, summarized, and reported within the requisitetime periods, including ensuring that such material information is accumulatedand communicated to the Company’s management to allow timely decisionsregarding required disclosure. There were no changes in the Company’s internalcontrol over financial reporting that occurred during the quarter endedDecember 31, 2005 that materially affected, or are reasonably likely tomaterially affect, the Company’s internal control over financial reporting.

The Company’s disclosure controls and procedures aredesigned to provide reasonable assurance of achieving their objectives. Becauseof the inherent limitations in all control systems, no evaluation of controlscan provide absolute assurance that all control issues and instances of fraud,if any, within the Company have been detected. These inherent limitationsinclude the realities that judgments in decision-making can be faulty, and thatbreakdowns can occur because of simple error or mistake. Additionally, controlscan be circumvented by the individual acts of some persons, by collusion of twoor more people, or by management override of the control. The design of anysystem of controls also is based in part upon certain assumptions about thelikelihood of future events, and there can be no assurance that any design willsucceed in achieving it stated goals under all potential future conditions.Over time, control may become inadequate because of changes in conditions, orthe degree of compliance with the policies or procedures may deteriorate.Because of the inherent limitations in a cost-effective control system,misstatements due to error or fraud may occur and not be detected.

**PART III**

**ITEM 10.**         DIRECTORSAND EXECUTIVE OFFICERS OF THE REGISTRANT

Information with respect to Directors and compliancewith Section 16(a) of the Securities Exchange Act may be found in thesections captioned, “Proposal No. 1—Election of Directors” and “Section 16(a)—BeneficialOwnership Reporting Compliance” appearing in the definitive Proxy Statement tobe delivered to shareholders in connection with the Annual Meeting ofShareholders to be held on May 24, 2006. Such information is incorporatedherein by reference.

The Company has adopted,ratified and approved a Code of Business Conduct and Ethics (the “Code”) thatapplies to all of the Company’s employees, including its executive officer, anddirectors. The Company shall also provide to any person without charge, uponrequest, a copy of the Code. Any such request must be made in writing to theCompany, c/o Investor Relations, 14 Celina Ave, Suite 17-18, Nashua,New Hampshire 03063.

**ITEM 11.**         EXECUTIVECOMPENSATION

The information requiredwith respect to this item may be found in the sections captioned “ExecutiveCompensation and Other Information Concerning Directors and Executive Officers”appearing in the definitive Proxy Statement to be delivered to shareholders inconnection with the Annual Meeting of Shareholders to be held on May 24,2006. Such information is incorporated herein by reference.

43

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**ITEM12.**         SECURITY OWNERSHIP OFCERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

The information found inthe section captioned, “Security Ownership of Certain Beneficial Owners andManagement” appearing in the definitive Proxy Statement to be delivered toshareholders in connection with the Annual Meeting of Shareholders to be heldon May 24, 2006 is incorporated herein by reference.

**EquityCompensation Plan Information**

The following table sets forth information as of December 31,2005 about the Company’s equity compensation plans under which shares of itscommon stock are authorized for issuance.

| **Plan Category**                                      | ** ** | ** ** | ** ** | **Number of securities to be  issued upon exercise  of outstanding options,  warrants and rights** | ** ** | **Weighted-average   exercise price of   outstanding options,  warrants and rights** | ** ** | **Number of securities remaining  available for future issuance  under equity compensation  plans (excluding securities  reflected in column (a))** | ** ** |
|-------------------------------------------------------------|------------|------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| ** **                                                  | ** ** | **(a)**    | ** ** | **(b)**                                                                                                                                              | ** ** | **(c)**                                                                                                                 | ** ** |
| Equity  compensation plans approved by security holders     |       |       | 1,606,202  | (1)                                                                                                                                                  |       |                                                                                                                    | $          | 4.14                                                                                                                                                                                                                 |       |   |   | 6,583,050 | (2) |   |
| Equity compensation plans not approved by security  holders |       |       | 239,437    | (3)                                                                                                                                                  |       |                                                                                                                    | $          | 0.36                                                                                                                                                                                                                 |       |   |   | — |   |   |
| Total                                                       |       |       | 1,845,639  |                                                                                                                                                 |       |                                                                                                                    | $          | 3.65                                                                                                                                                                                                                 |       |   |   | 6,583,050 |   |   |

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(1)          Includes655,252 shares of common stock to be issued upon exercise of outstandingoptions under the Amended and Restated 1991 Stock Incentive Plan, 34,000 sharesof common stock to be issued upon exercise of outstanding options under the1994 Non-Employee Director Option Plan, and 916,950 shares of common stock tobe issued upon exercise of outstanding options under the 2004 Stock IncentivePlan.

(2)          Includes6,583,050 shares of common stock remaining available for future issuance underthe 2004 Stock Incentive Plan. The Amended and Restated 1991 Stock IncentivePlan terminated on March 31, 2001, the 1994 Non Employee Director OptionPlan terminated on November 9, 2004, and the 1995 Employee Stock PurchasePlan terminated on January 31, 2005, and no additional options may begranted under these plans.

(3)          Representsshares of common stock to be issued upon exercise of outstanding options underthe 2001 Stock Incentive Plan. The 2001 Stock Incentive Plan terminated on December 31,2004, and no additional options may be granted under this plan.

A description of the StockIncentive Plans is included in Note 10 to the Company’s Consolidated FinancialStatements set forth herein.

**ITEM13.**         CERTAIN RELATIONSHIPS ANDRELATED TRANSACTIONS

The information requiredwith respect to this item may be found in the section captioned, “CertainTransactions” appearing in the definitive Proxy Statement to be delivered toshareholders in connection with the Annual Meeting of Shareholders to be heldon May 24, 2006. Such information is incorporated herein by reference.

**ITEM14.**         PRINCIPAL ACCOUNTANT FEESAND SERVICES

The information requiredwith respect to this item may be found in the section captioned, “PrincipalAccountant Fees and Services” appearing in the definitive Proxy Statement to bedelivered to shareholders in connection with the Annual Meeting of Shareholdersto be held on May 24, 2006. Such information is incorporated herein byreference.

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**PART IV**

**ITEM 15.**         EXHIBITS,AND FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K

**(a)****         DocumentsFiled as Part of Form 10-K**

**1.****                 ConsolidatedFinancial Statements.**

The followingconsolidated financial statements and supplementary data are included in Part II-Item 8filed as part of this report:

·       Reportof Independent Registered Public Accounting Firm

·       ConsolidatedBalance Sheets as of December 31, 2005 and 2004

·       ConsolidatedStatements of Operations for the years ended December 31, 2005, 2004 and2003

·       ConsolidatedStatements of Stockholders’ Equity for the years ended December 31, 2005,2004 and 2003

·       ConsolidatedStatements of Cash Flows for the years ended December 31, 2005, 2004 and2003

·       Notesto Consolidated Financial Statements

·       Quarterly FinancialInformation (unaudited)

**2.****                 FinancialStatement Schedule.**

·       ScheduleII—Valuation and Qualifying Accounts

Schedules notlisted above have been omitted because they are not applicable, not required orthe information required is shown in the consolidated financial statements orthe notes thereto.

**3.****                 Listof Exhibits.**

| ** Exhibit Number** | ** ** | **Description of Exhibit**                                                             |
|-------------------------------|------------|----------------------------------------------------------------------------------------|
| 3.1(1)                        |       | Amended and Restated Certificate of Incorporation of  the Registrant.                  |
| 3.2(1)                        |       | Amended and Restated By-Laws of the Registrant.                                        |
| 4.1(1)                        |       | Specimen Stock Certificate.                                                            |
| 10.1(1)+                      |       | Amended and Restated 1991 Stock Incentive Plan of  the Registrant.                     |
| 10.2(1)                       |       | Amended and Restated 1994 Non-Employee Director  Option Plan of the Registrant.        |
| 10.3(1)+                      |       | 1995 Employee Stock Purchase Plan of the Registrant.                                   |
| 10.4(9)                       |       | 2004 Stock Incentive Plan.                                                             |
| 10.15(1)                      |       | License Agreement dated January 2, 1995 between  the Registrant and Datapoint     |
|                          |       | Corporation.                                                                           |
| 10.16(1)                      |       | Letter Agreement dated December 31, 1994  between the Registrant and Fleet Bank   |
|                          |       | of Massachusetts, N.A.                                                                 |
| 10.19(3)+                     |       | Employment Agreement dated January 22, 1998  between the Registrant and           |
|                          |       | Khoa D. Nguyen.                                                                        |
| 10.20(4)                      |       | Asset Purchase Agreement dated as of  December 28, 2000 between the Registrant    |
|                          |       | and General Dynamics Government Systems Corporation,  as amended.                      |
| 10.21(a)(5)                   |       | Put Agreement dated as of March 27, 2001 (as  amended to date) by and between the |
|                          |       | Registrant and General Dynamics Government Systems  Corporation.                       |
| 10.21(b)(8)                   |       | Agreement and Release dated as of December 31,  2002 by and between the           |
|                          |       | Registrant and General Dynamics Government Systems  Corporation.                       |
| 10.22(6)+                     |       | 2001 Stock Incentive Plan of the Registrant.                                           |
| 10.23(7)                      |       | Asset Purchase Agreement dated as of August 1,  2002 between the Registrant and   |
|                          |       | Tandberg Telecom AS.                                                                   |

45

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| 10.24(7)  |   | License Agreement dated as of August 1, 2002  between the Registrant and            |
|-----------|--------|------------------------------------------------------------------------------------------|
|      |   | Telecom AS.                                                                              |
| 10.25(7)  |   | Promissory Note dated as of August 1, 2002 made  by the Registrant in favor         |
|      |   | Tandberg Telecom AS.                                                                     |
| 10.26(7)  |   | Security Agreement dated as of August 1, 2002  between the Registrant and Tandberg  |
|      |   | Telecom AS.                                                                              |
| 10.27(7)  |   | Ezenia! License Agreement dated as of  October 30, 2002 between the Registrant      |
|      |   | Tandberg Telecom AS.                                                                     |
| 10.28(10) |   | First Amended and Restated Software Distribution  License Agreement dated                |
|      |   | January 1, 2005 by and between Microsoft Corporation  and Ezenia! Inc.                   |
| 21.1      |   | Subsidiaries of the Registrant.                                                          |
| 23.1      |   | Consent of Brown & Brown, LLP.                                                  |
| 31.1      |   | Consent of the Company’s Chief Executive Officer and  Chief Financial Officer       |
|      |   | pursuant to 18 U.S.C. Section 1350, as adopted  pursuant to Section 302 of the |
|      |   | Sarbanes-Oxley Act of 2002.                                                              |
| 32.1      |   | Certification of the Company’s Chief Executive  Officer and Chief Financial Officer |
|      |   | pursuant to 18 U.S.C. Section 1350, as adopted  pursuant to Section 906 of the |
|      |   | Sarbanes-Oxley Act of 2002.                                                              |

 

Copies of any ofthese exhibits are available without charge upon written request to InvestorRelations, Ezenia! Inc., 14 Celina Avenue, Suite 17-18, Nashua, NH03063.

+                Managementcontract for compensatory plan or arrangement required to be filed as anexhibit to this report pursuant to Item 15(c) of this report.

(1)          Incorporated byreference from the Company’s Registration Statement on Form S-1.

(2)          Incorporated byreference from the Company’s Form 10-K filed with the Securities andExchange Commission for the year ended December 31, 1995.

(3)          Incorporated byreference from the Company’s Form 10-K filed with the Securities andExchange Commission for the year ended December 31, 1998.

(4)          Incorporated byreference from the Company’s Form 10-K filed with the Securities andExchange Commission for the year ended December 31, 2000.

(5)          Incorporated byreference from the Company’s Form 10-Q for the quarter ended September 30,2001.

(6)          Incorporated byreference from the Company’s Registration Statement on Form S-8filed with the Securities and Exchange Commission on December 21, 2001.

(7)          Incorporated byreference from the Company’s Form 10-Q for the quarter ended September 30,2002.

(8)          Incorporated byreference from the Company’s Form 10-K filed with the Securities andExchange Commission for the year ended December 31, 2002.

(9)          Incorporated byreference from the Company’s Form 10-K/A filed with the Securitiesand Exchange Commission for the year ended December 31, 2004.

(10)   Incorporatedby reference from the Company’s Form 10-Q for the quarter ended March 31,2005.

46

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**SIGNATURES**

Pursuant to the requirements of Section 13 or 15(d) ofthe Securities Exchange Act of 1934, the Registrant has duly caused this reportto be signed on its behalf by the undersigned, thereunto duly authorized.

|        | EZENIA! INC.                                        |
|--------|-----------------------------------------------------|
|   | /s/  KHOA D. NGUYEN                                 |
|   | Khoa D. Nguyen                                      |
|   | *Chairman,  Chief Executive Officer, President and* |
|   | *Chief  Financial Officer*                          |
|   | *(Principal  Financial and Accounting Officer,*     |
|   | *Authorized  Officer)*                              |
|   | *Date: March 31, 2006*                         |

 

Pursuant to therequirements of the Securities Exchange Act of 1934, this report has beensigned below by the following persons on behalf of the Registrant and in thecapacities and on the dates indicated.

|                          | **Signature** | ** **                                                                                                           | ** ** | ** **           | **Title** | ** ** | ** ** | ** ** | **Date** | ** ** |
|--------------------------|---------------|----------------------------------------------------------------------------------------------------------------------|------------|----------------------|-----------|------------|------------|------------|----------|------------|
| /s/ KHOA D.  NGUYEN      |          | Chairman, Chief  Executive Officer,                                                                                  |       | March 31,  2006 |
| Khoa  D. Nguyen          |          |    President and Chief Financial Officer (Principal  Financial and Accounting Officer, Authorized Officer) |       |                 |
| /s/ RONALD L.  BRELAND   |          | Director                                                                                                             |       | March 31,  2006 |
| Ronald  L. Breland       |          |                                                                                                                 |       |                 |
| /s/ GERALD P. CARMEN     |          | Director                                                                                                             |       | March 31,  2006 |
| Gerald  P. Carmen        |          |                                                                                                                 |       |                 |
| /s/ THOMAS G.  MCINERNEY |          | Director                                                                                                             |       | March 31,  2006 |
| Thomas  G. McInerney     |          |                                                                                                                 |       |                 |
| */*s/ JOHN A. MCMULLEN   |          | Director                                                                                                             |       | March 31,  2006 |
| John  A. McMullen        |          |                                                                                                                 |       |                 |
| */*s/ JOHN F. STEWART    |          | Director                                                                                                             |       | March 31,  2006 |
| John F. Stewart          |          |                                                                                                                 |       |                 |

 

 

47

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**EZENIA! INC.**

**SCHEDULEII—VALUATION AND QUALIFYING ACCOUNTS**

| **Column A—Description**           | ** ** | ** ** | ** ** | **Column B**                              | ** ** | **Column C - Additions**                   | ** ** | **Column D**                    | ** ** | **Column E**                                          | ** ** |
|----------------------------------------------|------------|------------|------------|------------------------------------------------|------------|-----------------------------------------------------------|------------|--------------------------------------|------------|------------------------------------------------------------|------------|
| **Accounts Receivable Allowances** | ** ** | ** ** | ** ** | **Balance At  Beginning Of  Period** | ** ** | **Charged  (Credited) to  Costs and  Expenses** | ** ** | **Charged to  Other  Accounts** | ** ** | **Deductions—  Uncollectible  Accounts  Written-off** | ** ** | **Balance at  End of  Period** | ** ** |
| Year Ended  December 31, 2005           |       |       | $          | 370,696                                        |       |                                                      |       | (50,000                              | )          |                                                       |       | 25,000 |   |   |   | (6,450 | ) |   | $ | 339,246 |   |
| Year Ended  December 31, 2004           |       |       | $          | 1,068,262                                      |       |                                                      |       | (110,000                             | )          |                                                       |       | — |   |   |   | (587,566 | ) |   | $ | 370,696 |   |
| Year Ended  December 31, 2003           |       |       | $          | 1,096,009                                      |       |                                                      |       | (50,000                              | )          |                                                       |       | 276,589 |   |   |   | (254,336 | ) |   | $ | 1,068,262 |   |
|                                              |            |            |            |                                                |            |                                                           |            |                                      |            |                                                            |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

48

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**Exhibit Index**

| ** **Exhibit Number | ** ** | **Description of Exhibit**                                                               |
|-------------------------------|------------|------------------------------------------------------------------------------------------|
| 3.1(1)                        |       | Amended and Restated Certificate of Incorporation of  the Registrant.                    |
| 3.2(1)                        |       | Amended and Restated By-Laws of the Registrant.                                          |
| 4.1(1)                        |       | Specimen Stock Certificate.                                                              |
| 10.1(1)+                      |       | Amended and Restated 1991 Stock Incentive Plan of  the Registrant.                       |
| 10.2(1)                       |       | Amended and Restated 1994 Non-Employee Director  Option Plan of the Registrant.          |
| 10.3(1)+                      |       | 1995 Employee Stock Purchase Plan of the Registrant.                                     |
| 10.4(9)                       |       | 2004 Stock Incentive Plan.                                                               |
| 10.15(1)                      |       | License Agreement dated January 2, 1995 between  the Registrant and Datapoint       |
|                          |       | Corporation.                                                                             |
| 10.16(1)                      |       | Letter Agreement dated December 31, 1994  between the Registrant and Fleet Bank     |
|                          |       | of Massachusetts, N.A.                                                                   |
| 10.19(3)+                     |       | Employment Agreement dated January 22, 1998  between the Registrant and             |
|                          |       | Khoa D. Nguyen.                                                                          |
| 10.20(4)                      |       | Asset Purchase Agreement dated as of  December 28, 2000 between the Registrant      |
|                          |       | and General Dynamics Government Systems Corporation,  as amended.                        |
| 10.21(a)(5)                   |       | Put Agreement dated as of March 27, 2001 (as  amended to date) by and between the   |
|                          |       | Registrant and General Dynamics Government Systems  Corporation.                         |
| 10.21(b)(8)                   |       | Agreement and Release dated as of December 31,  2002 by and between the             |
|                          |       | Registrant and General Dynamics Government Systems  Corporation.                         |
| 10.22(6)+                     |       | 2001 Stock Incentive Plan of the Registrant.                                             |
| 10.23(7)                      |       | Asset Purchase Agreement dated as of August 1,  2002 between the Registrant and     |
|                          |       | Tandberg Telecom AS.                                                                     |
| 10.24(7)                      |       | License Agreement dated as of August 1, 2002  between the Registrant and            |
|                          |       | Telecom AS.                                                                              |
| 10.25(7)                      |       | Promissory Note dated as of August 1, 2002 made  by the Registrant in favor         |
|                          |       | Tandberg Telecom AS.                                                                     |
| 10.26(7)                      |       | Security Agreement dated as of August 1, 2002  between the Registrant and Tandberg  |
|                          |       | Telecom AS.                                                                              |
| 10.27(7)                      |       | Ezenia! License Agreement dated as of  October 30, 2002 between the Registrant      |
|                          |       | Tandberg Telecom AS.                                                                     |
| 10.28(10)                     |       | First Amended and Restated Software Distribution  License Agreement dated                |
|                          |       | January 1, 2005 by and between Microsoft Corporation  and Ezenia! Inc.                   |
| 21.1                          |       | Subsidiaries of the Registrant.                                                          |
| 23.1                          |       | Consent of Brown & Brown, LLP.                                                  |
| 31.1                          |       | Consent of the Company’s Chief Executive Officer and  Chief Financial Officer       |
|                          |       | pursuant to 18 U.S.C. Section 1350, as adopted  pursuant to Section 302 of the |
|                          |       | Sarbanes-Oxley Act of 2002.                                                              |
| 32.1                          |       | Certification of the Company’s Chief Executive  Officer and Chief Financial 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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+                Managementcontract for compensatory plan or arrangement required to be filed as anexhibit to this report pursuant to Item 15(c) of this report.

(1)          Incorporatedby reference from the Company’s Registration Statement on Form S-1.

49

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(2)          Incorporatedby reference from the Company’s Form 10-K filed with the Securitiesand Exchange Commission for the year ended December 31, 1995.

(3)          Incorporatedby reference from the Company’s Form 10-K filed with the Securitiesand Exchange Commission for the year ended December 31, 1998.

(4)          Incorporatedby reference from the Company’s Form 10-K filed with the Securitiesand Exchange Commission for the year ended December 31, 2000.

(5)          Incorporatedby reference from the Company’s Form 10-Q for the quarter ended September 30,2001.

(6)          Incorporatedby reference from the Company’s Registration Statement on Form S-8filed with the Securities and Exchange Commission on December 21, 2001.

(7)          Incorporatedby reference from the Company’s Form 10-Q for the quarter ended September 30,2002.

(8)          Incorporatedby reference from the Company’s Form 10-K filed with the Securitiesand Exchange Commission for the year ended December 31, 2002.

(9)          Incorporatedby reference from the Company’s Form 10-K/A filed with theSecurities and Exchange Commission for the year ended December 31, 2004.

(10)   Incorporatedby reference from the Company’s Form 10-Q for the quarter endedMarch 31, 2005.

50

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