##### Table of Contents









SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549




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Form 10-K

FOR ANNUAL AND TRANSITION REPORTS

PURSUANT TO SECTIONS 13 OR 15(d) OF
THE


SECURITIES EXCHANGE ACT OF 1934


|  |  |                                                                                                 
|- |  | ------------------------------------------------------------------------------------------------
|þ |  | ANNUAL REPORT PURSUANT TO SECTION 13 OR
    15(d)
    OF THE SECURITIES EXCHANGE ACT OF 1934    
| 
|  |  | For the fiscal year ended December 31,
    2002                                                 
| 
|o |  | TRANSITION REPORT PURSUANT TO SECTION 13 OR
    15(d)
    OF THE SECURITIES EXCHANGE ACT OF 1934
|  |  | For the transition period
    from           to                                                 

Commission File Number 0-22190



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Verso Technologies, Inc.

(Exact Name of Registrant as Specified in Its
Charter)


|                                                                   |  |                                         
|------------------------------------------------------------------ |  | ----------------------------------------
|Minnesota                                                          |  | 41-1484525                              
|(State or Other Jurisdiction of
    Incorporation or Organization) |  | (I.R.S. Employer
    Identification No.)

400 Galleria Parkway

Suite 300


Atlanta, GA 30339


(Address of Principal Executive
Offices)


678-589-3750

(Registrants telephone number, including
area code)


Securities registered pursuant to
Section 12(b) of the Act: None

Securities registered pursuant to
Section 12(g) of the Act: common stock, $0.01 par value per
share

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

Indicate by check mark if disclosure of
delinquent filers pursuant to Item 405 of Regulation S-K is
not contained herein, and will not be contained, to the best of
registrants knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this
Form 10-K or any amendment to this
Form 10-K.     o

Indicate by check mark whether the registrant is
an accelerated filer (as defined in Exchange Act
Rule 12b-2).     Yes o          No þ

The aggregate market value of the voting and
non-voting common equity held by non-affiliates, computed at
$0.50 per share, as of the last business day of the
registrants most recently completed second fiscal quarter
(June 28, 2002), was $38,457,557.

As of March 31, 2003, 89,681,515 shares of
common stock of the registrant were outstanding.

DOCUMENTS INCORPORATED BY REFERENCE:

None.




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TABLE OF CONTENTS



|                                                 |                                                                                                         |  |  |  |  |  |  | 
|------------------------------------------------ | ------------------------------------------------------------------------------------------------------- |  |  |  |  |  |  | 
|PART I                                          
|Note Regarding Forward-Looking Statements       
|                                                 | Item 1. Business                                                                                       
|                                                 | Item 2. Properties                                                                                     
|                                                 | Item 3. Legal Proceedings                                                                              
|                                                 | Item 4. Submission of Matters to a Vote of Security Holders                                            
|                                                 | Item 4.5 Executive Officers of the Registrant                                                          
|PART II                                         
|                                                 | Item 5. Market for Registrants Common Equity and Related Stockholder Matters                          
|                                                 | Item 6. Selected Financial Data                                                                        
|                                                 | Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations          
|                                                 | Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure           
|PART III                                        
|                                                 | Item 10. Directors and Executive Officers of the Registrant                                            
|                                                 | Item 11. Executive Compensation                                                                        
|                                                 | Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
|Equity Compensation Plan Information            
|                                                 | Item 13. Certain Relationships and Related Transactions                                                
|                                                 | Item 14. Controls and Procedures                                                                       
|                                                 | PART IV                                                                                                
|                                                 | Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K                               
|SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS
|SIGNATURES                                      
|CERTIFICATION                                   
|CERTIFICATION                                   
|EX-4.45 FORM OF WARRANT                         
|EX-4.46 FORM OF REGISTRATION RIGHTS AGREEMENT   
|EX-10.10 AMENDMENT TO 1999 STOCK INCENTIVE PLAN 
|EX-10.65 SETTLEMENT AGREEMENT                   
|EX-10.66 ASSIGNMENT AND COLLECTION AGREEMENT    
|EX-10.67 CROSS-CORPORATE CONTINUING GUARANTY    
|EX-10.68 LEASE FOR 1221 WEST MINERAL AVENUE     
|EX-10.69 MOVABLE HYPOTHEC                       
|EX-10.70 MOVABLE HYPOTHEC                       
|EX-10.71 SETTLEMENT AGREEMENT AND FULL RELEASE  
|EX-10.72 ARBITRATION AWARD AGREEMENT            
|EX-10.73 ARBITRATION AWARD AGREEMENT            
|EX-10.74 CONSULTING AGREEMENT                   
|EX-10.75 CONSULTING AGREEMENT                   
|EX-10.76 AMENDMENT TO LOAN DOCUMENTS            
|EX-10.77 AMENDMENT TO LOAN DOCUMENTS            
|EX-21.1 SUBSIDIARIES OF THE REGISTRANT          
|EX-23.1 CONSENT OF KPMG LLP                     
|EX-99.1 SECTION 906 CERTIFICATION OF THE CEO    
|EX-99.2 SECTION 906 CERTIFICATION OF THE CFO    



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PART I




Note Regarding Forward-Looking
Statements

Certain statements contained in this Annual
Report on Form 10-K (this Annual Report),
including, without limitation, in the sections herein titled
Business and Managements Discussion and
Analysis of Financial Condition and Results of Operations,
or incorporated herein by reference, that are not statements of
historical facts are forward-looking statements
within the meaning of the Private Securities Litigation Reform
Act of 1995. The words believe, expect,
anticipate, intend, will and
similar expressions are examples of words that identify
forward-looking statements. Forward-looking statements include,
without limitation, statements regarding our future financial
position, business strategy and expected cost savings. These
forward-looking statements are based on our current beliefs, as
well as assumptions we have made based upon information
currently available to us.

Each forward-looking statement reflects our
current view of future events and is subject to risks,
uncertainties and other factors that could cause actual results
to differ materially from any results expressed or implied by
our forward-looking statements. Important factors that could
cause actual results to differ materially from the results
expressed or implied by any forward-looking statements include:
our ability to fund future growth; our ability to become
profitable; the volatility of the price of our common stock, par
value $0.01 per share (the Common Stock); the low
price of our Common Stock; the low trading volume for our Common
Stock; general economic conditions of the telecommunications
market; market demand for and market acceptance of our products;
legal claims against us; our ability to protect our intellectual
property rights; defects in our products; our current level of
indebtedness; new regulation and legislation; the effects of our
accounting policies and general changes in generally accepted
accounting practices; general economic and business conditions;
other risks and uncertainties included in the section of this
Annual Report titled Managements Discussion and
Analysis of Financial Condition and Results of
Operations  Risk Factors; and other factors
disclosed in our other filings made with the Securities and
Exchange Commission (the SEC).

All subsequent forward-looking statements
relating to the matters described in this Annual Report and
attributable to us or to persons acting on our behalf are
expressly qualified in their entirety by such factors. We have
no obligation to publicly update or revise these forward-looking
statements to reflect new information, future events, or
otherwise, except as required by applicable federal securities
laws, and we caution you not to place undue reliance on these
forward-looking statements.




Item 1.     Business

General

Verso Technologies, Inc., a Minnesota corporation
(herein referred to as the Company or
we), is a communications technology and solutions
provider for communications service providers and enterprises
seeking to implement application-based telephony services,
Internet usage management tools and outsourced customer support
services. Additionally, the Company provides a turn-key solution
for telecommunications carriers that wish to migrate from a
legacy circuit-based network to a next-generation, packet-based
network.

The Companys headquarters is located at 400
Galleria Parkway, Suite 300, Atlanta, Georgia 30339, and
the Companys telephone number at that location is
(678) 589-3500. The Company maintains a worldwide web
address at www.verso.com.

The Companys ongoing, strategic business
units consist of the Companys Carrier Solutions Group,
formerly known as the Gateway Solutions business, and the
Companys Enterprise Solutions Group, formerly known as the
Applications and Services business, which units are both
described below.

Carrier Solutions Group

During fiscal year 2002, the Companys
Carrier Solutions Group consisted of the operations of the
Companys switching subsidiary, NACT Telecommunications,
Inc. (NACT). NACT is a manufacturer of

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next-generation network gateways and public
switched telephone network (PSTN), Class 4
Tandem switches and telecommunication provisioning and billing
systems. NACTs complete Voice over Internet Protocol
(VoIP) migration solution includes state-of-the-art
hardware and software, operational support system
(OSS) integration, the industrys most widely
used applications, and expert training and technical support.


Beginning the first quarter of 2003, the
Companys Carrier Solutions Group will also include the
Companys softswitch operations which the Company acquired
on February 12, 2003, when it purchased substantially all
of the business assets, and assumed certain liabilities related
thereto, of Clarent Corporation (Clarent), a
provider of VoIP solutions for next generation networks and
convergent enterprise solutions (the Clarent Asset
Purchase). Pursuant to the Clarent Asset Purchase, the
Company acquired from Clarent its softswitch products, which
provide software-driven VoIP solutions for wholesale transport
and termination of voice traffic over global Internet protocol
(IP) networks, and its enterprise products, which
offer voice and data convergence solutions for businesses that
wish to integrate traffic over a variety of corporate wide area
network (WAN) infrastructures.

For the fiscal year ended December 31, 2002,
the Companys revenue from the Carrier Solutions Group was
$26.3 million, or 59%, of the Companys consolidated
revenue. Summarized financial information for the Companys
Carrier Solutions Group is set forth in Note 15 to the
Companys consolidated financial statements included
elsewhere in this Annual Report.

NACT Products
and Services

The Companys turn-key solutions provide an
integrated communications server, media gateway and applications
server that are bundled with Class 4 applications targeted
at service providers seeking a turn-key, pre-paid
telecommunications solution. The Companys pay as you
grow platform provides a complete, digital Class 4
switch capable of scaling from 48 ports per switch for small
emerging service providers up to 9600 ports per switch for more
established providers.

NACTs IPAX family of Class 4 Tandem
Digital Gateway Switches provides protocol support for T1, E1,
Integrated Services Digital Network, Signaling System 7
(SS7), C7 and VoIP. The IPAX and Pico IPAX switches
offer the same functionality but differ only in number of ports,
chassis size and, therefore, price. The IPAX product
functionality includes the most popular Class 4
applications such as long distance, toll-free and calling card
applications, providing comprehensive and feature rich
revenue-generating services over a low cost IP-based network
infrastructure.

The Companys provisioning and billing
platform supports multi-transport billing, allowing a
companys customer to receive one bill for all services,
regardless of whether such customers calls were
transported via the PSTN or over an IP-based network.
Additionally, the Company provides a graphical user interface to
support fast, efficient and intuitive provisioning of new
services and users over the web. The platform supports
comprehensive international functionality, including support for
95% of the worlds languages, simultaneous multiple
currencies and numbering plans. Finally, the platform may be
customized to support the customers unique billing and
reporting needs.

Clarent
Softswitch Products and Services

The Clarent PSTN Access Softswitch solution
provides a software-driven VoIP solution for wholesale transport
and termination of voice traffic over global IP networks.
Additionally, the Clarent PSTN Access Softswitch solution can
also support retail pre-paid and post-paid calling card
applications and minutes exchange (IP clearing house) across
hundreds of IP networks around the world. At the core, the
Clarent PSTN Access Softswitch solution consists of the Clarent
Command Center, the Clarent Class 4 Call Manager software,
the Clarent Element Management Systems and Clarent media
gateways. For advanced functionality, other elements may be
added, including connectivity to SS7 networks and partner IP
networks. Service providers who have deployed the Clarent PSTN
Access Softswitch solution can leverage the common underlying
platform to integrate with the Clarent Edge Access Softswitch
for the delivery of managed services for the enterprise ranging
from simple hosted network services for WAN trunking to
converged voice and data

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services and dialing plan uniformity across
dispersed enterprise sites. The Clarent Edge Access Softswitch
also supports primary or secondary line voice services to
residential customers over existing broadband connections and
can enable remote office participation in corporate networks.


Enterprise Solutions Group

During fiscal year 2002, the Companys
Enterprise Solutions Group consisted of the operations of the
Companys customer response center services as well as the
operations of the Companys Telemate.Net Software, Inc.
(Telemate.Net) subsidiary, which the Company
acquired in a merger transaction in November 2001. For the year
ended December 31, 2002, revenue from the Companys
Enterprise Solutions Group was $18.5 million, or 41%, of
the Companys consolidated revenue. Summarized financial
information for the Companys Enterprise Solutions Group is
set forth in Note 15 to the Companys consolidated
financial statements included elsewhere in this Annual Report.
Beginning in the first quarter of 2003, the Companys
Enterprise Solutions Group will also include the operations from
Clarents enterprise group.

Customer
Response Center Services

The Companys support team delivers
technical customer response center services for a
customers network engineers, operational support team and
end-users. Based on the customers specific business goals,
the Companys flexible and cost-effective programs can be
designed to support a variety of technical needs, from
short-term system or software upgrades to long-term outsourcing
and ongoing product support. The Companys support team
receives and responds to technical inquiries so that the
Companys customers have more time to focus on their day to
day businesses and on the satisfaction of their own customers.

The Companys technical support services
include 7 x 24 help desk outsourcing, Tier I, II and III
product support, in-sourcing, on-site deployment services,
hardware and software training, and project management resources.

Call
Accounting Solution and IP-based Usage Management

The Companys Telemate.Net subsidiary
provides telephone usage reporting that allows businesses to
improve productivity, optimize trunk resources, prevent
telephone call abuse, and allocate and recover
telecommunications costs. The Call Accounting Solution offered
by Telemate.Net collects call detail information from Private
Branch Exchanges (PBX) and formats that information
into reports.

The Companys Telemate.Net subsidiary also
offers products that provide complete Internet access
management, combining uniform resource locator filtering with
comprehensive reporting. These products enable entities such as
corporations, school systems, and government agencies, to
enforce compliance with their Internet usage policies, manage
and plan Internet bandwidth usage, and promote productive and
effective use of the Internet by users of their networks. The
Internet access management line of products consists of the
NetSpective Reporter and WebFilter.

Clarent
Enterprise Solutions

Clarent NetPerformer integrates voice and data
capabilities into a single unified platform for businesses
seeking to lower communications costs by using compressed voice
and data over efficient packetized networks. The Clarent
NetPerformer product family models provide telephony interfaces
in densities that accommodate enterprise sizes from large
headquarter installations to small, remote offices. Clarent
NetPerformer can converge voice and data over leased or switched
lines, frame relay, Asynchronous Transfer Mode, Integrated
Services Digital Network, satellite, and IP/Ethernet circuits.
The NetPerformer product line creates a unified network that
interconnects distributed offices with disparate technologies,
as well as allows users access to applications such as global
voicemail, unified messaging, instant teleconferencing and
data-empowered platforms that only IP can provide.

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Customers

For fiscal year 2002, the Companys primary
base of customers consisted of emerging domestic and
international long-distance providers, particularly those
service providers seeking to implement a turn-key, pre-paid
solution. These customers are buyers of NACTs family of
IPAX Class 4 Tandem switches and telecommunications
provisioning and billing systems. To date, the Company has
installed over 500 of NACTs intelligent gateways for more
than 400 customers.

Currently, the Company services over 21,000
end-users through the Companys customer response center
services. The Companys largest client of these services is
Six Continents PLC, which has been a customer of the Company
since 1992.

Through the Companys Telemate.Net
subsidiary, the Company has recorded to date more than 14,000
installations of its call accounting and IP-based usage
management solutions whereby approximately 4,000 customers are
using Telemate.Net software to manage communications cost and
network efficiency. Typical end-user customers of the
Companys Telemate.Net solutions are domestic commercial
enterprises or government agencies with 100 to 10,000 employees.

The assets and associated business purchased by
the Company pursuant to the Clarent Asset Purchase are expected
to attract additional customers to the Company in fiscal year
2003, including service providers, system integrators, resellers
and enterprises seeking to implement a converged communications
solution. The Clarent customer base has historically been
primarily international customers and has included traditional
local international and wholesale long distance
telecommunications companies, as well as next-generation service
providers, including Internet Service Providers
(ISPs), Application Service Providers
(ASPs), web-to-phone providers and others employing
Internet-based business models.

For the years ended December 31, 2002, and
December 31, 2001, Six Continents PLC and Telco Group, Inc.
were the Companys only customers that accounted for more
than 10% of the Companys consolidated revenue. The revenue
from Six Continents PLC represented approximately 15% and 24% of
the Companys consolidated revenues for the years ended
December 31, 2002, and December 31, 2001,
respectively. The revenue from Telco Group, Inc. represented
approximately 12% and 10% of the Companys consolidated
revenue for the years ended December 31, 2002, and
December 31, 2001, respectively.

Sales and Marketing

The Companys marketing organization is
responsible for building brand awareness, identifying key
markets, and developing innovative products and services to meet
the evolving demands of the marketplace. Another objective of
the marketing effort is to stimulate the demand for services
through a broad range of marketing communications and public
relations activities. Primary communication vehicles include
advertising, tradeshows, direct response programs, event
sponsorship and websites.

The Company seeks to achieve broader market
penetration of its solutions in primarily three ways: expanding
international distribution; pursuing new markets and customers,
including ISPs, IP telephony service providers and pre-paid
service bureaus; and selling new, next-generation communication
solutions to its current base of customers. Historically, sales
of Clarent products and services have primarily been sold
through distributors, and the Company expects this trend to
continue. During fiscal year 2002, the Company sold its services
primarily through a direct sales force of 22 individuals located
in Provo, Utah, Atlanta, Georgia and the United Kingdom and, as
a result of the Clarent Asset Purchase on February 12,
2003, added 15 people to its direct sales force located in the
United States, the United Kingdom, France, Italy and Dubai.

Competition

Carrier
Solutions Group

The market for application-based telephony
services is intensely competitive, subject to rapid
technological change and significantly affected by new product
introductions and market entrants. In the market for the
Companys gateway solutions, the Companys primary
sources of competition include Class 4 solution

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providers, vendors of networking and
telecommunications equipment, and telephony applications
companies that bundle their offering with third-party equipment.
Some competitors, especially networking and telecommunications
equipment vendors, such as Lucent Technologies Inc., Cisco
Systems, Inc. and Nortel Networks Ltd., have significantly
greater financial resources and broader customer relationships
than does the Company. Other public companies, such as Tekelec
and Sonus Networks, Inc., are focusing on market opportunities
similar to the Companys, as are a number of smaller,
private companies, including Nuera Communications, Inc.,
Voiceware Systems Corporation and iSoftel Ltd. The Company does
not expect the competition facing it to change substantially
with the acquisition of Clarents softswitch products.


Enterprise
Solutions Group

In the market for the Companys call
accounting solutions, the Company competes with a number of
similar-sized companies, such as IntegraTrak, MicroTel
International, Inc., and Veramark Technologies, Inc., that
provide enterprise communication network usage accounting and
billing. In the market for Internet usage reporting and access
management, the Company competes with providers of Internet
filtering software, such as WebTrends Corporation, Elron
Electronic Industries, Inc., SurfControl PLC, Websense, Inc.,
Symantec Corporation and Secure Computing Corporation.

The Companys customer response center
services compete with those of companies that provide
integrated, multi-channel customer contact centers, including
APAC Customer Services, Inc., ClientLogic Corporation, Convergys
Corporation and SITEL Corporation. The Company also faces
competition from a customers own in-house information
technology staff.

The Companys Clarent enterprise products
compete with a number of communications solutions providers
including Cisco Systems, Inc., Nortel Networks, Ltd., Motorola
Inc., Alcatel and Hughes Electronics Corporation.

Intellectual Property Rights

The Company regards its copyrights, trade secrets
and other intellectual property as critical to its success.
Unauthorized use of the Companys intellectual property by
third parties may damage its brand and its reputation. The
Company relies on trademark and copyright law, trade secret
protection, and confidentiality, license and other agreements
with its employees, customers, partners and others to protect
its intellectual property rights. Despite precautions, it may be
possible for third parties to obtain and use the Companys
intellectual property without the Companys authorization.
Furthermore, the validity, enforceability and scope of
protection of intellectual property in Internet-related
industries is still evolving. The laws of some foreign countries
do not protect intellectual property to the same extent as do
the laws of the United States.

The Company cannot be certain that its services
and the finished products that it delivers do not or will not
infringe valid patents, copyrights, trademarks or other
intellectual property rights held by third parties. The Company
may be subject to legal proceedings and claims from time to time
relating to the Companys intellectual property other than
in the ordinary course of business. Successful infringement
claims against the Company may result in substantial monetary
liability or may materially disrupt the conduct of the
Companys business.

On September 18, 2001, U.S. Patent
No. 6,292,801 was issued to Telemate.Net. The patent covers
technology developed by Telemate.Net for tracking PBX, VoIP and
IP traffic from a variety of network sources and correlating
communications activity with database user accounts. The
patented techniques are employed in several of
Telemate.Nets products, including Telemate.Nets call
accounting and NetSpective Internet access management solutions.
This technology allows users to combine statistics from diverse
network sources to create cohesive network information and
reporting. This unique technology for aggregating and
correlating network data from different vendors and device types
has application to the VoIP softswitch, OSS and billing markets.
The patented processes allow the Companys OSS software to
gather billing, reporting and maintenance from a variety of data
sources and vendors products, in addition to its own.

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On February 12, 2003, pursuant to the
Clarent Asset Purchase, the Company acquired U.S. Patent
Nos. 6,167,060 and 6,477,164, which were issued to Clarent
on December 26, 2000 and November 5, 2002,
respectively. The patents cover technology developed by Clarent
for real-time voice and data transmissions over an Internet
network and a dynamic error correction algorithm for Internet
telephones.

The Company also has several patent applications
pending relating to its VoIP product and to certain products the
Company acquired from Clarent pursuant to the Clarent Asset
Purchase.

Research and Development

The Companys research and development
expenses in 2002 were primarily related to the research and
development initiatives associated with the development of
NACTs VoIP migration solution as well as for the initial
development of a pre-paid wireless solution. Additionally, the
Company invested in additional unique feature functionality for
the Telemate.Net Webfilter product. These expenses totaled
$5.9 million for the year ended December 31, 2002. The
Company expects that further research and development expenses
will relate to subsequent product enhancements, the development
of additional features and functionality, and research and
development associated with the newly-purchased Clarent products.

Employees

As of March 15, 2003, the Company had 382
employees, 172 of whom are located at the Companys
headquarters in Atlanta, Georgia, 102 of whom are located at the
Companys NACT subsidiary in Provo, Utah, 47 of whom are
located at the Companys Clarent operations in Littleton,
Colorado, and 49 of whom are located at the Companys
Clarent operations in Montreal, Canada, and 12 international
Clarent sales support individuals located in France, Belgium,
India, Italy, Germany and the United Kingdom.

Background

The Company was incorporated in Minnesota on
March 20, 1984. Until 2001, the Company historically
operated a value-added reseller (VAR) business and
an associated network performance management consulting and
integration practice. The Company also operated a Hospitality
Services Group (HSG), which provided technology
solutions to lodging, restaurant, and energy management
customers. Over the years, the Company has moved away from these
lines of business and now focuses on providing the products and
services offered by its Carrier Solutions Group and its
Enterprise Solutions Group. During the last five years, the
Companys business developed as described below.

In 1997, the Company made five acquisitions,
adding service offerings in the data communications business.
Also during 1997, the Company began focusing its efforts on its
end-user network systems business, as well as on its entry into
the network monitoring and management business.

In 1998, the Company acquired Encore Systems,
Inc., Global Systems and Support, Inc. and Five Star Systems,
Inc. (collectively, the Encore Group). At the time
of such acquisition, the Encore Group provided software and
technology services to the hospitality industry, including
industry leading customer response center services. The customer
response center services remain part of the Companys
ongoing business.

In 1999, the Company merged with Sulcus
Hospitality Technologies Corp. (Sulcus). Sulcus
developed, manufactured, marketed and installed computerized
systems primarily intended to automate hospitality industry
property management systems and the Squirrel point-of-sale
system for the restaurant industry. Also in 1999, the Company
merged with Windward Technology Group, Inc.
(Windward). Windward focused on providing networking
and network management services to the application development
market.

Early in 2000, the Companys Board of
Directors (the Board) decided to explore the sale of
all or a portion of the Companys HSG, which consisted of
the Companys lodging business, its restaurant solutions
business and its energy management business. Subsequently, the
operations of HSG were classified as discontinued operations,
and each of the operating units of HSG was sold between late
2000 and early 2001. The sale of these operating units included
all of the operations of Sulcus and the Encore Group, with the
exception of the Companys customer response center
services.

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In September 2000, the Company acquired Cereus
Technology Partners, Inc. (Cereus) in a merger
transaction. Cereus provided end-to-end e-business and B2B
technology solutions, including ebusiness strategy, network
consulting and hosting and application integration. In
connection with the acquisition of Cereus, the Company changed
its name to Verso Technologies, Inc. and put in
place the Companys current executive management team and
all but one of the directors currently serving on the Board.

In November 2000, the Company acquired
MessageClick, Inc. (MessageClick) in a merger
transaction. The acquisition of MessageClick provided the
Company with a propriety unified communications application
delivered as an ASP. In the second quarter of 2001, the Company
decided to discontinue offering its MessageClick application and
to refocus the development of the MessageClick application to be
offered as a licensed software product. The Company has since
focused its overall strategy on pursuing the market for next
generation communications and, therefore, the development of the
MessageClick application as a licensed product is currently
dormant.

The Companys acquisition of NACT in July
2001 was the Companys first significant investment in the
area of next generation communications. The acquisition of NACT
and its portfolio of products and services allowed the Company
to begin to offer proprietary, integrated switching solutions
for communications service providers seeking turn-key, pre-paid
telecommunications solutions. The acquisition of NACT was funded
by a $15 million investment by Telemate.Net, as
contemplated by the Companys merger agreement with
Telemate.Net.

On November 16, 2001, the Company acquired
Telemate.Net in a merger transaction, pursuant to which
Telemate.Net became a wholly-owned subsidiary of the Company.
Telemate.Net develops proprietary Internet access, voice and IP
network usage management, and intelligence applications that
enable businesses to monitor, analyze, and manage the use of
their internal network resources. As a result of the acquisition
of Telemate.Net, the Company added next generation applications
and application development competencies to the Companys
solutions portfolio.

During the quarter ended December 31, 2001,
and in keeping with the Companys focus on providing next
generation communications solutions, the Company determined that
its VAR business and associated network performance management
consulting and integration practice were not strategic to the
Companys ongoing objectives and, therefore, decided to
discontinue capital and human resource investment in these
businesses. Accordingly, the Company elected to report its VAR
and associated consulting and integration operations as
discontinued operations by early adoption of Statement of
Financial Accounting Standards (SFAS) No. 144,
Accounting for the Impairment or Disposal of Long-Lived
Assets (SFAS No. 144), which is intended
to allow a company to more clearly communicate a change in its
business that results from a decision to dispose of
non-strategic operations.

On October 1, 2002, the Company purchased a
51% interest in Shanghai BeTrue Infotech Co., Ltd.
(BeTrue) for $100,000; $50,000 paid at closing,
$25,000 paid on December 30, 2002, and $25,000 paid on
March 30, 2003. Upon closing the transaction, the Company
also contributed to the joint venture certain next-generation
communication equipment and software valued at approximately
$236,000 and $50,000 cash. Additionally, the Company contributed
$25,000 on December 30, 2002 and March 30, 2003. The
remaining 49% interest in BeTrue is owned by Shanghai Tangsheng
Investments & Development Co. Ltd. (Shanghai
Tangsheng). BeTrue provides VoIP and satellite network
solutions, including systems integration, project
implementation, technical support, consulting and training to
leading telecommunications companies in China and the
Asia-Pacific region. The Company plans to leverage BeTrues
sales channels and support infrastructure capabilities,
including pre- and post- sales support. Due to shared
decision-making between the Company and Shanghai Tangsheng, the
results for BeTrue will be recorded as an equity investment
rather than consolidated in the Companys results.

On February 12, 2003, the Company
consummated the Clarent Asset Purchase for a purchase price of
$9.8 million in notes. The assets purchased from Clarent
pursuant to the Clarent Asset Purchase include the following key
products: next generation switching and call control software;
high density media gateways; multi-service access devices,
signaling and announcement servers; network management systems;
and high demand telephony applications based on packet-switched
technology.

7



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Item
2.     Properties

The Company is headquartered in Atlanta, Georgia,
where the Company currently leases 45,000 square feet of space,
which is used for the Companys corporate offices and
certain components of the Companys Enterprise Solutions
Group, including the Telemate.Net operations and the
Companys customer response center services operations. The
Company is obligated to pay rent on this space of approximately
$110,000 per month, plus a share of operating expenses, through
February 2010. Additionally, the Company is also obligated
through February 2010 to pay rent of $29,000 per month with
respect to an additional 13,000 square feet of space at the
Atlanta facility, the cost of which is included in discontinued
operations. The Company is actively pursuing a sublease on the
additional space.

The Company also leases approximately 40,000
square feet of office space in Provo, Utah, which is used for
the Companys NACT operations, a component of the
Companys Carrier Solutions Group. Pursuant to the lease,
the Company is obligated to pay rent of approximately $46,000
per month through December 2009.

In connection with the Clarent Asset Purchase,
the Company assumed two leases for real property located in
Quebec, Canada. Pursuant to the first lease, the Company leases
approximately 18,000 square feet of office and laboratory space
for software research and development purposes related to the
Companys Clarent enterprise solutions, a component of the
Companys Enterprise Solutions Group. The Company is
obligated to pay rent of approximately $22,000 per month through
October 2003 and approximately $10,400 per month from November
2003 through the termination of the lease in October 2006.
Subsequent to the Clarent Asset Purchase, the Company assigned
the second lease to Clarent Canada Ltd., a wholly-owned
subsidiary of the Company which the Company acquired in the
Clarent Asset Purchase (Clarent Canada). Pursuant to
the second lease, Clarent Canada leases approximately 10,000
square feet of office, warehouse and storage space for
commercial and manufacturing purposes also related to the
Companys Clarent enterprise solutions. Clarent Canada is
obligated to pay $2,900 per month, plus a share of operating
expenses, until the lease terminates in May 2007.

In connection with the Clarent Asset Purchase,
the Company entered into a lease for 23,000 square feet of space
in Littleton, Colorado, which space is used for office space and
research and development activities related to the
Companys Clarent softswitch products and services, a
component of the Companys Carrier Solutions Group.
Pursuant to this lease, the Company is obligated to pay rent of
approximately $31,000 per month, plus a share of operating
expenses, until the lease terminates in January 2006.

The Company is also obligated on leases in a
number of other locations in North America through 2004, which
are included in its discontinued operations. The Company has
either subleased or is actively attempting to sublease these
locations.

The Company believes that its leased facilities
are adequate to meet its current needs and that additional
facilities are available to the Company to meet its expansion
needs for the foreseeable future.




Item 3.     Legal
Proceedings

From time to time, the Company is involved in
litigation with customers, vendors, suppliers and others in the
ordinary course of business, and a number of such claims may
exist at any given time. All such existing proceedings, taken
together, are not expected to have a material adverse impact on
the Companys results of operations or financial condition.

In addition, certain proceedings against the
Company have been resolved as discussed below.

On or about February 8, 2002, William P.
OReilly, a former executive officer and director of the
Company; Montana Corporation, Mr. OReillys
consulting company; Clunet R. Lewis, a former officer of the
Company; and CLR Enterprises, Inc., Mr. Lewis
consulting company, filed with the American Arbitration
Association (AAA) a demand for arbitration against
the Company. Messrs. OReilly and Lewis and their
respective consulting companies sought to have enforced the
Consulting Agreements dated April 1, 1999, as amended, to
which they and the Company are parties (together, the
Consulting Agreements). Messrs. OReilly
and Lewis claimed that the Companys attempt by written
notice dated June 1, 2001, to

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terminate the Consulting Agreements effective
March 31, 2002, was ineffective and, as a result, such
Consulting Agreements automatically renewed for additional
two-year terms, which terms expire on March 31, 2004. Under
the terms of the Consulting Agreements,
Messrs. OReilly and Lewis are to receive, among other
things, consulting fees of $250,000 and $240,000 per year,
respectively. The Company denied their claims, and the matter
was presented to an AAA arbitrator in a hearing held on
December 10, 2002. While the matter remained pending before
the arbitrator for decision, the parties settled the claims
presented in the arbitration proceeding pursuant to that certain
Arbitration Award Agreement, dated as of February 3, 2003,
between Mr. OReilly, Montana Corporation and the
Company and that certain Arbitration Award Agreement, dated as
of February 3, 2003, between Mr. Lewis, CLR
Enterprises, Inc. and the Company (together, the
Arbitration Award Agreements). Pursuant to the
Arbitration Award Agreements, (i) on February 4, 2003,
the Company issued to each of Mr. OReilly and
Mr. Lewis 275,000 shares of restricted Common Stock; and
(ii) on March 14, 2003, the Company entered into
thirty-month consulting agreements with each of
Mr. OReilly and Mr. Lewis (together, the
New Consulting Agreements). During the terms of the
New Consulting Agreements, the Company shall pay to
Mr. OReilly and Mr. Lewis an aggregate of
approximately $173,000 and $160,000, respectively, in three
installment payments due on January 21, 2004,
January 21, 2005, and January 21, 2006, payable
entirely in shares of restricted Common Stock, valued at the
average closing price per share of the Common Stock for a period
of twenty trading days prior to the date the installment
payments are due. The Arbitration Award Agreements provide that
the consideration set forth therein and in the New Consulting
Agreements shall be full satisfaction of any and all amounts the
AAA arbitrator may award. On March 14, 2003, the AAA
arbitrator awarded $250,000 and $240,000 to
Mr. OReilly and Mr. Lewis, respectively, plus
$22,000 in attorneys fees and expenses.


On or about April 29, 2002, Omni Systems of
Georgia, Inc. (Omni) and Joseph T. Dyer
(Dyer) filed with the AAA a demand for arbitration
against the Company and Eltrax International, Inc., a
wholly-owned subsidiary of the Company (Eltrax
International). Omni and Dyer claimed that the Company and
Eltrax International breached that certain Assignment dated as
of August 31, 1998, among Eltrax International, Dyer and
Omni, which was executed in connection with the Companys
acquisition of the Encore Group (the Assignment).
Pursuant to the Assignment, Omni and Dyer assigned and
transferred to Eltrax International all of their right, title
and interest in and to a certain computer software property
management system in exchange for a one-time payment. The
Assignment also provided for an earn-out component of the
acquisition consisting of certain contingent monthly payments
equal to a percentage of the maintenance and licensing net
revenues received by Eltrax International with respect to a
certain contract. Omni and Dyer claimed that the Company and
Eltrax International had not paid to Omni and Dyer the
contingent monthly payments owned to them pursuant to the
Assignment beginning in June 2002. Omni and Dyer sought recovery
of over $400,000 for contingent monthly payments alledgedly
owned for the period from May 15, 2002 through January
2003, plus payments in like amounts going forward, together with
interest thereon, attorneys fees and expenses. In January
2003, the matter was heard for six days by a three-arbitrator
panel of the AAA. On April 1, 2003, the Company received
notice that the AAA panel awarded to Omni and Dyer
(i) payments and interest thereon with respect to the
Assignment in the aggregate amount of approximately $506,000;
and (ii) attorneys fee and expenses, excluding
expenses of the AAA, in the aggregate amount of approximately
$199,000 (net of attorneys fees and expenses awarded to
the Company), which amounts are to be paid by Eltrax
International (and not the Company) no later than April 30,
2003. Additionally, the AAA panel determined that Eltrax
International (and not the Company) will be liable for future
payments as they become due in accordance with the terms of the
Assignment.

On or about May 21, 2001, John M. Good, a
former employee of the Company, filed a lawsuit in the Court of
Common Pleas, Cuyahoga County, Ohio, against the Company
claiming, among other things, fraud, negligence, securities
fraud, breach of contract, conversion and damages resulting from
and related to the Companys alleged failure to deliver, on
or about January 3, 2000, 50,000 shares of Common Stock to
Mr. Good upon his exercise of an option to purchase such
shares. The matter was set for jury trial on February 17,
2003. Based upon the Companys anticipated exposure and the
expected cost of litigation, on January 16, 2003, the
Company and Mr. Good reached an agreement to settle all
claims against the Company, which settlement had no material
impact on the Companys consolidated financial statements
included elsewhere in this Annual Report.

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Item
4.     Submission of Matters to a
Vote of Security Holders

The Annual Meeting of Shareholders of the Company
was held on December 5, 2002, in Atlanta, Georgia (the
Meeting). At the Meeting, the shareholders of the
Company voted on a proposal to elect a Board of eight directors
to serve until the Companys next annual meeting of
shareholders and until their successors are elected and
qualified. The results of such vote were as follows:

|                      |  |     |            |                    |  |  |           | 
|--------------------- |  | --- | ---------- | ------------------ |  |  | --------- | 
|Director Nominee      |  | For |            | Withheld Authority
|                      |  |     |            |                   
|Murali Anantharaman   |  |     | 70,029,563 |                    |  |  | 1,225,532 | 
|Gary H. Heck          |  |     | 70,029,578 |                    |  |  | 1,225,517 | 
|James M. Logsdon      |  |     | 69,623,539 |                    |  |  | 1,631,556 | 
|Amy L. Newmark        |  |     | 69,872,063 |                    |  |  | 1,383,032 | 
|Steven A. Odom        |  |     | 69,479,991 |                    |  |  | 1,775,104 | 
|Stephen E. Raville    |  |     | 69,789,654 |                    |  |  | 1,465,441 | 
|Juliet M. Reising     |  |     | 69,480,743 |                    |  |  | 1,774,352 | 
|Joseph R. Wright, Jr. |  |     | 70,029,578 |                    |  |  | 1,225,517 | 

There were no abstentions or broker non-votes
with respect to the election of any of the director nominees
listed above.

The foregoing proposal was set forth and
described in the Notice of Annual Meeting of Shareholders and
Proxy Statement of the Company dated November 7, 2002.




Item
4.5     Executive Officers of the
Registrant

Pursuant to General Instruction G(3) of
Form 10-K under the Securities Exchange Act of 1934, as
amended (the Exchange Act), the information
regarding the Companys executive officers required by
Item 401 of Regulation S-K is hereby included in
Part I of this Annual Report.

The following table sets forth the name of each
executive officer of the Company, the office held by such
officer and the age, as of March 15, 2003, of such officer:

|                  |  |     |    |          |  |                                                                               
|----------------- |  | --- | -- | -------- |  | ------------------------------------------------------------------------------
|Name              |  | Age |    | Position
|                  |  |     |    |         
|Steven A. Odom    |  |     | 49 |          |  | Chairman of the Board and Chief Executive Officer                             
|James M. Logsdon  |  |     | 56 |          |  | President and Chief Operating Officer                                         
|Juliet M. Reising |  |     | 52 |          |  | Executive Vice President, Chief Financial
    Officer, Secretary and Treasurer

Certain additional information concerning the
individuals named above is set forth below:

Steven A. Odom,age 49, has served as the Chief Executive Officer and a
director of the Company since September 2000 and as the Chairman
of the Board since December 2000. From January 2000 to September
2000, Mr. Odom served as the Chairman of the Board and the
Chief Executive Officer of Cereus. From 1994 until June 1998,
Mr. Odom served as Chairman of the Board and Chief
Executive Officer of World Access, Inc., a provider of voice,
data and Internet products and services around the world
(World Access). Mr. Odom served as Chairman of
World Access from June 1998 until June 1999. He served as Chief
Executive Officer of World Access from 1994 until 1998. From
1990 until 1994, Mr. Odom was a private investor in several
companies, including World Access and its predecessor. From 1987
until 1990, he served as President of the PCS Division of
Executone Information Systems in Atlanta, Georgia, a public
company that manufactured and distributed telephone systems.
From 1983 until 1987, Mr. Odom was the founder, Chairman
and Chief Executive Officer of Data Contract Company, Inc., a
manufacturer of telephone switching equipment and intelligent
pay telephones. From 1974 until 1983, he served as the Executive
Vice President of Instrument Repair Service, a private company
co-founded by Mr. Odom in 1974 that repaired test
instruments for local exchange carriers.

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James M. Logsdon,age 56, has served as President, Chief Operating Officer
and a director of the Company since September 2000. From January
2000 to September 2000, Mr. Logsdon also served as
President, Chief Operating Officer and a director of Cereus.
From January 1998 to January 2000, Mr. Logsdon served as
Vice President and General Manager of Branch
Operations  East for the Network Services division of
GTE Corporation, a global telecommunications company. From
January 1991 to December 1997, he served as GTEs Vice
President, Sales & Marketing  Commercial Markets.

Juliet M. Reising,age 52, has served as Executive Vice President, Chief Financial
Officer, Secretary, Treasurer and a director of the Company
since September 2000. Ms. Reising also served as the
Executive Vice President, Chief Financial Officer and a director
of Cereus from March 2000 to September 2000. From February 1999
to March 2000, Ms. Reising served as Chief Financial
Officer of MindSpring Enterprises, Inc., an Internet service
provider that merged with EarthLink, Inc. in February 2000. From
September 1998 to February 1999, Ms. Reising served as
Chief Financial Officer of AvData, Inc., a network management
services company acquired by ITC DeltaCom, Inc. in 1999. From
September 1997 to September 1998, Ms. Reising served as
Vice President and Chief Financial Officer for Composit
Communications International, Inc., an international software
development company. From August 1995 to September 1997,
Ms. Reising served as Vice President and Chief Financial
Officer of InterServ Services Corporation, which was merged with
Aegis Communications, Inc. in 1997. Ms. Reising started her
career with Ernst & Young LLP in Atlanta, Georgia, where she
received her certified public accountant license.

There are no family relationships among any of
the executive officers or directors of the Company. Except as
disclosed in the applicable employment agreements discussed in
the section of this Annual Report titled Executive
Compensation  Employment Agreements, no
arrangement or understanding exists between any executive
officer and any other person pursuant to which any executive
officer was selected to serve as an executive officer. To the
best of the Companys knowledge, (i) there are no
material proceedings to which any executive officer of the
Company is a party, or has a material interest, adverse to the
Company; and (ii) there have been no events under any
bankruptcy act, no criminal proceedings and no judgments or
injunctions that are material to the evaluation of the ability
or integrity of any executive officer during the past five
years. Executive officers of the Company are elected or
appointed by the Board and hold office until their successors
are elected and qualified, or until their death, resignation or
removal, subject to the terms of applicable employment
agreements.




PART II




Item 5.     Market
for Registrants Common Equity and Related Stockholder
Matters

The Common Stock is currently traded on the
Nasdaq SmallCap Market under the symbol VRSO. Prior
to September 13, 2002, the Common Stock was traded on the
Nasdaq National Market under the same symbol, and from
February 17, 2000 to October 1, 2000, the Common Stock
was traded on the Nasdaq National Market under the symbol
ELTX. Prior to February 17, 2000, the Common
Stock was traded on the Nasdaq SmallCap Market under the same
symbol. The following table sets forth the quarterly high and
low bid prices for the Common Stock for the periods indicated
below, as reported by the Nasdaq Stock

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Market. The stock prices set forth below do not
include adjustments for retail mark-ups, markdowns or
commissions, and represent inter-dealer prices and do not
necessarily represent actual transactions.


|                              |                |      |   |       |  |  |   |       | 
|----------------------------- | -------------- | ---- | - | ----- |  |  | - | ----- | 
|                              |                | High |   | Low  
|                              |                |      |   |      
|Year ended December 31, 2002: |                |      |   |       |  |  |   |      
|                              | First Quarter  |      | $ | 1.830 |  |  | $ | 0.970 | 
|                              | Second Quarter |      |   | 1.210 |  |  |   | 0.440 | 
|                              | Third Quarter  |      |   | 0.600 |  |  |   | 0.250 | 
|                              | Fourth Quarter |      |   | 0.760 |  |  |   | 0.220 | 
|Year ended December 31, 2001: |                |      |   |       |  |  |   |      
|                              | First Quarter  |      | $ | 2.250 |  |  | $ | 0.688 | 
|                              | Second Quarter |      |   | 1.690 |  |  |   | 0.469 | 
|                              | Third Quarter  |      |   | 1.240 |  |  |   | 0.600 | 
|                              | Fourth Quarter |      |   | 1.500 |  |  |   | 0.500 | 

As of March 15, 2003, there were
approximately 1,772 holders of record of the Common Stock.

The Company has never declared or paid cash
dividends on the Common Stock. The Company currently intends to
retain any earnings for use in its operations and does not
anticipate paying cash dividends in the foreseeable future. In
addition, the Companys credit facility with Silicon Valley
Bank, the Companys primary lender (Silicon),
prohibits the payment of cash dividends on the Common Stock
without Silicons prior written consent.

In connection with amending the Companys
existing credit facility with Silicon, on February 12,
2003, the Company issued to Silicon a warrant to purchase
350,000 shares of Common Stock. The warrant may be exercised
with respect to all of the underlying shares of Common Stock at
any time from February 12, 2003, until February 12,
2008, at an exercise price of $0.44 per share of Common Stock.
The number of shares of Common Stock underlying the warrant and
the exercise price of the warrant are subject to certain
adjustments described in the warrant and that certain
Antidilution Agreement, dated as of February 12, 2003,
between the Company and Silicon. The shares of Common Stock
underlying the warrant are entitled to certain piggy
back registration rights as set forth in that certain
Registration Rights Agreement, dated as of February 12,
2003, between the Company and Silicon. The warrant issued to
Silicon was issued without registration under the Securities Act
of 1933, as amended (the Securities Act), in
reliance upon the exemption from registration set forth in
Regulation D promulgated pursuant to Section 4(2) of the
Securities Act (Regulation D). The Company
based such reliance upon factual representations made to the
Company by Silicon as to Silicons investment intent,
sophistication, and status as an accredited
investor, as that term is defined in Rule 501 of
Regulation D, among other things.

In connection with a private placement offering
of securities conducted by the Company in October 2002, the
Company sold and issued an aggregate of 9,646,303 Units of the
Companys securities, with each Unit consisting
of one share of Common Stock and one warrant to purchase one
share of Common Stock for an aggregate offering price of
$3.0 million. The warrants issued in connection with the
offering are immediately exercisable over a five-year period at
an exercise price of $0.311 per share and are callable by the
Company at any time after the closing price of the Common Stock
as reported by the Nasdaq Stock Market equals or exceeds $1.20
per share for ten consecutive trading days and a registration
statement permitting the resale of the shares underlying the
warrants is then in effect. The shares of Common Stock
underlying the warrants are entitled to certain
piggyback registration rights as set forth in that
certain form of Registration Rights Agreement entered into by
the Company and each purchaser of a Unit. The Units were issued
without registration under the Securities Act, in reliance upon
the exemptions from registration set forth in Section 4(2)
of the Securities Act and Regulation D. The Company based
such reliance upon factual representations made to the Company
by the purchasers of the Units as to such purchasers
investment intent, sophistication, and status as an accredited
investor, among other things.

12



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Pursuant to the terms of the Arbitration Award
Agreements executed as part of a settlement of claims made by
Mr. Lewis and Mr. OReilly against the Company,
on February 4, 2003, the Company issued 275,000 shares of
restricted Common Stock to each of Mr. Lewis and
Mr. OReilly. The shares issued under the Arbitration
Award Agreements and to be issued under the New Consulting
Agreements constitute full satisfaction of the award granted by
an AAA arbitrator to Mr. OReilly and Mr. Lewis
of $250,000 and $240,000, respectively, and attorneys fees
and expenses of $22,000. The shares of restricted Common Stock
are entitled to certain piggy back registration
rights as set forth in the Arbitration Award Agreements. The
shares of restricted Common Stock were issued without
registration under the Securities Act, in reliance upon the
exemptions from the registration set forth in Section 4(2)
of the Securities Act and Regulation D. The Company based
such reliance upon factual representations made to the Company
by each of Mr. Lewis and Mr. OReilly as to their
investment intent, sophistication, and status as an accredited
investor, among other things.




Item 6.     Selected
Financial Data

The following selected financial data should be
read in conjunction with the Companys financial statements
and related notes thereto, set forth in Item 15 hereof, and
Managements Discussion and Analysis of Financial
Condition and Results of Operations, set forth in
Item 7 hereof. The statement of operations data and the
balance sheet data have been derived from the audited
consolidated financial statements of the Company. The historical
results are not necessarily indicative of future results. All
amounts in thousands except per share data.

|                                                                         |  |                          |        |         |  |         |        |         |  |      |         |   |  |   |        |   |  |   |        |  
|------------------------------------------------------------------------ |  | ------------------------ | ------ | ------- |  | ------- | ------ | ------- |  | ---- | ------- | - |  | - | ------ | - |  | - | ------ | -
|                                                                         |  |                         
|                                                                         |  | Years Ended December 31,
|                                                                         |  |                         
|                                                                         |  | 2002(2)                  |        | 2001(3) |  | 2000(4) |        | 1999(5) |  | 1998
|                                                                         |  |                          |        |         |  |         |        |         |  |     
|Statement of Operations
    Data(1):                                     |  |                          |        |         |  |         |        |         |  |      |         |   |  |   |        |   |  |   |        |  
|Revenue                                                                  |  | $                        | 44,798 |         |  | $       | 29,899 |         |  | $    | 12,732  |   |  | $ | 10,017 |   |  | $ | 2,914  |  
|Loss from Continuing Operations                                          |  |                          | (2,745 | )       |  |         | (9,877 | )       |  |      | (12,532 | ) |  |   | (5,361 | ) |  |   | (1,231 | )
|Loss from Continuing Operations per Common
    Share  basic and diluted |  |                          | (0.03  | )       |  |         | (0.18  | )       |  |      | (0.48   | ) |  |   | (0.23  | ) |  |   | (0.06  | )
|Balance Sheet Data:                                                      |  |                          |        |         |  |         |        |         |  |      |         |   |  |   |        |   |  |   |        |  
|Total Assets(6)                                                          |  |                          | 39,835 |         |  |         | 45,159 |         |  |      | 175,473 |   |  |   | 56,054 |   |  |   | 69,981 |  
|Long-term Obligations                                                    |  |                          | 6,133  |         |  |         | 5,200  |         |  |      | 3,153   |   |  |   |       |   |  |   | 2,333  |  



---



|    |                                                                                                                                                                                                                                                                                                                                                                                                              
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Includes the continuing operations of the
    following companies acquired by the Company from their
    respective dates of acquisition: Customer Response Center, a
    division of Encore Group (September 1, 1998); MessageClick
    (November 22, 2000); NACT (July 27, 2001); and
    Telemate.Net (November 16, 2001).                                                                                
|   
|(2) | The fiscal year 2002 loss from continuing
    operations includes $592,000 of intangibles amortization,
    $1.2 million in amortization of deferred compensation and
    $601,000 in non-cash interest expense related to the
    amortization of the discount on convertible subordinated
    debentures and loan fees.                                                                                    
|   
|(3) | The fiscal year 2001 loss from continuing
    operations includes $1.5 million of intangibles amortization,
    $1.8 million in amortization of deferred compensation and
    $606,000 in non-cash interest expense related to the
    amortization of the discount on convertible subordinated
    debentures and loan fees.                                                                                
|   
|(4) | The fiscal year 2000 loss from continuing
    operations includes $982,000 of goodwill amortization, $482,000
    in amortization of deferred compensation, $511,000 in
    reorganization costs, $1.8 million in loss on asset
    abandonment and $715,000 in non-cash interest expense primarily
    related to the amortization of the discount on convertible
    subordinated debentures and loan fees.
|   
|(5) | The fiscal year 1999 loss from continuing
    operations includes $982,000 in goodwill amortization and
    $543,000 in merger-related transaction and reorganization costs.                                                                                                                                                                                                                                 
|   
|(6) | Includes $0, $582,000, $153.0 million,
    $47.2 million and $57.9 million of assets of discontinued
    operations, as of December 31, 2002, 2001, 2000, 1999 and
    1998, respectively. The assets of discontinued                                                                                                                                                                                        

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| |                                                                                                                                                      
| | -----------------------------------------------------------------------------------------------------------------------------------------------------
| | operations on December 2000, 1999 and 1998
    included intangible assets totaling $119.2 million,
    $12.8 million and $14.1 million, respectively.




Item 7.     Managements
Discussion and Analysis of Financial Condition and Results of
Operations

General

The Company is a communications technology
solutions provider for communications service providers and
enterprises seeking to implement application-based telephony
services, Internet usage management tools and outsourced
customer support services. The Companys continuing
operations include two separate business segments, the Carrier
Solutions Group, which for the fiscal year 2002 includes the
Companys subsidiary NACT, and the Enterprise Solutions
Group, which includes the Companys customer response
center operations, the Companys subsidiary, Telemate.Net
and, for 2000 and 2001, the Companys MessageClick
operations. The Company acquired Message.Click in November 2000,
NACT in July 2001 and Telemate.Net in November 2001. The
Companys discontinued operations include its legacy VAR
business and HSG.

The consolidated financial statements include the
accounts of the Company and its wholly-owned subsidiaries,
including Telemate.Net, NACT and MessageClick. The Company
acquired Telemate.Net, NACT and MessageClick each in
transactions accounted for as purchases.

The Company believes that the foregoing events
significantly affect the comparability of the Companys
results of operations from year to year. You should read the
following discussion of the Companys results of operations
and financial condition in conjunction with the Companys
consolidated financial statements and related notes thereto
included in Item 15 of this Annual Report.

Results of Operations

Fiscal Year
2002 Compared with Fiscal Year 2001

For the year ended December 31, 2002, the
Companys net loss totaled $2.7 million, or $0.03 per
share, compared with net loss of $147.6 million, or $2.71
per share, for the same period in 2001. The 2002 results include
$592,000 in amortization of intangibles, $1.2 million in
amortization of deferred compensation, $324,000 in
reorganization costs, a loss from discontinued operations of
$331,000 and an extraordinary item  gain on early
retirement of debt totaling $350,000. The 2001 results include
$1.5 million in amortization of intangibles,
$1.8 million in amortization of deferred compensation, a
loss from discontinued operations of $136.1 million and an
extraordinary item  loss from debt conversion
totaling $1.6 million.

Continuing
Operations

For the year ended December 31, 2002, the
Companys net loss from continuing operations totaled
$2.7 million, or $0.03 per share, compared with a net loss
of $9.9 million, or $0.18 per share, for the same period in
2001. The 2002 results included $592,000 in amortization of
intangibles, $1.2 million in amortization of deferred
compensation and $324,000 in reorganization costs. The 2001
results included $1.5 million in amortization of
intangibles and $1.8 million in amortization of deferred
compensation.

Total revenue was $44.8 million in the year
ended December 31, 2002, reflecting a 50% increase from the
same period in 2001. NACT accounted for $10.5 million and
Telemate.Net accounted for $4.9 million of the increase in
revenue. Products revenue was $23.0 million in the year
ended December 31, 2002, and was primarily related to the
NACT products. Products revenue was $14.4 million for the
year ended December 31, 2001. Services revenue was $21.8
million in the year ended December 31, 2002, reflecting a
40% increase from 2001. Gross profit increased by
$11.3 million in the year ended December 31, 2002, to
$26.3 million, and was 59% of revenue, compared with 50% of
revenue for 2001. The increase in revenue, gross profit
percentage and gross profit dollars resulted primarily from the
Companys acquisition of NACT in July 2001 and Telemate.Net
in November 2001, both of which sell higher margin proprietary
products and services.

Total operating expenses incurred in continuing
operations for the year ended December 31, 2002, were
$28.7 million, an increase of $5.0 million compared to
the same period in 2001. The increase is primarily

14



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##### Table of Contents



attributable to the following items:
reorganization costs of $324,000, increases in sales, general
and administrative expenses of $2.5 million, research and
development of $3.1 million and depreciation expense of
$570,000 offset by decreases in intangible amortization of
$919,000 and amortization of deferred compensation of $593,000.


The increase in sales, general and administrative
expenses resulted from the addition of personnel and related
costs related to the acquisitions of NACT in July 2001 of
approximately $3.9 million and Telemate.Net in November
2001 of approximately $1.5 million offset by the reduction
of corporate and customer response center operations sales,
general and administrative expenses of approximately
$2.9 million. The decrease in corporate and customer
response center operations sales, general and administrative
expenses resulted primarily from on-going cost reduction
initiatives resulting in reduced personnel, telecom and other
general and administrative expenses.

The increase in research and development is
primarily related to the acquisitions of NACT and Telemate.Net
in July 2001 and November 2001, respectively.

The increase in depreciation expense is primarily
related to the purchase of furniture and equipment of
approximately $889,000 and $1.4 million during 2002 and
2001, respectively, as well as the increased depreciation
related to the assets acquired in the NACT and Telemate.Net
acquisitions. Capital expenditures are primarily depreciated on
a straight-line basis over an estimated useful life of three
years.

The $919,000 decrease in intangible amortization
is primarily related to the adoption of SFAS No. 142,
Goodwill and Other Intangible Assets (SFAS
No. 142), which eliminated amortization of goodwill
beginning January 1, 2002.

The $593,000 decrease in amortization of deferred
compensation primarily related to the termination of certain
options and full vesting of other options outstanding since the
Companys acquisition of Telemate.Net in November 2001 and
Cereus in September 2000. The deferred compensation represents
the intrinsic value of the Telemate.Net and Cereus unvested
options outstanding at the date of the acquisitions of
Telemate.Net and Cereus and is amortized over the remaining
vesting period of the options.

In the third and fourth quarters of 2002, the
Company implemented several restructuring plans as a part of its
effort to improve operational efficiencies and financial
performance and eliminated 42 positions held by employees. As a
result of these actions, the Company recorded reorganization
costs of $324,000. Annualized savings beginning in the first
quarter of 2003 are expected to be approximately
$2.8 million.

As a percent of revenue, operating expenses from
continuing operations were 64% during the year ended
December 31, 2002, down from 79% for the same period in
2001.

Other income was $531,000 during the year ended
December 31, 2002, compared with $203,000 for the same
period in 2001. Included in other income during the year ended
December 31, 2002 was $254,000 of non-recurring
transactions related to health insurance proceeds and sale of
non-operating assets.

Equity in loss of BeTrue was $5,000 during the
year ended December 31, 2002. This amount represents the
Companys portion of BeTrues losses since the
Companys acquisition of a 51% interest in BeTrue on
October 1, 2002.

Interest expense was $1.1 million during the
year ended December 31, 2002, a decrease of $220,000
compared to the same period in 2001. The decrease was
attributable to the reduction of interest on the Companys
5% convertible subordinated debentures, which were paid or
converted to Common Stock in 2001, and interest on the
Companys Series B Preferred Stock issued in
connection with the Companys acquisition of NACT offset by
the amortization of the fair value of warrants issued to Silicon
in connection with the new credit facility.

The Company recorded an income tax benefit of
$200,000 during the year ended December 31, 2002, due to
the reversal of a previously accrued exposure item no longer
deemed necessary.

15



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##### Table of Contents



Business Unit
Performance

|                                                                               |                                                               |                                 |        |                      |  |              |        |      |  |      |        |      |  |   |        |   |  |   |        |        |        |   |        |        |        |  
|------------------------------------------------------------------------------ | ------------------------------------------------------------- | ------------------------------- | ------ | -------------------- |  | ------------ | ------ | ---- |  | ---- | ------ | ---- |  | - | ------ | - |  | - | ------ | ------ | ------ | - | ------ | ------ | ------ | -
|                                                                               |                                                               |                                 |        |                      |  |              |        |      |  |     
|                                                                               |                                                               |                                 |        | Enterprise           |  |              |        |     
|                                                                               |                                                               | Carrier Solutions               |        | Enterprise Solutions |  |             
|                                                                               |                                                               | Group                           |        | Group                |  | Consolidated
|                                                                               |                                                               |                                 |        |                      |  |             
|                                                                               |                                                               |                                
|                                                                               |                                                               | For the Year Ended December 31,
|                                                                               |                                                               |                                
|                                                                               |                                                               | 2002                            |        | 2001                 |  | 2002         |        | 2001 |  | 2002 |        | 2001
|                                                                               |                                                               |                                 |        |                      |  |              |        |      |  |      |        |     
|                                                                               |                                                               |                                
|                                                                               |                                                               | (Dollars in thousands)         
|Revenue                                                                        |                                                               | $                               | 26,319 |                      |  | $            | 15,773 |      |  | $    | 18,479 |      |  | $ | 14,126 |   |  | $ | 44,798 |        |        | $ | 29,899 |       
|Gross profit                                                                   |                                                               |                                 | 16,378 |                      |  |              | 9,106  |      |  |      | 9,971  |      |  |   | 5,981  |   |  |   | 26,349 |        |        |   | 15,087 |       
|Gross margin                                                                   |                                                               |                                 | 62     | %                    |  |              | 58     | %    |  |      | 54     | %    |  |   | 42     | % |  |   | 59     | %      |        |   | 50     | %     
|Sales, general and administrative                                              |                                                               |                                 | 7,474  |                      |  |              | 3,599  |      |  |      | 2,618  |      |  |   | 2,566  |   |  |   | 10,092 |        |        |   | 6,165  |       
|Research and development                                                       |                                                               |                                 | 5,417  |                      |  |              | 1,938  |      |  |      | 457    |      |  |   | 817    |   |  |   | 5,874  |        |        |   | 2,755  |       
|                                                                               |                                                               |                                 |        |                      |  |              |        |      |  |      |        |      |  |   |        |   |  |   |        |        |        |   |        |       
|Contribution before unallocated items(1)                                       |                                                               | $                               | 3,487  |                      |  | $            | 3,569  |      |  | $    | 6,896  |      |  | $ | 2,598  |   |  |   | 10,383 |        |        |   | 6,167  |       
|                                                                               |                                                               |                                 |        |                      |  |              |        |      |  |      |        |      |  |   |        |   |  |   |        |        |        |   |        |       
|Unallocated items Corporate, sales, general and
    administrative expenses(2) |                                                               |                                 |        |                      |  |              |        |      |  |      |        |      |  |   |        |   |  |   | 7,894  |        |        |   | 9,349  |       
|                                                                               | Depreciation                                                  |                                 |        |                      |  |              |        |      |  |      |        |      |  |   |        |   |  |   |        | 2,730  |        |   |        | 2,160  |       
|                                                                               | Amortization of intangibles                                   |                                 |        |                      |  |              |        |      |  |      |        |      |  |   |        |   |  |   |        | 592    |        |   |        | 1,511  |       
|                                                                               | Deferred compensation                                         |                                 |        |                      |  |              |        |      |  |      |        |      |  |   |        |   |  |   |        | 1,173  |        |   |        | 1,766  |       
|                                                                               | Reorganization costs                                          |                                 |        |                      |  |              |        |      |  |      |        |      |  |   |        |   |  |   |        | 324    |        |   |        |       |       
|                                                                               |                                                               |                                 |        |                      |  |              |        |      |  |      |        |      |  |   |        |   |  |   |        |        |        |   |        |       
|                                                                               |                                                               | Operating loss                  |        |                      |  |              |        |      |  |      |        |      |  |   |        |   |  |   |        |        | (2,330 | ) |        |        | (8,619 | )
|Other income                                                                   |                                                               |                                 |        |                      |  |              |        |      |  |      |        |      |  |   |        |   |  |   | 531    |        |        |   | 203    |       
|Equity in loss of Shanghai BeTrue Infotech Co.
    Ltd.                        |                                                               |                                 |        |                      |  |              |        |      |  |      |        |      |  |   |        |   |  |   | (5     | )      |        |   |       |       
|Interest expense, net                                                          |                                                               |                                 |        |                      |  |              |        |      |  |      |        |      |  |   |        |   |  |   | (1,141 | )      |        |   | (1,361 | )     
|Income taxes                                                                   |                                                               |                                 |        |                      |  |              |        |      |  |      |        |      |  |   |        |   |  |   | 200    |        |        |   | (100   | )     
|                                                                               |                                                               |                                 |        |                      |  |              |        |      |  |      |        |      |  |   |        |   |  |   |        |        |        |   |        |       
|                                                                               | Loss from continuing operations before
    extraordinary item |                                 |        |                      |  |              |        |      |  |      |        |      |  |   |        |   |  |   | $      | (2,745 | )      |   | $      | (9,877 | )     
|                                                                               |                                                               |                                 |        |                      |  |              |        |      |  |      |        |      |  |   |        |   |  |   |        |        |        |   |        |       



---



|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Beginning in August 2001, the Carrier Solutions
    Group includes costs associated with certain corporate and
    administrative functions to support this business unit, which
    functions are located in Utah. Prior to the acquisition of NACT
    on July 27, 2001, the Company became an NACT reseller in
    the first quarter of 2001. The Company resold NACT gateway
    solutions totaling $2.8 million with cost of product sales
    of $2.1 million prior to July 27, 2001. The Enterprise
    Solutions Group includes no allocation of corporate overhead
    costs. See also (2) below.
|   
|(2) | All rent, utilities and other corporate office
    expenses, corporate marketing expenses, corporate development
    costs and corporate human resources, accounting and information
    technology functions that support corporate, as well as the
    Enterprise Solutions Group, are reflected in unallocated
    corporate, sales, general and administrative expenses. Office
    expenses, human resources, accounting and information technology
    costs specifically related to the Carrier Solutions Group are
    reflected in its contribution before unallocated items.                    

Carrier Solutions Group

Total revenue from the Companys Carrier
Solutions Group was $26.3 million in the year ended
December 31, 2002, a 67% increase from the same period in
2001. The increase in revenue reflects a full year of activity
in 2002 versus only five months of activity in 2001 since the
acquisition of NACT on July 27, 2001,

16



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##### Table of Contents



plus the resale activity in the first and second
quarters of 2001. Prior to the acquisition of NACT in July 2001,
the Company became an NACT reseller in the first quarter of
2001. The Company resold NACT gateway solutions totaling
$2.8 million with cost of product sales of
$2.1 million prior to July 27, 2001.


Gross profit increased by $7.3 million in
the year ended December 31, 2002, and was 62% of revenue,
an increase from 58% of revenue in the same period in 2001. The
increase in gross profit dollars reflects a full year of
activity in 2002 versus only five months of activity in 2001.
The increase in gross margin is related to the lower margin
resale activity in the first and second quarters of 2001.

Allocated operating expenses incurred in the
Carrier Solutions Group for the year ended December 31,
2002, were $12.9 million, an increase of $7.4 million
compared to the same period in 2001. The increases in sales,
general and administrative expenses and research and development
expenses reflect the operations of NACT for a full year of
activity in 2002 versus only five months of activity in 2001.
Prior to the acquisition of NACT, there were no material
operating expenses related to the Carrier Solutions Group
segment. As a percent of revenue, operating expenses for the
Carrier Solutions Group were 49% during the year ended
December 31, 2002, up from 35% for 2001 due to increased
research and development activities.

Enterprise
Solutions Group

Total revenue for the Companys Enterprise
Solutions Group was $18.5 million in the year ended
December 31, 2002, a 31% increase from 2001. The increase
in revenue is primarily related to the Companys
acquisition of Telemate.Net in November 2001.

Gross profit increased by $4.0 million in
the year ended December 31, 2002 and was 54% of revenue
compared with 42% for 2001. The improvement in gross margin was
primarily attributable to a full year of operations in 2002 of
the Companys Telemate.Net operations, which offers higher
margin proprietary products.

Allocated operating expenses incurred in the
Enterprise Solutions Group for the year ended December 31,
2002, were $3.1 million, a decrease of $308,000 compared to
the same period in 2001. Sales, general and administrative
expenses increased by $52,000. This increase relates to a full
year of expenses for Telemate.Net, which was acquired in
November 2001, of approximately $1.5 million offset by
lower expenses related to MessageClick, the activities of which
were substantially eliminated in the second quarter of 2001, of
approximately $838,000 and lower expenses in the Companys
customer response center of approximately $564,000. The decrease
in research and development expenses relates to the elimination
of the research and development activity related to
MessageClicks ASP operations in 2001 of approximately
$715,000 offset by the addition of the research and development
activities of Telemate.Net, which was acquired in November 2001,
of approximately $355,000. As a percent of revenue, allocated
operating expenses for the Enterprise Solutions Group were 17%
during the year ended December 31, 2002, down from 24% for
2001.

Discontinued
Operations

Following the acquisition of NACT in July of
2001, the Company determined that its legacy VAR business was
not strategic to the Companys ongoing objectives and
discontinued capital and human resource investment in this
business. Accordingly, the Company elected to report its legacy
VAR business as discontinued operations by early adoption of
SFAS No. 144. This business was added to HSG (which was
reported as discontinued operations in 2000) for a combined
presentation of discontinued operations, and the consolidated
financial statements have been reclassified to segregate the net
assets and operating results of these business segments.

17



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##### Table of Contents



Summary operating results of the discontinued
operations for the years ended December 31, 2002 and 2001
(in thousands) were as follows:

|                                  |  |              |      |      |  |   |          |  
|--------------------------------- |  | ------------ | ---- | ---- |  | - | -------- | -
|                                  |  |             
|                                  |  | Years ended 
|                                  |  | December 31,
|                                  |  |             
|                                  |  | 2002         |      | 2001
|                                  |  |              |      |     
|Revenue                           |  | $            | 223  |      |  | $ | 12,762   |  
|                                  |  |              |      |      |  |   |          |  
|Gross (loss) profit               |  | $            | (331 | )    |  | $ | 374      |  
|                                  |  |              |      |      |  |   |          |  
|Operating loss                    |  | $            | (331 | )    |  | $ | (135,598 | )
|Loss on disposal of assets        |  |              |     |      |  |   | (500     | )
|                                  |  |              |      |      |  |   |          |  
|Loss from discontinued operations |  | $            | (331 | )    |  | $ | (136,098 | )
|                                  |  |              |      |      |  |   |          |  

The loss from discontinued operations in the year
ended December 30, 2001 includes depreciation of $546,000,
amortization of intangibles of $22.7 million, write-down of
goodwill of $95.3 million, amortization of deferred
compensation of $267,000 and reorganization costs of
$9.2 million.

The reorganization costs consist of the following
(in thousands):

|                               |  |      |       | 
|------------------------------ |  | ---- | ----- | 
|                               |  | 2001
|                               |  |     
|Severance costs                |  | $    | 1,217 | 
|Facilities closings            |  |      | 6,162 | 
|Inventory write-down           |  |      | 1,005 | 
|MessageClick ASP exiting costs |  |      | 824   | 
|                               |  |      |       | 
|                               |  | $    | 9,208 | 
|                               |  |      |       | 

Extraordinary
Item

In November 2002, the Company negotiated the
early retirement of the remaining $1.75 million plus
accrued interest due on the note made by the Company on
April 25, 2002, in favor of WA Telcom Products Co.,
Inc., in connection with the acquisition of NACT (the
Note). The Company paid $1.4 million plus accrued
interest and recognized a gain on early retirement of debt of
$350,000.

In January 2001, the Company modified the terms
of the $7.0 million outstanding balance of its 5%
convertible subordinated debentures as follows: the Company
repurchased $4.5 million, converted $1.5 million into
Common Stock at a price of $1.40 per share, fixed the conversion
rate at $1.19 per share for the remaining $1.0 million and
issued warrants to purchase 954,455 shares of Common Stock at an
exercise price of $1.98 per share. The cost of this conversion
and early retirement of debt totaled $1.6 million.

Fiscal Year
2001 Compared with Fiscal Year 2000

For the year ended December 31, 2001, the
Companys net loss totaled $147.6 million, or $2.71
per share, compared with net loss of $55.5 million, or
$2.14 per share, for 2000. The 2001 results include $1.5 million
in amortization of intangibles, $1.8 million in
amortization of deferred compensation, a loss from discontinued
operations of $136.1 million and an extraordinary
item  loss from debt conversion totaling
$1.6 million. The 2000 results include $982,000 in
amortization of intangibles, $482,000 in amortization of
deferred compensation, $1.8 million loss on asset
abandonment, $511,000 in reorganization costs and a loss from
discontinued operations of $43.0 million.

Continuing
Operations

For the year ended December 31, 2001, the
Companys net loss from continuing operations totaled
$9.9 million, or $0.18 per share, compared with a net loss
of $12.5 million, or $0.48 per share, for 2000. The 2001
results included $1.5 million in amortization of
intangibles and $1.8 million in amortization of deferred

18



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##### Table of Contents



compensation. The 2000 results included $982,000
in amortization of intangibles, $482,000 in amortization of
deferred compensation, $1.8 million loss on asset
abandonment and $511,000 in reorganization costs.


Total revenue was $29.9 million in the year
ended December 31, 2001, reflecting a 135% increase from
2000. Products revenue was $14.4 million in the year ended
December 31, 2001, and was primarily related to the NACT
products. Services revenue was $15.5 million in the year
ended December 31, 2001, reflecting a 22% increase from
2000. Gross profit increased by $9.8 million in the year
ended December 31, 2001, and was 50% of revenue in 2001,
compared with 42% of revenue for 2000. The increase in revenue,
gross profit percentage and gross profit dollars resulted
primarily from the acquisition of NACT in 2001.

Total operating expenses incurred in continuing
operations for the year ended December 31, 2001, were
$23.7 million, an increase of $7.1 million compared to
2000. The increase is primarily attributable to the following
items: increases in sales, general and administrative expenses
of $3.5 million, research and development of
$2.8 million, depreciation expense of $1.3 million,
intangible amortization of $529,000, and amortization of
deferred compensation of $1.3 million offset by decreases
in reorganization costs of $511,000 and loss on asset
abandonment of $1.8 million.

The increase in sales, general and administrative
expenses resulted from the addition of personnel and related
costs related to the acquisitions of NACT and MessageClick of
approximately $4.4 million offset by the reduction of
corporate sales, general and administrative expenses of
approximately $1.2 million. The decrease in corporate
sales, general and administrative expenses resulted primarily
from the cost savings from the reorganizations during 2000, as
well as on-going cost reduction initiatives affecting personnel,
telecom and other general and administrative expenses.

The increase in research and development is
primarily related to the acquisition of NACT in the third
quarter of 2001.

The increase in depreciation expense is primarily
related to the purchase of furniture and equipment of
approximately $1.4 million and $5.3 million during
2001 and 2000, respectively, as well as the increased
depreciation related to the assets acquired in the NACT
acquisition. Capital expenditures are primarily depreciated on a
straight-line basis over an estimated useful life of three years.

The $529,000 increase in intangible amortization
is primarily related to the reduction in the remaining estimated
life of a previously existing intangible asset and an intangible
asset acquired in the acquisition of NACT.

The $1.3 million increase in amortization of
deferred compensation primarily related to the Companys
acquisition of Cereus in September 2000. The deferred
compensation represents the intrinsic value of the Cereus
unvested options outstanding at the date of the acquisition of
Cereus and is amortized over the remaining vesting period.

In 2000, the Company recorded reorganization
costs of approximately $511,000 related to a reorganization
announced during the second quarter of 2000.

In 2000, the Company decided to replace software
used internally and recorded a loss on asset abandonment of
$1.8 million.

As a percent of revenue, operating expenses from
continuing operations were 79% during the year ended
December 31, 2001, down from 131% for the same period in
2000 as a result of cost savings related to reorganizations.

Other income was $203,000 during the year ended
December 31, 2001. Other income is primarily related to the
operations of NACT, which was acquired in July 2001.

Interest expense was $1.4 million during the
year ended December 31, 2001, an increase of $121,000
compared to the same period of 2000. The increase was
attributable to the interest on the Note made by the Company in
connection with the acquisition of NACT and interest on the
Companys Series B Preferred Stock issued in
connection with the acquisition of NACT offset by the reduction
of interest on the Companys 5% convertible subordinated
debentures, which were paid or converted to Common Stock in 2001.

19



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##### Table of Contents



Business Unit
Performance

|                                                                               |                                                               |                                 |        |                      |  |              |   |      |  |      |        |      |  |   |        |   |  |   |        |        |        |   |        |         |         |  
|------------------------------------------------------------------------------ | ------------------------------------------------------------- | ------------------------------- | ------ | -------------------- |  | ------------ | - | ---- |  | ---- | ------ | ---- |  | - | ------ | - |  | - | ------ | ------ | ------ | - | ------ | ------- | ------- | -
|                                                                               |                                                               |                                 |        |                      |  |              |   |     
|                                                                               |                                                               | Carrier Gateway                 |        | Enterprise Solutions |  |             
|                                                                               |                                                               | Solutions Group                 |        | Group                |  | Consolidated
|                                                                               |                                                               |                                 |        |                      |  |             
|                                                                               |                                                               |                                
|                                                                               |                                                               | For the Year Ended December 31,
|                                                                               |                                                               |                                
|                                                                               |                                                               | 2001                            |        | 2000                 |  | 2001         |   | 2000 |  | 2001 |        | 2000
|                                                                               |                                                               |                                 |        |                      |  |              |   |      |  |      |        |     
|                                                                               |                                                               |                                
|                                                                               |                                                               | (Dollars in thousands)         
|Revenue                                                                        |                                                               | $                               | 15,773 |                      |  | $            |  |      |  | $    | 14,126 |      |  | $ | 12,732 |   |  | $ | 29,899 |        |        | $ | 12,732 |        
|Gross profit                                                                   |                                                               |                                 | 9,106  |                      |  |              |  |      |  |      | 5,981  |      |  |   | 5,330  |   |  |   | 15,087 |        |        |   | 5,330  |        
|Gross margin                                                                   |                                                               |                                 | 58     | %                    |  |              |  |      |  |      | 42     | %    |  |   | 42     | % |  |   | 50     | %      |        |   | 42     | %      
|Sales, general and administrative                                              |                                                               |                                 | 3,599  |                      |  |              |  |      |  |      | 2,566  |      |  |   | 1,462  |   |  |   | 6,165  |        |        |   | 1,462  |        
|Research and development                                                       |                                                               |                                 | 1,938  |                      |  |              |  |      |  |      | 817    |      |  |   |       |   |  |   | 2,755  |        |        |   |       |        
|                                                                               |                                                               |                                 |        |                      |  |              |   |      |  |      |        |      |  |   |        |   |  |   |        |        |        |   |        |        
|Contribution before unallocated items(1)                                       |                                                               | $                               | 3,569  |                      |  | $            |  |      |  | $    | 2,598  |      |  | $ | 3,868  |   |  |   | 6,167  |        |        |   | 3,868  |        
|                                                                               |                                                               |                                 |        |                      |  |              |   |      |  |      |        |      |  |   |        |   |  |   |        |        |        |   |        |        
|Unallocated items Corporate, sales, general and
    administrative expenses(2) |                                                               |                                 |        |                      |  |              |   |      |  |      |        |      |  |   |        |   |  |   | 9,349  |        |        |   | 10,562 |        
|                                                                               | Depreciation                                                  |                                 |        |                      |  |              |   |      |  |      |        |      |  |   |        |   |  |   |        | 2,160  |        |   |        | 863     |        
|                                                                               | Amortization of intangibles                                   |                                 |        |                      |  |              |   |      |  |      |        |      |  |   |        |   |  |   |        | 1,511  |        |   |        | 982     |        
|                                                                               | Deferred compensation                                         |                                 |        |                      |  |              |   |      |  |      |        |      |  |   |        |   |  |   |        | 1,766  |        |   |        | 482     |        
|                                                                               | Reorganization costs                                          |                                 |        |                      |  |              |   |      |  |      |        |      |  |   |        |   |  |   |        |       |        |   |        | 511     |        
|                                                                               | Loss on asset abandonment                                     |                                 |        |                      |  |              |   |      |  |      |        |      |  |   |        |   |  |   |        |       |        |   |        | 1,760   |        
|                                                                               |                                                               |                                 |        |                      |  |              |   |      |  |      |        |      |  |   |        |   |  |   |        |        |        |   |        |        
|                                                                               |                                                               | Operating loss                  |        |                      |  |              |   |      |  |      |        |      |  |   |        |   |  |   |        |        | (8,619 | ) |        |         | (11,292 | )
|Other income                                                                   |                                                               |                                 |        |                      |  |              |   |      |  |      |        |      |  |   |        |   |  |   | 203    |        |        |   |       |        
|Interest expense, net                                                          |                                                               |                                 |        |                      |  |              |   |      |  |      |        |      |  |   |        |   |  |   | (1,361 | )      |        |   | (1,240 | )      
|Income taxes                                                                   |                                                               |                                 |        |                      |  |              |   |      |  |      |        |      |  |   |        |   |  |   | (100   | )      |        |   |       |        
|                                                                               |                                                               |                                 |        |                      |  |              |   |      |  |      |        |      |  |   |        |   |  |   |        |        |        |   |        |        
|                                                                               | Loss from continuing operations before
    extraordinary item |                                 |        |                      |  |              |   |      |  |      |        |      |  |   |        |   |  |   | $      | (9,877 | )      |   | $      | (12,532 | )      
|                                                                               |                                                               |                                 |        |                      |  |              |   |      |  |      |        |      |  |   |        |   |  |   |        |        |        |   |        |        



---



|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Beginning in August 2001, Carrier Solutions Group
    includes costs associated with certain corporate and
    administrative functions to support this business unit, which
    functions are located in Utah. Prior to the acquisition of NACT
    on July 27, 2001, the Company became an NACT reseller in
    the first quarter of 2001. The Company resold NACT carrier
    solutions totaling $2.8 million with cost of product sales
    of $2.1 million prior to July 27, 2001. The Enterprise
    Solutions Group includes no allocation of corporate overhead
    costs. See also (2) below.
|   
|(2) | All rent, utilities and other corporate office
    expenses, corporate marketing expenses, corporate development
    costs and corporate human resources, accounting and information
    technology functions that support corporate, as well as, the
    Enterprise Solutions Group are reflected in unallocated
    corporate, sales, general and administrative expenses. Office
    expenses, human resources, accounting and information technology
    costs specifically related to the Carrier Solutions Group are
    reflected in its contribution before unallocated items.                

Carrier
Solutions Group

For 2002, the Carrier Solutions Group represents
the sales of NACT products and related services. Prior to the
acquisition of NACT on July 27, 2001, the Company became an
NACT reseller in the first quarter of 2001. The Company resold
NACT carrier solutions totaling $2.8 million and cost of
product sales of $2.1 million during the first and second
quarters of 2001. All other revenue and expenses represent the
operations of NACT after it was acquired by the Company. Prior
to the acquisition of NACT, there were no identifiable operating
expenses related to the Carrier Solutions Group.

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Enterprise
Solutions Group

Total revenue from the Companys Enterprise
Solutions Group was $14.1 million in the year ended
December 31, 2001, a 11% increase from the same period in
2000. The $1.4 million increase in revenue is comprised of
an increase in customer resource center revenues of $530,000 and
revenue from Telemate.Net subsequent to its acquisition by the
Company on November 16, 2001 of $971,000.

Gross profit remained constant in the year ended
December 31, 2001, and was 42% percent of revenue, compared
with 42% of revenue for 2000.

Allocated operating expenses incurred in the
Enterprise Solutions Group for the year ended December 31,
2001, were $3.4 million, an increase of $1.9 million
compared to 2000. The increase of $817,000 in research and
development relates primarily to MessageClick (which was
acquired in 2000), the operations of which were substantially
eliminated in the second quarter of 2001. The increase in sales,
general and administrative expenses relates to Telemate.Net
subsequent to its acquisition by the Company and MessageClick
totaling $823,000. As a percent of revenue, allocated operating
expenses for the Enterprise Solutions Group were 24% during the
year ended December 31, 2001, up from 11% for 2000.

Discontinued
Operations

Following the acquisition of NACT in July of
2001, the Company determined that its legacy VAR business was
not strategic to the Companys ongoing objectives and
discontinued capital and human resource investment in this
business. Accordingly, the Company has elected to report its
legacy VAR business as discontinued operations by early adoption
of SFAS No. 144. This business was added to HSG (which was
reported as discontinued operations in 2000) for a combined
presentation of discontinued operations, and the consolidated
financial statements have been reclassified to segregate the net
assets and operating results of these business segments.

During 2000, the Board formally decided to
dispose of HSG. In December 2000, the Company completed the sale
of its domestic lodging business and international hospitality
business for aggregate proceeds of $10.0 million. The
Company sold its restaurant solutions business for aggregate
proceeds of $8.5 million in January 2001.

The loss on the sale of HSG totaled
$11.5 million. A loss of $11.0 million was recorded in the
third and fourth quarters of 2000. The loss included a reduction
in asset values of approximately $6.7 million and a
provision for anticipated closing costs and operating losses
until disposal of approximately $4.8 million. An additional
$500,000 was recorded in the third quarter of 2001, related to
winding up the Companys international hospitality
operations, the assets of which were sold in the fourth quarter
of 2000.

Summary operating results of the discontinued
operations (in thousands) are as follows:

|                                  |  |              |          |      |  |   |         |  
|--------------------------------- |  | ------------ | -------- | ---- |  | - | ------- | -
|                                  |  |             
|                                  |  | December 31,
|                                  |  |             
|                                  |  | 2001         |          | 2000
|                                  |  |              |          |     
|Revenue                           |  | $            | 12,762   |      |  | $ | 96,944  |  
|                                  |  |              |          |      |  |   |         |  
|Gross profit                      |  | $            | 374      |      |  | $ | 23,429  |  
|                                  |  |              |          |      |  |   |         |  
|Operating loss                    |  | $            | (135,598 | )    |  | $ | (35,291 | )
|Interest expense                  |  |              |         |      |  |   | (785    | )
|Loss on disposal of assets        |  |              | (500     | )    |  |   | (6,704  | )
|Income tax expense                |  |              |         |      |  |   | (170    | )
|                                  |  |              |          |      |  |   |         |  
|Loss from discontinued operations |  | $            | (136,098 | )    |  | $ | (42,950 | )
|                                  |  |              |          |      |  |   |         |  

The loss from discontinued operations in the year
ended December 30, 2001, includes depreciation of $546,000,
amortization of intangibles of $22.7 million, write-down of
goodwill of $95.3 million, amortization of deferred
compensation of $267,000 and reorganization costs of
$9.2 million. The operating loss in 2000

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includes depreciation of $1.8 million,
amortization of intangibles of $11.5 million, amortization
of deferred compensation of $126,000, reorganization costs of
$1.0 million and loss on asset abandonment of $218,000.


The reorganization costs consist of the following
(in thousands):

|                               |  |      |       |      |  |   |     | 
|------------------------------ |  | ---- | ----- | ---- |  | - | --- | 
|                               |  | 2001 |       | 2000
|                               |  |      |       |     
|Severance costs                |  | $    | 1,217 |      |  | $ | 731 | 
|Facilities closings            |  |      | 6,162 |      |  |   | 258 | 
|Inventory write-down           |  |      | 1,005 |      |  |   |    | 
|MessageClick ASP exiting costs |  |      | 824   |      |  |   |    | 
|                               |  |      |       |      |  |   |     | 
|                               |  | $    | 9,208 |      |  | $ | 989 | 
|                               |  |      |       |      |  |   |     | 

Extraordinary
Item

In January 2001, the Company modified the terms
of the $7.0 million outstanding balance of its 5%
convertible subordinated debentures as follows: the Company
repurchased $4.5 million, converted $1.5 million into
Common Stock at a price of $1.40 per share, fixed the conversion
rate at $1.19 per share for the remaining $1.0 million and
issued warrants to purchase 945,378 shares of Common Stock at an
exercise price of $2.00 per share. The cost of this conversion
and early retirement of debt totaled $1.6 million.

Critical and Significant Accounting
Policies

The preparation of financial statements and
related disclosures in conformity with accounting principles
generally accepted in the United States of America requires
management to make judgments, assumptions and estimates that
affect the amounts reported in the consolidated financial
statements and accompanying notes. Factors that could affect the
Companys future operating results and cause actual results
to vary from expectations include, but are not limited to, lower
than anticipated growth from existing customers, an inability to
attract new customers, an inability to successfully integrate
acquisitions and technology changes, or a decline in the
financial stability of the Companys customers. Negative
developments in these or other risk factors could have a
material adverse affect on the Companys financial position
and results of operations.

A summary of the Companys critical and
significant accounting policies follows:

Allowance for
Doubtful Accounts

The Company is required to estimate the
collectibility of its trade receivables. Considerable judgment
is required in assessing the ultimate realization of these
receivables, including the creditworthiness of each customer.
The Company determines the allowance for doubtful accounts based
on a specific review of outstanding customer balances and a
general reserve based upon aging of customer accounts and
write-off history. Significant changes in required reserves have
been recorded in recent periods and may occur in the future due
to the current telecommunications and general economic
environments.

Inventory
Obsolescence

The Company is required to state its inventories
at the lower of cost or market. In assessing the ultimate
realization of inventories, the Company is required to make
judgments as to future demand requirements and compare that with
the current or committed inventory levels. The Company has
recorded changes in net realizable values in recent periods due
to impact of current and future technology trends and changes in
strategic direction, such as discontinuances of product lines,
as well as, changes in market conditions due to changes in
demand requirements. It is possible that changes in the net
realizable value of inventory may continue to occur in the
future due to the current market conditions.

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Revenue
Recognition

The Companys principal sources of revenues
are from sales of broadband transmission networks, digital
interactive subscriber systems and content distribution
networks. The Companys revenue recognition policies are in
compliance with Staff Accounting Bulletin No. 101,
Revenue Recognition in Financial Statements, issued
by the SEC. The Company recognizes revenue when (i) there
is an agreement with the customer, (ii) product is shipped
and title has passed, (iii) the amount due from the
customer is fixed and determinable, and (iv) collectibility
is reasonably assured. Revenue is also recognized only when the
Company has no significant future performance obligation. At the
time of the transaction, the Company assesses whether the amount
due from the customer is fixed and determinable and collection
of the resulting receivable is reasonably assured. The Company
assesses whether the amount due from the customer is fixed and
determinable based on the terms of the agreement with the
customer, including, but not limited to, the payment terms
associated with the transaction. The Company assesses collection
based on a number of factors, including past transaction history
with the customer and creditworthiness of the customer. If the
Company determines that collection of an amount due is not
reasonably assured, then the Company defers recognition of
revenue until collection becomes reasonably assured.

The Companys right of return policy, which
is standard for virtually all sales, allows a customer the right
to return product for refund only if the product does not
conform to product specifications; the non-conforming product is
identified by the customer; and the customer rejects the
non-conforming product and notifies the Company within ten days
of receipt. If an agreement contains a non-standard right of
return, the Company defers recognizing revenue until the
conditions of the agreement are met. From time to time, the
Companys agreements include acceptance clauses. If an
agreement includes an acceptance clause, the revenue is recorded
at the time of acceptance.

Restructuring
Accruals

Continuing Operations:

During the third and fourth quarters of 2002, the
Company initiated certain restructuring plans. In conjunction
with these plans, the Company established a reserve account of
$324,000 for the estimated costs related to these plans. These
costs primarily relate to severance costs. The balance of the
reserve related to the 2002 restructuring was $69,000 at
December 31, 2002.

Discontinued Operations:

During the second and third quarters of 2001, the
Company initiated certain restructuring plans. In conjunction
with these restructuring plans, the Company established a
restructuring reserve account for the estimated costs related to
the plans. These costs primarily related to facilities closings,
severance costs and MessageClick ASP service exiting costs. For
the facilities closings cost, a reserve was established for all
remaining lease payments due on buildings and equipment that
were no longer being utilized in continuing operations, less
assumptions for sub-leases. The accrual for one of the leases
with total payments remaining of $2.7 million assumes that
the building will be sub-leased for 50% of the total lease
liability over the term of the lease. As of December 31,
2002, the Company had a remaining reserve balance of
approximately $2.0 million, which is included in
liabilities of discontinued operations. The Company currently
believes that this remaining estimated balance is appropriate to
cover future obligations associated with the restructurings.
Activity in the 2002 restructuring accruals was as follows:

|                          |  |   |       |  
|------------------------- |  | - | ----- | -
|Balance December 31, 2001 |  | $ | 2,730 |  
|Lease payments            |  |   | (996  | )
|Additional lease accrual  |  |   | 276   |  
|                          |  |   |       |  
|Balance December 31, 2002 |  | $ | 2,010 |  
|                          |  |   |       |  

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Deferred Tax
Asset Valuation Allowance

The Company currently has significant deferred
tax assets, which are subject to periodic recoverability
assessment. Realization of the Companys deferred tax
assets is principally dependant upon achievement of projected
future taxable income. The Companys judgments regarding
future profitability may change due to market conditions, its
ability to continue to successfully execute its strategic plan
and other factors. These changes, if any, may require possible
material adjustments to these deferred tax asset balances. Due
to the uncertainty of the Companys ability to recognize
the entire tax benefit, the Company established an offsetting
provision for the tax assets.

Litigation
and Related Contingencies

The Company is subject to proceedings, lawsuits
and other claims related to labor, product and other matters.
The Company is required to assess the likelihood of any adverse
judgments or outcomes to these matters, as well as, potential
ranges of probable losses. A determination of the amount of
reserves required, if any, for these contingencies is made by
the Company with assistance of its legal counsel after careful
analysis of each individual issue based upon the then-current
facts and circumstances and discussions with legal counsel. The
required reserves may change in the future due to new
developments in each matter or changes in approach such as a
change in settlement strategy in dealing with these matters.

Intangible
Assets

The Company has significant intangible assets
related to goodwill and other acquired intangibles. The
determination of related estimated useful lives and whether or
not these assets are impaired involves significant judgments.
Changes in strategy and/or market conditions could significantly
impact these judgments and require adjustments to recorded asset
balances. The Company assesses the recoverability of its
intangible assets by determining whether the value of goodwill
and other acquired intangible assets over their remaining life
can be recovered through undiscounted future operating cash
flows of the acquired operation. The amount of impairment, if
any, is measured based on projected discounted future operating
cash flows using a discount rate reflecting the Companys
average cost of funds. Effective January 1, 2002, the
Company adopted SFAS No. 142, which stipulates an
impairment test is to be performed annually that requires a
comparison of the fair value of an intangible asset with its
carrying amount. If the carrying amount of an intangible asset
exceeds its fair value, then an impairment loss shall be
recognized in an amount equal to that excess. Based on the
Companys analysis, there is no impairment of goodwill as
of December 31, 2002.

Liquidity and Capital Resources

Summary

Liquidity is the measurement of the
Companys ability to have adequate cash or access to cash
at all times in order to meet financial obligations when due, as
well as to fund corporate expansion and other activities.
Historically, the Company has met its liquidity requirements
through a combination of cash provided by debt from third party
lenders, issuances of debt and equity securities, sale of
discontinued businesses and acquisitions.

At December 31, 2002, the Company had a
positive working capital position (excess of current assets over
current liabilities) of $1.8 million compared to a negative
working capital position of $2.2 million at
December 31, 2001. The Companys cash and cash
equivalents totaled $1.3 million at December 31, 2002,
and $7.4 million at December 31, 2001. Total long-term
debt, including current portion, net of discount, was
$3.7 million at December 31, 2002 and $3.4 million at
December 31, 2001. At December 31, 2002, the Company
had borrowed $800,000 under its $5.0 million credit
facility with Silicon. The Companys remaining borrowing
availability under the credit facility at December 31,
2002, was $3.8 million.

On February 12, 2003, in connection with the
Companys acquisition of the assets of Clarent, the Company
amended its existing credit facility with Silicon, and in
connection therewith, the Company and Silicon entered into
certain amendments to the existing credit facility and certain
additional credit

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agreements. Such amendments and additional
agreements increased the Companys asset-based revolving
credit line from $5.0 million to $10.0 million and
include an EX-IM (export-import) facility that will provide for
working capital based on the Companys international
accounts receivable and inventory related to export sales
primarily associated with Clarents assets. The amendments
and additional agreements also extended the term of the credit
facility for 18 months (through August 13, 2004). On
April 7, 2003, the Company and Silicon further amended the
credit facility to increase the EX-IM facility and to modify
certain financial covenants related to the timing of the closing
of the Clarent Asset Purchase (as amended on February 12,
2003, and April 7, 2003, the Credit Agreement).


On February 12, 2003, the Company
consummated the Clarent Asset Purchase whereby the Company
purchased substantially all the business assets and assumed
certain related liabilities of Clarent for $9.8 million in
notes. At the closing of the Clarent Asset Purchase, the Company
issued three promissory notes to Clarent: a $5.0 million
secured note due February 13, 2004, which bears interest at
10% per annum, of which $500,000 is due May 13, 2003, and
the remainder is due in monthly installments increasing in
amount; a $1.8 million non-interest bearing unsecured note
due February 13, 2004, of which $300,000 is due
May 13, 2003 and the remainder is due in quarterly
installments of $500,000; and a $3.0 million secured note
due February 12, 2008, which bears interest at 5% per
annum. The assets the Company purchased from Clarent secure the
secured notes.

Cash
Flow

Cash used in the Companys continuing
operations in the year ended December 31, 2002 totaled
approximately $3.5 million compared with cash used in
continuing operations of $6.8 million for 2001. The
Companys use of cash in continuing operations during 2002
resulted primarily from cash used for changes in current
operating assets and liabilities of approximately $7.7 million
and was offset by cash provided from continuing operations of
$4.2 million (net loss from continuing operations of
$2.4 million reduced by non-cash charges totaling
$6.6 million, including depreciation and amortization of
$5.1 million and provision for doubtful accounts of
$1.8 million offset by an extraordinary item 
gain on early retirement of debt of $350,000). The
Companys use of cash in continuing operations during 2001
resulted primarily from a net loss of $11.5 million and
cash used for changes in current operating assets and
liabilities of approximately $4.4 million and was offset by
non-cash charges totaling $9.1 million (including
depreciation and amortization of $6.0 million, provision
for doubtful accounts of $1.5 million and an extraordinary
item  loss from debt conversion of $1.6 million).

Cash used in the Companys discontinued
operations in the year ended December 31, 2002, totaled
$1.1 million compared with cash used in discontinued
operations of $5.8 million for 2001.

The Company used cash in investing activities for
continuing operations in the year ended December 31, 2002
of approximately $1.8 million, compared to
$17.6 million for 2001. In 2002, the Company used $605,000
in cash in connection with its acquisition of a 51% interest in
BeTrue. In 2001, the Company used $16.1 million in cash
related to the acquisition of NACT and Telemate.Net. The Company
spent $889,000 and $1.4 million on capital expenditures in
2002 and 2001, respectively. The Company also invested $348,000
and $48,000 on purchased software development costs in 2002 and
2001, respectively.

During the year ended December 31, 2001, the
Company received net proceeds from sale of discontinued
operations totaling $8.1 million for the sale of its
restaurant solutions business.

Cash provided by financing activities from
continuing operations totaled approximately $317,000 in the year
ended December 31, 2002, compared to $11.3 million for
2001. Payments on the Note made by the Company in connection
with the acquisition of NACT totaling $3.9 million were
offset by net proceeds from a private placement of
$3.0 million, borrowings on the Companys credit line
of $800,000, proceeds from the issuance of the Common Stock
totaling $408,000 and payments on notes receivable from
shareholders totaling $24,000 in 2002. The proceeds from
issuance of the Companys Series B Preferred Stock to
Telemate.Net in connection with the acquisition of NACT totaling
$15.0 million and proceeds from the issuance of Common
Stock totaling $755,000 were offset by payments to repurchase
convertible subordinated debentures totaling $4.5 million
in 2001.

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Contractual Obligations and Commercial
Commitments

The following summarizes the Companys
future contractual obligations at December 31, 2002 (in
thousands):

|                                                            |                         |                        |        |           |  |           |       |           |  |         |       |       |  |   |       |       |  |   |       |       | 
|----------------------------------------------------------- | ----------------------- | ---------------------- | ------ | --------- |  | --------- | ----- | --------- |  | ------- | ----- | ----- |  | - | ----- | ----- |  | - | ----- | ----- | 
|                                                            |                         |                       
|                                                            |                         | Payments Due By Period
|                                                            |                         |                       
|                                                            |                         |                        |        | Less than |  |           |       | After    
|Contractual Obligations                                     |                         | Total                  |        | 1 year    |  | 1-3 years |       | 4-5 years |  | 5 years
|                                                            |                         |                        |        |           |  |           |       |           |  |        
|Line of credit                                              |                         |                        | 800    |           |  |           | 800   |           |  |         |      |       |  |   |      |       |  |   |      |      
|Additional payments for the acquisition of Encore
    Group |                         |                        | 2,403  |           |  |           | 1,275 |           |  |         | 884   |       |  |   | 244   |       |  |   |      |      
|Convertible subordinated debentures                         |                         |                        | 4,500  |           |  |           |      |           |  |         | 4,500 |       |  |   |      |       |  |   |      |      
|Operating Leases:                                           |                         |                        |        |           |  |           |       |           |  |         |       |       |  |   |       |       |  |   |       |      
|                                                            | Continuing operations   |                        |        | 14,401    |  |           |       | 2,165     |  |         |       | 4,069 |  |   |       | 4,041 |  |   |       | 4,126 | 
|                                                            | Discontinued operations |                        |        | 2,012     |  |           |       | 756       |  |         |       | 496   |  |   |       | 374   |  |   |       | 386   | 
|                                                            |                         |                        |        |           |  |           |       |           |  |         |       |       |  |   |       |       |  |   |       |      
|Total contractual cash obligations                          |                         | $                      | 24,116 |           |  | $         | 4,996 |           |  | $       | 9,949 |       |  | $ | 4,659 |       |  | $ | 4,512 |      
|                                                            |                         |                        |        |           |  |           |       |           |  |         |       |       |  |   |       |       |  |   |       |      

Sources of Cash

For 2003, the Company expects that its primary
sources of cash will be from cash on hand, working capital
provided by operating activities, borrowings under its Credit
Agreement with Silicon and other possible sources, including
issuances of equity or debt securities. The Company believes
that, with its current operations, which were cash flow positive
for the last five quarters, it will have sufficient liquidity
from these sources to meet its current financial obligations
through 2003. The Credit Agreement with Silicon, however, is
subject to certain financial covenants and limitations on the
Companys ability to access funds under the Credit
Agreement. If the Company is in violation of the Credit
Agreement, or does not have sufficient eligible accounts
receivable and inventory to support the level of borrowings it
may need, the Company may be unable to draw on the Credit
Agreement to the extent necessary. To the extent the Company
does not have borrowing availability under the Credit Agreement,
the Company may be required to obtain additional sources of
capital, sell assets, obtain an amendment to the Credit
Agreement or otherwise restructure its outstanding indebtedness.
If the Company is unable to obtain additional capital, sell
assets, obtain an amendment to the Credit Agreement or otherwise
restructure its outstanding indebtedness, then the Company may
not be able to meet its obligations.

The Companys short-term cash needs are to
cover working capital needs, including cash operating losses, if
any, capital expenditures, transaction costs related to the
acquisition of Clarents assets not paid in 2002, payments
on the secured and unsecured notes made by the Company in
connection with the Clarent Asset Purchase, totaling
approximately $4.8 million plus interest due
February 13, 2004, payments pursuant to the award of the
AAA panel in connection with the Assignment totaling
approximately $1.3 million, and payments related to
discontinued operations. At December 31, 2002, liabilities
of discontinued operations included $2.0 million in lease
payments related to discontinued operations. The Company expects
to pay out approximately $756,000 related to discontinued
operations in 2003.

The Companys long-term cash needs are
related to the costs of growing its current business as well as
prospective businesses to be acquired, including capital
expenditures and working capital. The Company expects to meet
these cash needs through cash from operations, if any, cash on
hand, borrowings under the Credit Agreement or other debt
facilities, if available, as well as through possible issuances
of equity or debt securities. If sufficient borrowing capacity
under a working capital line of credit is unavailable (or if the
Company is unable to restructure its existing Credit Agreement
in the event that the Company requires additional borrowing
capacity), or if the Company is otherwise unable to obtain
additional capital or sell assets, then the Company may not be
able to meet its obligations and growth plans.

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Risk Factors



| |                                                     
| | ----------------------------------------------------
| | The Company may be unable to fund future
    growth.

The Companys business strategy calls for
growth internally as well as through acquisitions. This growth
will require funding for additional personnel, capital
expenditures and other expenses, as well as for working capital
purposes. Financing may not be available to the Company on
favorable terms or at all. If adequate funds are not available
on acceptable terms, then the Company may not be able to meet
its business objectives for expansion. This in turn could harm
the Companys business, results of operations and financial
condition. In addition, if the Company raises additional funds
through the issuance of equity or convertible debt securities,
then the percentage of ownership of the Companys existing
shareholders will be reduced, and any new securities could have
rights, preferences and privileges senior to those of the Common
Stock. Furthermore, if the Company raises capital or acquires
businesses by incurring indebtedness, then the Company will
become subject to the risks associated with indebtedness,
including interest rate fluctuations and any financial or other
covenants that the Companys lender may require.



| |                                           
| | ------------------------------------------
| | The Company may not become
    profitable.

The Company has a history of net losses,
including net losses of approximately $2.7 million for the
fiscal year 2002, $147.6 million for the fiscal year 2001
and $55.5 million for the fiscal year 2000. As of
December 31, 2002, the Company had accumulated deficit of
approximately $254.9 million. The Companys revenues
may not increase, and the Company may never generate sufficient
revenues to achieve or sustain profitability.



| |                                                     
| | ----------------------------------------------------
| | The price of the Common Stock has been
    volatile.

The stock market in general, and the market for
technology companies in particular, has recently experienced
extreme volatility that has often been unrelated to the
operating performance of particular companies. From
January 1, 2002 to September 12, 2002, the per share
closing price of the Common Stock on the Nasdaq National Market
fluctuated from a high of $1.79 to a low of $0.26. From
September 13, 2002 to March 15, 2003, the per share
closing price of the Common Stock on the Nasdaq SmallCap Market
fluctuated from a high of $0.77 to a low of $0.26. The Company
believes that the volatility of the price of its Common Stock
does not necessarily relate to the Companys performance
and is broadly consistent with volatility experienced in the
Companys industry. Fluctuations may occur, among other
reasons, in response to operating results, announcements by
competitors, regulatory changes, economic changes, market
valuation of technology firms, and general market conditions.
Additionally, the Companys operating results in one or
more future quarters may fall below the expectations of
securities analysts and investors, which would likely cause the
trading price of the Common Stock to decline. The trading price
of the Common Stock could continue to be subject to wide
fluctuations in response to these or other factors, many of
which are beyond the Companys control. If the market price
of the Common Stock decreases, then shareholders may not be able
to sell their shares of Common Stock at a profit.



| |                                                                                                                             
| | ----------------------------------------------------------------------------------------------------------------------------
| | The low price of the Common Stock could
    result in the delisting of the Common Stock from the Nasdaq
    SmallCap Market.

The Common Stock is currently quoted on the
Nasdaq SmallCap Market. The Company must satisfy certain minimum
listing maintenance requirements to maintain such quotation,
including a series of financial tests relating to net tangible
assets, public float, number of market makers and shareholders,
market capitalization, and maintaining a minimum bid price of
$1.00 per share for the Common Stock. In the past, the Company
has had difficulty maintaining the minimum bid price for the
Common Stock.

Prior to September 13, 2002, the Common
Stock was quoted on the Nasdaq National Market. On June 6,
2002, the Nasdaq National Market notified the Company that the
bid price of the Common Stock had closed at less than $1.00 per
share over the previous 30 consecutive trading days, and as a
result, the Company did not comply with the minimum bid price
continued listing requirement of the Nasdaq National Market. The
Company was then provided 90 calendar days, or until
September 4, 2002, to regain compliance with the

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minimum bid price requirement. The Company was
unable to regain compliance, and on September 13, 2002, the
Company transferred the Common Stock to the Nasdaq SmallCap
Market. The Company was afforded the remainder of the 180
calendar day grace period established by the Nasdaq SmallCap
Market, or until December 3, 2002, to regain compliance
with the minimum $1.00 bid price per share requirement. Although
the Company did not regain compliance of the minimum bid price
per share requirement by December 3, 2002, the Company did
meet the Nasdaq SmallCap Markets other listing
requirements and was given until June 2, 2003, to regain
compliance with the minimum bid price requirement. Recently, the
Nasdaq Small Cap Market granted the Company an additional
90 days to regain compliance with the $1.00 minimum bid
price requirement, giving the Company until September 2,
2003, to regain compliance. Although the Nasdaq Stock Market
currently has a proposal before the SEC that would grant an
additional grace period to companies with bid price
deficiencies, there can be no assurances that the SEC will
approve such proposal.


If the Company is not able to regain compliance
with the minimum bid price requirement by September 2,
2003, then the Common Stock may be delisted from the Nasdaq
SmallCap Market. If the Common Stock is delisted from the Nasdaq
SmallCap Market, then the Common Stock may trade on the
Over-the-Counter-Bulletin Board, or its successor, the Bulletin
Board Exchange, both of which are viewed by most investors as
less desirable and less liquid market places. Delisting from the
Nasdaq SmallCap Market could make trading the Common Stock more
difficult for the Companys investors, leading to further
declines in share price. Delisting of the Common Stock would
also make it more difficult and expensive for the Company to
raise additional capital. Furthermore, delisting of the Common
Stock is an event of default under the Companys
outstanding convertible debentures and, through certain cross
default provisions, the Loan and Security Agreement the Company
entered into with Clarent in connection with the Clarent Asset
Purchase and the Credit Agreement with Silicon.

Historically
low trading volume in the Common Stock may affect shareholder
liquidity.

The trading volume of the Common Stock has been
low historically. As of March 15, 2003, there were
approximately 89.6 million shares of Common Stock issued
and outstanding; however, there can be no assurance that there
will be an active market for the Common Stock. Low trading
volume may result in shareholders being unable to sell shares of
Common Stock at the times and at the prices they desire.

The Company
is exposed to the general condition of the telecommunications
market.

The Companys business is subject to global
economic conditions, and in particular, market conditions in the
telecommunications industry. The Companys operations could
be adversely affected if declines in capital spending from
telecommunications service providers continue. If global
economic conditions worsen, or if there is a prolonged slowdown
in the telecommunications industry, then the Company may
experience adverse operating results.

The market
for next generation communications solutions is new and evolving
and, if this market does not develop as the Company expects,
then it could have a material adverse effect on the
Companys business.

While the Company believes there is a significant
growth opportunity in providing next generation communications
solutions to communications service providers, there can be no
assurances that this technology will be widely accepted or that
a viable market for the Companys products will fully
develop or be sustainable. If this market does not develop, or
develops more slowly than the Company expects, then the Company
may not be able to sell its products in significant volume, or
at all.

Further, the Company believes that, with the its
recent acquisitions, it is positioned to succeed in leveraging
the competencies acquired with these acquisitions to develop
solutions for communication service providers. However, because
of the intense competition in the market and the recent
introduction of this technology, there can be no assurance that
the Company will succeed in this evolving marketplace.

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Intellectual
property infringement claims against the Company, even without
merit, could require the Company to enter into costly licenses
or deprive the Company of the technology it needs.

The Companys industry is technology
intensive. As the number of competitors in the Companys
target markets increases and the functionality of the software
products produced by such competitors further overlaps, third
parties may claim that the technology the Company develops or
licenses infringes their proprietary rights. Any claims against
the Company or any of the Companys subsidiaries may affect
the Companys business, results of operations and financial
conditions. Any infringement claims, even those without merit,
could require the Company to pay damages or settlement amounts
or could require the Company to develop non-infringing
technology or enter into costly royalty or licensing agreements
to avoid service implementation delays. Any litigation or
potential litigation could result in product delays, increased
costs or both. In addition, the cost of litigation and the
resulting distraction of the Companys management resources
could have a material adverse effect on the Companys
business, results of operations and financial condition. If
successful, a claim of product infringement could deprive the
Company of the technology the Company needs altogether.

Failure to
protect the Companys intellectual property rights could
have a material adverse effect on the Companys
business.

The Companys success depends in part upon
the protection of the Companys proprietary application
software and hardware products. The Company has taken steps that
it believes are adequate to establish, protect and enforce its
intellectual property rights. The Company cannot assure
potential investors or shareholders that its efforts to
safeguard and maintain its proprietary rights will be adequate.
Despite the Companys efforts to protect the Companys
proprietary rights, unauthorized parties may attempt to copy or
otherwise to use the Companys products or technology.

The Company has pending several patent
applications related to the Companys VoIP product and
several patent applications which the Company acquired in
connection with the Clarent Asset Purchase related to system
architecture for Internet telephone, interaction of VoIP calls
and cellular networks, real-time addition of devices to a
subscriber accounting, and system and method applications for
electronic transaction settlement and dynamic changes error
correction . There can be no assurance that these patents will
be issued. Even if these patents are issued, the limited legal
protection afforded by patent, trademark, trade secret and
copyright laws may not be sufficient to protect the
Companys proprietary rights.

Furthermore, the laws of many foreign countries
in which the Company does business do not protect intellectual
property rights to the same extent or in the same manner as do
the laws of the United States. Although the Company has
implemented and will continue to implement protective measures
in those countries, these efforts may not be successful.
Additionally, even if the Companys domestic and
international efforts to protect its intellectual property
rights are successful, the Companys competitors may
independently develop non-infringing technologies that are
substantially similar or superior to the Companys
technologies.

If the
Companys products contain defects, then the Companys
sales are likely to suffer and the Company may be exposed to
legal claims.

The Companys business strategy calls for
the development of new products and product enhancements which
may from time to time contain defects or result in failures that
the Company did not detect or anticipate when introducing such
products or enhancements to the market. In addition, the markets
in which the Companys products are used are characterized
by a wide variety of standard and non-standard configurations
and by errors, failures and bugs in third-party platforms that
can impede proper operation of the Companys products.
Despite testing by the Company, defects may still be discovered
in some new products or enhancements after the products or
enhancements are delivered to customers. The occurrence of these
defects could result in product returns, adverse publicity, loss
of or delays in market acceptance of the Companys
products, delays or cessation of service to the Companys
customers, and legal claims by customers against the Company.

29



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To the extent that contractual provisions that
limit the Companys exposure to legal claims are
unenforceable or such claims are not covered by insurance, a
successful products liability claim could have a material
adverse effect on the Companys business, results of
operations and financial condition.

The Company
may be obligated to indemnify customers who purchase or lease
equipment from the Company against claims of patent
infringement.

In the course of the Companys business, the
Company may sell or lease certain equipment to the
Companys customers, and in connection with such sale or
lease, the Company may agree to indemnify these customers from
claims made against them by third parties for patent
infringement related to such equipment. If the Company is
required to make any payments in respect of these
indemnification obligations, then it could have a material
adverse effect on the Companys business, results of
operations and financial condition.

The
Companys growth could be limited if the Company is unable
to attract and retain qualified personnel.

The Company believes that its success depends
largely on its ability to attract and retain highly skilled and
qualified technical, managerial and marketing personnel.
Competition for highly skilled engineering, sales, marketing and
support personnel is intense because there is a limited number
of people available with the necessary technical skills and
understanding of the Companys markets. Workforce
reductions by the Company during 2000, 2001, 2002 and 2003 may
adversely affect the Companys ability to retain its
current employees and recruit new employees. The inability to
hire or retain qualified personnel could hinder the
Companys ability to implement the Companys business
strategy and harm the Companys business.

The Company
has incurred significant debt in connection with the
consummation of the Clarent Asset Purchase, and as a result, the
Company has become subject to risks associated with
indebtedness.

The Company funded the $9.8 million purchase
price of the Clarent Asset Purchase using debt financing,
$6.8 million of which will mature, and must be repaid with
interest by the Company, in installments beginning May 13,
2003, through February 13, 2004. In addition to incurring
such additional principal indebtedness, the Company has incurred
interest expense with respect to such indebtedness. As a result
of such additional principal indebtedness and interest expense,
the Company is subject to risks associated with indebtedness
including certain financial and other covenants required by the
Companys lender, and the risk that such additional
principal indebtedness and interest expense could have an
adverse effect on the market price of the Common Stock and the
Companys ability to fund future growth.

The new
softswitch and communication products which the Company intends
to offer may not achieve acceptance in the
marketplace.

As a result of the consummation of the Clarent
Asset Purchase, the Company is now able to offer products which
it could not offer previously, including Class 5 softswitch
products and satellite communication products. The markets for
these products are relatively new, unpredictable and evolving
rapidly. Lack of acceptance in the marketplace for these new
products could have a material adverse effect on the
Companys business, results of operations and financial
condition.

The
Company expects to conduct business in new geographic markets
which will subject the Company and its business to new
regulation and legislation and risks associated with foreign
currency fluctuations.

As a result of the consummation of the Clarent
Asset Purchase, the Company has an operational presence in
Canada which the Company did not have previously. Furthermore,
although customers outside the United States and Canada have
historically accounted for a large portion of Clarents
revenues, the Company expects to conduct an even greater portion
of its business in Europe than Clarent conducted. Consequently,
the Company now has the additional responsibility of complying
with the legislation and regulation in these new geographic
markets. Failure of the Company to comply with such regulation
and legislation could have a material adverse effect on the
Companys business, results of operations and financial
condition. Additionally, increasing the amount of business that
the Company conducts outside the United States increases the

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Companys exposure to risks associated with
foreign currency fluctuations, which risks could have a material
adverse effect on the Companys business, results of
operations and financial condition.


The
Company may become subject to certain patent infringement claims
with respect to certain assets and technology purchased from
Clarent.

Pursuant to the Clarent Asset Purchase, the
Company purchased from Clarent assets and technology related to
Clarents Sky Performer product, which has been the subject
of certain patent infringement claims made against Clarent. If
such patent infringement claims are made against the Company in
the future, even if such claims do not have merit, then the
Company could be required to pay damages or settlement amounts
or could be required to develop non-infringing technology or
enter into costly royalty or licensing agreements. Any
litigation could result in increase product costs, service
delays or both. If successful, a claim of product infringement
could deprive the Company of the assets and technology related
to the Sky Performer product.

The Company
may be subject to litigation.

The Company may be subject to claims involving
how the Company conducts its business or the market for or
issuance of its Common Stock or other securities. Any such
claims against the Company may affect the Companys
business, results of operations and financial conditions. Such
claims, even those without merit, could require the Company to
pay damages or settlement amounts and would require a
substantial amount of time and attention from the Companys
senior management as well as considerable legal expenses.
Although the Company does not anticipate that its activities
would warrant such claims, there can be no assurances that such
claims will not be made.

Item
7A.     Quantitative and Qualitative
Disclosures About Market Risk

Market and Interest Rate Risks

The Company is exposed to various market risks,
including changes in interest rates. Market risk is the
potential loss arising from adverse changes in market rates and
prices, such as interest rates. The Company does not enter into
derivatives or other financial instruments for trading or
speculative purposes. The Company has also not entered into
financial instruments to manage and reduce the impact of changes
in interest rates, although the Company may enter into such
transactions in the future.

At December 31, 2002, the Companys
outstanding debt, primarily consisting of convertible
subordinated debentures (see Note 7 to the consolidated
financial statements included elsewhere in this Annual Report),
carries interest rates which are fixed. In addition, the Company
has $800,000 outstanding under its Credit Agreement with
Silicon. If interest rates increase or decrease by 1%, then the
Companys interest expense would increase or decrease,
respectively, by $8,000.

Item
8.     Financial Statements and
Supplementary Data

The financial statements required to be filed
with this Annual Report are filed under Item 15 hereof and
are listed on the Index to Consolidated Financial
Statements on page F-1 hereof.

Quarterly Financial Data (Unaudited)

The following table presents unaudited quarterly
statements of operations data for each quarter of the
Companys last two completed fiscal years. The unaudited
quarterly financial statements have been prepared on
substantially the same basis as the audited financial statements
contained elsewhere in this Annual Report. In the opinion of the
Companys management, the unaudited financial statements
include all adjustments, consisting only of normal recurring
adjustments, that management considers to be necessary to fairly
present this information when read in conjunction with the
Companys consolidated financial statements and related

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notes appearing elsewhere in this Annual Report.
The results of operations for any quarter are not necessarily
indicative of the results to be expected for any future period.


|     |                                                               |                                          |                   |         |       |         |   |            |       |          |   |        |       |         |   |        |       |         |   |        |       |          |  
|---- | ------------------------------------------------------------- | ---------------------------------------- | ----------------- | ------- | ----- | ------- | - | ---------- | ----- | -------- | - | ------ | ----- | ------- | - | ------ | ----- | ------- | - | ------ | ----- | -------- | -
|     |                                                               | First                                    |                   | Second  |       | Third   |   | Fourth     |       | Total   
|     |                                                               | Quarter(1)                               |                   | Quarter |       | Quarter |   | Quarter(2) |       | Year    
|     |                                                               |                                          |                   |         |       |         |   |            |       |         
|     |                                                               |                                         
|     |                                                               | (In thousands, except per share amounts)
|2002 |                                                               |                                          |                   |         |       |         |   |            |       |          |   |        |       |         |   |        |       |         |   |       
|     | Revenue                                                       |                                          | $                 | 11,994  |       |         | $ | 11,671     |       |          | $ | 10,412 |       |         | $ | 10,721 |       |         | $ | 44,798 |      
|     | Gross profit                                                  |                                          |                   | 7,045   |       |         |   | 6,878      |       |          |   | 5,852  |       |         |   | 6,574  |       |         |   | 26,349 |      
|     | Sales, general and administrative                             |                                          |                   | 4,877   |       |         |   | 4,862      |       |          |   | 3,947  |       |         |   | 4,300  |       |         |   | 17,986 |      
|     | Research and development                                      |                                          |                   | 1,675   |       |         |   | 1,464      |       |          |   | 1,455  |       |         |   | 1,280  |       |         |   | 5,874  |      
|     | Operating loss from continuing operations                     |                                          |                   | (735    | )     |         |   | (635       | )     |          |   | (719   | )     |         |   | (241   | )     |         |   | (2,330 | )    
|     | Loss from continuing operations before
    extraordinary item |                                          |                   | (859    | )     |         |   | (599       | )     |          |   | (1,019 | )     |         |   | (268   | )     |         |   | (2,745 | )    
|     |                                                               |                                          |                   |         |       |         |   |            |       |          |   |        |       |         |   |        |       |         |   |       
|     |                                                               |                                          | Net (loss) income |         | $     | (1,190  | ) |            | $     | (599     | ) |        | $     | (1,019  | ) |        | $     | 82      |   |        | $     | (2,726   | )
|     |                                                               |                                          |                   |         |       |         |   |            |       |          |   |        |       |         |   |        |       |         |   |       
|     | Net loss per common share  basic and
    diluted:(3)         |                                          |                   |         |       |         |   |            |       |          |   |        |       |         |   |        |       |         |   |        |      
|     | Loss from continuing operations before
    extraordinary item |                                          | $                 | (0.01   | )     |         | $ | (0.01      | )     |          | $ | (0.01  | )     |         | $ |       |       |         | $ | (0.03  | )    
|     | Loss from discontinued operations                             |                                          |                   | (0.01   | )     |         |   |           |       |          |   |       |       |         |   |       |       |         |   |       |      
|     | Loss on disposal of discontinued operations                   |                                          |                   |        |       |         |   |           |       |          |   |       |       |         |   |       |       |         |   |       |      
|     | Extraordinary item                                           |                                          |                   |         |       |         |   |            |       |          |   |        |       |         |   |        |       |         |   |        |      
|     |                                                               | Gain on early retirement of debt         |                   |         |      |         |   |            |      |          |   |        |      |         |   |        |      |         |   |        |      |         
|     |                                                               |                                          |                   |         |       |         |   |            |       |          |   |        |       |         |   |        |       |         |   |       
|     |                                                               | Net loss per common share                |                   | $       | (0.02 | )       |   | $          | (0.01 | )        |   | $      | (0.01 | )       |   | $      |      |         |   | $      | (0.03 | )       
|     |                                                               |                                          |                   |         |       |         |   |            |       |          |   |        |       |         |   |        |       |         |   |       
|2001 |                                                               |                                          |                   |         |       |         |   |            |       |          |   |        |       |         |   |        |       |         |   |       
|     | Revenue                                                       |                                          | $                 | 4,162   |       |         | $ | 5,495      |       |          | $ | 8,322  |       |         | $ | 11,920 |       |         | $ | 29,899 |      
|     | Gross profit                                                  |                                          |                   | 1,813   |       |         |   | 1,415      |       |          |   | 4,363  |       |         |   | 7,496  |       |         |   | 15,087 |      
|     | Sales, general and administrative                             |                                          |                   | 3,257   |       |         |   | 2,423      |       |          |   | 3,814  |       |         |   | 6,020  |       |         |   | 15,514 |      
|     | Research and development                                      |                                          |                   | 219     |       |         |   | 273        |       |          |   | 904    |       |         |   | 1,359  |       |         |   | 2,755  |      
|     | Operating loss from continuing operations                     |                                          |                   | (2,936  | )     |         |   | (2,513     | )     |          |   | (1,957 | )     |         |   | (1,213 | )     |         |   | (8,619 | )    
|     | Loss from continuing operations before
    extraordinary item |                                          |                   | (3,178  | )     |         |   | (2,677     | )     |          |   | (2,443 | )     |         |   | (1,579 | )     |         |   | (9,877 | )    
|     |                                                               |                                          |                   |         |       |         |   |            |       |          |   |        |       |         |   |        |       |         |   |       
|     |                                                               |                                          | Net loss          |         | $     | (18,008 | ) |            | $     | (105,701 | ) |        | $     | (12,905 | ) |        | $     | (11,001 | ) |        | $     | (147,615 | )
|     |                                                               |                                          |                   |         |       |         |   |            |       |          |   |        |       |         |   |        |       |         |   |       
|     | Net loss per common share  basic and
    diluted:(3)         |                                          |                   |         |       |         |   |            |       |          |   |        |       |         |   |        |       |         |   |        |      
|     | Loss from continuing operations before
    extraordinary item |                                          | $                 | (0.07   | )     |         | $ | (0.05      | )     |          | $ | (0.05  | )     |         | $ | (0.02  | )     |         | $ | (0.18  | )    
|     | Loss from discontinued operations                             |                                          |                   | (0.26   | )     |         |   | (2.02      | )     |          |   | (0.19  | )     |         |   | (0.15  | )     |         |   | (2.49  | )    
|     | Loss on disposal of discontinued operations                   |                                          |                   |        |       |         |   |           |       |          |   | (0.01  | )     |         |   |       |       |         |   | (0.01  | )    
|     | Extraordinary item  loss from
    debt conversion            |                                          |                   | (0.03   | )     |         |   |           |       |          |   |       |       |         |   |       |       |         |   | (0.03  | )    
|     |                                                               |                                          |                   |         |       |         |   |            |       |          |   |        |       |         |   |        |       |         |   |       
|     |                                                               | Net loss per common share                |                   | $       | (0.36 | )       |   | $          | (2.07 | )        |   | $      | (0.25 | )       |   | $      | (0.17 | )       |   | $      | (2.71 | )       
|     |                                                               |                                          |                   |         |       |         |   |            |       |          |   |        |       |         |   |        |       |         |   |       



---



|    |                                                                                                                                     
|--- | ------------------------------------------------------------------------------------------------------------------------------------
|(1) | First quarter 2001 net loss includes an extra
    ordinary item  loss from debt conversion totaling
    $1.6 million.              
|   
|(2) | Fourth quarter 2002 net income includes an extra
    ordinary item  gain on early retirement of debt of
    approximately $350,000.

32



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##### Table of Contents





|    |                                                                                                                                                                                                                                                               
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(3) | Per common share amounts for the quarters and
    full years have been calculated separately. Accordingly,
    quarterly amounts may not add to the annual amounts because of
    differences in the average common shares outstanding during each
    period.






|        |                                                                                         
|------- | ----------------------------------------------------------------------------------------
|Item 9. | Changes in and Disagreements With
    Accountants on Accounting and Financial Disclosure

None.




PART III




Item
10.     Directors and Executive
Officers of the Registrant

Board of Directors

Set forth below is certain information, as of
March 15, 2003, concerning each of the directors of the
Company. Each of the individuals listed below shall serve as a
director of the Company until the next annual meeting of the
Companys shareholders and until their successors have been
elected and qualified, or until their resignation, death or
removal.

|                      |  |     |    |          |  |                                                                                         
|--------------------- |  | --- | -- | -------- |  | ----------------------------------------------------------------------------------------
|Name                  |  | Age |    | Position
|                      |  |     |    |         
|Gary H. Heck          |  |     | 58 |          |  | Director                                                                                
|James M. Logsdon      |  |     | 56 |          |  | Director, President and Chief Operating Officer                                         
|Amy L. Newmark        |  |     | 45 |          |  | Director                                                                                
|Steven A. Odom        |  |     | 49 |          |  | Director, Chairman of the Board and Chief
    Executive Officer                         
|Stephen E. Raville    |  |     | 55 |          |  | Director                                                                                
|Juliet M. Reising     |  |     | 52 |          |  | Director, Executive Vice President, Chief
    Financial Officer, Secretary and Treasurer
|Joseph R. Wright, Jr. |  |     | 64 |          |  | Director                                                                                

Certain additional information concerning the
individuals named above is set forth below:

Gary H. Heck,age
58, has served as a director of the Company since September
2000. From January 2000 to September 2000, Mr. Heck served
as a director of Cereus. Mr. Heck has been a consultant
since 1989, most recently serving as a Managing Partner and a
co-founder of PacifiCom, a consulting services company. From
1987 until 1989, Mr. Heck was President and Chief Executive
Officer of Telematics Products, Inc., a telecommunications
products company. From 1983 until 1987, Mr. Heck held
various executive positions at Pacific Telesis Corporation, one
of the nations largest Regional Bell Operating Companies,
and completed his tenure as a corporate officer of several
subsidiaries of Pacific Telesis and as Chief Executive Officer
of PacTel Products Corporation. From 1977 until 1983,
Mr. Heck was a Division Manager and District Manager at
AT&T Corporation, where he was responsible for sales and
marketing programs. From 1967 until 1977, Mr. Heck held
various positions at Pacific Telephone & Telegraph.

Amy L. Newmark,age
45, has served as a director of the Company since September
2000. From January 2000 to September 2000, Ms. Newmark
served as a director of Cereus. Ms. Newmark is a private
investor in the technology, Internet and telecommunications
fields. From 1995 to 1997, she served as Executive Vice
President of Strategic Planning at Winstar Communications, Inc.
Prior to 1995, Ms. Newmark served as the general partner of
Information Age Partners, L.P., a hedge fund investing primarily
in technology and emerging growth companies. Before that, Ms.
Newmark was a securities analyst specializing in
telecommunications and technology companies. Ms. Newmark is
also a director of U.S. Wireless Data, Inc. and ParkerVision,
Inc.

Stephen E. Raville,age 55, has served as a director of the Company since October
1997. Mr. Raville also currently serves as a member of the
Companys audit committee. Since 1996, Mr. Raville
served as Chief

33



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##### Table of Contents



Executive Officer and Chairman of the Board of
Telscape Communications, Inc. Mr. Raville is also President
and controlling shareholder of First Southeastern Corporation, a
private investment company he formed in 1992. In 1983,
Mr. Raville founded TA Communications, a long-distance
telephone company, and served as its President, Chief Executive
Officer and Chairman of the Board. In 1985, in conjunction with
a merger between TA Communications and Advanced
Telecommunications Corporation, Mr. Raville became Chairman
and Chief Executive Officer of Advanced Telecommunications until
the merger of Advanced Telecommunications into MCI WorldCom,
Inc. in late 1992.


Joseph R. Wright,
Jr., age 64, has served as a director
of the Company since September 2000. Mr. Wright also
currently serves as a member of the Companys audit
committee. From January 2000 to September 2000, Mr. Wright
served as a director of Cereus. Mr. Wright is presently
President and Chief Executive Officer of PanAmSat Corp., a
provider of global satellite-based communications services,
servicing news organizations, telecommunications companies,
DirectTV services, Internet networks and others around the
globe. In the six years prior to taking these positions in 2001,
Mr. Wright served as Vice Chairman of Terremark Worldwide,
Inc., a public company that develops and operates Network Access
Point centers in the United States and Brazil. Mr. Wright also
served as Chairman and director of GRC International, Inc., a
public company that provides advanced Internet and software
technologies to government and commercial customers
(GRC). In March 2000, GRC was acquired by AT&T
Corp. From 1989 through 1994, Mr. Wright also served as a
Co-Chairman and a director of Baker & Taylor Holdings, Inc.,
an international book/video/software distribution and e-commerce
company. Mr. Wright also served as Vice Chairman, Executive
Vice President and director of W.R. Grace & Company, a
specialty chemicals and healthcare company, Chairman of Grace
Energy Company, and President of Grace Environmental Company. He
served as Deputy Director, then Director, of the Federal Office
of Management and Budget under President Reagan, serving in the
Cabinet and the Executive Office of the President from 1982 to
1989. He also served as Deputy Secretary of the Department of
Commerce from 1981 to 1982. Mr. Wright previously held
positions as President of two of Citibanks subsidiaries,
as a partner of Booze Allen and Hamilton and in various
management and economic positions in the Federal Departments of
Commerce and Agriculture. In addition, Mr. Wright currently
serves on the Board of Advisors/Directors of Terramark
Worldwide, Inc., Titan Corporation, Baker & Taylor Holdings,
Inc., Jefferson Consulting Group, AT&T Government Markets,
Proxim Corp. and Barington Capital.

The biographical information for
Messrs. Odom and Logsdon and Ms. Reising is set forth
in Item 4.5 of Part I of this Annual Report.

As a condition to completing the Companys
acquisition of Telemate.Net, the Board was required to appoint,
as of the effective time of such acquisition, two additional
directors to serve on the Board who were selected by
Telemate.Net and reasonably acceptable to the Board. In
satisfaction of such condition, the Board appointed
Murali Anantharaman and Richard L. Mauro as directors of
the Company effective November 16, 2001, the date the
acquisition of Telemate.Net was consummated. Mr. Mauro and
Mr. Anantharaman resigned as directors of the Company on
February 19, 2002, and March 27, 2003, respectively.

There are no family relationships among any of
the executive officers or directors of the Company. Except as
disclosed above, no arrangement or understanding exists between
any director and any other person pursuant to which any director
was selected to serve as a director. To the best of the
Companys knowledge, (i) there are no material
proceedings to which any director of the Company is a party, or
has a material interest, adverse to the Company; and
(ii) there have been no events under any bankruptcy act, no
criminal proceedings and no judgments or injunctions that are
material to the evaluation of the ability or integrity of any of
the directors during the past five years.

Executive Officers

The information with respect to the
Companys executive officers is set forth in Item 4.5
of Part I of this Annual Report.

34



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##### Table of Contents



Section 16(a) Beneficial Ownership
Reporting Compliance

Section 16(a) of the Exchange Act requires
the Companys directors and executive officers, and all
persons (Reporting Persons) who beneficially own
more than 10% of the outstanding shares of Common Stock, to file
with the SEC initial reports of ownership and reports of changes
in ownership of the Common Stock and other equity securities of
the Company. Reporting Persons are also required to furnish the
Company with copies of all Section 16(a) forms they file.
To the Companys knowledge, based solely upon a review of
the copies of such forms furnished to the Company for the year
ended December 31, 2002, and the information provided to the
Company by Reporting Persons of the Company, no Reporting Person
failed to file the forms required by Section 16(a) of the
Exchange Act on a timely basis, except Ms. Reising did not
file a Form 4 reporting the acquisition of 86,207 shares of
Common Stock on October 1, 2002 until October 23, 2002.




Item 11.     Executive
Compensation

Director Compensation

The Company reimburses directors for
out-of-pocket expenses incurred in attending Board or committee
meetings. In addition, non-employee directors are eligible to
receive grants of stock options under the Companys 1999
Stock Incentive Plan.

Compensation of Executive Officers

The following table sets forth the cash and
non-cash compensation for each of the last three fiscal years
awarded to or earned by each person who served as the Chief
Executive Officer of the Company during the year ended December
31, 2002, as well as for other executive officers of the Company
and its subsidiaries whose salary and bonus exceeded $100,000
during the year ended December 31, 2002 (the Named
Executive Officers).

Summary Compensation Table

|                            |                              |      |      |                     |  |            |         |                        |  |                 |   |         |  |  |         |         |  |   |   |   | 
|--------------------------- | ---------------------------- | ---- | ---- | ------------------- |  | ---------- | ------- | ---------------------- |  | --------------- | - | ------- |  |  | ------- | ------- |  | - | - | - | 
|                            |                              |      |      |                     |  |            |         | Long-Term Compensation |  |                
|                            |                              |      |      |                     |  |            |         |                       
|                            |                              |      |      | Annual Compensation |  | Securities |         |                       
|                            |                              |      |      |                     |  | Underlying |         | All Other             
|Name and Principal Position |                              | Year |      | Salary($)           |  | Bonus($)   |         | Options(#)(1)          |  | Compensation($)
|                            |                              |      |      |                     |  |            |         |                        |  |                
|Steven A. Odom              |                              |      | 2002 |                     |  | $          | 443,180 |                        |  | $               |  |         |  |  |        |         |  | $ |  |  
|                            | Chief Executive Officer(2)   |      |      | 2001                |  |            |         | 431,250                |  |                 |   | 225,000 |  |  |         |        |  |   |   |  | 
|                            |                              |      |      | 2000                |  |            |         |                       |  |                 |   |        |  |  |         | 725,000 |  |   |   |  | 
|James M. Logsdon            |                              |      | 2002 |                     |  |            | 266,180 |                        |  |                 |  |         |  |  |        |         |  |   |  |  
|                            | President and                |      |      | 2001                |  |            |         | 270,000                |  |                 |   | 85,000  |  |  |         |        |  |   |   |  | 
|                            | Chief Operating Officer(3)   |      |      | 2000                |  |            |         | 58,333                 |  |                 |   |        |  |  |         | 95,000  |  |   |   |  | 
|Juliet M. Reising           |                              |      | 2002 |                     |  |            | 258,680 |                        |  |                 |  |         |  |  | 437,500 |         |  |   |  |  
|                            | Executive Vice President and |      |      | 2001                |  |            |         | 225,000                |  |                 |   | 112,500 |  |  |         |        |  |   |   |  | 
|                            | Chief Financial Officer(4)   |      |      | 2000                |  |            |         | 58,333                 |  |                 |   |        |  |  |         | 50,000  |  |   |   |  | 



---



|    |                                                                                                                                                                                                                                                                                                     
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | The exercise prices of all options granted to the
    Named Executive Officers are equal to or greater than the fair
    market value of the Common Stock on the dates such options were
    granted.                                                                                               
|   
|(2) | Mr. Odom became the Chief Executive Officer
    of the Company in September 2000. Pursuant to the terms of
    Mr. Odoms employment agreement, he received stock
    options in lieu of cash compensation for 2000. See the section
    of this Annual Report titled  Employment
    Agreements.
|   
|(3) | Mr. Logsdon became the President and Chief
    Operating Officer of the Company in September 2000. See the
    section of this Annual Report titled
     Employment Agreements.                                                                                                                  
|   
|(4) | Ms. Reising became the Executive Vice
    President and Chief Financial Officer of the Company in
    September 2000. See the section of this Annual Report entitled
     Employment Agreements.                                                                                                 

35



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##### Table of Contents



Option Grants in Last Fiscal Year

The following table sets forth information with
respect to options granted under the Companys 1999 Stock
incentive Plan to the Named Executive Officers for the year
ended December 31, 2002.

|                     |  |                   |         |              |  |                |      |              |  |    |      |     |  |  |        |  |  |  |       |  |  |  |       | 
|-------------------- |  | ----------------- | ------- | ------------ |  | -------------- | ---- | ------------ |  | -- | ---- | --- |  |  | ------ |  |  |  | ----- |  |  |  | ----- | 
|                     |  |                  
|                     |  | Individual Grants
|                     |  |                  
|                     |  |                   |         |             
|                     |  |                   |         | Potential   
|                     |  |                   |         | Realizable  
|                     |  |                   |         | Value at    
|                     |  |                   |         | Assumed     
|                     |  |                   |         | Annual Rates
|                     |  |                   |         | of Stock    
|                     |  |                   |         | Percent of   |  |                |      | Price       
|                     |  | Number of         |         | Total        |  |                |      | Appreciation
|                     |  | Securities        |         | Options      |  |                |      | for Option  
|                     |  | Underlying        |         | Granted to   |  |                |      | Term(1)     
|                     |  | Options           |         | Employees    |  | Exercise Price |      | Expiration   |  |   
|Name                 |  | Granted           |         | in 2002      |  | (per share)    |      | Date         |  | 5% |      | 10%
|                     |  |                   |         |              |  |                |      |              |  |    |      |    
|Steven A. Odom       |  |                   |        |              |  |                |     |              |  |    |     |     |  |  |       |  |  |  |      |  |  |  |      | 
|James M. Logsdon     |  |                   |        |              |  |                |     |              |  |    |     |     |  |  |       |  |  |  |      |  |  |  |      | 
|Juliet M. Reising(2) |  |                   | 437,500 |              |  |                | 30.0 | %            |  | $  | 2.14 |     |  |  | 8/2/12 |  |  |  | $0.85 |  |  |  | $1.35 | 



---



|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Amounts represent certain assumed rates of
    appreciation as set forth by the rules of the SEC. Actual gains,
    if any, on stock option exercises are dependent on the future
    performance of the Common Stock and overall market conditions.
    The amounts reflected in this table may not necessarily be
    achieved.                                                                                                                                            
|   
|(2) | On August 2, 2002, the Company granted
    Ms. Reising a non-qualified stock option to purchase
    437,500 shares of Common Stock at an exercise price of $2.14 per
    share; the fair market value of the Common Stock on
    August 2, 2002, was $0.52 per share. In February 2002, the
    Company terminated options and warrants held by Ms. Reising
    to purchase 1,190,000 shares of Common Stock with exercise
    prices ranging from $4.14 to $10.14 per share.

Aggregated Option Exercises in the Last Fiscal
Year and Fiscal Year-End Option Values

The following table sets forth information
concerning the value at December 31, 2002, of the
unexercised options held by each of the Named Executive
Officers. The value of unexercised options reflects the increase
in market value of the Common Stock from the date of grant
through December 31, 2002. No Named Executive Officer
exercised any options during the year ended December 31,
2002.

|                     |  |                            |           |                             |  |             |           |               |  |   |   |  |  |   |   | 
|-------------------- |  | -------------------------- | --------- | --------------------------- |  | ----------- | --------- | ------------- |  | - | - |  |  | - | - | 
|                     |  |                            |           |                            
|                     |  | Number of Securities       |           | Value of Unexercised In-   
|                     |  | Underlying Unexercised     |           | The-Money Options at Fiscal
|                     |  | Options at Fiscal Year-End |           | Year-End(1)                
|                     |  |                            |           |                            
|Name                 |  | Exercisable                |           | Unexercisable               |  | Exercisable |           | Unexercisable
|                     |  |                            |           |                             |  |             |           |              
|Steven A. Odom(2)    |  |                            | 2,079,453 |                             |  |             | 1,062,500 |               |  | $ | 0 |  |  | $ | 0 | 
|James M. Logsdon(3)  |  |                            | 720,802   |                             |  |             | 437,500   |               |  |   | 0 |  |  |   | 0 | 
|Juliet M. Reising(4) |  |                            | 1,070,287 |                             |  |             | 87,500    |               |  |   | 0 |  |  |   | 0 | 



---



|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Value of the Companys unexercised,
    in-the-money options based on the average of the high and low
    price of the Common Stock as of December 31, 2002, which
    was $0.495.                                                                                                                                                                                                                                                                                                      
|   
|(2) | Includes options and warrants originally issued
    by Cereus prior to September 29, 2000, which were converted
    into options or warrants to acquire an aggregate of 2,416,953
    shares of Common Stock, of which options or warrants to acquire
    an aggregate of 1,716,953 shares of Common Stock were
    exercisable at December 31, 2002, and options or warrants
    to acquire an aggregate of 700,000 shares of Common Stock were
    unexercisable at December 31, 2002.
|   
|(3) | Includes options and warrants originally issued
    by Cereus prior to September 29, 2000, which were converted
    into options or warrants to acquire an aggregate of 1,063,302
    shares of Common Stock, of which options or warrants to acquire
    an aggregate of 625,802 shares of Common Stock were exercisable
    at December 31, 2002, and options or warrants to acquire an
    aggregate of 437,500 shares of Common Stock were unexercisable
    at December 31, 2002.  

36



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##### Table of Contents





|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(4) | Includes options and warrants originally issued
    by Cereus prior to September 29, 2000, which were converted
    into options or warrants to acquire an aggregate of 670,287
    shares of Common Stock, of which options or warrants to acquire
    an aggregate of 582,787 shares of Common Stock were exercisable
    at December 31, 2002, and options or warrants to acquire an
    aggregate of 87,500 shares of Common Stock were unexercisable at
    December 31, 2002.

Employment Agreements

On September 29, 2000, the Company entered
into an Executive Employment Agreement with Mr. Odom,
pursuant to which Mr. Odom has agreed to serve as the Chief
Executive Officer of the Company for a term of three years. The
agreement provides for: (i) a term which will be
automatically renewed for an additional one-year term unless
either party gives notice to the other of its intention not to
so renew at least 90 days prior to the termination of the
then-current term; (ii) the payment of a specified base
salary and an annual bonus in the discretion of the Board;
(iii) a prohibition against Mr. Odoms disclosure
of confidential information for a period of two years following
termination; and (iv) continuation of Mr. Odoms
salary and the benefits for the 24 months following his
termination by the Company without cause or by him for
good reason. Effective January 16, 2001,
Mr. Odoms base salary under the agreement was
increased to $450,000. Effective November 2, 2002,
Mr. Odoms base salary under the agreement was reduced
by 10%, or $45,000, for a period of six months.

On September 29, 2000, the Company entered
into an Executive Employment Agreement with Mr. Logsdon,
pursuant to which Mr. Logsdon has agreed to serve as the
President and Chief Operating Officer of the Company for a term
of three years for a base salary at an annual rate per year of
$175,000 through and including February 1, 2001, and at an
annual rate per year of $225,000 thereafter. The agreement
provides for: (i) a term which will be automatically
renewed for an additional one-year term unless either party
gives notice to the other of its intention not to so renew at
least 90 days prior to the termination of the then-current
term; (ii) the payment of a specified base salary and an
annual bonus in the discretion of the Board; (iii) a
prohibition against Mr. Logsdons disclosure of
confidential information for a period of two years following
termination; and (iv) continuation of
Mr. Logsdons salary and the benefits for
24 months following his termination by the Company without
cause or by him for good reason. Effective
January 1, 2001, Mr. Logsdons base salary under
the agreement was increased to $270,000. Effective November 2,
2002, Mr. Logsdons base salary under the agreement
was reduced by 10%, or $27,000, for a period of six months.

On September 29, 2000, the Company entered
into an Executive Employment Agreement with Ms. Reising,
pursuant to which Ms. Reising has agreed to serve as the
Executive Vice President and Chief Financial Officer of the
Company for a term of three years for a base salary at an annual
rate per year of $175,000 through and including March 23,
2001, and at an annual rate per year of $200,000 thereafter. The
agreement provides for: (i) a term which will be
automatically renewed for an additional one-year term unless
either party gives notice to the other of its intention not to
so renew at least 90 days prior to the termination of the
then-current term; (ii) the payment of a specified base
salary and an annual bonus in the discretion of the Board;
(iii) a prohibition against Ms. Reisings
disclosure of confidential information for a period of two years
following termination; and (iv) continuation of
Ms. Reisings salary and the benefits for the
24 months following her termination by the Company without
cause or by her for good reason. Effective
January 1, 2001, and March 1, 2002, Ms. Reisings
base salary under the agreement was increased to $225,000 and
$270,000, respectively. Effective November 2, 2003,
Ms. Reisings base salary under the agreement was
reduced by 10%, or $27,000, for a period of six months.

Compensation Committee Interlocks And Insider
Participation

From January 1, 2002 through
December 31, 2002, the Compensation Committee of the Board
was comprised of non-employee directors Ms. Newmark and
Mr. Heck. There were no Compensation Committee Interlocks.

In the second quarter of 2002, PacifiCom, a
consulting firm in which Mr. Heck is a partner, provided to the
Company consulting services relating to performance management.
In exchange for such services, in

37



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##### Table of Contents



December 2002 and January 2003, the Company
issued to Mr. Heck and his partner options to purchase an
aggregate of 125,000 and 15,000 shares of Common Stock,
respectively, with exercise prices equal to the fair market
value of the Common Stock on the date of grant. The services
provided by PacifiCom had a fair market value in excess of the
options granted to Mr. Heck and his partner for such
services.







|         |                                                                                                       
|-------- | ------------------------------------------------------------------------------------------------------
|Item 12. | Security Ownership of Certain Beneficial
    Owners and Management and Related Stockholder
    Matters

Equity Compensation




Equity Compensation Plan Information

The following table sets forth information
regarding equity compensation plans under which the Common Stock
is authorized for issuance as of December 31, 2002.

|                                                                |  |                            |           |                   |  |                      |      |        |  |  |           | 
|--------------------------------------------------------------- |  | -------------------------- | --------- | ----------------- |  | -------------------- | ---- | ------ |  |  | --------- | 
|                                                                |  |                            |           | Weighted Average  |  | Number of Securities
|                                                                |  | Number of Securities to be |           | Exercise Price of |  | Remaining Available 
|                                                                |  | Issued Upon Exercise of    |           | Outstanding       |  | for Future Issuance 
|                                                                |  | Outstanding Options,       |           | Options, Warrants |  | Under Equity        
|Plan Category                                                   |  | Warrants and Rights        |           | and Rights        |  | Compensation Plans  
|                                                                |  |                            |           |                   |  |                     
|Equity compensation plans approved by security
    holders:(1)  |  |                            | 7,842,492 |                   |  | $                    | 2.07 |        |  |  | 4,587,693 | 
|Equity compensation plans not approved by
    security holders: |  |                            | 991,975   | (2)(3)            |  | $                    | 0.79 | (2)(3) |  |  | 0         | 
|Total                                                           |  |                            | 8,834,467 |                   |  | $                    | 1.93 |        |  |  | 4,587,693 | 






|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Represents options granted pursuant to the
    Companys 1999 Stock Incentive Plan.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|   
|(2) | Does not include (i) options to purchase
    2,184,094 shares of Common Stock with a weighted average
    exercise price per share of $1.11, which were originally granted
    as options to purchase shares of Telemate.Nets common
    stock pursuant to the Telemate Stock Incentive Plan and the
    Telemate.Net Software, Inc. 1999 Stock Incentive Plan and which
    were assumed by the Company in connection with the
    Companys acquisition of Telemate.Net; and
    (ii) options and warrants to purchase 5,771,702 shares of
    Common Stock with a weighted average exercise price per share of
    $2.66, which were originally granted as options and warrants to
    purchase shares of Cereus common stock pursuant to the
    Cereus Outside Director Warrant Plan, Directors
    Warrant Plan and 1997 Stock Option Plan and which were assumed
    by the Company in connection with the Companys acquisition
    of Cereus. The Company has not made, and will not make, any
    grants under the stock option or warrant plans of Telemate.Net
    or Cereus.
|   
|(3) | Includes options and warrants to purchase Common
    Stock granted under plans not approved by the Companys
    shareholders. The material features of such plans are set forth
    below.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  



| |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | (a) On February 12, 2003, the Company
    issued a warrant to purchase 350,000 shares of Common Stock to
    Silicon in consideration for Silicon agreeing to amend the
    Companys Credit Agreement on such date. The warrant is
    exercisable until February 12, 2008, at an exercise price
    of $0.44 per share. The number of shares underlying the warrant
    and the exercise price are subject to adjustment as set forth in
    the warrant and that certain Antidilution Agreement, dated as of
    February 12, 2003, between the Company and Silicon. The shares
    underlying the warrant are entitled to certain
    piggyback registration rights as set forth in that
    certain Registration Rights Agreement, dated as of
    February 12, 2003, between the Company and Silicon.
|
| |  | (b) On May 15, 2002, the Company issued
    a warrant to purchase 308,641 shares of Common Stock to Silicon
    in consideration for Silicon consenting to certain transactions
    engaged in by the Company. The warrant is exercisable until
    May 15, 2007, at an exercise price of $0.81 per share. The
    number of shares underlying the warrant and the exercise price
    are subject to adjustment as set forth in the warrant and that
    certain Antidilution Agreement, dated as of May 15, 2002,
    between the Company and Silicon. The shares underlying the
    warrant are entitled to certain piggyback
    registration rights                                                                                                                                                    

38



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##### Table of Contents



| |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | as set forth in that certain Registration Rights
    Agreement, dated as of May 15, 2002, between the Company
    and Silicon.                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|
| |  | (c) On November 16, 2001, the Company
    issued warrants to purchase an aggregate of 250,000 shares of
    Common Stock to an investment bank and five of its affiliates in
    consideration for investment banking services rendered in
    connection with the Companys acquisition of Telemate.Net,
    which services had a fair market value in excess of the fair
    market value of such warrants. The warrants may be exercised
    until November 16, 2004, at an exercise price of $1.00 per
    share of Common Stock, subject to certain adjustments as set
    forth in the warrants.
|
| |  | (d) On January 30, 2001, the Company
    issued a warrant to purchase 83,334 shares of Common Stock to
    PNC Bank, National Association, a former lender to the Company
    (PNC), in consideration of PNC consenting to certain
    transactions engaged in by the Company. The warrant is
    exercisable until January 30, 2006, at an exercise price of
    $1.50 per share. The number of shares of Common Stock underlying
    the warrant and the exercise price are subject to adjustment as
    set forth in the warrant.                                                                

Beneficial Ownership

The following table sets forth information
regarding the beneficial ownership of the Common Stock of the
Company as of March 15, 2003 by (i) each shareholder
who is known by the Company to own beneficially more than 5% of
the outstanding Common Stock, (ii) each director,
(iii) each Named Executive Officer, and (iv) all
executive officers and directors of the Company as a group.

|                                                                    |  |                       |           |             |  |  |     |  
|------------------------------------------------------------------- |  | --------------------- | --------- | ----------- |  |  | --- | -
|                                                                    |  |                      
|                                                                    |  | Common Stock         
|                                                                    |  | Beneficially Owned(1)
|                                                                    |  |                      
|                                                                    |  | Number of Shares      |           | Percentage 
|Name of Beneficial Owner                                            |  | of Common Stock       |           | of Class(2)
|                                                                    |  |                       |           |            
|William K. Jurika(3)                                                |  |                       | 6,786,314 |             |  |  | 7.4 | %
|Steven A. Odom(4)                                                 |  |                       | 2,959,671 |             |  |  | 3.2 | %
|Juliet M. Reising(5)                                              |  |                       | 1,446,913 |             |  |  | 1.6 | %
|James M. Logsdon(6)                                               |  |                       | 1,007,138 |             |  |  | 1.1 | %
|Amy L. Newmark(7)                                                  |  |                       | 550,000   |             |  |  | *   |  
|Gary H. Heck(8)                                                    |  |                       | 521,875   |             |  |  | *   |  
|Joseph R. Wright, Jr.(9)                                           |  |                       | 462,465   |             |  |  | *   |  
|Stephen E. Raville(10)                                             |  |                       | 252,500   |             |  |  | *   |  
|All executive officers and directors as a group
    (7) persons(11) |  |                       | 7,200,562 |             |  |  | 7.5 | %



---



|  |                        
|- | -----------------------
| | Director of the Company
| 
| | Officer of the Company 



|  |                                                                          
|- | -------------------------------------------------------------------------
|* | Less than 1% of the issued and outstanding shares
    of the Common Stock



| |     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| | --- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | (1) | Unless otherwise noted, all of the shares shown
    are held by individuals or entities possessing sole voting and
    investment power with respect to such shares. Shares not
    outstanding but deemed beneficially owned by virtue of the right
    of a person or member of a group to acquire them within 60 days
    of March 15, 2003, are treated as outstanding only when
    determining the amount and percentage owned by such individual
    or group.
|
| | (2) | In accordance with regulations of the SEC, the
    percentage calculations are based on 89,661,015 shares of Common
    Stock issued and outstanding as of March 15, 2003, plus
    shares of Common Stock which may be acquired within 60 days
    of March 15, 2003, by each individual or group listed.                                                                                                                                                           
|
| | (3) | Includes 1,607,717 shares of Common Stock
    issuable pursuant to a warrant exercisable within 60 days
    of March 15, 2003. Mr. Jurikas address is 2030
    Franklin Street, Suite 210, Oakland, California 94612.                                                                                                                                                                                                                                               
|
| | (4) | Includes (i) 1,300 shares of Common Stock
    held by Mr. Odoms wife as to which Mr. Odom may
    be deemed to share voting and investment power; (ii) 14,600
    shares of Common Stock held by                                                                                                                                                                                                                                                                    

39



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##### Table of Contents



| |     |                                                                                                                                                                                                                                                                                                                                                                          
| | --- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |     | Mr. Odoms son as to which
    Mr. Odom may be deemed to share voting and investment
    power; and (iii) 2,639,571 shares of Common Stock issuable
    pursuant to options or warrants exercisable within 60 days
    of March 15, 2003.                                                                                                                                
|
| | (5) | Includes 143,082 shares of Common Stock held in
    an account owned by Ms. Reisings husband as to which
    Ms. Reising may be deemed to share voting and investment
    power and 1,303,831 shares of Common Stock issuable pursuant to
    options or warrants exercisable within 60 days of
    March 15, 2003.                                                     
|
| | (6) | Includes 964,724 shares of Common Stock issuable
    pursuant to options or warrants exercisable within 60 days
    of March 15, 2003.                                                                                                                                                                                                                                   
|
| | (7) | Includes 375,000 shares of Common Stock issuable
    pursuant to warrants or options exercisable within 60 days
    of March 15, 2003.                                                                                                                                                                                                                                   
|
| | (8) | Includes 500,000 shares of Common Stock issuable
    pursuant to warrants or options exercisable within 60 days
    of March 15, 2003.                                                                                                                                                                                                                                   
|
| | (9) | Includes 17,500 shares of Common Stock held by
    Cadet, LLC, of which Mr. Wright serves as manager and in which
    he holds an equity interest and over which Mr. Wright may
    be deemed to have sole investment and voting power and 358,853
    shares of Common Stock issuable pursuant to warrants and options
    exercisable within 60 days of March 15, 2003.



|     |                                                                                                                                                                                                                                                                                                                                                        
|---- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(10) | Includes 50,000 shares of Common Stock owned by
    the Raville 1994 Family Limited Partnership over which
    Mr. Raville does not have investment or voting power and
    over which Mr. Raville disclaims beneficial ownership and
    147,500 shares of Common Stock issuable pursuant to options
    exercisable within 60 days of March 15, 2003.
|    
|(11) | Includes 6,289,479 shares of Common Stock
    issuable pursuant to options or warrants exercisable within
    60 days of March 15, 2003.                                                                                                                                                                                                               






|         |                                                   
|-------- | --------------------------------------------------
|Item 13. | Certain Relationships and Related
    Transactions

Descriptions of the Executive Employment
Agreements between the Company and each of Messrs. Odom and
Logsdon and Ms. Reising are set forth in the section of
this Annual Report titled Executive
Compensation  Employment Agreements.

In connection with the consummation of the
Companys acquisition of Telemate.Net, on November 16,
2001, Telemate.Net entered into a Separation Agreement (the
Mauro Agreement) with Mr. Mauro, who served as
a director of the Company from November 16, 2001, to
February 19, 2002, pursuant to which Mr. Mauros
employment as Chief Executive Officer and President of
Telemate.Net was terminated effective November 23, 2001.
Pursuant to the Mauro Agreement (i) in November 2001,
Telemate.Net paid Mr. Mauro $15,769 for accrued but unused
time off and $89,819 as a prorated quarterly bonus for the
quarter and year ended December 2001; and (ii) Telemate.Net
shall pay Mr. Mauro separation pay in the amount of
$308,807 over a 12 month period and continue
Mr. Mauros health insurance coverage for the same
such period at the same cost such coverage is offered to
Telemate.Net employees.

In the second quarter of 2002, PacifiCom, a
consulting firm in which Mr. Heck, a director of the Company and
a member of the Compensation Committee of the Board, is a
partner, provided to the Company consulting services relating to
management performance. In exchange for such services, in
December 2002 and January 2003, the Company issued to
Mr. Heck and his partner options to purchase an aggregate
of 125,000 and 15,000 shares of Common Stock, respectively, with
exercise prices equal to the fair market value of the Common
Stock on the date of grant. The services provided by PacifiCom
had a fair market value in excess of the options granted to
Mr. Heck and his partner for such services.

There are no material relationships between the
Company and its directors or executive officers except as
previously discussed herein. In the ordinary course of business
and from time to time, the Company and its affiliates and
subsidiaries may do business with each other.

40



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##### Table of Contents






Item 14.     Controls
and Procedures

(a) Evaluation of Disclosure Controls and
Procedures.

The Companys Chief Executive Officer and
Chief Financial Officer have evaluated the effectiveness of the
Companys disclosure controls and procedures (as defined in
Rules 13a-14(c) and 15d-14(c) under the Exchange Act) as of
a date within 90 days prior to the filing date of this
Annual Report (the Evaluation Date). Based on such
evaluation, such officers have concluded that, as of the
Evaluation Date, the Companys disclosure controls and
procedures are effective in alerting them on a timely basis to
material information relating to the Company (including its
consolidated subsidiaries) required to be included in the
Companys periodic filings under the Exchange Act.

(b) Changes in Internal Controls.

Since the Evaluation Date, there have not been
any significant changes in the Companys internal controls
or in other factors that could significantly affect such
controls.




PART IV






|         |                                                                    
|-------- | -------------------------------------------------------------------
|Item 15. | Exhibits, Financial Statement Schedules and
    Reports on Form 8-K

(a) Lists of certain documents filed
herewith as part of this Annual Report may be found as
follows:



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | (1) A list of the consolidated financial
    statements required to be filed as a part of this Annual Report
    is shown in the Index to Consolidated Financial
    Statements on page F-1.                                                                                                                                                                                                                                                                                                                                                               
|
| | (2) Except for Financial Statement
    Schedule II, Valuation and Qualifying Accounts,
    which is filed herewith, the financial statement schedules
    required to be filed as a part of this Annual Report are omitted
    from this Annual Report because the information required by such
    schedules is either not applicable or is included in the
    consolidated financial statements and notes thereto, which
    statements and notes are listed on the Index to
    Consolidated Financial Statements on page F-1 and filed
    herewith.
|
| | (3) A list of the exhibits required by
    Item 601 of Regulation S-K to be filed as a part of
    this Annual Report is shown on the
    Exhibit Index filed herewith.                                                                                                                                                                                                                                                                                                                                                                                    

(b) Reports on Form 8-K.

During the quarter ended December 31, 2002,
the Company filed with the SEC on December 17, 2002, a
Current Report on Form 8-K which reported under Item 5
of such report the Companys execution on December 13,
2002, of the Asset Purchase Agreement between the Company and
Clarent.

41



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##### Table of Contents



INDEX TO CONSOLIDATED FINANCIAL
STATEMENTS

The following consolidated financial statements,
financial statement schedule and Independent Auditors
Report are included herein on the pages indicated:

|                                                                                                         |  |      |      | 
|-------------------------------------------------------------------------------------------------------- |  | ---- | ---- | 
|                                                                                                         |  | Page
|                                                                                                         |  |     
|Independent Auditors Report                                                                             |  |      | F-2  | 
|Consolidated Balance Sheets as of
    December 31, 2002 and 2001                                         |  |      | F-3  | 
|Consolidated Statements of Operations for the
    years ended December 31, 2002, 2001 and 2000           |  |      | F-4  | 
|Consolidated Statements of Shareholders
    Equity for the years ended December 31, 2002, 2001 and 2000 |  |      | F-5  | 
|Consolidated Statements of Cash Flows for the
    years ended December 31, 2002, 2001 and 2000           |  |      | F-6  | 
|Notes to Consolidated Financial Statements for
    the years ended December 31, 2002, 2001 and 2000      |  |      | F-8  | 
|Schedule II  Valuation and
    Qualifying Accounts                                                      |  |      | F-38 | 

F-1



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##### Table of Contents



INDEPENDENT AUDITORS REPORT

The Board of Directors and Shareholders

Verso Technologies, Inc.:


We have audited the consolidated balance sheets
of Verso Technologies, Inc. and subsidiaries (the Company) as of
December 31, 2002 and 2001, and the related consolidated
statements of operations, shareholders equity, and cash
flows for each of the years in the three-year period ended
December 31, 2002. In connection with our audits of the
consolidated financial statements, we have also audited the
financial statement schedule as listed in the accompanying
index. These consolidated financial statements and financial
statement schedule are the responsibility of the Companys
management. Our responsibility is to express an opinion on these
consolidated financial statements and financial statement
schedule based on our audits.

We conducted our audits in accordance with
auditing standards generally accepted in the United States of
America. Those standards require that we plan and perform the
audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits
provide a reasonable basis for our opinion.

In our opinion, the consolidated financial
statements referred to above present fairly, in all material
respects, the financial position of Verso Technologies, Inc. and
subsidiaries as of December 31, 2002 and 2001, and the
results of their operations and their cash flows for each of the
years in the three-year period ended December 31, 2002, in
conformity with accounting principles generally accepted in the
United States of America. Also in our opinion, the related
financial statement schedule, when considered in relation to the
basic consolidated financial statements taken as a whole,
presents fairly, in all material respects, the information set
forth therein.

As discussed in Note 2 to the consolidated
financial statements, effective July 1, 2001, Verso
Technologies, Inc. and subsidiaries adopted the provisions of
Statement of Financial Accounting Standards (SFAS)
No. 141, Business Combinations, and certain
provisions of SFAS No. 142, Goodwill and Other
Intangible Assets, as required for goodwill and other
intangible assets resulting from business combinations
consummated after June 30, 2001, and fully adopted all
provisions effective January 1, 2002.

/s/ KPMG LLP

Atlanta, Georgia

February 14, 2003, except as to
paragraph 1 of Note 6 and


paragraph 5 of Note 18, which are as of
April 7, 2003


F-2



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##### Table of Contents



VERSO TECHNOLOGIES, INC.

CONSOLIDATED BALANCE SHEETS

(In thousands, except share data)


|                                                                                                                                                  |                                                                                                                                      |                            |                                            |              |        |        |        |          |        |        | 
|------------------------------------------------------------------------------------------------------------------------------------------------- | ------------------------------------------------------------------------------------------------------------------------------------ | -------------------------- | ------------------------------------------ | ------------ | ------ | ------ | ------ | -------- | ------ | ------ | 
|                                                                                                                                                  |                                                                                                                                      | December 31,               |                                            | December 31,
|                                                                                                                                                  |                                                                                                                                      | 2002                       |                                            | 2001        
|                                                                                                                                                  |                                                                                                                                      |                            |                                            |             
|ASSETS:                                                                                                                                          
|Current assets:                                                                                                                                   |                                                                                                                                      |                            |                                            |              |        |        |        |         
|                                                                                                                                                  | Cash and cash equivalents                                                                                                            |                            | $                                          | 1,294        |        |        | $      | 7,445    |       
|                                                                                                                                                  | Restricted cash                                                                                                                      |                            |                                            | 300          |        |        |        | 300      |       
|                                                                                                                                                  | Accounts receivable, net of allowance for
    doubtful accounts of $1,853 and $2,455 at December 31, 2002
    and 2001, respectively |                            |                                            | 10,909       |        |        |        | 9,047    |       
|                                                                                                                                                  | Inventories                                                                                                                          |                            |                                            | 4,733        |        |        |        | 3,995    |       
|                                                                                                                                                  | Other current assets                                                                                                                 |                            |                                            | 681          |        |        |        | 1,104    |       
|                                                                                                                                                  | Assets of discontinued operations                                                                                                    |                            |                                            |             |        |        |        | 582      |       
|                                                                                                                                                  |                                                                                                                                      |                            |                                            |              |        |        |        |         
|                                                                                                                                                  |                                                                                                                                      | Total current assets       |                                            |              | 17,917 |        |        |          | 22,473 |       
|Property and equipment, net of accumulated
    depreciation and amortization of $4,893 and $2,188 at
    December 31, 2002 and 2001, respectively |                                                                                                                                      |                            | 4,962                                      |              |        |        | 6,737  |         
|Investment in Shanghai BeTrue Infotech Co. Ltd.,
    at equity                                                                                    |                                                                                                                                      |                            | 600                                        |              |        |        |       |         
|Intangibles, net of accumulated amortization of
    $828 and $236 at December 31, 2002 and 2001, respectively                                     |                                                                                                                                      |                            | 16,356                                     |              |        |        | 15,949 |         
|                                                                                                                                                  |                                                                                                                                      |                            |                                            |              |        |        |        |         
|                                                                                                                                                  |                                                                                                                                      | Total assets               |                                            | $            | 39,835 |        |        | $        | 45,159 |       
|                                                                                                                                                  |                                                                                                                                      |                            |                                            |              |        |        |        |         
|LIABILITIES AND SHAREHOLDERS
    EQUITY:                                                                                                        
|Current liabilities:                                                                                                                              |                                                                                                                                      |                            |                                            |              |        |        |        |         
|                                                                                                                                                  | Line of credit                                                                                                                       |                            | $                                          | 800          |        |        | $      |         |       
|                                                                                                                                                  | Note payable for the purchase of NACT                                                                                                |                            |                                            |             |        |        |        | 5,340    |       
|                                                                                                                                                  | Accounts payable                                                                                                                     |                            |                                            | 1,993        |        |        |        | 1,624    |       
|                                                                                                                                                  | Accrued compensation                                                                                                                 |                            |                                            | 1,586        |        |        |        | 3,130    |       
|                                                                                                                                                  | Accrued expenses                                                                                                                     |                            |                                            | 4,473        |        |        |        | 6,127    |       
|                                                                                                                                                  | Unearned revenue and customer deposits                                                                                               |                            |                                            | 5,387        |        |        |        | 5,904    |       
|                                                                                                                                                  | Current portion of liabilities of discontinued
    operations                                                                        |                            |                                            | 1,829        |        |        |        | 2,528    |       
|                                                                                                                                                  |                                                                                                                                      |                            |                                            |              |        |        |        |         
|                                                                                                                                                  |                                                                                                                                      | Total current liabilities  |                                            |              | 16,068 |        |        |          | 24,653 |       
|Liabilities of discontinued operations, net of
    current portion                                                                                |                                                                                                                                      |                            | 1,302                                      |              |        |        | 1,772  |         
|Other long-term liabilities                                                                                                                       |                                                                                                                                      |                            | 1,128                                      |              |        |        |       |         
|Convertible subordinated debentures, net of
    discount                                                                                          |                                                                                                                                      |                            | 3,703                                      |              |        |        | 3,428  |         
|                                                                                                                                                  |                                                                                                                                      |                            |                                            |              |        |        |        |         
|                                                                                                                                                  |                                                                                                                                      | Total liabilities          |                                            |              | 22,201 |        |        |          | 29,853 |       
|                                                                                                                                                  |                                                                                                                                      |                            |                                            |              |        |        |        |         
|Commitments and contingencies (Notes 6, 7, 14 and
    18)                                                                                         |                                                                                                                                      |                            |                                            |              |        |        |        |         
|Shareholders equity:                                                                                                                             |                                                                                                                                      |                            |                                            |              |        |        |        |         
|                                                                                                                                                  | Common stock, $.01 par value, 200,000,000 shares
    authorized; 89,077,846 and 77,619,654 shares issued and
    outstanding         |                            |                                            | 891          |        |        |        | 776      |       
|                                                                                                                                                  | Additional paid-in capital                                                                                                           |                            |                                            | 275,040      |        |        |        | 271,462  |       
|                                                                                                                                                  | Notes receivable from shareholders                                                                                                   |                            |                                            | (1,623       | )      |        |        | (1,620   | )     
|                                                                                                                                                  | Accumulated deficit                                                                                                                  |                            |                                            | (254,857     | )      |        |        | (252,131 | )     
|                                                                                                                                                  | Deferred compensation                                                                                                                |                            |                                            | (1,797       | )      |        |        | (3,166   | )     
|                                                                                                                                                  | Accumulated other comprehensive loss 
    foreign currency translation                                                              |                            |                                            | (20          | )      |        |        | (15      | )     
|                                                                                                                                                  |                                                                                                                                      |                            |                                            |              |        |        |        |         
|                                                                                                                                                  |                                                                                                                                      | Total shareholders equity |                                            |              | 17,634 |        |        |          | 15,306 |       
|                                                                                                                                                  |                                                                                                                                      |                            |                                            |              |        |        |        |         
|                                                                                                                                                  |                                                                                                                                      |                            | Total liabilities and shareholders equity |              | $      | 39,835 |        |          | $      | 45,159 | 
|                                                                                                                                                  |                                                                                                                                      |                            |                                            |              |        |        |        |         

The accompanying notes are an integral part of
these consolidated financial statements.

F-3



---



##### Table of Contents



VERSO TECHNOLOGIES, INC.

CONSOLIDATED STATEMENTS OF
OPERATIONS

(In thousands, except share data)


|                                                                                                                                                                                   |                                                                         |                                                                                |            |        |        |      |            |          |          |   |            |         |         |  
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ----------------------------------------------------------------------- | ------------------------------------------------------------------------------ | ---------- | ------ | ------ | ---- | ---------- | -------- | -------- | - | ---------- | ------- | ------- | -
|                                                                                                                                                                                   |                                                                         |                                                                               
|                                                                                                                                                                                   |                                                                         | For the Year Ended December 31,                                               
|                                                                                                                                                                                   |                                                                         |                                                                               
|                                                                                                                                                                                   |                                                                         | 2002                                                                           |            | 2001   |        | 2000
|                                                                                                                                                                                   |                                                                         |                                                                                |            |        |        |     
|Revenue:                                                                                                                                                                           |                                                                         |                                                                                |            |        |        |      |            |          |          |   |            |        
|                                                                                                                                                                                   | Products                                                                |                                                                                | $          | 22,983 |        |      | $          | 14,367   |          |   | $          |        |        
|                                                                                                                                                                                   | Services                                                                |                                                                                |            | 21,815 |        |      |            | 15,532   |          |   |            | 12,732  |        
|                                                                                                                                                                                   |                                                                         |                                                                                |            |        |        |      |            |          |          |   |            |        
|                                                                                                                                                                                   |                                                                         | Total revenue                                                                  |            |        | 44,798 |      |            |          | 29,899   |   |            |         | 12,732  |  
|Cost of revenue:                                                                                                                                                                   |                                                                         |                                                                                |            |        |        |      |            |          |          |   |            |        
|                                                                                                                                                                                   | Products                                                                |                                                                                |            | 8,141  |        |      |            | 5,762    |          |   |            |        |        
|                                                                                                                                                                                   | Services                                                                |                                                                                |            | 10,308 |        |      |            | 9,050    |          |   |            | 7,402   |        
|                                                                                                                                                                                   |                                                                         |                                                                                |            |        |        |      |            |          |          |   |            |        
|                                                                                                                                                                                   |                                                                         | Total cost of revenue                                                          |            |        | 18,449 |      |            |          | 14,812   |   |            |         | 7,402   |  
|Gross profit:                                                                                                                                                                      |                                                                         |                                                                                |            |        |        |      |            |          |          |   |            |        
|                                                                                                                                                                                   | Products                                                                |                                                                                |            | 14,842 |        |      |            | 8,605    |          |   |            |        |        
|                                                                                                                                                                                   | Services                                                                |                                                                                |            | 11,507 |        |      |            | 6,482    |          |   |            | 5,330   |        
|                                                                                                                                                                                   |                                                                         |                                                                                |            |        |        |      |            |          |          |   |            |        
|                                                                                                                                                                                   |                                                                         | Total gross profit                                                             |            |        | 26,349 |      |            |          | 15,087   |   |            |         | 5,330   |  
|Operating expenses:                                                                                                                                                                |                                                                         |                                                                                |            |        |        |      |            |          |          |   |            |        
|                                                                                                                                                                                   | Sales, general and administrative                                       |                                                                                |            | 17,986 |        |      |            | 15,514   |          |   |            | 12,024  |        
|                                                                                                                                                                                   | Research and development                                                |                                                                                |            | 5,874  |        |      |            | 2,755    |          |   |            |        |        
|                                                                                                                                                                                   | Depreciation and amortization of property and
    equipment             |                                                                                |            | 2,730  |        |      |            | 2,160    |          |   |            | 863     |        
|                                                                                                                                                                                   | Amortization of intangibles                                             |                                                                                |            | 592    |        |      |            | 1,511    |          |   |            | 982     |        
|                                                                                                                                                                                   | Deferred compensation, related to sales, general
    and administrative |                                                                                |            | 1,173  |        |      |            | 1,766    |          |   |            | 482     |        
|                                                                                                                                                                                   | Reorganization costs                                                    |                                                                                |            | 324    |        |      |            |         |          |   |            | 511     |        
|                                                                                                                                                                                   | Loss on asset abandonment                                               |                                                                                |            |       |        |      |            |         |          |   |            | 1,760   |        
|                                                                                                                                                                                   |                                                                         |                                                                                |            |        |        |      |            |          |          |   |            |        
|                                                                                                                                                                                   |                                                                         | Total operating expenses                                                       |            |        | 28,679 |      |            |          | 23,706   |   |            |         | 16,622  |  
|                                                                                                                                                                                   |                                                                         |                                                                                |            |        |        |      |            |          |          |   |            |        
|                                                                                                                                                                                   |                                                                         | Operating loss from continuing operations                                      |            |        | (2,330 | )    |            |          | (8,619   | ) |            |         | (11,292 | )
|Other income                                                                                                                                                                       |                                                                         |                                                                                | 531        |        |        |      | 203        |          |          |   |           |        
|Equity in loss of Shanghai BeTrue Infotech Co. Ltd                                                                                                                                 |                                                                         |                                                                                | (5         | )      |        |      |           |          |          |   |           |        
|Interest expense, net, including $601, $606 and
    $715 of amortization of loan fees and discount on convertible
    subordinated debentures in 2002, 2001 and 2000, respectively |                                                                         |                                                                                | (1,141     | )      |        |      | (1,361     | )        |          |   | (1,240     | )      
|                                                                                                                                                                                   |                                                                         |                                                                                |            |        |        |      |            |          |          |   |            |        
|                                                                                                                                                                                   |                                                                         | Loss from continuing operations before income
    taxes and extraordinary item |            |        | (2,945 | )    |            |          | (9,777   | ) |            |         | (12,532 | )
|Income tax benefit (expense)                                                                                                                                                       |                                                                         |                                                                                | 200        |        |        |      | (100       | )        |          |   |           |        
|                                                                                                                                                                                   |                                                                         |                                                                                |            |        |        |      |            |          |          |   |            |        
|                                                                                                                                                                                   |                                                                         | Loss from continuing operations before
    extraordinary item                  |            |        | (2,745 | )    |            |          | (9,877   | ) |            |         | (12,532 | )
|                                                                                                                                                                                   |                                                                         |                                                                                |            |        |        |      |            |          |          |   |            |        
|Discontinued operations:                                                                                                                                                           |                                                                         |                                                                                |            |        |        |      |            |          |          |   |            |        
|                                                                                                                                                                                   | Loss from discontinued operations                                       |                                                                                |            | (331   | )      |      |            | (135,598 | )        |   |            | (31,950 | )      
|                                                                                                                                                                                   | Loss on disposal of discontinued operations                             |                                                                                |            |       |        |      |            | (500     | )        |   |            | (11,000 | )      
|                                                                                                                                                                                   |                                                                         |                                                                                |            |        |        |      |            |          |          |   |            |        
|                                                                                                                                                                                   |                                                                         | Total discontinued operations                                                  |            |        | (331   | )    |            |          | (136,098 | ) |            |         | (42,950 | )
|                                                                                                                                                                                   |                                                                         |                                                                                |            |        |        |      |            |          |          |   |            |        
|Loss before extraordinary item                                                                                                                                                     |                                                                         |                                                                                | (3,076     | )      |        |      | (145,975   | )        |          |   | (55,482    | )      
|Extraordinary items:                                                                                                                                                               |                                                                         |                                                                                |            |        |        |      |            |          |          |   |            |        
|                                                                                                                                                                                   | Loss from debt conversion                                               |                                                                                |            |       |        |      |            | (1,640   | )        |   |            |        |        
|                                                                                                                                                                                   | Gain on early retirement of debt                                        |                                                                                |            | 350    |        |      |            |         |          |   |            |        |        
|                                                                                                                                                                                   |                                                                         |                                                                                |            |        |        |      |            |          |          |   |            |        
|                                                                                                                                                                                   |                                                                         | Net loss                                                                       |            | $      | (2,726 | )    |            | $        | (147,615 | ) |            | $       | (55,482 | )
|                                                                                                                                                                                   |                                                                         |                                                                                |            |        |        |      |            |          |          |   |            |        
|Net loss per common share  basic and
    diluted:                                                                                                                                 |                                                                         |                                                                                |            |        |        |      |            |          |          |   |            |        
|                                                                                                                                                                                   | Loss from continuing operations                                         |                                                                                | $          | (0.03  | )      |      | $          | (0.18    | )        |   | $          | (0.48   | )      
|                                                                                                                                                                                   | Loss from discontinued operations                                       |                                                                                |            |       |        |      |            | (2.49    | )        |   |            | (1.23   | )      
|                                                                                                                                                                                   | Loss on disposal of discontinued operations                             |                                                                                |            |       |        |      |            | (0.01    | )        |   |            | (0.43   | )      
|                                                                                                                                                                                   |                                                                         |                                                                                |            |        |        |      |            |          |          |   |            |        
|                                                                                                                                                                                   | Loss before extraordinary item                                          |                                                                                |            | (0.03  | )      |      |            | (2.68    | )        |   |            | (2.14   | )      
|                                                                                                                                                                                   | Extraordinary item                                                      |                                                                                |            |       |        |      |            | (0.03    | )        |   |            |        |        
|                                                                                                                                                                                   |                                                                         |                                                                                |            |        |        |      |            |          |          |   |            |        
|Net loss per common share  basic and
    diluted                                                                                                                                  |                                                                         | $                                                                              | (0.03      | )      |        | $    | (2.71      | )        |          | $ | (2.14      | )      
|                                                                                                                                                                                   |                                                                         |                                                                                |            |        |        |      |            |          |          |   |            |        
|Weighted average shares outstanding 
    basic and diluted                                                                                                                        |                                                                         |                                                                                | 80,533,324 |        |        |      | 54,431,651 |          |          |   | 25,903,431 |        
|                                                                                                                                                                                   |                                                                         |                                                                                |            |        |        |      |            |          |          |   |            |        

The accompanying notes are an integral part of
these consolidated financial statements.

F-4



---



##### Table of Contents



VERSO TECHNOLOGIES, INC.

CONSOLIDATED STATEMENTS OF SHAREHOLDERS
EQUITY

FOR THE YEARS ENDED DECEMBER 31, 2002, 2001
AND 2000


(In thousands, except share data)


|                                                                                                                           |                                         |              |            |            |  |            |     |              |  |          |         |              |  |             |        |       |  |   |          |          |   |   |        |   |  |   |     |     |   |   |         |          |  
|-------------------------------------------------------------------------------------------------------------------------- | --------------------------------------- | ------------ | ---------- | ---------- |  | ---------- | --- | ------------ |  | -------- | ------- | ------------ |  | ----------- | ------ | ----- |  | - | -------- | -------- | - | - | ------ | - |  | - | --- | --- | - | - | ------- | -------- | -
|                                                                                                                           |                                         |              |            |            |  | Notes      |     |              |  |          |         |              |  |            
|                                                                                                                           |                                         | Common Stock |            | Additional |  | Receivable |     |              |  |          |         | Foreign      |  |            
|                                                                                                                           |                                         |              |            | Paid-in    |  | from       |     | Accumulated  |  | Deferred |         | Currency     |  |            
|                                                                                                                           |                                         | Shares       |            | Amount     |  | Capital    |     | Shareholders |  | Deficit  |         | Compensation |  | Translation |        | Total
|                                                                                                                           |                                         |              |            |            |  |            |     |              |  |          |         |              |  |             |        |      
|BALANCES, December 31, 1999                                                                                                |                                         |              | 23,808,415 |            |  | $          | 238 |              |  | $        | 75,679  |              |  | $           |       |       |  | $ | (49,034  | )        |   | $ |       |   |  | $ |    |     |   | $ | 26,883  |         
|Net loss/comprehensive loss                                                                                                |                                         |              |           |            |  |            |    |              |  |          |        |              |  |             |       |       |  |   | (55,482  | )        |   |   |       |   |  |   |    |     |   |   | (55,482 | )       
|Issuance of common stock and replacement awards
    of common stock warrants and options in Cereus acquisition             |                                         |              | 21,866,600 |            |  |            | 219 |              |  |          | 149,102 |              |  |             | (667   | )     |  |   |         |          |   |   | (6,885 | ) |  |   |    |     |   |   | 141,769 |         
|Issuance of common stock and common stock
    warrants in MessageClick acquisition                                         |                                         |              | 1,405,923  |            |  |            | 14  |              |  |          | 3,530   |              |  |             |       |       |  |   |         |          |   |   |       |   |  |   |    |     |   |   | 3,544   |         
|Amortization of deferred compensation                                                                                      |                                         |              |           |            |  |            |    |              |  |          |        |              |  |             |       |       |  |   |         |          |   |   | 608    |   |  |   |    |     |   |   | 608     |         
|Exercise of stock options                                                                                                  |                                         |              | 1,005,596  |            |  |            | 10  |              |  |          | 3,392   |              |  |             |       |       |  |   |         |          |   |   |       |   |  |   |    |     |   |   | 3,402   |         
|Issuance of stock through Employee Stock Purchase
    Plan                                                                 |                                         |              | 60,355     |            |  |            | 1   |              |  |          | 297     |              |  |             |       |       |  |   |         |          |   |   |       |   |  |   |    |     |   |   | 298     |         
|Issuance of shares in private placement, net of
    associated fees                                                        |                                         |              | 1,374,532  |            |  |            | 14  |              |  |          | 13,991  |              |  |             |       |       |  |   |         |          |   |   |       |   |  |   |    |     |   |   | 14,005  |         
|Warrants issued in conjunction with convertible
    debentures                                                             |                                         |              |           |            |  |            |    |              |  |          | 2,378   |              |  |             |       |       |  |   |         |          |   |   |       |   |  |   |    |     |   |   | 2,378   |         
|Shares issued in exchange for services                                                                                     |                                         |              | 88,712     |            |  |            |    |              |  |          | 350     |              |  |             |       |       |  |   |         |          |   |   |       |   |  |   |    |     |   |   | 350     |         
|Warrants issued in exchange for services                                                                                   |                                         |              |           |            |  |            |    |              |  |          | 65      |              |  |             |       |       |  |   |         |          |   |   |       |   |  |   |    |     |   |   | 65      |         
|Issuance of common stock and compensatory options
    in reorganization                                                    |                                         |              | 5,000      |            |  |            |    |              |  |          | 556     |              |  |             |       |       |  |   |         |          |   |   |       |   |  |   |    |     |   |   | 556     |         
|                                                                                                                           |                                         |              |            |            |  |            |     |              |  |          |         |              |  |             |        |       |  |   |          |          |   |   |        |   |  |   |     |     |   |   |         |         
|BALANCES, December 31, 2000                                                                                                |                                         |              | 49,615,133 |            |  | $          | 496 |              |  | $        | 249,340 |              |  | $           | (667   | )     |  | $ | (104,516 | )        |   | $ | (6,277 | ) |  | $ |    |     |   | $ | 138,376 |         
|Comprehensive loss:                                                                                                        |                                         |              |            |            |  |            |     |              |  |          |         |              |  |             |        |       |  |   |          |          |   |   |        |   |  |   |     |     |   |   |         |         
|                                                                                                                           | Net loss                                |              |            |           |  |            |     |             |  |          |         |             |  |             |        |      |  |   |          | (147,615 | ) |   |        |  |  |   |     |    |   |   |         | (147,615 | )
|                                                                                                                           | Foreign currency translation adjustment |              |            |           |  |            |     |             |  |          |         |             |  |             |        |      |  |   |          |         |   |   |        |  |  |   |     | (15 | ) |   |         | (15      | )
|                                                                                                                           |                                         |              |            |            |  |            |     |              |  |          |         |              |  |             |        |       |  |   |          |          |   |   |        |   |  |   |     |     |   |   |         |         
|                                                                                                                           | Comprehensive loss                      |              |            |            |  |            |     |              |  |          |         |              |  |             |        |       |  |   |          |          |   |   |        |   |  |   |     |     |   |   |         | (147,630 | )
|Issuance of common stock and replacement awards
    of common stock options in Telemate.Net Software, Inc.
    acquisition |                                         |              | 24,758,070 |            |  |            | 248 |              |  |          | 18,234  |              |  |             | (947   | )     |  |   |         |          |   |   | (131   | ) |  |   |    |     |   |   | 17,404  |         
|Issuance of common stock options in NACT
    Telecommunications, Inc. acquisition                                          |                                         |              |           |            |  |            |    |              |  |          | 625     |              |  |             |       |       |  |   |         |          |   |   |       |   |  |   |    |     |   |   | 625     |         
|Amortization of deferred compensation                                                                                      |                                         |              |           |            |  |            |    |              |  |          |        |              |  |             |       |       |  |   |         |          |   |   | 2,033  |   |  |   |    |     |   |   | 2,033   |         
|Exercise of stock options                                                                                                  |                                         |              | 1,090,582  |            |  |            | 11  |              |  |          | 642     |              |  |             |       |       |  |   |         |          |   |   |       |   |  |   |    |     |   |   | 653     |         
|Issuance of stock through Employee Stock Purchase
    Plan                                                                 |                                         |              | 211,965    |            |  |            | 2   |              |  |          | 199     |              |  |             |       |       |  |   |         |          |   |   |       |   |  |   |    |     |   |   | 201     |         
|Reduction of deferred compensation due to
    forfeitures                                                                  |                                         |              |           |            |  |            |    |              |  |          | (1,209  | )            |  |             |       |       |  |   |         |          |   |   | 1,209  |   |  |   |    |     |   |   |        |         
|Accrued interest on notes receivable from
    shareholders                                                                 |                                         |              |           |            |  |            |    |              |  |          |        |              |  |             | (6     | )     |  |   |         |          |   |   |       |   |  |   |    |     |   |   | (6      | )       
|Shares issued in exchange for convertible
    debentures                                                                   |                                         |              | 1,918,675  |            |  |            | 19  |              |  |          | 2,266   |              |  |             |        |       |  |   |          |          |   |   |        |   |  |   |     |     |   |   | 2,285   |         
|Warrants issued in conjunction with convertible
    debentures                                                             |                                         |              |           |            |  |            |    |              |  |          | 977     |              |  |             |       |       |  |   |         |          |   |   |       |   |  |   |    |     |   |   | 977     |         
|Shares issued in exchange for services                                                                                     |                                         |              | 11,429     |            |  |            |    |              |  |          | 19      |              |  |             |       |       |  |   |         |          |   |   |       |   |  |   |    |     |   |   | 19      |         
|Warrants issued in exchange for services                                                                                   |                                         |              |           |            |  |            |    |              |  |          | 219     |              |  |             |       |       |  |   |         |          |   |   |       |   |  |   |    |     |   |   | 219     |         
|Issuance of common stock and compensatory options
    in reorganization                                                    |                                         |              | 13,800     |            |  |            |    |              |  |          | 150     |              |  |             |       |       |  |   |         |          |   |   |       |   |  |   |    |     |   |   | 150     |         
|                                                                                                                           |                                         |              |            |            |  |            |     |              |  |          |         |              |  |             |        |       |  |   |          |          |   |   |        |   |  |   |     |     |   |   |         |         
|BALANCES, December 31, 2001                                                                                                |                                         |              | 77,619,654 |            |  | $          | 776 |              |  | $        | 271,462 |              |  | $           | (1,620 | )     |  | $ | (252,131 | )        |   | $ | (3,166 | ) |  | $ | (15 | )   |   | $ | 15,306  |         
|Comprehensive loss:                                                                                                        |                                         |              |            |            |  |            |     |              |  |          |         |              |  |             |        |       |  |   |          |          |   |   |        |   |  |   |     |     |   |   |         |         
|                                                                                                                           | Net loss                                |              |            |           |  |            |     |             |  |          |         |             |  |             |        |      |  |   |          | (2,726   | ) |   |        |  |  |   |     |    |   |   |         | (2,726   | )
|                                                                                                                           | Foreign currency translation adjustment |              |            |           |  |            |     |             |  |          |         |             |  |             |        |      |  |   |          |         |   |   |        |  |  |   |     | (5  | ) |   |         | (5       | )
|                                                                                                                           |                                         |              |            |            |  |            |     |              |  |          |         |              |  |             |        |       |  |   |          |          |   |   |        |   |  |   |     |     |   |   |         |         
|                                                                                                                           | Comprehensive loss                      |              |            |            |  |            |     |              |  |          |         |              |  |             |        |       |  |   |          |          |   |   |        |   |  |   |     |     |   |   |         | (2,731   | )
|Amortization of deferred compensation                                                                                      |                                         |              |           |            |  |            |    |              |  |          |        |              |  |             |       |       |  |   |         |          |   |   | 1,173  |   |  |   |    |     |   |   | 1,173   |         
|Exercise of stock options                                                                                                  |                                         |              | 847,082    |            |  |            | 9   |              |  |          | 9       |              |  |             |       |       |  |   |         |          |   |   |       |   |  |   |    |     |   |   | 18      |         
|Issuance of stock through Employee Stock Purchase
    Plan                                                                 |                                         |              | 290,171    |            |  |            | 3   |              |  |          | 119     |              |  |             |       |       |  |   |         |          |   |   |       |   |  |   |    |     |   |   | 122     |         
|Reduction of deferred compensation due to
    forfeitures                                                                  |                                         |              |           |            |  |            |    |              |  |          | (196    | )            |  |             |       |       |  |   |         |          |   |   | 196    |   |  |   |    |     |   |   |        |         
|Accrued interest on notes receivable from
    shareholders                                                                 |                                         |              |           |            |  |            |    |              |  |          |        |              |  |             | (27    | )     |  |   |         |          |   |   |       |   |  |   |    |     |   |   | (27     | )       
|Issuance of compensatory options in reorganization                                                                         |                                         |              |           |            |  |            |    |              |  |          | 88      |              |  |             |       |       |  |   |         |          |   |   |       |   |  |   |    |     |   |   | 88      |         
|Issuance of shares and warrants in private
    placement, net of associated fees                                           |                                         |              | 9,646,302  |            |  |            | 96  |              |  |          | 2,889   |              |  |             |       |       |  |   |         |          |   |   |       |   |  |   |    |     |   |   | 2,985   |         
|Shares issued in litigation settlement                                                                                     |                                         |              | 588,430    |            |  |            | 6   |              |  |          | 431     |              |  |             |       |       |  |   |         |          |   |   |       |   |  |   |    |     |   |   | 437     |         
|Shares issued in lieu of compensation                                                                                      |                                         |              | 86,207     |            |  |            | 1   |              |  |          | 27      |              |  |             |       |       |  |   |         |          |   |   |       |   |  |   |    |     |   |   | 28      |         
|Warrants issued in connection with credit facility                                                                         |                                         |              |           |            |  |            |    |              |  |          | 211     |              |  |             |       |       |  |   |         |          |   |   |       |   |  |   |    |     |   |   | 211     |         
|Payment received on notes receivable from
    shareholders                                                                 |                                         |              |           |            |  |            |    |              |  |          |        |              |  |             | 24     |       |  |   |         |          |   |   |       |   |  |   |    |     |   |   | 24      |         
|                                                                                                                           |                                         |              |            |            |  |            |     |              |  |          |         |              |  |             |        |       |  |   |          |          |   |   |        |   |  |   |     |     |   |   |         |         
|BALANCES, December 31, 2002                                                                                                |                                         |              | 89,077,846 |            |  | $          | 891 |              |  | $        | 275,040 |              |  | $           | (1,623 | )     |  | $ | (254,857 | )        |   | $ | (1,797 | ) |  | $ | (20 | )   |   | $ | 17,634  |         
|                                                                                                                           |                                         |              |            |            |  |            |     |              |  |          |         |              |  |             |        |       |  |   |          |          |   |   |        |   |  |   |     |     |   |   |         |         

The accompanying notes are an integral part of
these consolidated financial statements.

F-5



---



##### Table of Contents



VERSO TECHNOLOGIES, INC.

CONSOLIDATED STATEMENTS OF CASH
FLOWS

(In thousands, except share data)


|                      |                          |                                                                                                                       |                                                                                   |                                                                          |        |        |        |   |          |         |         |   |         |         |         |  
|--------------------- | ------------------------ | --------------------------------------------------------------------------------------------------------------------- | --------------------------------------------------------------------------------- | ------------------------------------------------------------------------ | ------ | ------ | ------ | - | -------- | ------- | ------- | - | ------- | ------- | ------- | -
|                      |                          |                                                                                                                      
|                      |                          | For the Year Ended December 31,                                                                                      
|                      |                          |                                                                                                                      
|                      |                          | 2002                                                                                                                  |                                                                                   | 2001                                                                     |        | 2000  
|                      |                          |                                                                                                                       |                                                                                   |                                                                          |        |       
|Operating Activities: |                          |                                                                                                                       |                                                                                   |                                                                          |        |        |        |   |          |         |         |  
|                      | Continuing operations:   |                                                                                                                       |                                                                                   |                                                                          |        |        |        |   |          |         |         |   |        
|                      |                          | Net loss from continuing operations                                                                                   |                                                                                   | $                                                                        | (2,395 | )      |        | $ | (11,517  | )       |         | $ | (12,532 | )      
|                      |                          | Adjustments to reconcile net loss from continuing
    operations to net cash used in continuing operating activities: |                                                                                   |                                                                          |        |        |        |   |          |         |         |   |         |        
|                      |                          |                                                                                                                       | Extraordinary item  gain on early
    retirement of debt                         |                                                                          |        | (350   | )      |   |          |        |         |   |         |        |        
|                      |                          |                                                                                                                       | Extraordinary item  loss on debt
    conversion                                  |                                                                          |        |       |        |   |          | 1,640   |         |   |         |        |        
|                      |                          |                                                                                                                       | Equity in loss of Shanghai BeTrue Infotech Co. Ltd                                |                                                                          |        | 5      |        |   |          |        |         |   |         |        |        
|                      |                          |                                                                                                                       | Loss on asset abandonment                                                         |                                                                          |        |       |        |   |          |        |         |   |         | 1,760   |        
|                      |                          |                                                                                                                       | Depreciation                                                                      |                                                                          |        | 2,730  |        |   |          | 2,160   |         |   |         | 863     |        
|                      |                          |                                                                                                                       | Amortization of intangibles                                                       |                                                                          |        | 592    |        |   |          | 1,511   |         |   |         | 982     |        
|                      |                          |                                                                                                                       | Amortization of deferred compensation                                             |                                                                          |        | 1,173  |        |   |          | 1,766   |         |   |         | 482     |        
|                      |                          |                                                                                                                       | Provision for doubtful accounts                                                   |                                                                          |        | 1,760  |        |   |          | 1,516   |         |   |         | 198     |        
|                      |                          |                                                                                                                       | Amortization of loan fees and discount on
    convertible subordinated debentures |                                                                          |        | 601    |        |   |          | 606     |         |   |         | 715     |        
|                      |                          |                                                                                                                       | Other                                                                             |                                                                          |        | 73     |        |   |          | (22     | )       |   |         |        |        
|                      |                          |                                                                                                                       | Changes in current operating assets and
    liabilities:                          |                                                                          |        |        |        |   |          |         |         |   |         |         |        
|                      |                          |                                                                                                                       |                                                                                   | Accounts receivable, net                                                 |        |        | (3,403 | ) |          |         | (3,676  | ) |         |         | 1,522   |  
|                      |                          |                                                                                                                       |                                                                                   | Inventories                                                              |        |        | (913   | ) |          |         | 1,238   |   |         |         |        |  
|                      |                          |                                                                                                                       |                                                                                   | Other current assets                                                     |        |        | 308    |   |          |         | 1,060   |   |         |         | (2,238  | )
|                      |                          |                                                                                                                       |                                                                                   | Accounts payable                                                         |        |        | 369    |   |          |         | (1,178  | ) |         |         | (4,061  | )
|                      |                          |                                                                                                                       |                                                                                   | Accrued compensation                                                     |        |        | (1,492 | ) |          |         | 794     |   |         |         | 166     |  
|                      |                          |                                                                                                                       |                                                                                   | Accrued expenses                                                         |        |        | (2,187 | ) |          |         | (821    | ) |         |         | 637     |  
|                      |                          |                                                                                                                       |                                                                                   | Unearned revenue and customer deposits                                   |        |        | (396   | ) |          |         | (1,838  | ) |         |         | (805    | )
|                      |                          |                                                                                                                       |                                                                                   |                                                                          |        |        |        |   |          |         |         |  
|                      |                          |                                                                                                                       | Net cash used in continuing operating activities                                  |                                                                          |        | (3,525 | )      |   |          | (6,761  | )       |   |         | (12,311 | )      
|                      |                          |                                                                                                                       |                                                                                   |                                                                          |        |        |        |   |          |         |         |  
|                      | Discontinued operations: |                                                                                                                       |                                                                                   |                                                                          |        |        |        |   |          |         |         |   |        
|                      |                          | Loss from discontinued operations                                                                                     |                                                                                   |                                                                          | (331   | )      |        |   | (136,098 | )       |         |   | (42,950 | )      
|                      |                          | Estimated loss on disposal of discontinued
    operations                                                             |                                                                                   |                                                                          |       |        |        |   | 500      |         |         |   | 11,000  |        
|                      |                          | Adjustment to reconcile loss from discontinued
    operations to net cash used in discontinued operating activities   |                                                                                   |                                                                          | (775   | )      |        |   | 129,797  |         |         |   | 7,622   |        
|                      |                          |                                                                                                                       |                                                                                   |                                                                          |        |        |        |   |          |         |         |  
|                      |                          |                                                                                                                       | Net cash used in discontinued operating activities                                |                                                                          |        | (1,106 | )      |   |          | (5,801  | )       |   |         | (24,328 | )      
|                      |                          |                                                                                                                       |                                                                                   |                                                                          |        |        |        |   |          |         |         |  
|                      |                          |                                                                                                                       | Net cash used in operating activities                                             |                                                                          |        | (4,631 | )      |   |          | (12,562 | )       |   |         | (36,639 | )      
|                      |                          |                                                                                                                       |                                                                                   |                                                                          |        |        |        |   |          |         |         |  
|Investing Activities: |                          |                                                                                                                       |                                                                                   |                                                                          |        |        |        |   |          |         |         |  
|                      | Continuing operations:   |                                                                                                                       |                                                                                   |                                                                          |        |        |        |   |          |         |         |   |        
|                      |                          | Net cash used in investing activities for
    continuing operations                                                  |                                                                                   |                                                                          |        |        |        |   |          |         |         |   |         |        
|                      |                          |                                                                                                                       | Purchases of property and equipment, net                                          |                                                                          |        | (889   | )      |   |          | (1,429  | )       |   |         | (5,256  | )      
|                      |                          |                                                                                                                       | Software development costs capitalized                                            |                                                                          |        | (348   | )      |   |          | (48     | )       |   |         |        |        
|                      |                          |                                                                                                                       | Investment in Shanghai BeTrue Infotech Co. Ltd.                                   |                                                                          |        | (605   | )      |   |          |         |         |   |         |         |        
|                      |                          |                                                                                                                       | Purchase of NACT Telecommunications, Inc.                                         |                                                                          |        |       |        |   |          | (14,612 | )       |   |         |        |        
|                      |                          |                                                                                                                       | Purchase of Telemate.Net Software, Inc.                                           |                                                                          |        |       |        |   |          | (1,483  | )       |   |         |        |        
|                      |                          |                                                                                                                       | Advance to MessageClick, Inc. prior to purchase                                   |                                                                          |        |       |        |   |          |        |         |   |         | (300    | )      
|                      |                          |                                                                                                                       | Purchase of MessageClick, Inc.                                                    |                                                                          |        |       |        |   |          |        |         |   |         | (137    | )      
|                      |                          |                                                                                                                       |                                                                                   |                                                                          |        |        |        |   |          |         |         |  
|                      |                          |                                                                                                                       |                                                                                   | Net cash used in investing activities for
    continuing operations      |        |        | (1,842 | ) |          |         | (17,572 | ) |         |         | (5,693  | )
|                      |                          |                                                                                                                       |                                                                                   |                                                                          |        |        |        |   |          |         |         |  
|                      | Discontinued operations: |                                                                                                                       |                                                                                   |                                                                          |        |        |        |   |          |         |         |   |        
|                      |                          | Software development costs capitalized, net                                                                           |                                                                                   |                                                                          |       |        |        |   |         |         |         |   | (2,297  | )      
|                      |                          | Purchases of property and equipment, net                                                                              |                                                                                   |                                                                          |       |        |        |   |         |         |         |   | (1,975  | )      
|                      |                          | Purchase of Cereus Technology Partners, Inc.                                                                          |                                                                                   |                                                                          |       |        |        |   |         |         |         |   | (1,887  | )      
|                      |                          | Net proceeds from sale of discontinued operations                                                                     |                                                                                   |                                                                          |       |        |        |   | 8,122    |         |         |   | 8,566   |        
|                      |                          |                                                                                                                       |                                                                                   |                                                                          |        |        |        |   |          |         |         |  
|                      |                          |                                                                                                                       | Net cash provided by investing activities for
    discontinued operations         |                                                                          |        |       |        |   |          | 8,122   |         |   |         | 2,407   |        
|                      |                          |                                                                                                                       |                                                                                   |                                                                          |        |        |        |   |          |         |         |  
|                      |                          |                                                                                                                       | Net cash used in investing activities                                             |                                                                          |        | (1,842 | )      |   |          | (9,450  | )       |   |         | (3,286  | )      
|                      |                          |                                                                                                                       |                                                                                   |                                                                          |        |        |        |   |          |         |         |  
|                      |                          |                                                                                                                       |                                                                                   | Net cash used in operating and investing
    activities, carried forward |        |        | (6,473 | ) |          |         | (22,012 | ) |         |         | (39,925 | )
|                      |                          |                                                                                                                       |                                                                                   |                                                                          |        |        |        |   |          |         |         |  

F-6



---



##### Table of Contents



VERSO TECHNOLOGIES, INC.


CONSOLIDATED STATEMENTS OF CASH
FLOWS  (Continued)

(In thousands, except share data)


|                                                                         |                                                 |                                                                                        |                                                                                                                                                         |                     |        |        |         |       |        |         |         |        |        |         |       | 
|------------------------------------------------------------------------ | ----------------------------------------------- | -------------------------------------------------------------------------------------- | ------------------------------------------------------------------------------------------------------------------------------------------------------- | ------------------- | ------ | ------ | ------- | ----- | ------ | ------- | ------- | ------ | ------ | ------- | ----- | 
|                                                                         |                                                 |                                                                                       
|                                                                         |                                                 | For the Year Ended December 31,                                                       
|                                                                         |                                                 |                                                                                       
|                                                                         |                                                 | 2002                                                                                   |                                                                                                                                                         | 2001                |        | 2000  
|                                                                         |                                                 |                                                                                        |                                                                                                                                                         |                     |        |       
|Net cash used in operating and investing
    activities, carried forward |                                                 |                                                                                        | (6,473                                                                                                                                                  | )                   |        |        | (22,012 | )     |        |         | (39,925 | )     
|                                                                         |                                                 |                                                                                        |                                                                                                                                                         |                     |        |        |         |       |        |         |         |       
|Financing Activities:                                                    |                                                 |                                                                                        |                                                                                                                                                         |                     |        |        |         |       |        |         |         |       
|                                                                         | Continuing operations:                          |                                                                                        |                                                                                                                                                         |                     |        |        |         |       |        |         |         |        |       
|                                                                         |                                                 | Borrowings (payments) on credit line, net                                              |                                                                                                                                                         |                     | 800    |        |         |       |       |         |         |        | (9,654 | )      
|                                                                         |                                                 | Payments on long-term debt                                                             |                                                                                                                                                         |                     | (3,900 | )      |         |       |       |         |         |        |       |        
|                                                                         |                                                 | Proceeds from issuance of convertible
    subordinated debenture, net                  |                                                                                                                                                         |                     |       |        |         |       |       |         |         |        | 11,346 |        
|                                                                         |                                                 | Payments on convertible subordinated debentures                                        |                                                                                                                                                         |                     |       |        |         |       | (4,500 | )       |         |        |       |        
|                                                                         |                                                 | Advance from Cereus Technology Partners, Inc.
    prior to merger                      |                                                                                                                                                         |                     |       |        |         |       |       |         |         |        | 10,170 |        
|                                                                         |                                                 | Proceeds from private placement, net                                                   |                                                                                                                                                         |                     | 2,985  |        |         |       |       |         |         |        |       |        
|                                                                         |                                                 | Proceeds from issuances of common stock, net                                           |                                                                                                                                                         |                     | 408    |        |         |       | 755    |         |         |        | 17,705 |        
|                                                                         |                                                 | Proceeds from issuance of redeemable preferred
    stock                               |                                                                                                                                                         |                     |       |        |         |       | 15,000 |         |         |        |       |        
|                                                                         |                                                 | Payments of notes receivable from shareholders                                         |                                                                                                                                                         |                     | 24     |        |         |       |       |         |         |        |       |        
|                                                                         |                                                 |                                                                                        |                                                                                                                                                         |                     |        |        |         |       |        |         |         |       
|                                                                         |                                                 |                                                                                        | Net cash provided by financing activities for
    continuing operations                                                                                 |                     |        | 317    |         |       |        | 11,255  |         |        |        | 29,567  |      
|                                                                         |                                                 |                                                                                        |                                                                                                                                                         |                     |        |        |         |       |        |         |         |       
|                                                                         | Discontinued operations:                        |                                                                                        |                                                                                                                                                         |                     |        |        |         |       |        |         |         |        |       
|                                                                         |                                                 | Net cash used in financing activities for
    discontinued operations                 |                                                                                                                                                         |                     |        |        |         |       |        |         |         |        |        |        
|                                                                         |                                                 |                                                                                        | Payments on long-term debt                                                                                                                              |                     |        |       |         |       |        |        |         |        |        | (493    | )    
|                                                                         |                                                 |                                                                                        |                                                                                                                                                         |                     |        |        |         |       |        |         |         |       
|                                                                         |                                                 |                                                                                        | Net cash provided by financing activities                                                                                                               |                     |        | 317    |         |       |        | 11,255  |         |        |        | 29,074  |      
|                                                                         |                                                 |                                                                                        |                                                                                                                                                         |                     |        |        |         |       |        |         |         |       
|Effect of exchange rate changes on
    cash                              |                                                 |                                                                                        | 5                                                                                                                                                       |                     |        |        | (1      | )     |        |         |        |       
|                                                                         |                                                 |                                                                                        |                                                                                                                                                         |                     |        |        |         |       |        |         |         |       
|                                                                         |                                                 |                                                                                        | Decrease in cash and cash equivalents                                                                                                                   |                     |        | (6,151 | )       |       |        | (10,758 | )       |        |        | (10,851 | )    
|Cash and Cash Equivalents:                                               |                                                 |                                                                                        |                                                                                                                                                         |                     |        |        |         |       |        |         |         |       
|Beginning of year                                                        |                                                 |                                                                                        | 7,445                                                                                                                                                   |                     |        |        | 10,855  |       |        |         | 313     |       
|Cash acquired in purchase of NACT
    Telecommunications, Inc.           |                                                 |                                                                                        |                                                                                                                                                        |                     |        |        | 2,538   |       |        |         |        |       
|Cash acquired in purchase of Telemate.Net
    Software, Inc.             |                                                 |                                                                                        |                                                                                                                                                        |                     |        |        | 4,810   |       |        |         |        |       
|Cash acquired in purchase of Cereus Technology
    Partners, Inc.        |                                                 |                                                                                        |                                                                                                                                                        |                     |        |        |        |       |        |         | 21,215  |       
|Cash acquired in purchase of MessageClick, Inc.                          |                                                 |                                                                                        |                                                                                                                                                        |                     |        |        |        |       |        |         | 178     |       
|                                                                         |                                                 |                                                                                        |                                                                                                                                                         |                     |        |        |         |       |        |         |         |       
|End of year                                                              |                                                 | $                                                                                      | 1,294                                                                                                                                                   |                     |        | $      | 7,445   |       |        | $       | 10,855  |       
|                                                                         |                                                 |                                                                                        |                                                                                                                                                         |                     |        |        |         |       |        |         |         |       
|Cash and Cash Equivalents:                                               |                                                 |                                                                                        |                                                                                                                                                         |                     |        |        |         |       |        |         |         |       
|                                                                         | Continuing operations                           |                                                                                        | $                                                                                                                                                       | 1,294               |        |        | $       | 7,445 |        |         | $       | 10,659 |       
|                                                                         | Discontinued operations                         |                                                                                        |                                                                                                                                                         |                    |        |        |         |      |        |         |         | 196    |       
|                                                                         |                                                 |                                                                                        |                                                                                                                                                         |                     |        |        |         |       |        |         |         |       
|                                                                         |                                                 | Total cash and cash equivalents                                                        |                                                                                                                                                         | $                   | 1,294  |        |         | $     | 7,445  |         |         | $      | 10,855 |        
|                                                                         |                                                 |                                                                                        |                                                                                                                                                         |                     |        |        |         |       |        |         |         |       
|Supplemental disclosure of cash flow
    information:                    |                                                 |                                                                                        |                                                                                                                                                         |                     |        |        |         |       |        |         |         |       
|                                                                         | Cash payments during the year for:              |                                                                                        |                                                                                                                                                         |                     |        |        |         |       |        |         |         |        |       
|                                                                         |                                                 | Interest                                                                               |                                                                                                                                                         | $                   | 395    |        |         | $     | 170    |         |         | $      | 1,108  |        
|                                                                         |                                                 |                                                                                        |                                                                                                                                                         |                     |        |        |         |       |        |         |         |       
|                                                                         |                                                 | Income taxes                                                                           |                                                                                                                                                         | $                   | 47     |        |         | $     | 101    |         |         | $      | 289    |        
|                                                                         |                                                 |                                                                                        |                                                                                                                                                         |                     |        |        |         |       |        |         |         |       
|                                                                         | Non-cash investing and financing
    activities |                                                                                        |                                                                                                                                                         |                     |        |        |         |       |        |         |         |        |       
|                                                                         |                                                 | Common stock consideration for acquisitions:                                           |                                                                                                                                                         |                     |        |        |         |       |        |         |         |        |        |        
|                                                                         |                                                 |                                                                                        | Telemate.Net Software, Inc.  issuance
    of 24,758,070 shares and assumption of 5,420,206 stock options                                               |                     | $      |       |         |       | $      | 17,404  |         |        | $      |        |      
|                                                                         |                                                 |                                                                                        | NACT Telecommunications, Inc. 
    issuance of 1,395,089 stock options                                                                                 |                     |        |       |         |       |        | 625     |         |        |        |        |      
|                                                                         |                                                 |                                                                                        | MessageClick, Inc.  issuance of
    1,405,923 shares                                                                                                   |                     |        |       |         |       |        |        |         |        |        | 3,544   |      
|                                                                         |                                                 |                                                                                        | Cereus Technology Partners, Inc. 
    issuance of 21,866,600 shares and assumption of 19,571,192
    common stock warrants and 1,376,708 stock options |                     |        |       |         |       |        |        |         |        |        | 141,769 |      
|                                                                         |                                                 | Additional payments accrued for the acquisition
    of Encore Group                    |                                                                                                                                                         |                     | 2,403  |        |         |       |       |         |         |        |       |        
|                                                                         |                                                 | Common stock and compensatory options issued in
    reorganization                     |                                                                                                                                                         |                     | 88     |        |         |       | 150    |         |         |        | 556    |        
|                                                                         |                                                 | Common stock issued in exchange for convertible
    subordinated debentures            |                                                                                                                                                         |                     |       |        |         |       | 2,285  |         |         |        |       |        
|                                                                         |                                                 | Warrants issued in conjunction with convertible
    subordinated debentures            |                                                                                                                                                         |                     |       |        |         |       | 977    |         |         |        |       |        
|                                                                         |                                                 | Issuance of common stock in arbitration settlement                                     |                                                                                                                                                         |                     | 437    |        |         |       |       |         |         |        |       |        
|                                                                         |                                                 | Issuance of warrants in exchange for services                                          |                                                                                                                                                         |                     | 211    |        |         |       | 219    |         |         |        | 65     |        
|                                                                         |                                                 | Issuance of common stock in exchange for services                                      |                                                                                                                                                         |                     | 28     |        |         |       | 19     |         |         |        | 350    |        
|                                                                         |                                                 | Assets acquired and liabilities assumed in
    conjunction with business acquisitions: |                                                                                                                                                         |                     |        |        |         |       |        |         |         |        |        |        
|                                                                         |                                                 |                                                                                        | Fair value of assets acquired, excluding cash                                                                                                           |                     | $      |       |         |       | $      | 33,761  |         |        | $      | 8,827   |      
|                                                                         |                                                 |                                                                                        | Consideration paid                                                                                                                                      |                     |        |       |         |       |        | 16,095  |         |        |        | 2,024   |      
|                                                                         |                                                 |                                                                                        |                                                                                                                                                         |                     |        |        |         |       |        |         |         |       
|                                                                         |                                                 |                                                                                        |                                                                                                                                                         | Liabilities assumed |        | $      |        |       |        | $       | 17,666  |        |        | $       | 6,803 | 
|                                                                         |                                                 |                                                                                        |                                                                                                                                                         |                     |        |        |         |       |        |         |         |       

The accompanying notes are an integral part of
these consolidated financial statements.

F-7



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##### Table of Contents



VERSO TECHNOLOGIES, INC.

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS

December 31, 2002, 2001 and
2000


1.     Organization
and Basis of Presentation

Verso Technologies, Inc. and subsidiaries (the
Company), is a communications technology and
solutions provider for communications service providers and
enterprises seeking to implement application-based telephony
services, Internet usage management tools and outsourced
customer support services. The Companys continuing
operations include two separate business segments, the Carrier
Solutions Group, which the Company formerly referred to as its
Gateway Solutions business, which includes the Companys
subsidiary NACT Telecommunications, Inc. (NACT), and
the Enterprise Solutions Group, which the Company formerly
referred to as its Applications and Services business, which
includes the Companys customer response center operations
and the Companys subsidiary Telemate.Net Software, Inc.
(Telemate.Net). The Carrier Solutions Group includes
domestic and international sales of hardware and software,
integration, applications and technical training and support.
The Enterprise Solutions Group offers primarily domestic network
management, support and maintenance, customer response center
services and application services. The Company acquired NACT in
July 2001 and Telemate.Net in November 2001. The Companys
discontinued operations include the Companys value-added
reseller business and associated consulting practice
(legacy VAR business) and the Companys
hospitality services group, which developed and marketed
proprietary software and related integration and maintenance
services (HSG).

The consolidated financial statements include the
accounts of Verso Technologies, Inc. and its wholly-owned
subsidiaries, including Telemate.Net, NACT, MessageClick, Inc.
(MessageClick), which the Company acquired in
November 2000, and Cereus Technology Partners, Inc.
(Cereus) and its subsidiaries, which the Company
acquired in September 2000 and which the Company merged out of
existence in December 2001, with such acquisitions accounted for
as purchases (see Note 3). Cereus is included in discontinued
operations.

Certain prior year amounts in the consolidated
financial statements have been reclassified to conform with the
current year presentation. These reclassifications had no effect
on previously reported net loss.

2.     Summary of
Significant Accounting Policies



| |                            
| | ---------------------------
| | Principles of Consolidation

The consolidated financial statements include the
accounts of the Company and its wholly-owned subsidiaries.
Investments in joint ventures, where the Company does not
exercise control, are accounted for on the equity method. All
significant intercompany accounts and transactions have been
eliminated in consolidation.



| |                 
| | ----------------
| | Use of Estimates

The preparation of consolidated financial
statements in conformity with accounting principles generally
accepted in the United States of America requires management of
the Company to make estimates and assumptions that affect the
reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from
those estimates.



| |                 
| | ----------------
| | Cash Equivalents

The Company considers all investments purchased
with an original maturity of three months or less to be cash
equivalents. Cash equivalents at December 31, 2002 and 2001
totaling approximately $575,000 and $6.2 million,
respectively, consist primarily of money market investments,
which are recorded at cost, which approximates market.

F-8



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##### Table of Contents



VERSO TECHNOLOGIES, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

2.     Summary of
Significant Accounting Policies 
(Continued)



| |                
| | ---------------
| | Restricted Cash

The Company has $300,000 of restricted cash at
December 31, 2002 and 2001 related to a foreign cash
account.



| |                                   
| | ----------------------------------
| | Allowance or Doubtful
    Accounts

The Company is required to estimate the
collectibility of its trade receivables. Considerable judgment
is required in assessing the ultimate realization of these
receivables including the creditworthiness of each customer.
Significant changes in required reserves have been recorded in
recent periods and may occur in the future due to the current
telecommunications and general economic environments. The
Company determines the allowance for doubtful accounts based on
a specific review of outstanding customer balances plus a
general reserve based on the aging of customer accounts and
write-off history.



| |                                               
| | ----------------------------------------------
| | Credit, Customer and Vendor
    Concentrations

The Companys accounts receivable
potentially subjects the Company to credit risk. While the
Company has purchase-money-security-interests in its equipment
sold on credit terms and generally prepares and files UCC
financing statements with respect thereto, the Company does not
seek to perfect or claim a security interest in small dollar
value equipment sales and services. As of December 31,
2002, one customer of the Companys Carrier Solutions Group
accounted for more than 10%, totaling approximately
$3.4 million, of the Companys gross accounts
receivable. During the year ended December 31, 2002, two
customers, one from the Companys Carrier Solutions Group
and one from the Companys Enterprise Solutions Group,
individually accounted for more than 10% each of the
Companys total revenue, totaling approximately
$11.9 million combined.

As of December 31, 2001, two customers of
the Companys Carrier Solutions Group accounted for more
than 10%, totaling approximately $3.0 million, of the
Companys gross accounts receivable. During the year ended
December 31, 2001, two customers, one from the
Companys Carrier Solutions Group and one from the
Companys Enterprise Solutions Group, accounted for more
than 10%, totaling approximately $10.1 million, of the
Companys total revenue.

During the year ended December 31, 2000, one
customer of the Companys Enterprise Solutions Group
accounted for more than 10%, totaling approximately
$8.6 million, of the Companys total revenue.



| |            
| | -----------
| | Inventories

Inventories consist primarily of purchased
electronic components for the Companys Carrier Solutions
Group, and are stated at the lower of cost or market. Cost is
determined by using the first-in, first-out method.

Inventories as of December 31, 2002 and
2001, are comprised of the following (in thousands):

|                |                   |              |       |       |  |   |       |       | 
|--------------- | ----------------- | ------------ | ----- | ----- |  | - | ----- | ----- | 
|                |                   |             
|                |                   | December 31,
|                |                   |             
|                |                   | 2002         |       | 2001 
|                |                   |              |       |      
|Raw materials   |                   | $            | 1,566 |       |  | $ | 1,677 |      
|Work in process |                   |              | 2,380 |       |  |   | 1,376 |      
|Finished goods  |                   |              | 787   |       |  |   | 942   |      
|                |                   |              |       |       |  |   |       |      
|                | Total inventories |              | $     | 4,733 |  |   | $     | 3,995 | 
|                |                   |              |       |       |  |   |       |      

F-9



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##### Table of Contents



VERSO TECHNOLOGIES, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

2.     Summary of
Significant Accounting Policies 
(Continued)



| |                       
| | ----------------------
| | Property and Equipment

Property and equipment, substantially consisting
of furniture and equipment, are stated at cost or fair value if
acquired through a business acquisition. Depreciation is
computed using the straight-line method over estimated useful
lives, ranging from three to ten years. Upon retirement or
disposal of furniture and equipment, the cost and accumulated
depreciation are removed from the accounts, and any gain or loss
is included in operating income. Maintenance and repairs are
charged to expense as incurred.

Property and equipment are summarized as follows
(in thousands):

|                                               |                            |      |        |       |  |   |        |       | 
|---------------------------------------------- | -------------------------- | ---- | ------ | ----- |  | - | ------ | ----- | 
|                                               |                            | 2002 |        | 2001 
|                                               |                            |      |        |      
|Computers and equipment                        |                            | $    | 5,205  |       |  | $ | 4,005  |      
|Purchased software                             |                            |      | 1,252  |       |  |   | 1,208  |      
|Furniture and fixtures                         |                            |      | 1,082  |       |  |   | 1,402  |      
|Leasehold improvements                         |                            |      | 2,316  |       |  |   | 2,310  |      
|                                               |                            |      |        |       |  |   |        |      
|                                               |                            |      | 9,855  |       |  |   | 8,925  |      
|Less accumulated depreciation and amortization |                            |      | (4,893 | )     |  |   | (2,188 | )    
|                                               |                            |      |        |       |  |   |        |      
|                                               | Net property and equipment |      | $      | 4,962 |  |   | $      | 6,737 | 
|                                               |                            |      |        |       |  |   |        |      

Purchased software represents the cost of
purchased integration software tools and the cost of internal
use software acquired in connection with business combinations.
It also includes the cost of licenses to use, embed and sell
software tools developed by others. These costs are being
amortized ratably based on the projected revenue associated with
these purchased or licensed tools and products or based on the
straight-line method over three years, whichever method results
in a higher level of annual amortization. Amortization expense
related to purchased software amounted to approximately
$433,000, $193,000 and $550,000 in 2002, 2001 and 2000,
respectively. During 2000, the Company replaced certain internal
use software and recorded a loss on asset abandonment of
approximately $1.8 million. Accumulated amortization
related to purchased software totaled approximately $708,000 and
$275,000 at December 31, 2002 and 2001, respectively.



| |                     
| | --------------------
| | Capitalized Software

The Companys capitalized software consists
of purchased software for internal use, which is included in
property and equipment and purchased software used in the
Companys research and development efforts, which is
included in intangibles. Any internal software development costs
incurred after establishing technological feasibility are
immaterial and are charged to operations as research and
development costs.



| |            
| | -----------
| | Intangibles

Intangible assets represent the excess of cost
over the fair value of net tangible assets acquired and
identified other intangible assets, primarily purchased software
development costs and customer relationship costs. The purchased
software development costs are amortized on a straight-line
basis over estimated useful lives of three years once the
projects are placed in service. The customer relationship costs
are amortized on a straight-line basis over its estimated useful
life of ten years. Goodwill associated with the acquisitions of
NACT and Telemate.Net (see Note 3) is not being amortized
in accordance with Statement of Financial Accounting Standards
(SFAS) No. 142, Goodwill and Other
Intangible Assets (SFAS No. 142).

F-10



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##### Table of Contents



VERSO TECHNOLOGIES, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



2.     Summary of
Significant Accounting Policies 
(Continued)


Intangible assets consist of the following (in
thousands):

|                                         |                                |                                    |        |        |       |   |        |        |       | 
|---------------------------------------- | ------------------------------ | ---------------------------------- | ------ | ------ | ----- | - | ------ | ------ | ----- | 
|                                         |                                |                                   
|                                         |                                | December 31,                      
|                                         |                                |                                   
|                                         |                                | 2002                               |        | 2001  
|                                         |                                |                                    |        |       
|Intangibles subject to amortization:     |                                |                                    |        |        |       |   |        |       
|                                         | Purchased software development |                                    | $      | 2,096  |       |   | $      | 1,748  |      
|                                         | Customer relationship          |                                    |        | 2,403  |       |   |        |       |      
|                                         |                                |                                    |        |        |       |   |        |       
|                                         |                                |                                    | 4,499  |        |       |   | 1,748  |       
|                                         | Accumulated amortization       |                                    |        | (828   | )     |   |        | (236   | )    
|                                         |                                |                                    |        |        |       |   |        |       
|                                         |                                | Net purchased software development |        |        | 3,671 |   |        |        | 1,512 | 
|Intangibles not subject to amortization: |                                |                                    |        |        |       |   |        |       
|                                         | Goodwill                       |                                    |        | 12,685 |       |   |        | 14,437 |      
|                                         |                                |                                    |        |        |       |   |        |       
|Total intangibles                        |                                | $                                  | 16,356 |        |       | $ | 15,949 |       
|                                         |                                |                                    |        |        |       |   |        |       

Estimated annual amortization expense is as
follows (in thousands):

|           |  |              |       | 
|---------- |  | ------------ | ----- | 
|           |  | Annual      
|           |  | Amortization
|           |  |             
|2003       |  | $            | 939   | 
|2004       |  |              | 701   | 
|2005       |  |              | 348   | 
|2006       |  |              | 240   | 
|2007       |  |              | 240   | 
|Thereafter |  |              | 1,203 | 
|           |  |              |       | 
|Total      |  | $            | 3,671 | 
|           |  |              |       | 

The Company fully adopted SFAS No. 142 in
2002. Under the provisions of SFAS No. 142, goodwill is no
longer subject to amortization. Goodwill amortization expense
totaled approximately $1.3 million and $982,000 in 2001 and
2000, respectively. The impact of goodwill amortization on basic
and diluted loss per share is as follows (in thousands, except
per share amounts):

|                                  |                            |                                 |        |       |   |      |          |       |   |   |         |       |  
|--------------------------------- | -------------------------- | ------------------------------- | ------ | ----- | - | ---- | -------- | ----- | - | - | ------- | ----- | -
|                                  |                            |                                
|                                  |                            | For the Year Ended December 31,
|                                  |                            |                                
|                                  |                            | 2002                            |        | 2001  |   | 2000
|                                  |                            |                                 |        |       |   |     
|Reported net loss                 |                            | $                               | (2,726 | )     |   | $    | (147,615 | )     |   | $ | (55,482 | )    
|                                  | Add: Goodwill amortization |                                 |        |      |   |      |          | 1,275 |   |   |         | 982   |  
|                                  |                            |                                 |        |       |   |      |          |       |   |   |         |      
|Adjusted net loss                 |                            | $                               | (2,726 | )     |   | $    | (146,340 | )     |   | $ | (54,500 | )    
|                                  |                            |                                 |        |       |   |      |          |       |   |   |         |      
|Basic and diluted loss per share: |                            |                                 |        |       |   |      |          |       |   |   |         |      
|                                  | Reported net loss          |                                 | $      | (0.03 | ) |      | $        | (2.71 | ) |   | $       | (2.14 | )
|                                  | Goodwill amortization      |                                 |        |      |   |      |          | 0.02  |   |   |         | 0.04  |  
|                                  |                            |                                 |        |       |   |      |          |       |   |   |         |      
|Adjusted net loss                 |                            | $                               | (0.03  | )     |   | $    | (2.69    | )     |   | $ | (2.10   | )    
|                                  |                            |                                 |        |       |   |      |          |       |   |   |         |      

F-11



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##### Table of Contents



VERSO TECHNOLOGIES, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



2.     Summary of
Significant Accounting Policies 
(Continued)




| |                                    
| | -----------------------------------
| | Impairment of Long-Lived
    Assets

SFAS No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets (SFAS
No. 144) provides a single accounting model for
long-lived assets to be disposed of. SFAS No. 144 also
changes the criteria for classifying an asset as held for sale;
and broadens the scope of businesses to be disposed of that
qualify for reporting as discontinued operations and changes the
timing of recognizing losses on such operations. The Company
adopted SFAS No. 144 on January 1, 2002. The adoption
of SFAS No. 144 did not affect the Companys financial
statements.

In accordance with SFAS No. 144, long-lived
assets, such as property, plant, and equipment, and purchased
intangibles subject to amortization, are reviewed for impairment
whenever events or changes in circumstances indicate that the
carrying amount of an asset may not be recoverable.
Recoverability of assets to be held and used is measured by a
comparison of the carrying amount of an asset to estimated
undiscounted future cash flows expected to be generated by the
asset. If the carrying amount of an asset exceeds its estimated
future cash flows, an impairment charge is recognized by the
amount by which the carrying amount of the asset exceeds the
fair value of the asset. Assets to be disposed of would be
separately presented in the balance sheet and reported at the
lower of the carrying amount or fair value less costs to sell,
and are no longer depreciated. The assets and liabilities of a
disposed group classified as held for sale would be presented
separately in the appropriate asset and liability sections of
the balance sheet.

Goodwill and intangible assets not subject to
amortization are tested annually for impairment, and are tested
for impairment more frequently if events and circumstances
indicate that the asset might be impaired. An impairment loss is
recognized to the extent that the carrying amount exceeds the
assets fair value.

Prior to the adoption of SFAS No. 144, the
Company accounted for long-lived assets in accordance with SFAS
No. 121, Accounting for Impairment of Long-Lived
Assets and for Long-Lived Assets to be Disposed Of.



| |                                   
| | ----------------------------------
| | Product Returns and
    Warranties

The Company provides warranties for its products
for one year with optional pre-paid warranty renewals in
increments of either six-month or one-year terms when the
customer purchases maintenance coverage through the Company. The
Companys sales and service agreements do not permit
product returns by its customers. The Company has not
experienced significant warranty claims to date. Accordingly,
the Company has not provided a reserve for warranty costs at
December 31, 2002 or 2001.



| |                                        
| | ---------------------------------------
| | Fair Value of Financial
    Instruments

Estimates of fair value of financial instruments
are made at a specific point in time, based on relevant market
prices and information about the financial instrument. The
estimated fair values of financial instruments are not
necessarily indicative of the amounts the Company might realize
in actual market transactions. The following methods and
assumptions were used by the Company in estimating its fair
value disclosures for financial instruments:

Cash and cash equivalents, accounts receivable,
inventories, accrued expenses, accounts payable, unearned
revenue and customer deposits: The carrying amounts reported in
the consolidated balance sheets approximate their fair value.

Short and long-term debt: The carrying amount of
the Companys borrowings under floating rate debt
approximates its fair value. The carrying amount of convertible
subordinated debentures under fixed rate debt approximates its
fair value because it approximates the Companys current
short-term borrowing rate.

F-12



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##### Table of Contents



VERSO TECHNOLOGIES, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



2.     Summary of
Significant Accounting Policies 
(Continued)


At December 31, 2002 and 2001, the carrying
amounts of all financial instruments approximate their fair
values.



| |                    
| | -------------------
| | Revenue Recognition



| |                        
| | -----------------------
| | Carrier Solutions Group

The Company recognizes revenue from its Carrier
Solutions Group from product sales of its gateway solution
systems in accordance with Staff Accounting Bulletin
(SAB) No. 101, Revenue Recognition in
Financial Statements (SAB No. 101) when
persuasive evidence of an agreement exists, delivery has
occurred and installation, if to be performed by the Company,
has been substantially complete, the fee is fixed and
determinable, and collection of the resulting receivable,
including receivables of customers to which the Company has
provided customer financing, is probable. The determination of
whether the collectibility of receivables is reasonably assured
is based upon an assessment of the creditworthiness of the
customers. In instances where collection of a receivable is not
reasonably assured, revenue and related costs are deferred.
Services revenue related to hardware sales are generally
recognized at the time of performance.



| |                           
| | --------------------------
| | Enterprise Solutions Group

The Company recognizes revenue from its
Enterprise Solutions Group segment from two primary sources,
product sales (hardware and software licenses) and services.
Revenue from software licensing and support fees is recognized
in accordance with Statement of Position (SOP)
No. 97-2, Software Revenue Recognition
(SOP No. 97-2) and SOP No. 98-9,
Software Revenue Recognition with Respect to Certain
Transactions (SOP No. 98-9). Accordingly,
the Company recognizes software license revenue when:
(1) persuasive evidence of an arrangement exists;
(2) delivery has occurred; (3) the fee is fixed or
determinable; and (4) collectibility is probable.

SOP No. 97-2 generally requires revenue
earned on software arrangements involving multiple elements to
be allocated to each element based on the relative fair values
of the elements. The fair value of an element must be based on
the evidence that is specific to the vendor. License revenue
allocated to software products generally is recognized upon
delivery of the products or deferred and recognized in future
periods to the extent that an arrangement includes one or more
elements to be delivered at a future date and for which fair
values have not been established. Revenue allocated to
maintenance is recognized ratably over the maintenance term
which is typically twelve months and revenue allocated to
training and other service elements, such as implementation and
training, are recognized as the services are performed.

Under SOP No. 98-9, if evidence of fair
value does not exist for all elements of a license agreement and
post-contract customer support is the only undelivered element,
then all revenue for the license arrangement is recognized
ratably over the term of the agreement as license revenue. If
evidence of fair value of all undelivered elements exists but
evidence does not exist for one or more delivered elements, then
revenue is recognized using the residual method. Under the
residual method, the fair value of the undelivered elements is
deferred and the remaining portion of the arrangement fee is
recognized as revenue.

Amounts that have been received in cash or billed
but that do not yet qualify for revenue recognition are
reflected as deferred revenues.

F-13



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##### Table of Contents



VERSO TECHNOLOGIES, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



2.     Summary of
Significant Accounting Policies 
(Continued)


Stock-Based
Compensation Plan

The Company accounts for its stock option plans
in accordance with the provisions of Accounting Principles Board
(APB) Opinion No. 25, Accounting for
Stock Issued to Employees (APB Opinion
No. 25), and related interpretations. As such,
compensation expense to be recognized over the related vesting
period is generally determined on the date of grant only if the
current market price of the underlying stock exceeds the
exercise price. SFAS No. 123, Accounting for
Stock-Based Compensation (SFAS No. 123),
permits entities to recognize as expense over the vesting period
the fair value of all stock-based awards on the date of grant.
Alternatively, SFAS No. 123 allows entities to continue to
apply the provisions of APB Opinion No. 25 and provide pro
forma net income (loss) and pro forma income
(loss) per share disclosures for employee stock option
grants as if the fair-value-based method defined in SFAS
No. 123 had been applied. The Company has elected to
continue to apply the provisions of APB Opinion No. 25 and
provide the pro forma disclosures required by SFAS No. 123
(See Note 10).

Income
Taxes

Income taxes are computed using an asset and
liability method, which requires the recognition of taxes
payable or refundable for the current year and deferred tax
assets and liabilities for the future tax consequences of events
that have been recognized in the Companys consolidated
financial statements or tax returns. The measurement of current
and deferred tax assets and liabilities are based on provisions
of the enacted tax law; the effects of future changes in tax
laws or rates are not anticipated. The measurement of deferred
tax assets is reduced, if necessary, by the amount of any tax
benefits that, based on available evidence, are not expected to
be realized.

Net Loss Per
Share

Basic and diluted net loss per share are computed
in accordance with SFAS No. 128, Earnings Per
Share, using the weighted average number of common shares
outstanding. The diluted net loss per share for the twelve-month
periods ended December 31, 2002, 2001 and 2000 does not
include the effect of the common stock equivalents, calculated
by the treasury stock method, as their impact would be
antidilutive. Using the treasury stock method, excluded common
stock equivalents are as follows:

|                                                                  |  |      |           |      |  |      |           |  |  |  |           | 
|----------------------------------------------------------------- |  | ---- | --------- | ---- |  | ---- | --------- |  |  |  | --------- | 
|                                                                  |  | 2002 |           | 2001 |  | 2000
|                                                                  |  |      |           |      |  |     
|Shares issuable under stock options                               |  |      | 2,376,136 |      |  |      | 717,302   |  |  |  | 1,827,356 | 
|Shares issuable pursuant to warrants to purchase
    common stock |  |      | 1,641,781 |      |  |      | 39,323    |  |  |  | 3,016,212 | 
|Shares issuable under convertible subordinated
    debentures     |  |      | 1,020,408 |      |  |      | 1,011,236 |  |  |  | 1,664,351 | 
|                                                                  |  |      |           |      |  |      |           |  |  |  |           | 
|                                                                  |  |      | 5,038,325 |      |  |      | 1,767,861 |  |  |  | 6,507,919 | 
|                                                                  |  |      |           |      |  |      |           |  |  |  |           | 

Comprehensive
Income (Loss)

SFAS No. 130, Reporting Comprehensive
Income, establishes standards for reporting and
presentation of comprehensive income (loss) and its
components in a full set of financial statements. The statement
requires additional disclosures in the consolidated financial
statements; it does not affect the Companys financial
position or results of operations. Comprehensive loss has been
included in the Consolidated Statements of Shareholders
Equity for the three-year period ended December 31, 2002.

F-14



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##### Table of Contents



VERSO TECHNOLOGIES, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



2.     Summary of
Significant Accounting Policies 
(Continued)


Segment and
Geographic Information

In accordance with the provisions of SFAS
No. 131, Disclosures about Segments of an Enterprise
and Related Information, the Company has determined, with
the acquisition of NACT, that it has two separately reportable
operating segments, Carrier Solutions Group and Enterprise
Solutions Group. Substantially all of the Companys
continuing operating results and identifiable assets are in the
United States of America.

New
Accounting Pronouncements

In April 2002, the Financial Accounting Standards
Board (FASB) issued SFAS No. 145,
Rescission of FASB Statements No. 4, 44, and 64,
Amendment of FASB Statement No. 13, and Technical
Corrections, which eliminates the requirement to report
gains and losses related to extinguishments of debt as
extraordinary items. The statement also included other
amendments and technical corrections, which will not have a
material impact on the Company. The provisions of the statement
related to the treatment of debt extinguishments are required to
be applied in fiscal years beginning after May 15, 2002.
Upon adoption, previously recorded extraordinary items for debt
extinguishments will be reclassified to continuing operations.

In June 2002, the FASB issued SFAS No. 146,
Accounting for Costs Associated with Exit or Disposal
Activities (SFAS No. 146). SFAS
No. 146 addresses financial accounting and reporting for
costs associated with exit or disposal activities and nullifies
Emerging Issues Task Force Issue No. 94-3, Liability
Recognition for Certain Employee Termination Benefits and Other
Costs to Exit an Activity (including Certain Costs Incurred in a
Restructuring). SFAS No. 146 requires that a
liability for costs associated with an exit or disposal activity
be recognized when the liability is incurred rather than when a
company commits to such an activity and also establishes fair
value as the objective for initial measurement of the liability.
The Company will adopt SFAS No. 146 for exit or disposal
activities that are initiated after December 31, 2002.

In December 2002, the FASB issued SFAS
No. 148, Accounting for Stock Based
Compensations  Transition and Disclosure
(SFAS No. 148). SFAS No. 148 is an
amendment to SFAF No. 123 providing alternative methods of
transition for a voluntary change to the fair value based method
of accounting for stock-based employee compensation. Amendments
are effective for financial statements for fiscal years ending
after December 15, 2002 and for interim periods beginning
after December 15, 2002. The Company has currently chosen
to not adopt the voluntary change to the fair value based method
of accounting for stock-based employee compensation, pursuant to
SFAS No. 148, which, if adopted, could have a material
effect on the Companys financial position or results of
operations.

In November 2002, the Emerging Issues Task Force
(EITF) of the FASB reached a consensus on EITF
No. 00-21, Accounting for Revenue Arrangements with
Multiple Element Deliverables. The issue addresses how to
account for arrangements that may involve multiple
revenue-generating activities, i.e., the delivery or performance
of multiple products, services, and/or rights to use assets. In
applying this guidance, separate contracts with the same party,
entered into at or near the same time, will be presumed to be a
package, and the consideration will be measured and allocated to
the separate units based on their relative fair values. This
consensus guidance will be applicable to agreements entered into
in quarters beginning after June 15, 2003. The Company will
adopt this new accounting effective July 1, 2003. The
Company is currently evaluating the impact of this change.

F-15



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##### Table of Contents



VERSO TECHNOLOGIES, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



2.     Summary of
Significant Accounting Policies 
(Continued)


In November 2002, the FASB issued FASB
Interpretation No. 45, Guarantors Accounting
and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others, which clarifies the
disclosure and recognition/measurement requirements related to
certain guarantees. The disclosure requirements are effective
for financial statements issued after December 15, 2002 and
the recognition/measurement requirements are effective on a
prospective basis for guarantees issued or modified after
December 31, 2002. The Company typically grants its
customers a warranty, which guarantees that our products will
substantially conform to our current specifications for twelve
months from the delivery date. Historically, costs related to
these guarantees have not been significant and the Company is
unable to estimate the potential impact of these guarantees on
the Companys future results of operations.

In January 2003, the FASB issued Interpretation
No. 46, Consolidation of Variable Interest Entities,
an interpretation of ARB No. 51. This Interpretation
addresses the consolidation by business enterprises of variable
interest entities as defined in the Interpretation. The
Interpretation applies immediately to variable interests in
variable interest entities created after January 31, 2003,
and to variable interests in variable interest entities obtained
after January 31, 2003. The Company is currently evaluating
the impact of applying this Interpretation.



|   |                         
|-- | ------------------------
|3. | Mergers and Acquisitions



| |                            
| | ---------------------------
| | Telemate.Net Software, Inc.

On November 16, 2001, to increase capital
and add patented communications billing and reporting for
next-generation converged Internet protocol and public switched
telephone networks to the Companys product offering, the
Company acquired all of the outstanding capital stock of
Telemate.Net by means of a subsidiary merger. The merger
consideration was approximately $4.1 million, consisting of
24,758,070 shares of the Companys common stock with a fair
value of $16.6 million, assumed options to acquire
5,420,206 shares of the Companys common stock with
exercise prices ranging from $.20 to $5.42 per share (estimated
fair value of $1.8 million, using the Black-Scholes option
pricing model based on the following weighted-average
assumptions: expected volatility  128%; expected
life  one year; risk-free interest rate 
3.3%; and expected dividend yield  0%), deferred
compensation of $131,000 discussed in Note 9 and acquisition
costs of approximately $2.0 million, reduced by retirement
of the Companys Series B redeemable preferred stock
(Series B Preferred Stock) of
$15.0 million and $438,000 of accrued interest thereon and
notes receivable from shareholders assumed of $947,000, which
are included in shareholders equity.

The acquisition was treated as a purchase for
accounting purposes, and accordingly, the assets and liabilities
were recorded at their fair value at the date of the
acquisition. The excess of the purchase price over the estimated
fair value of net assets acquired totaled approximately
$1.1 million and was allocated to goodwill. In accordance
with SFAS No. 142, the Company is not amortizing this
goodwill. Based on the Companys analysis, there has been
no impairment of goodwill as of December 31, 2002.

F-16



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##### Table of Contents



VERSO TECHNOLOGIES, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



|   |                                           
|-- | ------------------------------------------
|3. | Mergers and Acquisitions 
    (Continued)



| |                              
| | -----------------------------
| | NACT Telecommunications, Inc.

On July 27, 2001, in order to enter the
next-generation networking and technology market, the Company
acquired from WA Telcom Products Co., Inc. (WATP)
all of the outstanding capital stock of NACT pursuant to that
certain Stock Purchase Agreement, between the Company and WATP,
dated as of June 4, 2001, as amended (the Purchase
Agreement), whereby NACT became a wholly-owned subsidiary
of the Company. The purchase consideration was approximately
$20.6 million, consisting of a cash payment of
$14.2 million at closing funded primarily by the sale by
the Company of $15.0 million of Series B Preferred
Stock to Telemate.Net, an additional amount payable on
March 31, 2002 of up to $5.3 million plus interest at
prime, a grant to NACTs employees of in-the-money
non-qualified options to purchase shares of the Companys
common stock with a value of $625,000 and acquisition costs of
approximately $500,000.

On March 29, 2002, the Company entered into
a Settlement Agreement and General Release (the WATP
Settlement Agreement) with WATP which provided for a
restructuring of the $5.3 million deferred payment due by
the Company to WATP pursuant to the Purchase Agreement. Pursuant
to the WATP Settlement Agreement, the Companys obligation
to pay to WATP the deferred payment (the Deferred
Amount) on the date the Company filed its Annual Report on
Form 10-K for the year ended December 31, 2001, was
restructured pursuant to the terms and conditions of a
Convertible Secured Promissory Note dated April 25, 2002,
made by the Company in favor of WATP, in the aggregate principal
amount of $4.25 million, together with interest accrued
thereon (the Note). Pursuant to the WATP Settlement
Agreement, the Company paid to WATP $1.5 million on
April 1, 2002, which payment was applied to the
$1.5 million payment due on April 25, 2002, by the
Company to WATP pursuant to the Note. Pursuant to the Note, the
Company also paid $500,000 on July 1, 2002 and
October 1, 2002. In November 2002, the Company negotiated
the early retirement of the remaining $1.75 million plus
accrued interest due on the Note. The Company paid $1.4 million
plus accrued interest and recognized an extraordinary
item  gain on early retirement of debt of $350,000.
The WATP Settlement Agreement was approved by the United States
Bankruptcy Court for the Northern District of Illinois, Eastern
Division, which has jurisdiction over WATPs pending
bankruptcy proceeding.

Furthermore, pursuant to the WATP Settlement
Agreement, the Company and WATP released each other from claims
against each other arising out of or related to the Purchase
Agreement. Managements estimate of the claims against WATP
totaled approximately $1.3 million, which equaled the
reduction of the deferred payment and previously accrued
interest expense on the deferred payment.

In accordance with the terms of the definitive
stock purchase agreement between the Company and Telemate.Net,
on July 27, 2001, Telemate.Net purchased $15.0 million
of Series B Preferred Stock to fund the Companys
acquisition of NACT (see Note 9).

The acquisition was treated as a purchase for
accounting purposes, and accordingly, the assets and liabilities
were recorded at their fair value at the date of the
acquisition. The excess of the purchase price over the estimated
fair value of net assets acquired (including identified
intangible assets of $1.7 million, which are being
amortized over a three year life) totaled approximately
$10.2 million and was allocated to goodwill. Based on the
Companys analysis, there has been no impairment of
goodwill as of December 31, 2002.

Prior to the purchase of NACT, the Company became
an NACT reseller in the first quarter of 2001. The Company
resold NACT gateway solution systems with product revenues for
the six months prior to acquisition totaling $2.8 million
and cost of product sales of $2.1 million.

F-17



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##### Table of Contents



VERSO TECHNOLOGIES, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



|   |                                           
|-- | ------------------------------------------
|3. | Mergers and Acquisitions 
    (Continued)



| |                   
| | ------------------
| | MessageClick, Inc.

On November 22, 2000, the Company acquired
all of the outstanding capital stock of MessageClick, Inc by
means of a subsidiary merger. The merger consideration was
approximately $4.2 million, consisting of 1,405,923 shares
of the Companys common stock with a fair value of
$3.2 million, warrants to acquire 181,901 shares of the
Companys common stock with an exercise price of $4.03 per
share (estimated fair value of $301,000 using the Black-Scholes
option pricing model based on the following weighted-average
assumptions: expected volatility  88%; expected
life  five years; risk-free interest rate 
5.5%; and expected dividend yield  0%), cash of
$5,000 and acquisition costs of approximately $417,000.

The acquisition was treated as a purchase for
accounting purposes, and accordingly, the assets and liabilities
were recorded at their fair value at the date of the
acquisition. The excess of the purchase price over the estimated
fair value of net liabilities acquired totaled approximately
$9.8 million and was allocated to goodwill. The goodwill has
historically been amortized over three years. In the second
quarter of 2001, the Company decided to discontinue offering its
MessageClick ASP service and refocus the development of this
proprietary application to be offered as a licensed software
product. As a result of this decision, the remaining unamortized
balance of goodwill related to MessageClick totaling
$7.9 million was written off as part of the loss from
discontinued operations.

Prior to the Companys acquisition of Cereus
in September 2000 (as described below) and MessageClick in
November 2000, Cereus purchased 3,000,000 shares of
MessageClicks Series E Preferred Stock for an
aggregate purchase price of $1,500,000. In addition, in November
2000, the Company loaned MessageClick $300,000 pursuant to a
90-day promissory note.



| |                             
| | ----------------------------
| | Allocation of Purchase Price

|                                     |  |              |        |      |  |              |        |   |  |   |        |  
|------------------------------------ |  | ------------ | ------ | ---- |  | ------------ | ------ | - |  | - | ------ | -
|                                     |  | Telemate.Net |        | NACT |  | MessageClick
|                                     |  |              |        |      |  |             
|Cash                                 |  | $            | 4,810  |      |  | $            | 2,538  |   |  | $ | 176    |  
|Other current assets                 |  |              | 1,361  |      |  |              | 10,547 |   |  |   | 192    |  
|Property and equipment               |  |              | 563    |      |  |              | 2,505  |   |  |   | 1,273  |  
|Intangibles                          |  |              | 1,062  |      |  |              | 11,871 |   |  |   | 9,874  |  
|Current liabilities                  |  |              | (3,821 | )    |  |              | (1,544 | ) |  |   | (4,207 | )
|Deferred payment on purchase of NACT |  |              |       |      |  |              | (5,340 | ) |  |   |       |  
|Convertible subordinated debentures  |  |              |       |      |  |              |       |   |  |   | (3,124 | )
|Deferred compensation                |  |              | 131    |      |  |              |       |   |  |   |       |  
|                                     |  |              |        |      |  |              |        |   |  |   |        |  
|Purchase consideration               |  | $            | 4,106  |      |  | $            | 20,577 |   |  | $ | 4,184  |  
|                                     |  |              |        |      |  |              |        |   |  |   |        |  

F-18



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##### Table of Contents



VERSO TECHNOLOGIES, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



|   |                                           
|-- | ------------------------------------------
|3. | Mergers and Acquisitions 
    (Continued)



| |                                                            
| | -----------------------------------------------------------
| | Pro Forma Effect of Telemate.Net, NACT and
    MessageClick

The following unaudited pro forma information
presents the results of continuing operations of the Company as
if the acquisitions of Telemate.Net, NACT and MessageClick had
taken place on January 1, 2000 (in thousands, except per
share amounts):

|                                                                             |  |      |         |      |  |   |         |  
|---------------------------------------------------------------------------- |  | ---- | ------- | ---- |  | - | ------- | -
|                                                                             |  | 2001 |         | 2000
|                                                                             |  |      |         |     
|Revenues                                                                     |  | $    | 47,567  |      |  | $ | 46,506  |  
|Net loss from continuing operations                                          |  | $    | (17,623 | )    |  | $ | (40,830 | )
|Net loss from continuing operations per common
    share  basic and diluted |  | $    | (0.23   | )    |  | $ | (0.81   | )
|Loss before extraordinary item per common
    share  basic and diluted      |  |      | (2.02   | )    |  |   | (1.65   | )
|Net loss per common share  basic and
    diluted                            |  |      | (2.04   | )    |  |   | (1.65   | )
|Weighted average shares outstanding 
    basic and diluted                  |  |      | 76,137  |      |  |   | 50,662  |  



| |                                     
| | ------------------------------------
| | Cereus Technology Partners,
    Inc.

On September 29, 2000, the Company acquired
all of the outstanding capital stock of Cereus, a reseller of
business applications and consulting practice, by means of a
subsidiary merger. The merger consideration was approximately
$133.6 million, consisting of 21,866,600 shares of the
Companys common stock with a fair value of
$106.6 million, assumed options and warrants to acquire
20,947,900 shares of the Companys common stock with
exercise prices ranging from $.51 to $10.14 per share (estimated
fair value of $35.8 million, net of $6.9 million of
deferred compensation discussed in Note 9, using the
Black-Scholes option pricing model based on the following
weighted-average assumptions: expected volatility 
88%; expected life  five years; risk-free interest
rate  5.5%; and expected dividend yield 
0%) and acquisition costs of approximately $1.9 million,
reduced by notes receivable from shareholders of $667,000 and a
$10.2 million bridge facility advanced to the Company by
Cereus prior to closing.

The acquisition was treated as a purchase for
accounting purposes, and accordingly, the assets and liabilities
were recorded at their fair value at the date of the
acquisition. The excess of the purchase price over the estimated
fair value of net assets acquired totaled approximately
$113.0 million and was allocated to goodwill. The goodwill
has historically been amortized over three years.

During the second quarter of 2001, the Company
changed its strategic direction from primarily acting as a
value-added reseller of prepackaged software to pursuing
opportunities in the next generation networking and softswitch
technology market. As a result of the Companys change in
strategy, the Company re-evaluated its operations obtained
through prior acquisition transactions, and determined that
several operations, including its Cereus business, did not add
value to the new strategic direction. Management evaluated its
net intangibles associated with these non-strategic operations,
and based upon its consolidated operating projections of
expected future cash flows over a three-year period, discounted
using a 8.0% interest rate, determined that the related net
intangibles were impaired. Accordingly, the Company recognized a
write-down of goodwill of $77.1 million during the quarter
ended June 30, 2001.

The Company decided to discontinue investment in
its legacy VAR business during the fourth quarter of 2001. As a
result, the Company has accounted for the operations of Cereus
as discontinued operations.

F-19



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##### Table of Contents



VERSO TECHNOLOGIES, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

4.     Unconsolidated
Affiliates



| |                                       
| | --------------------------------------
| | Shanghai BeTrue Infotech Co.,
    Ltd.

On October 1, 2002, the Company acquired a
51% interest in Shanghai BeTrue Infotech Co., Ltd.
(BeTrue). The remaining 49% interest in BeTrue is
owned by Shanghai Tangsheng Investments & Development
Co. Ltd (Shanghai Tangsheng). The joint venture
provides the Company with an immediate distribution channel into
the China and Asia-Pacific region for the Companys
application-based Voice over Internet Protocol gateway
solutions, billing systems, value-added applications and web
filtering solutions. Due to the shared decision making between
the Company and its equity partner, the results of BeTrue are
treated as an equity investment rather than being consolidated.

The Company purchased the 51% interest in BeTrue
for $100,000 from NeTrue Communications, Inc., Shanghai
Tangshengs former joint venture partner with $50,000 paid
at closing, $25,000 paid on December 30, 2002, and $25,000
to be paid on March 30, 2003. Upon closing the transaction,
the Company also contributed to the joint venture certain
next-generation communication equipment and software valued at
approximately $236,000 and $50,000 cash. Additionally, the
Company contributed $25,000 on December 30, 2002 and will
also contribute $25,000 on March 30, 2003.

Summarized unaudited financial information
reported by this affiliate for the period subsequent to the
Companys investment and as of December 31, 2002 (in
thousands) are as follows:

|                    |                      |                                            |   |       |       | 
|------------------- | -------------------- | ------------------------------------------ | - | ----- | ----- | 
|Operating results:  |                      |                                            |   |      
|                    | Revenues             |                                            | $ | 725   |      
|                    |                      |                                            |   |      
|                    | Operating loss       |                                            | $ | (5    | )    
|                    |                      |                                            |   |      
|                    | Net loss             |                                            | $ | (9    | )    
|                    |                      |                                            |   |      
|Financial position: |                      |                                            |   |      
|                    | Current assets       |                                            | $ | 2,053 |      
|                    | Noncurrent assets    |                                            |   | 80    |      
|                    |                      |                                            |   |      
|                    |                      | Total assets                               |   | $     | 2,133 | 
|                    |                      |                                            |   |      
|                    | Current liabilities  |                                            | $ | 1,775 |      
|                    | Stockholders equity |                                            |   | 358   |      
|                    |                      |                                            |   |      
|                    |                      | Total liabilities and stockholders equity |   | $     | 2,133 | 
|                    |                      |                                            |   |      

F-20



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##### Table of Contents



VERSO TECHNOLOGIES, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

5.     Discontinued
Operations

Following the acquisition of NACT in July 2001,
the Company determined that its legacy VAR business was not
strategic to the Companys ongoing objectives and
discontinued capital and human resource investment in its legacy
VAR business. Accordingly, the Company elected to report its
legacy VAR business as discontinued operations by early adoption
of SFAS No. 144, effective for the fourth quarter of 2001.
The legacy VAR business is included with HSG (which was reported
as discontinued operations in 2001) for a combined presentation
of discontinued operations.

During 2000, the Companys board of
directors decided to dispose of HSG. In December 2000, the
Company completed the sale of its domestic lodging business and
international hospitality business for aggregate proceeds of
$10.0 million. The Company sold its restaurant solutions
business for aggregate proceeds of $8.5 million in January
2001.

The loss on the sale of HSG totaled
$11.5 million. A loss of $11.0 million was recorded in
the third and fourth quarters of 2000 and an additional $500,000
was recorded in the third quarter of 2001, the latter related to
winding up the Companys international hospitality
operations, the assets of which were sold in the fourth quarter
of 2000. The 2000 loss included a reduction in asset values of
approximately $6.7 million and a provision for anticipated
closing costs and operating losses until disposal of
approximately $4.3 million.

Summary operating results of the discontinued
operations (in thousands) are as follows:

|                                  |  |                                 |      |      |  |      |          |   |  |   |         |  
|--------------------------------- |  | ------------------------------- | ---- | ---- |  | ---- | -------- | - |  | - | ------- | -
|                                  |  |                                
|                                  |  | For the Year Ended December 31,
|                                  |  |                                
|                                  |  | 2002                            |      | 2001 |  | 2000
|                                  |  |                                 |      |      |  |     
|Revenue                           |  | $                               | 223  |      |  | $    | 12,762   |   |  | $ | 96,944  |  
|                                  |  |                                 |      |      |  |      |          |   |  |   |         |  
|Gross (loss) profit               |  |                                 | (331 | )    |  |      | 374      |   |  |   | 23,429  |  
|                                  |  |                                 |      |      |  |      |          |   |  |   |         |  
|Operating loss                    |  |                                 | (331 | )    |  |      | (135,598 | ) |  |   | (35,291 | )
|Interest expense                  |  |                                 |     |      |  |      |         |   |  |   | (785    | )
|Loss on disposal of assets        |  |                                 |     |      |  |      | (500     | ) |  |   | (6,704  | )
|Income tax expense                |  |                                 |     |      |  |      |         |   |  |   | (170    | )
|                                  |  |                                 |      |      |  |      |          |   |  |   |         |  
|Loss from discontinued operations |  | $                               | (331 | )    |  | $    | (136,098 | ) |  | $ | (42,950 | )
|                                  |  |                                 |      |      |  |      |          |   |  |   |         |  

The loss from discontinued operations in 2001
includes depreciation of $546,000, amortization of intangibles
of $22.7 million, write-down of goodwill of
$95.3 million, reorganization costs of $9.2 million
and amortization of deferred compensation of $267,000. The loss
from discontinued operations in 2000 includes depreciation of
$1.8 million, amortization of intangibles of
$11.5 million, loss on asset abandonment of $218,000,
reorganization costs of $1.0 million and amortization of
deferred compensation of $126,000.

The reorganization costs consist of the following
(in thousands):

|                               |  |      |       |      |  |   |     | 
|------------------------------ |  | ---- | ----- | ---- |  | - | --- | 
|                               |  | 2001 |       | 2000
|                               |  |      |       |     
|Severance costs                |  | $    | 1,217 |      |  | $ | 731 | 
|Facilities closings            |  |      | 6,162 |      |  |   | 258 | 
|Inventory write-down           |  |      | 1,005 |      |  |   |     | 
|MessageClick ASP exiting costs |  |      | 824   |      |  |   |    | 
|                               |  |      |       |      |  |   |     | 
|                               |  | $    | 9,208 |      |  | $ | 989 | 
|                               |  |      |       |      |  |   |     | 

F-21



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##### Table of Contents



VERSO TECHNOLOGIES, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

5.     Discontinued
Operations  (Continued)

Assets and liabilities of discontinued operations
(in thousands) are as follows:

|                            |                                        |              |       |       |  |   |       |       | 
|--------------------------- | -------------------------------------- | ------------ | ----- | ----- |  | - | ----- | ----- | 
|                            |                                        |             
|                            |                                        | December 31,
|                            |                                        |             
|                            |                                        | 2002         |       | 2001 
|                            |                                        |              |       |      
|Accounts receivable, net    |                                        | $            |      |       |  | $ | 501   |      
|Other current assets        |                                        |              |      |       |  |   | 81    |      
|                            |                                        |              |       |       |  |   |       |      
|                            | Assets of discontinued operations      |              | $     |      |  |   | $     | 582   | 
|                            |                                        |              |       |       |  |   |       |      
|Accrued restructuring costs |                                        | $            | 2,010 |       |  | $ | 2,730 |      
|Accrued compensation        |                                        |              |      |       |  |   | 210   |      
|Other current liabilities   |                                        |              | 1,121 |       |  |   | 1,360 |      
|                            |                                        |              |       |       |  |   |       |      
|                            | Liabilities of discontinued operations |              | $     | 3,131 |  |   | $     | 4,300 | 
|                            |                                        |              |       |       |  |   |       |      

Accrued reorganization costs relates primarily to
several leases for buildings and equipment that are no longer
being utilized in continuing operations. The accrual is for all
remaining payments due on these leases, less amounts to be paid
by any sublessors. The accrual for one of the leases with total
payments remaining of $2.7 million assumes that the
building will be sub-leased for approximately 50% of the total
lease liability over the term of the lease.

Activity in the accrued reorganization costs was
as follows:

|                          |  |   |       |  
|------------------------- |  | - | ----- | -
|Balance December 31, 2001 |  | $ | 2,730 |  
|Lease payments            |  |   | (996  | )
|Additional lease accrual  |  |   | 276   |  
|                          |  |   |       |  
|Balance December 31, 2002 |  | $ | 2,010 |  
|                          |  |   |       |  



|   |                       
|-- | ----------------------
|6. | Financing Arrangements

On February 12, 2003, the Company amended
its original credit agreement (the Original Credit
Agreement) with its primary lender, Silicon Valley Bank
(Silicon) to increase the Companys credit line
with Silicon from $5.0 million to $10.0 million,
subject to borrowing availability. The Company also entered into
certain additional arrangements with Silicon including an EX-IM
(export-import) facility that will provide for working capital
based on the Companys international accounts receivable
and inventory related to export sales. On April 7, 2003,
the Company and Silicon further amended the credit facility to
increase the EX-IM facility and to modify certain financial
covenants related to the timing of the Companys purchase
of substantially all of the business assets along with related
liabilities of Clarent Corporation on February 12, 2003 (as
amended on February 12, 2003, and April 7, 2003, the
Amended Credit Agreement). The Amended Credit
Agreement is secured by substantially all of the assets of the
Company. Interest is computed at 2.0% above Silicons Base
Rate (6.25% at December 31, 2002). The Amended Credit
Agreement provides for up to $1,000,000 in letters of credit.
Advances are limited by a formula based on eligible receivables,
inventory, certain cash balances, outstanding letters of credit
and certain subjective limitations. Interest payments are due
monthly, and the Amended Credit Agreement expires in August
2004. The Amended Credit Agreement includes a loan fee of
$130,000 and .375% on unused available borrowings. Under the
terms of the Amended Credit Agreement, the Company is required
to maintain a minimum EBITDA (earnings before interest, taxes,
depreciation and amortization), computed monthly, and cannot
declare dividends or incur any additional indebtedness without
the consent of Silicon, and maintain other financial covenants,
as defined. Pursuant to the loan commitment letter with Silicon,
on February 12, 2003, the Company issued to Silicon a
warrant to purchase 350,000 shares of the Companys
common stock at an exercise price of $0.44 per share. The fair
value of the warrant issued, totaled approximately $119,000,
using the Black-Scholes option pricing method based on the
following weighted-average assumptions: expected
volatility  104%; expected

F-22



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##### Table of Contents



VERSO TECHNOLOGIES, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



|   |                                         
|-- | ----------------------------------------
|6. | Financing
    Arrangements  (Continued)

life  five years; risk-free interest
rate  3.0%; and expected dividend yield 
0%. The loan fees and fair value of the warrants issued will be
amortized to interest expense over the term of the Amended
Credit Agreement.

The Company had $800,000 of borrowings under the
Original Credit Agreement as of December 31, 2002. The
remaining availability under the Original Credit Agreement at
December 31, 2002 was $3.8 million. Under the terms of
the Original Credit Agreement, the Company was required to
maintain a minimum tangible net worth calculation and maintain
other financial covenants, as defined. The Company was in
compliance with these covenants as of December 31, 2002.
The Original Credit Agreement included a loan fee of $50,000 and
a fee of .25% on unused available borrowings. The Company paid
certain loan fees and attorneys fees totaling
approximately $109,000 in connection with the Original Credit
Agreement. On May 15, 2002, the Company issued to Silicon a
warrant to purchase 308,641 shares of the Companys common
stock at an exercise price of $0.81 per share. The fair value of
the warrant issued, totaled approximately $211,000, using the
Black-Scholes option pricing method based on the following
weighted-average assumptions: expected volatility 
128%; expected life  five years; risk-free interest
rate  3.3%; and expected dividend yield 
0%. The loan fees, attorneys fees and fair value of the
warrants were fully amortized to interest expense as of
December 31, 2002.



|   |                                    
|-- | -----------------------------------
|7. | Convertible Subordinated Debentures

In connection with the Companys acquisition
of MessageClick, certain investors of MessageClick purchased
$4.5 million of the Companys 7.5% convertible
subordinated debentures and warrants to purchase an aggregate of
181,901 shares of the Companys common stock at an
exercise price of $7.39 per share. The debentures are
convertible into the Companys common stock at a conversion
price of $4.45. The convertible subordinated debentures are due
November 22, 2005. The debentures have been discounted to
reflect the fair value of the warrants issued, totaling
approximately $1.4 million, using the Black-Scholes option
pricing method based on the following weighted-average
assumptions: expected volatility  88%; expected
life  five years; risk-free interest rate 
5.5%; and expected dividend yield  0%. The
unamortized discount totaled approximately $797,000 million
at December 31, 2002. In addition, the Company paid certain
private placement fees and attorneys fees in connection
with the sale of the debentures totaling $50,000. The fees are
being amortized to interest expense over the term of the
debentures. The net value of the convertible subordinated
debentures are approximately $3.7 million at
December 31, 2002.

The Company issued $7.0 million of its 5%
convertible subordinated debentures during the year ended
December 31, 2000. The convertible subordinated debentures
were issued with warrants to purchase 364,584 shares of the
Companys common stock at an exercise price of
$5.03 per share. The debentures were discounted to reflect
the fair value of the warrants issued, totaling approximately
$1.0 million, using the Black-Scholes option pricing method
based on the following weighted-average assumptions: expected
volatility  88%; expected life  five
years; risk-free interest rate  5.5%; and expected
dividend yield  0%. In addition, the Company paid
certain private placement fees (including 88,712 shares of
the Companys common stock with a fair value at the date of
issuance totaling $350,000) and attorneys fees in
connection with the sale of the debentures totaling $454,000.
The fees were amortized to interest expense over the term of the
debentures until the debentures were retired or converted into
the Companys common stock.

F-23



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##### Table of Contents



VERSO TECHNOLOGIES, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



|   |                                                      
|-- | -----------------------------------------------------
|7. | Convertible Subordinated
    Debentures  (Continued)

In January 2001, the Company modified the terms
of its 5% convertible subordinated debentures. According to the
modified terms of the convertible subordinated debentures, the
Company repurchased $4.5 million of the outstanding
$7.0 million of its 5% convertible subordinated debentures.
Of the remaining $2.5 million in outstanding 5% convertible
subordinated debentures, $1.5 million were converted by the
investors into the Companys common stock at a price of
$1.40 per share. The remaining $1.0 million of 5%
convertible subordinated debentures was converted at
$1.19 per share. In connection with this modification, the
Company issued warrants to purchase 945,378 shares of the
Companys common stock at an exercise price of
$2.00 per share. The fair value of the warrants issued,
totaled approximately $977,000, using the Black-Scholes option
pricing method based on the following weighted-average
assumptions: expected volatility  91%; expected
life  five years; risk-free interest rate 
5.5%; and expected dividend yield  0%. The cost of
conversion, including the warrants issued, totaled
$1.6 million in the year ended December 31, 2001.

The cost of conversion is reflected as an
extraordinary item in the consolidated statement of operations
for the year ended December 31, 2001 and consisted of the
following (in thousands):

|                               |  |   |       | 
|------------------------------ |  | - | ----- | 
|Fair value of warrants issued  |  | $ | 977   | 
|Write off of related discount  |  |   | 365   | 
|Write off of related loan fees |  |   | 165   | 
|Beneficial conversion          |  |   | 107   | 
|Legal and other costs          |  |   | 26    | 
|                               |  |   |       | 
|                               |  | $ | 1,640 | 
|                               |  |   |       | 



|   |                     
|-- | --------------------
|8. | Reorganization Costs

In the third and fourth quarters of 2002, the
Company initiated certain restructuring plans. As a part of the
Companys efforts to improve operational efficiencies and
financial performance the Company eliminated 42 positions
held by employees. As a result of these actions, the Company
recorded reorganization costs of $324,000 during the year ended
December 31, 2002. The reorganization costs consist of
severance costs and the balance of the accrued severance costs
as of December 31, 2002 is $69,000.

In the second quarter 2000, the Company announced
a reorganization and accelerated the vesting of options for
certain board members and executives who were going to be
terminated in connection with the Companys acquisition of
Cereus. The costs associated with these eliminations included
the fair value of 5,000 shares of the Companys common
stock issued to an employee and the intrinsic value of
accelerated vesting and extended exercise dates on options
previously issued to employees and directors totaling
approximately $511,000.



|   |                     
|-- | --------------------
|9. | Shareholders Equity



| |                
| | ---------------
| | Preferred Stock

The Company originally authorized 1,000,000
shares of preferred stock, 30,000 shares of which were
designated as Series A Convertible Preferred Stock
(Series A Preferred Stock). All
30,000 shares of the Series A Preferred Stock have
been converted into 300,000 shares of the Companys common
stock.

F-24



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##### Table of Contents



VERSO TECHNOLOGIES, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



|   |                                       
|-- | --------------------------------------
|9. | Shareholders
    Equity  (Continued)

In 2001, concurrent with the acquisition of NACT,
the Company issued and sold to Telemate.Net an aggregate of
$15.0 million of Series B Preferred Stock at a price
of $20.00 per share. Upon the acquisition of Telemate.Net,
these shares were retired. There were no outstanding shares of
the Companys preferred stock at December 31, 2002 and
2001. Currently, there are 220,000 shares of undesignated
preferred stock, which are authorized but unissued.



| |                   
| | ------------------
| | Private Placements

On October 17, 2002, the Company issued
9,646,302 units of the Companys securities
(Units), with each Unit consisting of one share of
common stock and a warrant to purchase one share of common
stock, at a purchase price of $0.311 per Unit, resulting in
aggregate proceeds of approximately $3.0 million less
issuance costs of $15,000. Each warrant entitles the holder to
purchase one share of restricted common stock at an exercise
price of $0.311 per share. The warrants are immediately
exercisable for a five-year period and are callable at any time
following the date of issuance if the closing price of the
Companys common stock equals or exceeds $1.20 for ten
consecutive trading days. The fair value of the warrants issued,
totaled approximately $2.3 million, using the Black-Scholes
option pricing method based on the following weighted-average
assumptions: expected volatility  103%; expected
life  five years; risk-free interest rate 
2.9%; and expected dividend yield  0%.

On March 29, 2000, the Company sold
1,194,532 shares of its common stock to accredited
investors in a private placement for aggregate proceeds of
approximately $13.3 million less issuance costs of $240,000.

On June 29, 2000, the Company sold
180,000 shares of its common stock to an accredited
investor in a private placement for aggregate proceeds of
$990,000.



| |               
| | --------------
| | Stock Warrants

In connection with various financing and
acquisition transactions, and related services provided to the
Company, the Company has issued warrants to purchase the
Companys common stock.

During 2002, the Company issued
9,646,302 warrants in connections with the Companys
private placement on October 17, 2002, per above
discussion, and 308,641 on May 15, 2002 in connection with
the Companys Original Credit Agreement (see Note 6).

During 2001, the Company issued
945,378 warrants in connection with the modification of the
terms of its 5% convertible subordinated debt agreement. The
fair value of the warrants issued, totaled approximately
$977,000, using the Black-Scholes option pricing method based on
the following weighted-average assumptions: expected
volatility  91%; expected life  five
years; risk-free interest rate  5.5%; and expected
dividend yield  0% (see Note 7).

F-25



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##### Table of Contents



VERSO TECHNOLOGIES, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



|   |                                       
|-- | --------------------------------------
|9. | Shareholders
    Equity  (Continued)

During 2000, the Company issued 364,584 warrants
in connection with its 5% convertible subordinated debentures
and 181,901 warrants in connection with its
7.5% convertible subordinated debentures. In addition,
warrants issued by Cereus to purchase shares of Cereus common
stock were assumed by the Company and converted at a rate of
1.75 shares of the Companys common stock per share of
Cereus common stock at the time the Company acquired Cereus.
These warrants, after conversion, totaled 13,131,192 and were
issued to employees and non-employees related to financing
transactions of Cereus. The fair value of these warrants at the
time of merger, estimated to be $17.5 million using the
Black-Scholes option pricing model based on the following
weighted-average assumptions: expected volatility 
88%; expected life  five years; risk-free interest
rate  5.5%; and expected dividend yield 
0%, was included in the cost of the acquisition. A summary of
warrants outstanding at December 31, 2002, is as follows:

|                             |  |           |            |          |  |                 |           |  |  |  |                               | 
|---------------------------- |  | --------- | ---------- | -------- |  | --------------- | --------- |  |  |  | ----------------------------- | 
|                             |  | Number of |            | Exercise |  |                
|Year issued                  |  | Warrants  |            | Price    |  | Expiration Date
|                             |  |           |            |          |  |                
|Year ended December 31, 1996 |  |           | 175,000    |          |  | $               | 5.38-6.00 |  |  |  | September 2003  October 2006 | 
|Year ended December 31, 1997 |  |           | 365,000    |          |  | $               | 5.00-6.00 |  |  |  | January 2004  September 2007 | 
|Year ended December 31, 2000 |  |           | 14,736,914 |          |  | $               | 0.01-7.30 |  |  |  | February 2003  November 2010 | 
|Year ended December 31, 2001 |  |           | 1,312,790  |          |  | $               | 0.01-1.98 |  |  |  | November 2004  January 2006  | 
|Year ended December 31, 2002 |  |           | 9,954,943  |          |  | $               | 0.31-0.81 |  |  |  | May 2007  October 2007       | 
|                             |  |           |            |          |  |                 |           |  |  |  |                               | 
|                             |  |           | 26,544,647 |          |  |                 |           |  |  |  |                               | 
|                             |  |           |            |          |  |                 |           |  |  |  |                               | 

As of December 31, 2002, all of the warrants
are vested.



|    |                  
|--- | -----------------
|10. | Stock Option Plan

The Company has a stock option plan for
employees, consultants, and other individual contributors to the
Company which enables the Company to grant up to
15.0 million qualified and nonqualified incentive stock
options (the 1999 Plan). In 2001, the 1999 Plan was
amended to increase the amount of stock options available for
grant from 10.0 million to 15.0 million shares. The
Company adopted the 1999 Plan which aggregates the
Companys prior stock option plans, in the second quarter
of 1999. The qualified options are to be granted at an exercise
price not less than the fair market value at the date of grant.
Subject to certain exceptions, the aggregate number of shares of
common stock that may be granted through awards under the 1999
Plan to any employee in any calendar year may not exceed 300,000
shares. The compensation committee of the Companys board
of directors determines the period within which options may be
exercised, but no option may be exercised more than ten years
from the date of grant. The compensation committee also
determines the period over which the options vest. Options are
generally exercisable for ten years from the grant date and
generally vest over a four-year period from the date of grant.

The 1999 Plan also provides for stock purchase
authorizations and stock bonus awards. Stock bonus awards
totaling 86,000 shares and 5,000 shares have been granted under
the 1999 Plan as of December 31, 2002 and December 31,
2000, respectively. None were awarded for 2001. The total number
of shares available for awards under the 1999 Plan as of
December 31, 2002 was 4,587,693.

F-26



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##### Table of Contents



VERSO TECHNOLOGIES, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



|    |                                    
|--- | -----------------------------------
|10. | Stock Option
    Plan  (Continued)

Upon the acquisition of Telemate.Net in November
2001, the Company assumed the Telemate Stock Incentive Plan and
the Telemate.Net Software, Inc. 1999 Stock Incentive Plan (the
Telemate.Net Plans), and the options outstanding
thereunder. The options outstanding under the Telemate.Net Plans
were converted at a rate of 2.62 shares of the
Companys common stock per share of Telemate.Nets
common stock at the time of the acquisition and totaled
5,420,206 shares. These options, at the time of
acquisition, had an estimated fair value of $1.8 million
using the Black-Scholes option pricing model based on the
following weighted-average assumptions: expected
volatility  128%; expected life  one year;
risk-free interest rate  3.3%; and expected dividend
yield  0%, was included in the cost of the
acquisition. The Company does not plan to issue any additional
shares under the Telemate.Net Plans.

In connection with the acquisition of
Telemate.Net, the Company recorded deferred compensation of
approximately $131,000 for the aforementioned options granted by
Telemate.Net prior to the acquisition which were exchanged for
the Companys options. The Company amortizes deferred
compensation over three years, the weighted-average vesting
period of the options. The Company amortized to non-cash
compensation expense approximately $48,000 and $8,000 of the
deferred compensation related to these option grants for the
year ended December 31, 2002 and 2001, respectively. The
Company reduced deferred compensation due to forfeitures
relating to these options totaling approximately $41,000 during
the year ended December 31, 2002.

Upon the acquisition of Cereus in September 2000,
the Company assumed the Cereus Technology Partners, Inc. 1997
Stock Option Plan (the Cereus Plan), and the options
outstanding thereunder. The options outstanding under the Cereus
Plan were converted at a rate of 1.75 shares of the
Companys common stock per share of Cereus common stock at
the time of the acquisition and totaled 1,376,708. These
options, at the time of acquisition, had an estimated fair value
of $2.8 million using the Black-Scholes option pricing
model based on the following weighted-average assumptions:
expected volatility  88%; expected life 
five years; risk-free interest rate  5.5%; and
expected dividend yield  0%, was included in the cost
of the acquisition. The Company does not plan to issue any
additional shares under the Cereus Plan.

In connection with the acquisition of Cereus, the
Company recorded deferred compensation of approximately
$6.9 million for the aforementioned options granted by
Cereus prior to the acquisition which were exchanged for the
Companys options. The Company amortizes deferred
compensation over four years, the vesting period of the options.
The Company amortized to non-cash compensation expense
approximately $1.1 million, $1.8 million and $500,000
of the deferred compensation related to these option grants for
the years ended December 31, 2002, 2001 and 2000,
respectively. The Company reduced deferred compensation due to
forfeitures relating to these options totaling approximately
$155,000 and $1.2 million during the years ended
December 31, 2002 and 2001, respectively.

Prior to the acquisition of Cereus, Cereus
granted stock warrants totaling 3,680,000 in 2000 to certain
employees and directors outside the Cereus Plan in addition to
the warrants discussed in Note 9. These stock warrants have
contractual terms of 5-10 years. The majority of these
warrants have an exercise price equal to the fair market value
of Cereuss common stock at the grant date. The warrants
granted in 2000 vest over various terms not to exceed seven
years, beginning on the date of the grant. These warrants were
assumed by the Company and converted as contemplated in the
merger agreement with respect to the Companys acquisition
of Cereus to 6,440,000 warrants at the time of the Cereus
acquisition. The fair value of these warrants at the time of the
acquisition, estimated to be $15.5 million using the
Black-Scholes option pricing model based on the following
weighted-average assumptions: expected volatility 
88%; expected life  five years; risk-free interest
rate  5.5%; and expected dividend yield 
0%, was included in the cost of the acquisition.

F-27



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##### Table of Contents



VERSO TECHNOLOGIES, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



|    |                                    
|--- | -----------------------------------
|10. | Stock Option
    Plan  (Continued)

The Company accelerated vesting and extended
exercise dates on options for certain terminated individuals due
to reorganizations during 2002 and 2000 (see Note 8). As a
result, the Company recorded a non-cash charge of approximately
$23,000 and $482,000 for the year ended December 31, 2002
and 2000, respectively, representing the value of the
accelerated vesting and extended exercise dates for certain
terminated employees. The expense is included in reorganization
costs.

A summary of the status of the Companys
stock options granted to employees, and the above warrants
granted by Cereus, prior to its acquisition by the Company, as
of December 31, 2002, December 31, 2001, and
December 31, 2000 and the changes during the year ended on
these dates is presented below:

Employee
Stock Options and Warrants

|                                                   |  |            |            |          |  |            |      |          |  |            |            |          |  |   |      |  |  |  |            |  |  |   |      | 
|-------------------------------------------------- |  | ---------- | ---------- | -------- |  | ---------- | ---- | -------- |  | ---------- | ---------- | -------- |  | - | ---- |  |  |  | ---------- |  |  | - | ---- | 
|                                                   |  |            |            |          |  |           
|                                                   |  | 2002       |            | 2001     |  | 2000      
|                                                   |  |            |            |          |  |           
|                                                   |  | Number of  |            | Weighted |  | Number of  |      | Weighted |  | Number of  |            | Weighted
|                                                   |  | Shares of  |            | Average  |  | Shares of  |      | Average  |  | Shares of  |            | Average 
|                                                   |  | Underlying |            | Exercise |  | Underlying |      | Exercise |  | Underlying |            | Exercise
|                                                   |  | Options    |            | Prices   |  | Options    |      | Prices   |  | Options    |            | Prices  
|                                                   |  |            |            |          |  |            |      |          |  |            |            |         
|Outstanding at beginning of the year               |  |            | 18,029,478 |          |  | $          | 2.56 |          |  |            | 14,599,370 |          |  | $ | 4.19 |  |  |  | 4,058,207  |  |  | $ | 4.05 | 
|Granted                                            |  |            | 1,366,300  |          |  |            | 1.46 |          |  |            | 9,547,453  |          |  |   | 0.90 |  |  |  | 12,665,797 |  |  |   | 4.35 | 
|Exercised                                          |  |            | 847,082    |          |  |            | 0.34 |          |  |            | 1,090,702  |          |  |   | 0.60 |  |  |  | 1,005,596  |  |  |   | 3.41 | 
|Forfeited                                          |  |            | 2,750,408  |          |  |            | 5.10 |          |  |            | 5,026,643  |          |  |   | 4.53 |  |  |  | 1,119,038  |  |  |   | 6.25 | 
|Expired                                            |  |            |           |          |  |            |     |          |  |            |           |          |  |   |     |  |  |  |           |  |  |   |     | 
|                                                   |  |            |            |          |  |            |      |          |  |            |            |          |  |   |      |  |  |  |            |  |  |   |      | 
|Outstanding at end of year                         |  |            | 15,798,288 |          |  |            | 2.13 |          |  |            | 18,029,478 |          |  |   | 2.57 |  |  |  | 14,599,370 |  |  |   | 4.19 | 
|                                                   |  |            |            |          |  |            |      |          |  |            |            |          |  |   |      |  |  |  |            |  |  |   |      | 
|Exercisable at end of year                         |  |            | 9,901,956  |          |  |            | 2.16 |          |  |            | 8,210,833  |          |  |   | 2.49 |  |  |  | 5,670,100  |  |  |   | 3.92 | 
|                                                   |  |            |            |          |  |            |      |          |  |            |            |          |  |   |      |  |  |  |            |  |  |   |      | 
|Weighted-average fair value of all options granted |  |            |            |          |  |            | 0.70 |          |  |            |            |          |  |   | 0.75 |  |  |  |            |  |  |   | 4.19 | 

The fair value of each stock option granted is
estimated on the date of grant using the Black-Scholes
option-pricing model with the following weighted-average
assumptions:

|                        |  |      |        |      |  |      |        |   |  |  |       |  
|----------------------- |  | ---- | ------ | ---- |  | ---- | ------ | - |  |  | ----- | -
|Assumption              |  | 2002 |        | 2001 |  | 2000
|                        |  |      |        |      |  |     
|Expected Term           |  |      | 4.00   |      |  |      | 4.00   |   |  |  | 4.00  |  
|Expected Volatility     |  |      | 110.00 | %    |  |      | 130.00 | % |  |  | 91.00 | %
|Expected Dividend Yield |  |      | 0.00   | %    |  |      | 0.00   | % |  |  | 0.00  | %
|Risk-Free Interest Rate |  |      | 3.00   | %    |  |      | 3.32   | % |  |  | 5.50  | %

F-28



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##### Table of Contents



VERSO TECHNOLOGIES, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



|    |                                    
|--- | -----------------------------------
|10. | Stock Option
    Plan  (Continued)

The following table summarizes information about
employee stock options and the above warrants granted by Cereus,
prior to its acquisition by the Company, outstanding at
December 31, 2002:

|                  |  |                     |            |                     |  |            |      |             |  |                |      |  |  |  |           |  |  |   |      | 
|----------------- |  | ------------------- | ---------- | ------------------- |  | ---------- | ---- | ----------- |  | -------------- | ---- |  |  |  | --------- |  |  | - | ---- | 
|                  |  |                     |            |                    
|                  |  | Options Outstanding |            | Options Exercisable
|                  |  |                     |            |                    
|                  |  | Number              |            |                     |  | Wgtd. Avg. |      | Number      |  |               
|Range of Exercise |  | Outstanding         |            | Wgtd. Avg.          |  | Remaining  |      | Exercisable |  | Wgtd. Avg.    
|Prices            |  | at 12/31/02         |            | Exercise Price      |  | Contr.Life |      | at 12/31/02 |  | Exercise Price
|                  |  |                     |            |                     |  |            |      |             |  |               
|$0.19 to 0.53     |  |                     | 3,813,316  |                     |  | $          | 0.33 |             |  |                | 5.04 |  |  |  | 3,297,507 |  |  | $ | 0.32 | 
|0.55 to 1.19      |  |                     | 2,380,064  |                     |  |            | 1.07 |             |  |                | 6.83 |  |  |  | 1,044,256 |  |  |   | 0.94 | 
|1.20 to 1.50      |  |                     | 578,000    |                     |  |            | 1.43 |             |  |                | 8.31 |  |  |  | 67,500    |  |  |   | 1.22 | 
|1.51 to 2.14      |  |                     | 5,030,000  |                     |  |            | 2.14 |             |  |                | 7.35 |  |  |  | 2,506,792 |  |  |   | 2.14 | 
|2.15 to 5.25      |  |                     | 3,278,525  |                     |  |            | 3.79 |             |  |                | 6.25 |  |  |  | 2,380,141 |  |  |   | 3.81 | 
|5.31 to 18.00     |  |                     | 718,383    |                     |  |            | 8.12 |             |  |                | 6.11 |  |  |  | 605,760   |  |  |   | 8.08 | 
|                  |  |                     |            |                     |  |            |      |             |  |                |      |  |  |  |           |  |  |   |      | 
|$0.19 to $18.00   |  |                     | 15,798,288 |                     |  | $          | 2.13 |             |  |                | 6.60 |  |  |  | 9,901,956 |  |  | $ | 2.16 | 
|                  |  |                     |            |                     |  |            |      |             |  |                |      |  |  |  |           |  |  |   |      | 

If the Company had used the fair value-based
method of accounting for its stock option and incentive plans
and charged compensation cost against income, over the vesting
period, based on the fair value of options at the date of grant,
then the net loss and net loss per common share would have been
increased to the following pro forma amounts (in thousands,
except for per share amounts):

|                                                                                                                      |             |      |        |       |   |      |          |       |   |   |         |       |  
|--------------------------------------------------------------------------------------------------------------------- | ----------- | ---- | ------ | ----- | - | ---- | -------- | ----- | - | - | ------- | ----- | -
|                                                                                                                      |             | 2002 |        | 2001  |   | 2000
|                                                                                                                      |             |      |        |       |   |     
|Net loss as reported                                                                                                  |             | $    | (2,726 | )     |   | $    | (147,615 | )     |   | $ | (55,482 | )    
|Add: Stock-based compensation expense
    included in net loss                                                        |             |      | 1,173  |       |   |      | 1,766    |       |   |   | 482     |      
|Less: Total stock-based employee
    compensation expense determined under fair value based method
    for all awards |             |      | (3,296 | )     |   |      | (4,114   | )     |   |   | (10,419 | )    
|                                                                                                                      |             |      |        |       |   |      |          |       |   |   |         |      
|Pro forma net loss                                                                                                    |             | $    | (4,849 | )     |   | $    | (149,963 | )     |   | $ | (65,419 | )    
|                                                                                                                      |             |      |        |       |   |      |          |       |   |   |         |      
|Net loss per common share                                                                                             |             |      |        |       |   |      |          |       |   |   |         |      
|                                                                                                                      | As reported |      | $      | (0.03 | ) |      | $        | (2.71 | ) |   | $       | (2.14 | )
|                                                                                                                      | Pro forma   |      |        | (0.06 | ) |      |          | (2.76 | ) |   |         | (2.53 | )



|    |             
|--- | ------------
|11. | Income Taxes

The significant components of income taxes, for
continuing operations are as follows (in thousands):

|              |                   |                              |   |      |      |      |   |     |     |  |   |   |   | 
|------------- | ----------------- | ---------------------------- | - | ---- | ---- | ---- | - | --- | --- |  | - | - | - | 
|              |                   |                             
|              |                   | Years Ended December 31,    
|              |                   |                             
|              |                   | 2002                         |   | 2001 |      | 2000
|              |                   |                              |   |      |      |     
|Income Taxes: |                   |                              |   |      |      |      |   |     |     |  |   |  
|              | Currently Payable |                              | $ | (200 | )    |      | $ | 100 |     |  | $ |  |  
|              | Deferred          |                              |   |     |      |      |   |    |     |  |   |  |  
|              |                   |                              |   |      |      |      |   |     |     |  |   |  
|              |                   | Income Tax (Benefit) Expense |   | $    | (200 | )    |   | $   | 100 |  |   | $ |  | 
|              |                   |                              |   |      |      |      |   |     |     |  |   |  

F-29



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##### Table of Contents



VERSO TECHNOLOGIES, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



|    |                               
|--- | ------------------------------
|11. | Income
    Taxes  (Continued)

A reconciliation of the statutory U.S. federal
income tax rate to the Companys effective tax was as
follows:

|                                                 |  |                          |       |      |  |      |       |    |  |  |       |   
|------------------------------------------------ |  | ------------------------ | ----- | ---- |  | ---- | ----- | -- |  |  | ----- | --
|                                                 |  |                         
|                                                 |  | Years Ended December 31,
|                                                 |  |                         
|                                                 |  | 2002                     |       | 2001 |  | 2000
|                                                 |  |                          |       |      |  |     
|Statutory U.S. rate                              |  |                          | (34.0 | )%   |  |      | (34.0 | )% |  |  | (34.0 | )%
|State income taxes, net of federal benefit       |  |                          | (4.0  | )    |  |      | (4.0  | )  |  |  | (3.8  | ) 
|Non-deductible amortization                      |  |                          | 7.5   |      |  |      | 29.3  |    |  |  | 7.1   |   
|Effect of acquisitions                           |  |                          |      |      |  |      | (8.4  | )  |  |  | (22.1 | ) 
|Effect of valuation allowance                    |  |                          | 1.2   |      |  |      | 8.3   |    |  |  | 52.8  |   
|Other permanent differences                      |  |                          | 15.2  |      |  |      | 8.9   |    |  |  |      |   
|Non-deductible compensation                      |  |                          | 0.9   |      |  |      |      |    |  |  |      |   
|Effect of expiring net operating loss            |  |                          | 13.2  |      |  |      |      |    |  |  |      |   
|Reversal of accrued exposure no longer necessary |  |                          | (6.8  | )    |  |      |      |    |  |  |      |   
|                                                 |  |                          |       |      |  |      |       |    |  |  |       |   
|Total income tax expense (benefit)               |  |                          | (6.8  | )%   |  |      | 0.1   | %  |  |  | 0.0   | % 
|                                                 |  |                          |       |      |  |      |       |    |  |  |       |   

Deferred income taxes are recognized to reflect
the net tax effects of temporary differences between the
carrying amounts of assets and liabilities for financial
reporting purposes and the amounts used for income tax purposes.
Significant components of the Companys net deferred tax
assets are as follows (in thousands):

|                     |                                  |                        |   |         |   |  |   |         |   | 
|-------------------- | -------------------------------- | ---------------------- | - | ------- | - |  | - | ------- | - | 
|                     |                                  |                       
|                     |                                  | December 31,          
|                     |                                  |                       
|                     |                                  | 2002                   |   | 2001   
|                     |                                  |                        |   |        
|Deferred tax assets: |                                  |                        |   |         |   |  |   |        
|                     | Net operating loss carryforwards |                        | $ | 48,161  |   |  | $ | 46,700  |  
|                     | Capital loss carryforwards       |                        |   | 269     |   |  |   | 269     |  
|                     | Research and development credits |                        |   | 1,248   |   |  |   | 1,248   |  
|                     | Unearned revenue                 |                        |   | 2,044   |   |  |   | 1,500   |  
|                     | Reserves                         |                        |   | 1,929   |   |  |   | 3,356   |  
|                     | Compensation accruals            |                        |   | 1,843   |   |  |   | 2,167   |  
|                     | Intangible assets                |                        |   | 2,099   |   |  |   | 2,318   |  
|                     | Depreciable assets               |                        |   | 1,182   |   |  |   | 1,182   |  
|                     | Valuation allowance              |                        |   | (58,775 | ) |  |   | (58,740 | )
|                     |                                  |                        |   |         |   |  |   |        
|                     |                                  | Net deferred tax asset |   | $       |  |  |   | $       |  | 
|                     |                                  |                        |   |         |   |  |   |        

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##### Table of Contents



VERSO TECHNOLOGIES, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



|    |                               
|--- | ------------------------------
|11. | Income
    Taxes  (Continued)

The valuation allowance for deferred tax assets
as of December 31, 2002, was approximately
$58.8 million. The change of $(35,000), $12.3 million
and $29.3 million in the total valuation allowance for
2002, 2001 and 2000, respectively, resulted primarily from
increases in the above described temporary differences on which
a valuation allowance was provided. Based on the level of
historical taxable income and projections for future taxable
income over the periods in which the deferred tax assets are
deductible, the Companys management believes it is more
likely than not the Company will not realize the benefits of the
deferred tax assets, net of existing valuation allowances as of
December 31, 2002 and 2001.

The realization of deferred tax assets of
$584,000 will not result in income tax expense. These deferred
tax assets arose from net operating losses acquired in
conjunction with an acquisition for which the Company recorded
goodwill.

At December 31, 2002, the Company had net
operating loss (NOL) carry-forwards of approximately
$126.9 million, a portion of which are subject to certain
limitations under the Internal Revenue Code Section 382,
and other business tax credits of approximately
$1.2 million. If not utilized, the NOLs will begin expiring
in years 2003 through 2022.

12.     Savings and
Retirement Plan

The Company sponsors a 401(k) savings and
retirement plan which is available to all eligible employees.
Under the plan, the Company may make a discretionary matching
contribution. Discretionary matching contributions were
approximately $209,000, $132,000 and $151,000 for the years
ended December 31, 2002, 2001 and 2000, respectively.

13.     Employee
Stock Purchase Plan

On November 16, 1999, the Company adopted
the Verso Technologies, Inc. 1999 Employee Stock Purchase Plan
(the Stock Purchase Plan), which offers employees
the right to purchase shares of the Companys common stock
at 85% of the market price, as defined. Under the Stock Purchase
Plan, full-time or part-time employees, except persons owning 5%
or more of the Companys common stock, who have worked for
the Company for at least 15 consecutive days before the
beginning of the offering period are eligible to participate in
the Stock Purchase Plan. Employees may elect to have withheld up
to 10% of their annual salary up to a maximum of $25,000 per
year to be applied to the purchase of the Companys
unissued common stock. The purchase price is generally equal to
85% of the lesser of the market price on the beginning or ending
date of the offering periods under the Stock Purchase Plan. A
maximum of 1,000,000 shares of the Companys common stock
may be purchased under the Stock Purchase Plan. Shares issued
under the Stock Purchase Plan were 290,171, 211,965 and 60,355
for the years ended December 31, 2002, 2001 and 2000,
respectively.

14.     Commitments
and Contingencies

Leases

The Company leases office space and certain
equipment under operating leases which expire at various dates
through 2010 with some leases containing options for renewal.
Rent expense for continuing operations under these leases was
$2.3 million, $1.9 million and $1.3 million for
the years ended December 31, 2002, 2001 and 2000, respectively.

F-31



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##### Table of Contents



VERSO TECHNOLOGIES, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



14.     Commitments
and Contingencies  (Continued)


As of December 31, 2002, approximate future
commitments under operating leases in excess of one year are as
follows (in thousands):

|           |  |            |        |                         |  |   |       | 
|---------- |  | ---------- | ------ | ----------------------- |  | - | ----- | 
|           |  | Continuing |        | Discontinued           
|           |  | Operations |        | Operations (See Note 5)
|           |  |            |        |                        
|2003       |  | $          | 2,165  |                         |  | $ | 756   | 
|2004       |  |            | 2,084  |                         |  |   | 308   | 
|2005       |  |            | 1,985  |                         |  |   | 188   | 
|2006       |  |            | 2,006  |                         |  |   | 186   | 
|2007       |  |            | 2,035  |                         |  |   | 188   | 
|Thereafter |  |            | 4,126  |                         |  |   | 384   | 
|           |  |            |        |                         |  |   |       | 
|Total      |  | $          | 14,401 |                         |  | $ | 2,010 | 
|           |  |            |        |                         |  |   |       | 

15.     Segment
Information

As a result of the Companys acquisition of
NACT, the Company is now reporting information for two segments,
Carrier Solutions Group, which the Company formerly referred to
as its Gateway Solutions business and Enterprise Solutions
Group, which the Company formerly referred to as its
Applications and Services business.

Carrier
Solutions Group:

The Companys Carrier Solutions Group
consists of the operations of the Companys switching
subsidiary, NACT. The Companys Carrier Solutions Group
includes hardware and software, integration, applications and
technical training and support.

Enterprise
Solutions Group:

The Companys Enterprise Solutions Group
consists of the operations of the Companys customer
response center services as well as the operations of the
Companys Telemate.Net subsidiary. The Enterprise Solutions
Group offers application and network design, enterprise
application integration, network management, support and
maintenance, customer response center services, enterprise
management system solutions and application services.

Management evaluates the business segment
performance based on contributions before unallocated items.
Inter-segment sales and transfers are not significant. The
Company began offering carrier solutions in 2001.

F-32



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##### Table of Contents



VERSO TECHNOLOGIES, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



15.     Segment
Information  (Continued)


Summarized financial information concerning the
Companys reportable segments is shown in the following
table (in thousands):

|                                     |                                       |           |   |            |  |       |   |        |  |  |   |        |  | 
|------------------------------------ | ------------------------------------- | --------- | - | ---------- |  | ----- | - | ------ |  |  | - | ------ |  | 
|                                     |                                       | Carrier   |   | Enterprise |  |      
|                                     |                                       | Solutions |   | Solutions  |  |      
|                                     |                                       | Group(a)  |   | Group(a)   |  | Total
|                                     |                                       |           |   |            |  |      
|For the Years Ended
    December 31, |                                       |           |   |            |  |       |   |        |  |  |   |       
|                                     |                                       | 2002      |   |            |  |       |   |        |  |  |   |        |  | 
|                                     | Revenue                               |           | $ | 26,319     |  |       | $ | 18,479 |  |  | $ | 44,798 | 
|                                     | Contribution before unallocated items |           |   | 3,487      |  |       |   | 6,896  |  |  |   | 10,383 | 
|                                     | Goodwill and other intangibles        |           |   | 11,439     |  |       |   | 4,917  |  |  |   | 16,356 | 
|                                     | Total assets                          |           |   | 28,045     |  |       |   | 6,218  |  |  |   | 34,263 | 
|                                     | Capital expenditures                  |           |   | 960        |  |       |   |       |  |  |   | 960    | 
|                                    
|                                     |                                       | 2001      |   |            |  |       |   |        |  |  |   |        |  | 
|                                     | Revenue                               |           | $ | 15,773     |  |       | $ | 14,126 |  |  | $ | 29,899 | 
|                                     | Contribution before unallocated items |           |   | 3,569      |  |       |   | 2,598  |  |  |   | 6,167  | 
|                                     | Goodwill and other intangibles        |           |   | 12,957     |  |       |   | 2,992  |  |  |   | 15,949 | 
|                                     | Total assets                          |           |   | 26,205     |  |       |   | 5,458  |  |  |   | 31,663 | 
|                                     | Capital expenditures                  |           |   | 377        |  |       |   |       |  |  |   | 377    | 
|                                    
|                                     |                                       | 2000      |   |            |  |       |   |        |  |  |   |        |  | 
|                                     | Revenue                               |           | $ |           |  |       | $ | 12,732 |  |  | $ | 12,732 | 
|                                     | Contribution before unallocated items |           |   |           |  |       |   | 3,868  |  |  |   | 3,868  | 
|                                     | Goodwill and other intangibles        |           |   |           |  |       |   | 2,727  |  |  |   | 2,727  | 
|                                     | Total assets                          |           |   |           |  |       |   | 4,049  |  |  |   | 4,049  | 
|                                     | Capital expenditures                  |           |   |           |  |       |   |       |  |  |   |       | 



---



|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(a) | Beginning in August 2001, Carrier Solutions Group
    includes costs associated with certain corporate and
    administrative functions to support this business unit, which
    functions are located in Utah. Prior to the acquisition of NACT
    on July 27, 2001, the Company became an NACT reseller in
    the first quarter of 2001. The Company resold NACT carrier
    solutions totaling $2.8 million with cost of product sales
    of $2.1 million prior to July 27, 2001. Enterprise
    Solutions Group includes no allocation of corporate overhead
    costs. See also (b) below.

F-33



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##### Table of Contents



VERSO TECHNOLOGIES, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



15.     Segment
Information  (Continued)


The following table reconciles the total segment
profit to the loss from continuing operations before
extraordinary item (in thousands):

|                                                                        |  |                          |        |      |  |      |        |   |  |   |         |  
|----------------------------------------------------------------------- |  | ------------------------ | ------ | ---- |  | ---- | ------ | - |  | - | ------- | -
|                                                                        |  |                         
|                                                                        |  | Years Ended December 31,
|                                                                        |  |                         
|                                                                        |  | 2002                     |        | 2001 |  | 2000
|                                                                        |  |                          |        |      |  |     
|Contribution before unallocated items, per above                        |  | $                        | 10,383 |      |  | $    | 6,167  |   |  | $ | 3,868   |  
|Corporate and administrative expenses (b)                               |  |                          | (7,894 | )    |  |      | (9,349 | ) |  |   | (10,562 | )
|Depreciation                                                            |  |                          | (2,730 | )    |  |      | (2,160 | ) |  |   | (863    | )
|Amortization of intangibles                                             |  |                          | (592   | )    |  |      | (1,511 | ) |  |   | (982    | )
|Deferred compensation                                                   |  |                          | (1,173 | )    |  |      | (1,766 | ) |  |   | (482    | )
|Reorganization costs                                                    |  |                          | (324   | )    |  |      |       |   |  |   | (511    | )
|Loss on asset abandonment                                               |  |                          |       |      |  |      |       |   |  |   | (1,760  | )
|Other income                                                            |  |                          | 531    |      |  |      | 203    |   |  |   |        |  
|Equity in loss of Shanghai BeTrue Infotech Co.
    Ltd.                 |  |                          | (5     | )    |  |      |       |   |  |   |        |  
|Interest expense, net                                                   |  |                          | (1,141 | )    |  |      | (1,361 | ) |  |   | (1,240  | )
|Loss from continuing operations before taxes and
    extraordinary item |  | $                        | (2,945 | )    |  | $    | (9,777 | ) |  | $ | (12,532 | )
|                                                                        |  |                          |        |      |  |      |        |   |  |   |         |  



---



|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(b) | All rent, utilities and other corporate office
    expenses, corporate marketing expenses, corporate development
    costs and corporate human resources, accounting and information
    technology functions that support corporate, as well as, the
    Enterprise Solutions Group are reflected in unallocated
    corporate, sales, general and administrative expenses. Office
    expenses, human resources, accounting and information technology
    costs specifically related to the Carrier Solutions Group are
    reflected in its contribution before unallocated items.

The following table reconciles the segment total
assets to the Companys total assets (in thousands):

|                                                               |  |              |        |      |  |   |        | 
|-------------------------------------------------------------- |  | ------------ | ------ | ---- |  | - | ------ | 
|                                                               |  |             
|                                                               |  | Years Ended 
|                                                               |  | December 31,
|                                                               |  |             
|                                                               |  | 2002         |        | 2001
|                                                               |  |              |        |     
|Total assets before unallocated items, per above               |  | $            | 34,263 |      |  | $ | 31,663 | 
|Corporate assets:                                              |  |              |        |      |  |   |        | 
|Cash and cash equivalents                                      |  |              | 692    |      |  |   | 6,798  | 
|Restricted cash                                                |  |              | 300    |      |  |   | 300    | 
|Other current assets                                           |  |              | 592    |      |  |   | 1,018  | 
|Assets of discontinued operations                              |  |              |       |      |  |   | 582    | 
|Property and equipment, net                                    |  |              | 3,388  |      |  |   | 4,798  | 
|Investment in Shanghai BeTrue Infotech Co. Ltd.,
    at equity |  |              | 600    |      |  |   |       | 
|Total assets                                                   |  | $            | 39,835 |      |  | $ | 45,159 | 
|                                                               |  |              |        |      |  |   |        | 

F-34



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##### Table of Contents



VERSO TECHNOLOGIES, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

16.     Other
Events

Settlement
with RSL Communications, Ltd. and Affiliates

On or about July 6, 2000, RSL
Communications, Ltd., (together with certain of its affiliates
(collectively, RSL)) filed with the American
Arbitration Association (AAA) a demand for
arbitration against NACT, which became a wholly-owned subsidiary
of the Company on July 27, 2001. In the arbitration, RSL
claimed that, pursuant to a Sales Agreement between RSL and
NACT, NACT breached its obligation to indemnify and defend RSL
against patent infringement claims made against RSL by Aerotel,
Ltd. in an action pending in the United States District Court
for the Southern District of New York. RSL sought to recover
from NACT amounts paid by RSL to defend itself in such patent
infringement action, which RSL claimed was approximately
$2.0 million, together with other unspecified damages
resulting from NACTs alleged breach. On March 13,
2002, the Company entered into a Settlement Agreement and
General Release (the RSL Settlement Agreement) with
RSL, which provided that the Company issue to RSL 523,430 shares
of the Companys common stock (the Settlement
Shares) and deposit $200,000 in escrow. Pursuant to the
terms of the RSL Settlement Agreement, the Company filed with
the Securities Exchange Commission (SEC) a
Registration Statement on Form S-3 covering the resale of
the Settlement Shares (the Registration Statement),
which Registration Statement was declared effective by the SEC
on June 17, 2002. On June 17, 2002, the Company issued
523,430 shares of the Companys common stock with a market
value on the effective date of the Registration Statement of
approximately $403,000 and the $200,000 plus accrued interest
held in escrow was released to RSL at that time.

17.     Litigation

The Company is not a party to any material legal
proceedings other than ordinary routine claims and proceedings
incidental to its business, and the Company does not expect
these claims and proceedings, either individually or in the
aggregate, to have a material adverse effect on the Company.

18.     Subsequent
Events

Purchase of
Clarent Corporation Assets

On February 12, 2003, the Company purchased
substantially all the business assets along with certain related
liabilities of Clarent Corporation (Clarent) for a
purchase price of $9.8 million in notes made by the
Company. At closing of the purchase, the Company issued three
promissory notes to Clarent: a $5.0 million secured note
due February 13, 2004, which bears interest at 10% per
annum, of which $500,000 is due May 13, 2003, and the
remainder is due in monthly installments increasing in amount; a
$1.8 million non-interest bearing unsecured note due
February 13, 2004, of which $300,000 is due May 13,
2003 and the remainder is due in quarterly installments of
$500,000; and a $3.0 million secured note due
February 12, 2008, which bears interest at 5% per annum.
The assets the Company purchased from Clarent secure the secured
notes.

Reorganization

On February 14, 2003, the Company eliminated
approximately 14 full-time employees. In connection with this
reorganization, the Company will record a restructuring charge
of $194,000 related to severance costs. Annualized savings are
expected to be approximately $987,000.

F-35



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##### Table of Contents



VERSO TECHNOLOGIES, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



18.     Subsequent
Events  (Continued)


Settlement of
Certain Litigation

On or about February 8, 2002, William P.
OReilly, a former executive officer and director of the
Company; Montana Corporation, Mr. OReillys
consulting company; Clunet R. Lewis, a former officer of the
Company; and CLR Enterprises, Inc., Mr. Lewis
consulting company, filed with the AAA a demand for arbitration
against the Company. Messrs. OReilly and Lewis and
their respective consulting companies sought to have enforced
the Consulting Agreements dated April 1, 1999, as amended,
to which they and the Company are parties (the Consulting
Agreements). Messrs. OReilly and Lewis claimed that
the Companys attempt by written notice dated June 1,
2001, to terminate the Consulting Agreements effective
March 31, 2002, was ineffective and, as a result, such
Consulting Agreements have automatically renewed for additional
two-year terms, which terms expire on March 31, 2004. Under
the terms of the Consulting Agreements,
Messrs. OReilly and Lewis are to receive, among other
things, consulting fees of $250,000 and $240,000 per year,
respectively. The Company denied their claims, and the matter
was presented to an AAA arbitrator in a hearing held on
December 10, 2002. While the matter remained pending before
the arbitrator for decision, the parties settled the claims
presented in the arbitration proceeding pursuant to that certain
Arbitration Award Agreement, dated as of February 3, 2003,
between Mr. OReilly, Montana Corporation and the Company
and that certain Arbitration Award Agreement, dated as of
February 3, 2003, between Mr. Lewis, CLR Enterprises,
Inc. and the Company (together, the Arbitration Award
Agreements). Pursuant to the Arbitration Award Agreements,
(i) on February 4, 2003, the Company issued to each of
Mr. OReilly and Mr. Lewis 275,000 restricted
shares of the Companys common stock; and (ii) on
March 14, 2003, the Company entered into thirty-month
consulting agreements with each of Mr. OReilly and
Mr. Lewis (together, the New Consulting
Agreements). During the terms of the New Consulting
Agreements, the Company shall pay to Mr. OReilly and
Mr. Lewis an aggregate of approximately $173,000 and
$160,000, respectively, in three installment payments, payable
entirely in shares of the Companys common stock, valued at
the average closing price per share for a period of twenty
trading days prior to the date the installment payments are due.
The Arbitration Award Agreements provide that the consideration
set forth therein and in the New Consulting Agreements shall be
full satisfaction of any and all amounts the AAA arbitrator may
award. On March 14, 2003, the AAA arbitrator awarded
$250,000 and $240,000 to Mr. OReilly and
Mr. Lewis, respectively.

On or about May 21, 2001, John M. Good, a
former employee of the Company, filed a lawsuit in the Court of
Common Pleas, Cuyahoga County, Ohio, against the Company
claiming, among other things, fraud, negligence, securities
fraud, breach of contract, conversion and damages resulting from
and related to the Companys alleged failure to deliver, on
or about January 3, 2000, 50,000 shares of the
Companys common stock to Mr. Good upon his exercise
of an option to purchase such shares. The matter was set for
jury trial on February 17, 2003. Based upon the
Companys anticipated exposure and the cost of litigation,
on January 16, 2003, the Company and Mr. Good reached
an agreement to settle all claims against the Company, which had
no material impact on the Companys consolidated financial
statements.

F-36



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##### Table of Contents



VERSO TECHNOLOGIES, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

18.     Subsequent
Events  (Continued)

On or about April 29, 2002, Omni Systems of
Georgia, Inc. (Omni) and Joseph T. Dyer
(Dyer) filed with the AAA a demand for arbitration
against the Company and Eltrax International, Inc., a
wholly-owned subsidiary of the Company (Eltrax
International). Omni and Dyer claimed that the Company and
Eltrax International breached that certain Assignment dated as
of August 31, 1998, among Eltrax International, Dyer and
Omni (the Assignment), which was executed in
connection with the Companys acquisition of Encore
Systems, Inc., Global Systems and Support, Inc. and Five Star
Systems, Inc. (collectively, the Encore Group) in
1998. Pursuant to the Assignment, Omni and Dyer assigned and
transferred to Eltrax International all of their right, title
and interest in and to a certain computer software property
management system in exchange for a one-time payment. The
Assignment also provided for an earn-out component of the
acquisition consisting of certain contingent monthly payments
equal to a percentage of the maintenance and licensing net
revenues received by Eltrax International with respect to a
certain contract. Omni and Dyer claimed that the Company and
Eltrax International had not paid to Omni and Dyer the
contingent monthly payments owed to them pursuant to the
Assignment beginning in June 2002. Omni and Dyer sought recovery
of over $400,000 for contingent monthly payments allegedly owed
for the period from May 15, 2002 through January 2003, plus
payments in like amounts going forward, together with interest
thereon, attorneys fees and expenses. In January 2003, the
matter was heard for six days by a three-arbitrator panel of the
AAA. On April 1, 2003, the Company received notice that the
AAA panel awarded to Omni and Dyer (i) payments and
interest thereon with respect to the Assignment in the aggregate
amount of approximately $506,000; and (ii) attorneys
fees and expenses, excluding expenses of the AAA, in the
aggregate amount of approximately $199,000 (net of
attorneys fees and expenses awarded to the Company), which
amounts are to be paid by Eltrax International (and not the
Company) no later than April 30, 2003. Additionally, the
AAA panel determined that Eltrax International (and not the
Company) will be liable for future payments as they become due
in accordance with the terms of the Assignment. The Company
estimates that the payments to be made by Eltrax International
through 2007, pursuant to the award of the AAA panel, will total
approximately $2.4 million. These payments are additional
costs of the Companys acquisition of the Encore Group.
Accordingly, the Company accrued the total amount of the
estimated payments and increased intangibles by
$2.4 million. The long-term portion of the estimated
payments is included on the Companys consolidated balance
sheet in other long-term liabilities.

F-37



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##### Table of Contents






SCHEDULE II  VALUATION AND
QUALIFYING ACCOUNTS

|                                  |      |              |   |             |   |            |   |             |   |                |   |            |   |  |   |           |  |  |   |             |  
|--------------------------------- | ---- | ------------ | - | ----------- | - | ---------- | - | ----------- | - | -------------- | - | ---------- | - |  | - | --------- |  |  | - | ----------- | -
|                                  |      |              |   |             |   |           
|                                  |      | Additions    |   |             |   |           
|                                  |      |              |   |             |   |           
|                                  |      | Balance at   |   | Charges to  |   |            |   |             |   |               
|                                  |      | beginning of |   | costs and   |   | Allowances |   |             |   | Balance at end
|Description                       |      | period       |   | expenses    |   | acquired   |   | Deductions  |   | of period     
|                                  |      |              |   |             |   |            |   |             |   |               
|Allowance for doubtful accounts: 
|                                  | 2002 |              | $ | (2,455,000  | ) |            | $ | (1,760,000  | ) |                | $ |           |   |  | $ | 2,362,000 |  |  | $ | (1,853,000  | )
|                                  | 2001 |              | $ | (401,000    | ) |            | $ | (1,516,000  | ) |                | $ | (1,454,000 | ) |  | $ | 916,000   |  |  | $ | (2,455,000  | )
|                                  | 2000 |              | $ | (658,000    | ) |            | $ | (198,000    | ) |                | $ |           |   |  | $ | 455,000   |  |  | $ | (401,000    | )
|Deferred tax valuation allowance:
|                                  | 2002 |              | $ | (58,740,000 | ) |            | $ | (35,000     | ) |                | $ |           |   |  | $ |          |  |  | $ | (58,775,000 | )
|                                  | 2001 |              | $ | (46,402,000 | ) |            | $ | (12,338,000 | ) |                | $ |           |   |  | $ |          |  |  | $ | (58,740,000 | )
|                                  | 2000 |              | $ | (17,125,000 | ) |            | $ | (29,277,000 | ) |                | $ |           |   |  | $ |          |  |  | $ | (46,402,000 | )

F-38



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##### Table of Contents






SIGNATURES

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



| |                         
| | ------------------------
| | VERSO TECHNOLOGIES, INC.



| |     |                   
| | --- | ------------------
| | By: | /s/ STEVEN A. ODOM

| |                          
| | -------------------------
| |                          
| | Steven A. Odom           
| | Chairman of the Board and
| | Chief Executive Officer  

Pursuant to the requirements of the Securities
Exchange Act of 1934, this report has been signed below by the
following persons on behalf of the registrant and in the
capacities and on the dates indicated.

|                                               |  |                                                                                                                                           |  |                |  | 
|---------------------------------------------- |  | ----------------------------------------------------------------------------------------------------------------------------------------- |  | -------------- |  | 
|                                               |  |                                                                                                                                           |  |               
|Name                                           |  | Title                                                                                                                                     |  | Date          
|                                               |  |                                                                                                                                           |  |               
|                                              
|/s/ GARY H. HECKGary H. Heck                   |  | Director                                                                                                                                  |  | April 14, 2003
|                                              
|/s/ JAMES M. LOGSDONJames M. Logsdon           |  | President, Chief Operating Officer
    and Director                                                                                       |  | April 14, 2003
|                                              
|/s/ AMY L. NEWMARKAmy L. Newmark               |  | Director                                                                                                                                  |  | April 14, 2003
|                                              
|/s/ STEVEN A. ODOMSteven A. Odom               |  | Chief Executive Officer and
    Chairman of the Board
    (Principal Executive Officer)                                                   |  | April 14, 2003
|                                              
|/s/ STEPHEN E. RAVILLEStephen E. Raville       |  | Director                                                                                                                                  |  | April 14, 2003
|                                              
|/s/ JULIET M. REISINGJuliet M. Reising         |  | Executive Vice President, Chief Financial
    Officer, Secretary, Treasurer and Director (Principal Accounting
    and Financial Officer) |  | April 14, 2003
|                                              
|/s/ JOSEPH R. WRIGHT, JR.Joseph R. Wright, Jr. |  | Director                                                                                                                                  |  | April 14, 2003



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##### Table of Contents






CERTIFICATION

I, Steven A. Odom, certify that:

1. I have reviewed this annual report on
Form 10-K of Verso Technologies, Inc.;

2. Based on my knowledge, this annual report
does not contain any untrue statement of a material fact or omit
to state a material fact necessary to make the statements made,
in light of the circumstances under which such statements were
made, not misleading with respect to the period covered by this
annual report;

3. Based on my knowledge, the financial
statements, and other financial information included in this
annual report, fairly present in all material respects the
financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual
report;

4. The registrants other certifying
officers and I are responsible for establishing and maintaining
disclosure controls and procedures (as defined in Exchange Act
Rules 13a-14 and 15d-14) for the registrant and have:



| |                                                                                                                                                                                                                                                                                                                
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | a) designed such disclosure controls and
    procedures to ensure that material information relating to the
    registrant, including its consolidated subsidiaries, is made
    known to us by others within those entities, particularly during
    the period in which this annual report is being prepared;
|
| | b) evaluated the effectiveness of the
    registrants disclosure controls and procedures as of a
    date within 90 days prior to the filing date of this annual
    report (the Evaluation Date); and                                                                                                      
|
| | c) presented in this annual report our
    conclusions about the effectiveness of the disclosure controls
    and procedures based on our evaluation as of the Evaluation Date;                                                                                                                                

5. The registrants other certifying
officers and I have disclosed, based on our most recent
evaluation, to the registrants auditors and the audit
committee of registrants board of directors (or persons
performing the equivalent functions):



| |                                                                                                                                                                                                                                                                                                                      
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | a) all significant deficiencies in the design or
    operation of internal controls which could adversely affect the
    registrants ability to record, process, summarize and
    report financial data and have identified for the
    registrants auditors any material weaknesses in internal
    controls; and
|
| | b) any fraud, whether or not material, that
    involves management or other employees who have a significant
    role in the registrants internal controls; and                                                                                                                                                    

6. The registrants other certifying
officers and I have indicated in this annual report whether
there were significant changes in internal controls or in other
factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies
and material weaknesses.



| |     |                   
| | --- | ------------------
| | By: | /s/ STEVEN A. ODOM

| |                                     
| | ------------------------------------
| |                                     
| | Steven A. Odom                      
| | Chairman and Chief Executive Officer

Date: April 14, 2003



---



##### Table of Contents






CERTIFICATION

I, Juliet M. Reising, certify that:

1. I have reviewed this annual report on
Form 10-K of Verso Technologies, Inc.;

2. Based on my knowledge, this annual report
does not contain any untrue statement of a material fact or omit
to state a material fact necessary to make the statements made,
in light of the circumstances under which such statements were
made, not misleading with respect to the period covered by this
annual report;

3. Based on my knowledge, the financial
statements, and other financial information included in this
annual report, fairly present in all material respects the
financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual
report;

4. The registrants other certifying
officers and I are responsible for establishing and maintaining
disclosure controls and procedures (as defined in Exchange Act
Rules 13a-14 and 15d-14) for the registrant and have:



| |                                                                                                                                                                                                                                                                                                                
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | a) designed such disclosure controls and
    procedures to ensure that material information relating to the
    registrant, including its consolidated subsidiaries, is made
    known to us by others within those entities, particularly during
    the period in which this annual report is being prepared;
|
| | b) evaluated the effectiveness of the
    registrants disclosure controls and procedures as of a
    date within 90 days prior to the filing date of this annual
    report (the Evaluation Date); and                                                                                                      
|
| | c) presented in this annual report our
    conclusions about the effectiveness of the disclosure controls
    and procedures based on our evaluation as of the Evaluation Date;                                                                                                                                

5. The registrants other certifying
officers and I have disclosed, based on our most recent
evaluation, to the registrants auditors and the audit
committee of registrants board of directors (or persons
performing the equivalent functions):



| |                                                                                                                                                                                                                                                                                                                      
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | a) all significant deficiencies in the design or
    operation of internal controls which could adversely affect the
    registrants ability to record, process, summarize and
    report financial data and have identified for the
    registrants auditors any material weaknesses in internal
    controls; and
|
| | b) any fraud, whether or not material, that
    involves management or other employees who have a significant
    role in the registrants internal controls; and                                                                                                                                                    

6. The registrants other certifying
officers and I have indicated in this annual report whether
there were significant changes in internal controls or in other
factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies
and material weaknesses.



| |     |                      
| | --- | ---------------------
| | By: | /s/ JULIET M. REISING

| |                          
| | -------------------------
| |                          
| | Juliet M. Reising        
| | Chief Financial Officer, 
| | Executive Vice President,
| | Secretary and Treasurer  

Date: April 14, 2003



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##### Table of Contents



EXHIBIT INDEX

|            |      |         |  |                                                                                                                                                                                                                                                        |  |                                                                                                                                                      
|----------- | ---- | ------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ |  | -----------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |      | Exhibit |  | Method of Filing                                                                                                                                                                                                                                      
|            |      |         |  |                                                                                                                                                                                                                                                       
|            | 2.1  |         |  | Second Amended and Restated Agreement and Plan of
    Merger dated as of July 27, 2000, among the Registrant,
    Solemn Acquisition Corporation and Cereus Technology Partners,
    Inc.                                                              |  | Incorporated by reference to Appendix A to
    the Registrants Registration Statement on Form S-4
    filed August 7, 2000 (File No. 333-43224).    
|            | 2.2  |         |  | Agreement and Plan of Merger dated as of
    August 31, 1998, among the Registrant, Encore Acquiring
    Corporation, Encore Systems, Inc., Global Systems and Support,
    Inc., Five Star Systems, Inc., Penelope A. Sellers and
    Joseph T. Dyer. |  | Incorporated by reference to Exhibit 2.1 to
    the Registrants Current Report on Form 8-K filed
    September 10, 1998.                            
|            | 2.3  |         |  | Agreement and Plan of Merger dated as of
    November 11, 1998, among the Registrant, Sulcus Hospitality
    Technologies Corp. and Sulcus Acquiring Corporation.                                                                                      |  | Incorporated by reference to Exhibit 2.1 to
    the Registrants Registration Statement on Form S-4
    filed February 16, 1999 (File No. 333-68699).
|            | 2.4  |         |  | Stock Purchase Agreement dated as of
    October 26, 2000, among the Registrant, Squirrel Systems,
    Inc., Squirrel Systems of Canada Ltd. and SQS Acquisitions Inc.                                                                                 |  | Incorporated by reference to Exhibit 10.15
    to the Registrants Quarterly Report on Form 10-Q for
    the quarter ended September 30, 2000.       
|            | 2.5  |         |  | Agreement and Plan of Merger dated
    October 31, 2000, among the Registrant, MessageClick, Inc.
    and MCLICK Acquisition Corporation (the MessageClick
    Merger Agreement).                                                                    |  | Incorporated by reference to Exhibit 2.1 to
    the Registrants Current Report on Form 8-K filed
    December 6, 2000.                              
|            | 2.6  |         |  | First Amendment to the Agreement and Plan of
    Merger dated as of November 9, 2000, among the Registrant,
    MessageClick, Inc. and MCLICK Acquisition Corporation.                                                                                 |  | Incorporated by reference to Exhibit 2.2 to
    the Registrants Current Report on Form 8-K filed
    December 6, 2000.                              
|            | 2.7  |         |  | Second Amendment to the Agreement and Plan of
    Merger dated as of November 10, 2000, among the Registrant,
    MessageClick, Inc. and MCLICK Acquisition Corporation.                                                                               |  | Incorporated by reference to Exhibit 2.3 to
    the Registrants Current Report on Form 8-K filed
    December 6, 2000.                              
|            | 2.8  |         |  | Agreement for the Purchase and Sale of Assets
    dated as of September 28, 2000, among the Registrant,
    AremisSoft Corporation and Eltrax Hospitality Group, Inc. (the
    AremisSoft Agreement).                                                |  | Incorporated by reference to Exhibit 2.2 to
    the Registrants Current Report on Form 8-K filed
    December 29, 2000.                             
|            | 2.9  |         |  | Letter amending the AremisSoft Agreement dated as
    of October 18, 2000.                                                                                                                                                                             |  | Incorporated by reference to Exhibit 2.2 to
    the Registrants Current Report on Form 8-K filed
    December 29, 2000.                             
|            | 2.10 |         |  | Letter amending the AremisSoft Agreement dated as
    of November 22, 2000.                                                                                                                                                                            |  | Incorporated by reference to Exhibit 2.3 to
    the Registrants Current Report on Form 8-K filed
    December 29, 2000.                             
|            | 2.11 |         |  | Form of Agreement between AremisSoft Norway AS
    and Eltrax System Scandinavia AS.                                                                                                                                                                   |  | Incorporated by reference to Exhibit 2.4 to
    the Registrants Current Report on Form 8-K filed
    December 29, 2000.                             
|            | 2.12 |         |  | Form of Agreement among the Registrant,
    AremisSoft Corporation, AremisSoft Hospitality (Switzerland)
    GmbH, Eltrax AG and Eltrax Holdings AG.                                                                                                   |  | Incorporated by reference to Exhibit 2.5 to
    the Registrants Current Report on Form 8-K filed
    December 29, 2000.                             

1



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|            |      |         |  |                                                                                                                                                                                          |  |                                                                                                                                         
|----------- | ---- | ------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ----------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |      | Exhibit |  | Method of Filing                                                                                                                                                                        
|            |      |         |  |                                                                                                                                                                                         
|            | 2.13 |         |  | Form of Agreement among the Registrant,
    AremisSoft Corporation, AremisSoft Australia Pty Limited, Eltrax
    Systems Pty Ltd. and Eltrax International Group, Inc.                   |  | Incorporated by reference to Exhibit 2.6 to
    the Registrants Current Report on Form 8-K filed
    December 29, 2000.                
|            | 2.14 |         |  | Form of Agreement among the Registrant,
    AremisSoft Corporation, AremisSoft Hospitality (UK) Limited and
    Eltrax Hospitality UK Ltd.                                               |  | Incorporated by reference to Exhibit 2.7 to
    the Registrants Current Report on Form 8-K filed
    December 29, 2000.                
|            | 2.15 |         |  | Form of Agreement among the Registrant,
    AremisSoft Corporation, Impact Level (M) Sdn. Bhd., Eltrax
    Systems Sdn. Bhd. and Eltrax International Inc.                               |  | Incorporated by reference to Exhibit 2.8 to
    the Registrants Current Report on Form 8-K filed
    December 29, 2000.                
|            | 2.16 |         |  | Form of Agreement among the Registrant,
    AremisSoft Hospitality Group (US), Inc. and Eltrax Group, Inc.                                                                               |  | Incorporated by reference to Exhibit 2.9 to
    the Registrants Current Report on Form 8-K filed
    December 29, 2000.                
|            | 2.17 |         |  | Form of Agreement among the Registrant,
    AremisSoft Corporation, AremisSoft (HK) Corporation Limited,
    Eltrax Systems Pty Limited and Eltrax International Inc.                    |  | Incorporated by reference to Exhibit 2.10 to
    the Registrants Current Report on Form 8-K filed
    December 29, 2000.               
|            | 2.18 |         |  | Form of Agreement among the Registrant,
    AremisSoft Corporation, Latin America One Pte Ltd. and Eltrax
    Systems Pte Ltd.                                                           |  | Incorporated by reference to Exhibit 2.11 to
    the Registrants Current Report on Form 8-K filed
    December 29, 2000.               
|            | 2.19 |         |  | Agreement and Plan of Merger dated as of
    May 4, 2001, among the Registrant, Telemate.Net Software,
    Inc. and Titan Acquiring Sub, Inc. (the Telemate.Net
    Merger Agreement). |  | Incorporated by reference to Exhibit 2.1 to
    the Registrants Current Report on Form 8-K filed
    May 16, 2001.                     
|            | 2.20 |         |  | First Amendment to the Telemate.Net Merger
    Agreement dated as of June 1, 2001.                                                                                                       |  | Incorporated by reference to Exhibit 2.2 to
    Amendment No. 1 to the Registrants Current Report on
    Form 8-K/A filed June 5, 2001.
|            | 2.21 |         |  | Stock Purchase Agreement dated as of May 4,
    2001, between the Registrant and WA Telcom Products Co., Inc.                                                                            |  | Incorporated by reference to Exhibit 2.1 to
    the Registrants Current Report on Form 8-K filed
    June 5, 2001.                     
|            | 2.22 |         |  | Series B Preferred Stock Purchase Agreement
    dated as of May 4, 2001, between the Registrant and
    Telemate.Net Software, Inc. (the Series B Stock
    Purchase Agreement).       |  | Incorporated by reference to Exhibit 99.1 to
    the Registrants Current Report on Form 8-K filed
    May 16, 2001.                    
|            | 2.23 |         |  | First Amendment to the Series B Stock
    Purchase Agreement dated as of June 1, 2001, between the
    Registrant and Telemate.Net Software, Inc.                                        |  | Incorporated by reference to Exhibit 99.2 to
    Amendment No 1 to the Registrants Current Report on
    Form 8-K/A filed June 5, 2001.
|            | 2.24 |         |  | Second Amendment to the Series B Stock
    Purchase Agreement dated as of July 27, 2001, between the
    Registrant and Telemate.Net Software, Inc.                                      |  | Incorporated by reference to Exhibit 99.3 to
    the Registrants Current Report on Form 8-K filed
    August 10, 2001.                 
|            | 2.25 |         |  | Agreement and Plan of Merger dated as of
    January 10, 2001, among the Registrant, SS & Co.,
    Inc. and Senercomm, Inc.                                                              |  | Incorporated by reference to Exhibit 2.1 to
    the Registrants Quarterly Report on Form 10-Q for the
    quarter ended March 31, 2001.
|            | 2.26 |         |  | Asset Purchase Agreement dated as of
    December 13, 2002, between the Registrant and Clarent
    Corporation.                                                                          |  | Incorporated by reference to Exhibit 2.1 to
    the Registrants Current Report on Form 8-K filed
    December 17, 2002.                

2



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|            |      |         |  |                                                                                                                                                        |  |                                                                                                                                                    
|----------- | ---- | ------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------ |  | ---------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |      | Exhibit |  | Method of Filing                                                                                                                                      
|            |      |         |  |                                                                                                                                                       
|            | 2.27 |         |  | First Amendment to the Asset Purchase Agreement
    dated as of February 4, 2003, between the Registrant and
    Clarent Corporation.                  |  | Incorporated by reference to Exhibit 2.2 to
    the Registrants Current Report on Form 8-K filed
    February 13, 2003.                           
|            | 3.1  |         |  | Amended and Restated Articles of Incorporation of
    the Registrant.                                                                                  |  | Incorporated by reference to Exhibit 3.1 to
    the Registrants Registration Statement on Form S-18
    (File No. 33-51456).                      
|            | 3.2  |         |  | Amendment to the Amended and Restated Articles of
    Incorporation of the Registrant, as amended.                                                     |  | Incorporated by reference to Exhibit 3.1 to
    the Registrants Current Report on Form 8-K filed
    October 2, 2000.                             
|            | 3.3  |         |  | Amendment to the Amended and Restated Articles of
    Incorporation of the Registrant, as amended.                                                     |  | Incorporated by reference to Exhibit 4.1 to
    the Registrants Current Report on Form 8-K filed
    November 19, 2001.                           
|            | 3.4  |         |  | Bylaws of the Registrant, as amended.                                                                                                                  |  | Incorporated by reference to Exhibit 3.2 to
    the Registrants Registration Statement on Form S-4
    filed August 7, 2000 (File No. 333-43224). 
|            | 3.5  |         |  | Amendment to the Bylaws of the Registrant, as
    amended.                                                                                             |  | Incorporated by reference to Exhibit 4.2 to
    the Registrants Current Report on Form 8-K filed
    November 19, 2001.                           
|            | 4.1  |         |  | Specimen form of the Registrants common
    stock certificate.                                                                                        |  | Incorporated by reference to Exhibit 4.1 to
    the Registrants Registration Statement on Form S-18
    (File No. 33-51456).                      
|            | 4.2  |         |  | Warrant dated October 31, 1996, to purchase
    106,250 shares of the Registrants common stock granted to
    Walter C. Lovett.                       |  | Incorporated by reference to Exhibit 10.4 to
    the Registrants Current Report on Form 8-K filed
    November 12, 1996.                          
|            | 4.3  |         |  | Warrant dated October 31, 1996, to purchase
    106,250 shares of the Registrants common stock granted to
    Douglas L. Roberson.                    |  | Incorporated by reference to Exhibit 10.5 to
    the Registrants Current Report on Form 8-K filed
    November 12, 1996.                          
|            | 4.4  |         |  | Registration Rights Agreement dated as of
    July 27, 2000, among the Registrant, Strong River
    Investments, Inc. and Bay Harbor Investments, Inc. |  | Incorporated by reference to Exhibit 4.7 to
    the Registrants Registration Statement on Form S-4
    filed August 7, 2000 (File No. 333-43224). 
|            | 4.5  |         |  | Registration Rights Agreement dated as of June
    29, 2000, between the Registrant and E.piphany, Inc.                                                |  | Incorporated by reference to Exhibit 4.8 to
    the Registrants Registration Statement on Form S-4
    filed August 7, 2000 (File No. 333-43224). 
|            | 4.6  |         |  | Warrant dated as of July 27, 2000, to
    purchase 104,168 shares of the Registrants common stock
    granted to Strong River Investments, Inc.       |  | Incorporated by reference to Exhibit 4.10 to
    the Registrants Registration Statement on Form S-4
    filed August 7, 2000 (File No. 333-43224).
|            | 4.7  |         |  | Warrant dated as of July 27, 2000, to
    purchase 104,168 shares of the Registrants common stock
    granted to Bay Harbor Investments, Inc.         |  | Incorporated by reference to Exhibit 4.11 to
    the Registrants Registration Statement on Form S-4
    filed August 7, 2000 (File No. 333-43224).
|            | 4.8  |         |  | Warrant dated as of July 27, 2000, to
    purchase 26,041 shares of the Registrants common stock
    granted to Strong River Investments, Inc.        |  | Incorporated by reference to Exhibit 4.12 to
    the Registrants Registration Statement on Form S-4
    filed August 7, 2000 (File No. 333-43224).

3



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|            |      |         |  |                                                                                                                                                                                                                        |  |                                                                                                                                                    
|----------- | ---- | ------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |      | Exhibit |  | Method of Filing                                                                                                                                                                                                      
|            |      |         |  |                                                                                                                                                                                                                       
|            | 4.9  |         |  | Warrant dated as of July 27, 2000, to
    purchase 26,041 shares of the Registrants common stock
    granted to Bay Harbor Investments, Inc.                                                                          |  | Incorporated by reference to Exhibit 4.13 to
    the Registrants Registration Statement on Form S-4
    filed August 7, 2000 (File No. 333-43224).
|            | 4.10 |         |  | Warrant dated as of July 27, 2000, to
    purchase 52,083 shares of the Registrants common stock
    granted to Strong River Investments, Inc.                                                                        |  | Incorporated by reference to Exhibit 4.14 to
    the Registrants Registration Statement on Form S-4
    filed August 7, 2000 (File No. 333-43224).
|            | 4.11 |         |  | Warrant dated as of July 27, 2000, to
    purchase 52,083 shares of the Registrants common stock
    granted to Bay Harbor Investments, Inc.                                                                          |  | Incorporated by reference to Exhibit 4.15 to
    the Registrants Registration Statement on Form S-4
    filed August 7, 2000 (File No. 333-43224).
|            | 4.12 |         |  | Warrant dated as of September 29, 2000, to
    purchase 1,750,000 shares of the Registrants common stock
    granted to Steven A. Odom. Represents an executive
    compensation plan or arrangement.                 |  | Incorporated by reference to Exhibit 10.7 to
    the Registrants Quarterly Report on Form 10-Q for the
    quarter ended September 30, 2000.      
|            | 4.13 |         |  | Warrant dated as of September 29, 2000, to
    purchase 875,000 shares of the Registrants common stock
    granted to James M. Logsdon. Represents an executive
    compensation plan or arrangement.                 |  | Incorporated by reference to Exhibit 10.8 to
    the Registrants Quarterly Report on Form 10-Q for the
    quarter ended September 30, 2000.      
|            | 4.14 |         |  | Warrant dated as of September 29, 2000, to
    purchase 665,000 shares of the Registrants common stock
    granted to Juliet M. Reising. Represents an executive
    compensation plan or arrangement.                |  | Incorporated by reference to Exhibit 10.9 to
    the Registrants Quarterly Report on Form 10-Q for the
    quarter ended September 30, 2000.      
|            | 4.15 |         |  | Warrant dated as of August 21, 2000, to
    purchase 300,000 shares of Cereus Technology Partners,
    Inc.s common stock granted to Steven A. Odom.
    Represents an executive compensation plan or arrangement.    |  | Incorporated by reference to Exhibit 10.10
    to the Registrants Quarterly Report on Form 10-Q for
    the quarter ended September 30, 2000.     
|            | 4.16 |         |  | Warrant dated as of August 21, 2000, to
    purchase 100,000 shares of Cereus Technology Partners,
    Inc.s common stock granted to James M. Logsdon.
    Represents an executive compensation plan or arrangement.  |  | Incorporated by reference to Exhibit 10.11
    to the Registrants Quarterly Report on Form 10-Q for
    the quarter ended September 30, 2000.     
|            | 4.17 |         |  | Warrant dated as of August 21, 2000, to
    purchase 350,000 shares of Cereus Technology Partners,
    Inc.s common stock granted to Juliet M. Reising.
    Represents an executive compensation plan or arrangement. |  | Incorporated by reference to Exhibit 10.12
    to the Registrants Quarterly Report on Form 10-Q for
    the quarter ended September 30, 2000.     
|            | 4.18 |         |  | Warrant dated as of August 21, 2000, to
    purchase 250,000 shares of Cereus Technology Partners,
    Inc.s common stock granted to Juliet M. Reising.
    Represents an executive compensation plan or arrangement. |  | Incorporated by reference to Exhibit 10.13
    to the Registrants Quarterly Report on Form 10-Q for
    the quarter ended September 30, 2000.     
|            | 4.19 |         |  | Warrant dated as of August 21, 2000, to
    purchase 50,000 shares of Cereus Technology Partners,
    Inc.s common stock granted to Peter Pamplin. Represents an
    executive compensation plan or arrangement.      |  | Incorporated by reference to Exhibit 10.14
    to the Registrants Quarterly Report on Form 10-Q for
    the quarter ended September 30, 2000.     

4



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|            |      |         |  |                                                                                                                                                                                                                                 |  |                                                                                                                                                           
|----------- | ---- | ------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |      | Exhibit |  | Method of Filing                                                                                                                                                                                                               
|            |      |         |  |                                                                                                                                                                                                                                
|            | 4.20 |         |  | Warrant dated as of January 30, 2001, to
    purchase 83,334 shares of the Registrants common stock
    granted to PNC Bank, National Association.                                                                             |  | Incorporated by reference to Exhibit 4.1 to
    the Registrants Quarterly Report on Form 10-Q for the
    quarter ended March 31, 2001.                  
|            | 4.21 |         |  | Warrant dated as of January 30, 2001, to
    purchase 472,689 shares of the Registrants common stock
    granted to Strong River Investments, Inc.                                                                             |  | Incorporated by reference to Exhibit 4.2 to
    the Registrants Quarterly Report on Form 10-Q for the
    quarter ended March 31, 2001.                  
|            | 4.22 |         |  | Warrant dated as of January 30, 2001, to
    purchase 472,689 shares of the Registrants common stock
    granted to Bay Harbor Investments, Inc.                                                                               |  | Incorporated by reference to Exhibit 4.3 to
    the Registrants Quarterly Report on Form 10-Q for the
    quarter ended March 31, 2001.                  
|            | 4.23 |         |  | Form of Warrant issued in connection with the
    MessageClick Merger Agreement.                                                                                                                                                |  | Incorporated by reference to Exhibit 4.1 to
    the Registrants Current Report on Form 8-K filed
    December 6, 2000.                                   
|            | 4.24 |         |  | Form of Registration Rights Agreement entered
    into in connection with the MessageClick Merger Agreement.                                                                                                                    |  | Incorporated by reference to Exhibit 4.2 to
    the Registrants Current Report on Form 8-K filed
    December 6, 2000.                                   
|            | 4.25 |         |  | Form of 7.5% Convertible Debenture issued in
    connection with the Convertible Debenture and Warrant Purchase
    Agreement between the Registrant and the Purchasers named
    therein (the Debenture Purchase Agreement). |  | Incorporated by reference to Exhibit 4.5 to
    the Registrants Current Report on Form 8-K filed
    December 6, 2000.                                   
|            | 4.26 |         |  | Form of Warrant issued in connection with the
    Debenture Purchase Agreement.                                                                                                                                                 |  | Incorporated by reference to Exhibit 4.6 to
    the Registrants Current Report on Form 8-K filed
    December 6, 2000.                                   
|            | 4.27 |         |  | Form of Registration Rights Agreement entered
    into in connection with the Debenture Purchase Agreement.                                                                                                                     |  | Incorporated by reference to Exhibit 4.7 to
    the Registrants Current Report on Form 8-K filed
    December 6, 2000.                                   
|            | 4.28 |         |  | Registration Rights Agreement dated as of
    February 8, 2000, among Cereus Technology Partners, Inc.
    and the stockholders party thereto.                                                                                  |  | Incorporated by reference to Exhibit 4(e) to
    Cereus Technology Partners, Inc.s Annual Report on
    Form 10-KSB for the year ended December 31, 1999.
|            | 4.29 |         |  | Registration Rights Agreement dated as of
    August 18, 2000, among Cereus Technology Partners, Inc. and
    the stockholders party thereto.                                                                                   |  | Incorporated by reference to Exhibit 4.32 of
    the Registrants Annual Report for the year ended
    December 31, 2000.                                 
|            | 4.30 |         |  | Registration Rights Agreement dated as of
    September 15, 2000, among Cereus Technology Partners, Inc.
    and the stockholders party thereto.                                                                                |  | Incorporated by reference to Exhibit 4.31 to
    the Registrants Annual Report on Form 10-K for the
    year ended December 31, 2000.                    
|            | 4.31 |         |  | Registration Rights Agreement dated as of
    September 27, 2000, among Cereus Technology Partners, Inc.
    and the stockholders party thereto.                                                                                |  | Incorporated by reference to Exhibit 4.32 to
    the Registrants Annual Report on Form 10-K for the
    year ended December 31, 2000.                    
|            | 4.32 |         |  | Registration Rights Agreement dated as of July
    27, 2002, entered into in connection with the Series B
    Stock Purchase Agreement.                                                                                         |  | Incorporated by reference to Exhibit 4.1 to
    the Registrants Current Report on Form 8-K filed on
    August 10, 2001.                                 

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|            |      |         |  |                                                                                                                                                                                                       |  |                                                                                                                                          
|----------- | ---- | ------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | -----------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |      | Exhibit |  | Method of Filing                                                                                                                                                                                     
|            |      |         |  |                                                                                                                                                                                                      
|            | 4.33 |         |  | Purchase Agreement dated as of January 18,
    2001, among the Registrant, Strong River Investments, Inc. and
    Bay Harbor Investments, Inc. (the Strong River Debenture
    Purchase Agreement). |  | Incorporated by reference to Exhibit 10.2 to
    the Registrants Quarterly Report on Form 10-Q for the
    quarter ended March 31, 2001.
|            | 4.34 |         |  | Amendment dated as of January 23, 2001, to
    the Strong River Debenture Purchase Agreement.                                                                                                         |  | Incorporated by reference to Exhibit 10.4 to
    the Registrants Quarterly Report on Form 10-Q for the
    quarter ended March 31, 2001.
|            | 4.35 |         |  | Amendment dated as of January 25, 2001, to
    the Strong River Debenture Purchase Agreement.                                                                                                         |  | Incorporated by reference to Exhibit 10.5 to
    the Registrants Quarterly Report on Form 10-Q for the
    quarter ended March 31, 2001.
|            | 4.36 |         |  | Registration Rights Agreement dated as of
    January 30, 2001, among the Registrant, Strong River
    Investments, Inc. and Bay Harbor Investments, Inc.                                             |  | Incorporated by reference to Exhibit 10.3 to
    the Registrants Quarterly Report on Form 10-Q for the
    quarter ended March 31, 2001.
|            | 4.37 |         |  | Form of Warrant issued in connection with the
    Registrants acquisition of Telemate.Net Software, Inc.                                                                                             |  | Incorporated by reference to Exhibit 4.42 to
    the Registrants Annual Report on Form 10-K for the
    year ended December 31, 2001.   
|            | 4.38 |         |  | Warrant dated as of May 15, 2002, to
    purchase 308,641 shares of the Registrants common stock
    granted to Silicon Valley Bank.                                                                 |  | Incorporated by reference to Exhibit 4.2 to
    the Registrants Quarterly Report on Form 10-Q for the
    quarter ended June 30, 2002.  
|            | 4.39 |         |  | Registration Rights Agreement dated May 15,
    2002, between the Registrant and Silicon Valley Bank.                                                                                                 |  | Incorporated by reference to Exhibit 4.4 to
    the Registrants Quarterly Report on Form 10-Q for the
    quarter ended June 30, 2002.  
|            | 4.40 |         |  | Antidilution Agreement dated May 15, 2002,
    between the Registrant and Silicon Valley Bank.                                                                                                        |  | Incorporated by reference to Exhibit 4.3 to
    the Registrants Quarterly Report on Form 10-Q for the
    quarter ended June 30, 2002.  
|            | 4.41 |         |  | Convertible Secured Promissory Note dated
    April 25, 2002, executed by the Registrant in favor of WA
    Telcom Products Co., Inc.                                                                 |  | Incorporated by reference to Exhibit 4.1 to
    the Registrants Current Report on Form 8-K filed
    May 1, 2002.                       
|            | 4.42 |         |  | Warrant to Purchase Stock dated as of
    February 12, 2003, to purchase 350,000 shares of the
    Registrants common stock granted to Silicon Valley Bank.                                          |  | Incorporated by reference to Exhibit 4.1 to
    the Registrants Current Report on Form 8-K filed
    February 13, 2003.                 
|            | 4.43 |         |  | Registration Rights Agreement dated as of
    February 12, 2003, between the Registrant and Silicon
    Valley Bank.                                                                                  |  | Incorporated by reference to Exhibit 4.2 to
    the Registrants Current Report on Form 8-K filed
    February 13, 2003.                 
|            | 4.44 |         |  | Antidilution Agreement dated as of
    February 12, 2003, between the Registrant and Silicon
    Valley Bank.                                                                                         |  | Incorporated by reference to Exhibit 4.3 to
    the Registrants Current Report on Form 8-K filed
    February 13, 2003.                 
|            | 4.45 |         |  | Form of Warrant issued in connection with the
    Registrants October 2002 private placement offering.                                                                                               |  | Filed herewith.                                                                                                                          
|            | 4.46 |         |  | Form of Registration Rights Agreement issued in
    connection with the Registrants October 2002 private
    placement offering.                                                                     |  | Filed herewith.                                                                                                                          

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|            |       |         |  |                                                                                                                                   |  |                                                                                                                                                                  
|----------- | ----- | ------- |  | --------------------------------------------------------------------------------------------------------------------------------- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |       | Exhibit |  | Method of Filing                                                                                                                 
|            |       |         |  |                                                                                                                                  
|            | 10.1  |         |  | Form of Incentive Stock Option Agreement.                                                                                         |  | Incorporated by reference to Exhibit 10.6 to
    the Registrants Registration Statement on Form S-18
    (File 33-51456).                                       
|            | 10.2  |         |  | Form of Non-Statutory Option Agreement.                                                                                           |  | Incorporated by reference to Exhibit 10.7 to
    the Registrants Registration Statement on Form S-18
    (File 33-51456).                                       
|            | 10.3  |         |  | Form of Non-Employee Director Stock Option
    Agreement.                                                                         |  | Incorporated by reference to Exhibit 10.10
    to the Registrants Annual Report on Form 10-KSB for
    the year ended March 31, 1993.                           
|            | 10.4  |         |  | 1992 Stock Incentive Plan.                                                                                                        |  | Incorporated by reference to Exhibit 10.4 to
    the Registrants Registration Statement on Form S-18
    (File No. 33-51456).                                   
|            | 10.5  |         |  | 1995 Stock Incentive Plan.                                                                                                        |  | Incorporated by reference to Exhibit 10.12
    to the Registrants Annual Report on Form 10-KSB for
    the year ended March 31, 1995.                           
|            | 10.6  |         |  | 1997 Stock Incentive Plan.                                                                                                        |  | Incorporated by reference to the
    Registrants Proxy Statement for its 1997 Annual Meeting of
    Stockholders.                                               
|            | 10.7  |         |  | 1998 Stock Incentive Plan.                                                                                                        |  | Incorporated by reference to Exhibit 10.27
    to the Registrants Registration Statement on Form S-4
    filed February 16, 1999 (File No. 333-68699).          
|            | 10.8  |         |  | 1999 Stock Incentive Plan.                                                                                                        |  | Incorporated by reference to Exhibit 4.4 to
    the Registrants Registration Statement on Form S-8
    filed August 13, 1999.                                   
|            | 10.9  |         |  | First Amendment to the 1999 Stock Incentive Plan.                                                                                 |  | Incorporated by reference to Exhibit 10.9 to
    the Registrants Registration Statement on Form S-4
    filed August 7, 2000 (File No. 333-43224).              
|            | 10.10 |         |  | Amendment to the 1999 Stock Incentive Plan.                                                                                       |  | Filed herewith.                                                                                                                                                  
|            | 10.11 |         |  | 1999 Employee Stock Purchase Plan.                                                                                                |  | Incorporated by reference to Exhibit 10.1 to
    the Registrants Registration Statement on Form S-8
    filed December 8, 1999 (File No. 333-92337).            
|            | 10.12 |         |  | Real Estate Lease dated as of June 1, 1996,
    among Walt Lovett, Doug and Lisa Roberson, and Atlantic Network
    Systems, Inc. |  | Incorporated by reference to Exhibit 10.11
    to the Registrants Annual Report on Form 10-KSB for
    the nine-month transition period ended December 31, 1996.
|            | 10.13 |         |  | Lease Agreement dated as of September 15,
    1996, among Burgoe/Wyomissing Partners and Hi-Tech Connections,
    Inc.            |  | Incorporated by reference to Exhibit 10.30
    to the Registrants Annual Report on Form 10-KSB for
    the year ended December 31, 1997.                        
|            | 10.14 |         |  | Lease Agreement dated as of December 1,
    1996, among JMG Development Co. Ltd. and DataComm Associates,
    Inc.                |  | Incorporated by reference to Exhibit 10.31
    to the Registrants Annual Report on Form 10-KSB for
    the year ended December 31, 1997.                        

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|            |       |         |  |                                                                                                                                                                                    |  |                                                                                                                                                               
|----------- | ----- | ------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |       | Exhibit |  | Method of Filing                                                                                                                                                                  
|            |       |         |  |                                                                                                                                                                                   
|            | 10.15 |         |  | Amended and Restated Preferred Vendor Arrangement
    dated as of May 15, 1992, between Holiday Hospitality
    Corporation and Encore Systems, Inc.                               |  | Incorporated by reference to Exhibit 10.29
    to the Registrants Registration Statement on Form S-4
    filed February 16, 1999 (File No. 333-68699).       
|            | 10.16 |         |  | Office Lease Agreement dated as of
    September 20, 1999, between the Registrant and Galleria 400
    LLC.                                                                        |  | Incorporated by reference to Exhibit 10.51
    to the Registrants Registration Statement on Form S-4
    filed August 7, 2000 (File No. 333-43224).          
|            | 10.17 |         |  | First Amendment to Office Lease Agreement dated
    as of March 31, 2000, between the Registrant and Galleria
    400 LLC.                                                         |  | Incorporated by reference to Exhibit 10.52
    to the Registrants Registration Statement on Form S-4
    filed August 7, 2000 (File No. 333-43224).          
|            | 10.18 |         |  | Convertible Debenture Purchase Agreement dated as
    of July 27, 2000, among the Registrant, Strong River
    Investments, Inc. and Bay Harbor Investments, Inc.                  |  | Incorporated by reference to Exhibit 10.53
    to the Registrants Registration Statement on Form S-4
    filed August 7, 2000 (File No. 333-43224).          
|            | 10.19 |         |  | Subscription Agreement dated as of June 29,
    2000, between the Registrant and E.piphany, Inc.                                                                                   |  | Incorporated by reference to Exhibit 10.54
    to the Registrants Registration Statement on Form S-4
    filed August 7, 2000 (File No. 333-43224).          
|            | 10.20 |         |  | Executive Employment Agreement dated as of
    September 29, 2000, between the Registrant and Steven A.
    Odom. Represents an executive compensation plan or arrangement.        |  | Incorporated by reference to Exhibit 10.4 to
    the Registrants Quarterly Report on Form 10-Q for the
    quarter ended September 30, 2000.                 
|            | 10.21 |         |  | Executive Employment Agreement dated as of
    September 29, 2000, between the Registrant and James M.
    Logsdon. Represents an executive compensation plan or
    arrangement.  |  | Incorporated by reference to Exhibit 10.5 to
    the Registrants Quarterly Report on Form 10-Q for the
    quarter ended September 30, 2000.                 
|            | 10.22 |         |  | Executive Employment Agreement dated as of
    September 29, 2000, between the Registrant and Juliet M.
    Reising. Represents an executive compensation plan or
    arrangement. |  | Incorporated by reference to Exhibit 10.6 to
    the Registrants Quarterly Report on Form 10-Q for the
    quarter ended September 30, 2000.                 
|            | 10.23 |         |  | Form of Escrow Agreement entered into in
    connection with the MessageClick Merger Agreement.                                                                                    |  | Incorporated by reference to Exhibit 4.3 to
    the Registrants Current Report on Form 8-K filed
    December 6, 2000.                                       
|            | 10.24 |         |  | Convertible Debenture and Warrant Purchase
    Agreement dated as of October 31, 2000, between the
    Registrant and the purchasers signatory thereto.                            |  | Incorporated by reference to Exhibit 4.4 to
    the Registrants Current Report on Form 8-K filed
    December 6, 2000.                                       
|            | 10.25 |         |  | Cereus Technology Partners, Inc. Directors
    Warrant Incentive Plan. Represents an executive compensation
    plan or arrangement.                                              |  | Incorporated by reference to Exhibit 10(cc)
    to Cereus Technology Partners, Inc.s Annual Report on
    Form 10-KSB40 for the year ended December 31, 1999.
|            | 10.26 |         |  | Cereus Technology Partners, Inc. Outside
    Directors Warrant Plan. Represents an executive
    compensation plan or arrangement.                                                |  | Incorporated by reference to Exhibit 10(dd)
    to Cereus Technology Partners, Inc.s Annual Report on
    Form 10-KSB40 for the year ended December 31, 1999.

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|            |       |         |  |                                                                                                                                                                                                                                                                                                    |  |                                                                                                                                        
|----------- | ----- | ------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ---------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |       | Exhibit |  | Method of Filing                                                                                                                                                                                                                                                                                  
|            |       |         |  |                                                                                                                                                                                                                                                                                                   
|            | 10.27 |         |  | Assignment and Assumption Agreement dated as of
    September 29, 2000, between the Registrant and Cereus
    Technology Partners, Inc. assigning rights under the
    Registration Rights Agreements dated February 8, 2000,
    August 18, 2000, September 15, 2000, and
    September 27, 2000. |  | Incorporated by reference to Exhibit 10.40
    to the Registrants Annual Report on Form 10-K for the
    year ended December 31, 2000.
|            | 10.28 |         |  | Loan and Security Agreement dated
    December 14, 2001, among the Registrant, NACT
    Telecommunications, Inc., Telemate.Net Software, Inc. and
    Silicon Valley Bank, Commercial Finance Division.                                                                                            |  | Incorporated by reference to Exhibit 10.35
    to the Registrants Annual Report on Form 10-K for the
    year ended December 31, 2001.
|            | 10.29 |         |  | Final Settlement Agreement and General Release
    dated as of March 13, 2002, among the Registrant, NACT
    Telecommunications, Inc., RSL COM U.S.A., Inc., and RSL COM
    Primecall, Inc.                                                                                                      |  | Incorporated by reference to Exhibit 10.36
    to the Registrants Annual Report on Form 10-K for the
    year ended December 31, 2001.
|            | 10.30 |         |  | Separation Agreement dated as of
    November 16, 2001, between Telemate.Net Software, Inc. and
    Richard L. Mauro. Represents an executive compensation plan or
    arrangement.                                                                                                                |  | Incorporated by reference to Exhibit 10.37
    to the Registrants Annual Report on Form 10-K for the
    year ended December 31, 2001.
|            | 10.31 |         |  | Separation Agreement dated as of
    November 16, 2001, between Telemate.Net Software, Inc. and
    Janet Van Pelt. Represents an executive compensation plan or
    arrangement.                                                                                                                  |  | Incorporated by reference to Exhibit 10.38
    to the Registrants Annual Report on Form 10-K for the
    year ended December 31, 2001.
|            | 10.32 |         |  | Lease Agreement dated as of December 30,
    1999, between NACT Telecommunications, Inc. and
    Boggess-Riverwoods Company, L.L.C.                                                                                                                                                                |  | Incorporated by reference to Exhibit 10.39
    to the Registrants Annual Report on Form 10-K for the
    year ended December 31, 2001.
|            | 10.33 |         |  | Instrument of Assumption and Substitution of
    Guarantor of Lease dated as of July 27, 2001, among the
    Registrant, World Access, Inc., Boggess Holdings, L.L.C. and
    NACT Telecommunications, Inc.                                                                                        |  | Incorporated by reference to Exhibit 10.40
    to the Registrants Annual Report on Form 10-K for the
    year ended December 31, 2001.
|            | 10.34 |         |  | Intellectual Property Security Agreement dated as
    of December 14, 2001, between the Registrant and Silicon
    Valley Bank.                                                                                                                                                                    |  | Incorporated by reference to Exhibit 10.41
    to the Registrants Annual Report on Form 10-K for the
    year ended December 31, 2001.
|            | 10.35 |         |  | Intellectual Property Security Agreement dated as
    of December 14, 2001, between NACT Telecommunications, Inc.
    and Silicon Valley Bank.                                                                                                                                                     |  | Incorporated by reference to Exhibit 10.42
    to the Registrants Annual Report on Form 10-K for the
    year ended December 31, 2001.
|            | 10.36 |         |  | Intellectual Property Security Agreement dated as
    of December 14, 2001, between Telemate.Net Software, Inc.
    and Silicon Valley Bank.                                                                                                                                                       |  | Incorporated by reference to Exhibit 10.43
    to the Registrants Annual Report on Form 10-K for the
    year ended December 31, 2001.
|            | 10.37 |         |  | Form of Affiliate Agreement executed in
    connection with the Telemate.Net Merger Agreement.                                                                                                                                                                                                     |  | Incorporated by reference to Exhibit 99.4 to
    the Registrants Current Report on Form 8-K dated May
    16, 2001.                   

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|            |       |         |  |                                                                                                                                                                                                         |  |                                                                                                                                                                 
|----------- | ----- | ------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |       | Exhibit |  | Method of Filing                                                                                                                                                                                       
|            |       |         |  |                                                                                                                                                                                                        
|            | 10.38 |         |  | Telemate.Net Software, Inc. 1999 Stock Incentive
    Plan.                                                                                                                                              |  | Incorporated by reference to Exhibit 10.13
    to Telemate.Net Software, Inc.s Registration Statement on
    Form S-1 filed June 24, 1999 (File No. 333-81443).
|            | 10.39 |         |  | Amendment to the Telemate.Net 1999 Software, Inc.
    Stock Incentive Plan.                                                                                                                             |  | Incorporated by reference to Exhibit 10.18
    to Telemate.Net Software, Inc.s Registration Statement on
    Form S-1 filed June 24, 1999 (File No. 333-81443).
|            | 10.40 |         |  | Telemate Stock Incentive Plan.                                                                                                                                                                          |  | Incorporated by reference to Exhibit 10.10
    to Telemate.Net Software, Inc.s Registration Statement on
    Form S-1 filed June 24, 1999 (File No. 333-81443).
|            | 10.41 |         |  | Amendment to Telemate Stock Incentive Plan.                                                                                                                                                             |  | Incorporated by reference to Exhibit 10.14
    to Telemate.Net Software, Inc.s Registration Statement on
    Form S-1 filed June 24, 1999 (File No. 333-81443).
|            | 10.42 |         |  | Form of Indemnification Agreement entered into as
    of October 12, 2001, between the Registrant and each of its
    directors and non-director officers at the level of
    Vice-President and above. |  | Incorporated by reference to Appendix F-1 to
    the Registrants Registration Statement on Form S-4/A filed
    October 12, 2001 (File No. 333- 62262).        
|            | 10.43 |         |  | Settlement Agreement and General Release dated
    March 29, 2002, between the Registrant and WA Telcom
    Products Co., Inc.                                                                          |  | Incorporated by reference to Exhibit 99.1 to
    the Registrants Current Report on Form 8-K filed May
    1, 2002.                                             
|            | 10.44 |         |  | Stipulation for Settlement and Mutual Release
    dated as of July 19, 2002, among the Registrant, AremisSoft
    Corporation, Softbrands, Inc. and others.                                             |  | Incorporated by reference to Exhibit 10.8 to
    the Registrants Quarterly Report on Form 10-Q for the
    quarter ended June 30, 2002.                        
|            | 10.45 |         |  | Interest Purchase Agreement dated as of
    June 4, 2002, between the Registrant and NeTrue
    Communications, Inc.                                                                                    |  | Incorporated by reference to Exhibit 10.9 to
    the Registrants Quarterly Report on Form 10-Q for the
    quarter ended June 30, 2002.                        
|            | 10.46 |         |  | Security Agreement dated April 25, 2002,
    between the Registrant and WA Telcom Products Co., Inc.                                                                                                    |  | Incorporated by reference to Exhibit 99.2 to
    the Registrants Current Report on Form 8-K filed
    May 1, 2002.                                             
|            | 10.47 |         |  | Security Agreement dated April 25, 2002,
    among Telemate.Net Software, Inc., NACT Telecommunications, Inc.
    and WA Telcom Products Co., Inc.                                                      |  | Incorporated by reference to Exhibit 99.3 to
    the Registrants Current Report on Form 8-K filed
    May 1, 2002.                                             
|            | 10.48 |         |  | Pledge Agreement dated April 25, 2002,
    between the Registrant and WA Telcom Products Co., Inc.                                                                                                      |  | Incorporated by reference to Exhibit 99.4 to
    the Registrants Current Report on Form 8-K filed
    May 1, 2002.                                             
|            | 10.49 |         |  | Guaranty dated April 25, 2002, among
    Telemate.Net Software, Inc., NACT Telecommunications, Inc. and
    WA Telcom Products Co., Inc.                                                                |  | Incorporated by reference to Exhibit 99.5 to
    the Registrants Current Report on Form 8-K filed
    May 1, 2002.                                             
|            | 10.50 |         |  | Subordination Agreement dated April 25,
    2002, among the Registrant, Telemate.Net Software, Inc., NACT
    Telecommunications, Inc. and Silicon Valley Bank.                                         |  | Incorporated by reference to Exhibit 99.6 to
    the Registrants Current Report on Form 8-K filed
    May 1, 2002.                                             
|            | 10.51 |         |  | Form of Deposit Account Control Agreement among
    the Registrant, WA Telcom Products Co., Inc. and Silicon Valley
    Bank.                                                                           |  | Incorporated by reference to Exhibit 99.7 to
    the Registrants Current Report on Form 8-K filed
    May 1, 2002.                                             

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|            |       |         |  |                                                                                                                                                                                           |  |                                                                                                                           
|----------- | ----- | ------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | --------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |       | Exhibit |  | Method of Filing                                                                                                                                                                         
|            |       |         |  |                                                                                                                                                                                          
|            | 10.52 |         |  | Amendment to Loan Documents dated
    February 12, 2003, among the Registrant, Telemate.Net
    Software, Inc., NACT Telecommunications, Inc. and Silicon Valley
    Bank.                |  | Incorporated by reference to Exhibit 99.1 to
    the Registrants Current Report on Form 8-K filed
    February 13, 2003. 
|            | 10.53 |         |  | Loan and Security Agreement (Exim Program) dated
    February 12, 2003, among the Registrant, Telemate.Net
    Software, Inc., NACT Telecommunications, Inc. and Silicon Valley
    Bank. |  | Incorporated by reference to Exhibit 99.2 to
    the Registrants Current Report on Form 8-K filed
    February 13, 2003. 
|            | 10.54 |         |  | Borrower Agreement dated February 12, 2003,
    among the Registrant, Telemate.Net Software, Inc., NACT
    Telecommunications, Inc. and Silicon Valley Bank.                             |  | Incorporated by reference to Exhibit 99.3 to
    the Registrants Current Report on Form 8-K filed
    February 13, 2003. 
|            | 10.55 |         |  | Secured Promissory Note dated February 12,
    2003, in principal amount of $4.0 million, made by the
    Registrant in favor of Silicon Valley Bank.                                     |  | Incorporated by reference to Exhibit 99.4 to
    the Registrants Current Report on Form 8-K filed
    February 13, 2003. 
|            | 10.56 |         |  | Subordination Agreement dated February 12,
    2003, among the Registrant, Clarent Corporation and Silicon
    Valley Bank.                                                               |  | Incorporated by reference to Exhibit 99.5 to
    the Registrants Current Report on Form 8-K filed
    February 13, 2003. 
|            | 10.57 |         |  | Loan and Security Agreement dated as of February
    12, 2003, between the Registrant and Clarent Corporation.                                                                            |  | Incorporated by reference to Exhibit 99.6 to
    the Registrants Current Report on Form 8-K filed
    February 13, 2003. 
|            | 10.58 |         |  | Secured Subordinated Promissory Note dated
    February 12, 2003, in principal amount of
    $5.0 million, made by the Registrant in favor of Clarent
    Corporation.                    |  | Incorporated by reference to Exhibit 99.7 to
    the Registrants Current Report on Form 8-K filed
    February 13, 2003. 
|            | 10.59 |         |  | Secured Subordinated Promissory Note dated
    February 12, 2003, in principal amount of
    $3.0 million, made by the Registrant in favor of Clarent
    Corporation.                    |  | Incorporated by reference to Exhibit 99.8 to
    the Registrants Current Report on Form 8-K filed
    February 13, 2003. 
|            | 10.60 |         |  | Unsecured Subordinated Promissory Not, dated
    February 12, 2003, in principal amount of
    $1.8 million, made by the Registrant in favor of Clarent
    Corporation.                  |  | Incorporated by reference to Exhibit 99.9 to
    the Registrants Current Report on Form 8-K filed
    February 13, 2003. 
|            | 10.61 |         |  | Bill of Sale, Assignment and Assumption
    Agreement, dated as of February 12, 2003, between the
    Registrant and Clarent Corporation.                                                 |  | Incorporated by reference to Exhibit 99.10
    to the Registrants Current Report on Form 8-K filed
    February 13, 2003.
|            | 10.62 |         |  | Assignment of Patent Rights dated as of
    February 7, 2003, made by Clarent Corporation to the
    Registrant.                                                                          |  | Incorporated by reference to Exhibit 99.11
    to the Registrants Current Report on Form 8-K filed
    February 13, 2003.
|            | 10.63 |         |  | Assignment of Trademarks dated as of
    February 12, 2003, between the Registrant and Clarent
    Corporation.                                                                           |  | Incorporated by reference to Exhibit 99.12
    to the Registrants Current Report on Form 8-K filed
    February 13, 2003.
|            | 10.64 |         |  | Intellectual Property and Security Agreement
    dated as of February 12, 2003, between the Registrant and
    Clarent Corporation.                                                       |  | Incorporated by reference to Exhibit 99.13
    to the Registrants Current Report on Form 8-K filed
    February 13, 2003.
|            | 10.65 |         |  | Settlement Agreement dated November 6, 2002,
    between the Registrant and WA Telcom Products Co., Inc.                                                                                  |  | Filed herewith.                                                                                                           

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|            |       |         |  |                                                                                                                                                                                         |  |                
|----------- | ----- | ------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ---------------
|Exhibit No. |       | Exhibit |  | Method of Filing                                                                                                                                                                       
|            |       |         |  |                                                                                                                                                                                        
|            | 10.66 |         |  | Assignment and Collection Agreement dated
    December 5, 2002, between the Registrant and WA Telcom
    Products Co., Inc.                                                             |  | Filed herewith.
|            | 10.67 |         |  | Cross-Corporate Continuing Guaranty dated as of
    February 12, 2003, among the Registrant, Telemate.Net
    Software, Inc., NACT Telecommunications, Inc. and Clarent Canada
    Ltd. |  | Filed herewith.
|            | 10.68 |         |  | Lease for 1221 West Mineral Avenue, dated as of
    February 11, 2003, between the Registrant and A.S. Burger
    Investments, LLC.                                                     |  | Filed herewith.
|            | 10.69 |         |  | Movable Hypothec dated as of February 20,
    2003, between the Registrant and Silicon Valley Bank.                                                                                     |  | Filed herewith.
|            | 10.70 |         |  | Movable Hypothec dated as of February 20,
    2003, between the Clarent Canada Ltd. and Silicon Valley Bank.                                                                            |  | Filed herewith.
|            | 10.71 |         |  | Settlement Agreement and Full Release of Claims
    dated as of February 12, 2003, between the Registrant and
    John M. Good.                                                         |  | Filed herewith.
|            | 10.72 |         |  | Arbitration Award Agreement dated
    February 3, 2002, and among the Registrant, Clunet R.
    Lewis and CLR Enterprises, Inc.                                                         |  | Filed herewith.
|            | 10.73 |         |  | Arbitration Award Agreement dated
    February 3, 2002, among the Registrant, William P.
    OReilly and Montana Corporation.                                                          |  | Filed herewith.
|            | 10.74 |         |  | Consulting Agreement dated as of March 14,
    2003, between the Registrant and William P. OReilly.                                                                                    |  | Filed herewith.
|            | 10.75 |         |  | Consulting Agreement dated as of March 14,
    2003, between the Registrant and Clunet R. Lewis.                                                                                        |  | Filed herewith.
|            | 10.76 |         |  | Amendment to Loan Documents dated April 7,
    2003, among the Registrant, Telemate.Net Software, Inc., NACT
    Telecommunications, Inc. and Silicon Valley Bank.                      |  | Filed herewith.
|            | 10.77 |         |  | Amendment to Loan Documents (Exim Program) dated
    April 7, 2003, among the Registrant, Telemate.Net Software,
    Inc., NACT Telecommunications, Inc. and Silicon Valley Bank.       |  | Filed herewith.
|            | 21.1  |         |  | Subsidiaries of the Registrant.                                                                                                                                                         |  | Filed herewith.
|            | 23.1  |         |  | Consent of KPMG LLP.                                                                                                                                                                    |  | Filed herewith.
|            | 99.1  |         |  | Certification of the Registrants Chief
    Executive Officer pursuant to Section 906 of the
    Sarbanes-Oxley Act of 2002.                                                            |  | Filed herewith.
|            | 99.2  |         |  | Certification of the Registrants Chief
    Financial Officer pursuant to Section 906 of the
    Sarbanes-Oxley Act of 2002.                                                            |  | Filed herewith.

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